Russia's Military Modernization in Jeopardy

[Jacob]

... due to the state of the economy, according to the Russian defence minister.

A sad state of affairs

(Reuters) - Russia's finance minister said on Tuesday the country could no longer afford a multi-billion-dollar revamp of the armed forces approved by President Vladimir Putin, stepping up a campaign to trim spending as sanctions over the Ukraine crisis bite.

Anton Siluanov said a new defense program should be drawn up to take into account the changed economic situation, even though the deputy prime minister in charge of the sector has been ruling out any cuts in military spending.

"A new defense program will be prepared now, and in its framework we want to reconsider the amount of resources that will be spent from the budget in order to make it more realistic," said Siluanov, appointed three years ago after his veteran predecessor, Alexei Kudrin, quit in protest over the proposed military spending.

Siluanov's comments highlight a battle among different factions of the government over defense spending which has heated up in recent months, and which will ultimately be resolved by Putin himself.

They could indicate the president is preparing the way to postpone or trim some defense spending, foreseen at 23 trillion roubles ($576 billion) in the decade to 2020 under his original plan to upgrade 70 percent of military equipment by then.

"Since all such final decisions are made in the Kremlin, the decision about fine-tuning of the program will be made in the Kremlin and opponents of the finance ministry's proposals to adjust it will have to obey," said Ivan Konovalov, head of the Moscow-based Center for Strategic Trends Studies.

"WE CAN'T AFFORD IT"

When the ambitious program to revitalize the Russian army and its aging equipment was first proposed in 2011, the government expected gross domestic product growth of 6 percent throughout the decade.

But the economy may grow by 0.5 percent at best this year, and the International Monetary Fund and World Bank forecast stagnation in the next two years.

"When we were adopting the defense program, the forecasts for the economy and budget revenues were completely different. Right now, we just cannot afford it," Siluanov said.

Western sanctions against Russia over the Ukraine crisis are choking economic growth, weakening the rouble and isolating the market from foreign funding. Along with finance and oil, the arms industry is one of those targeted by the measures, which bar some top companies from seeking finance on Western capital markets and ban the sale of sensitive technology to nine Russian defense firms.

Deputy Prime Minister Dmitry Rogozin has previously said, however, that modernization of the military will continue as envisaged by Putin's decrees. "The idea is that by 2015 we should have upgraded 30 percent of military equipment, and by 2020 - 70 percent," Rogozin told the daily Kommersant in an interview.

He added that state defense orders could not be transferred "blindly" at the whim of the Finance Ministry -- at least, not without revising the presidential decree. "The program itself, the amount of funds allocated for it is not subject to revision," he said.

But Konovalov, the defense analyst, said that while some projects, such as modernizing Russia's air force, submarine forces or space technology will definitely continue at full speed, there is room to cut others.

"Consensus will have to be found," Konovalov said. "The initial plan did not take into account the fluctuations in the financial markets."

Some of the projects were created in haste. "Some were even to a certain extent populist," he said.

The 10-year-programme was created before the 2012 presidential election that brought Putin back to the Kremlin after a four-year stint as prime minister.

HIGHER SPENDING, LOWER OIL

While data from the Stockholm International Peace Research Institute show that U.S. military spending fell last year, Russia's increased in real terms, exceeding that of the United States for the first time since 2003 and reaching 4.1 percent of GDP.

Between 2004 and 2014, Russia doubled its military spending and according to the newly adopted budget, it will further increase it from 17.6 percent of all budget spending this year to 20.8 percent, or 3.36 trillion roubles ($84.19 billion), in 2017.

But the new budget, which envisages a deficit of no more than 0.6 percent of GDP over the next three years, is based on oil prices of $100 per barrel. On Tuesday, Urals, Russia's main blend, was at around $90 per barrel.

Siluanov admitted that the oil price penciled in the budget "already today seems high." Receipts from oil and gas make up nearly half of government revenues.

"We should have planned the budget more tightly, with a surplus," Siluanov said.

The decline in oil prices has been one of the chief factors that have pushed the rouble to all-time lows of 40 to the dollar..

Sanctions on Moscow for its involvement in Ukraine have cut growth by an estimated 1 percentage point this year, according to former finance minister Kudrin, and economists expect that the acceleration in capital outflows and the decrease in investment activity will hinder growth in coming years too.

The central bank and the finance ministry have begun work on a worst-case scenario that would provide for monetary and fiscal mechanisms to support the economy and the currency if oil prices were to drop to $60 per barrel.

On Monday, Putin signed a law that would allow the government to tap one of the country's oil windfall revenue funds, the Reserve Fund, next year, for the first time since the aftermath of the 2007-8 global financial crisis. The Fund has some $90 billion in it.

"Russia should refocus on domestic economic policy and avoid further distancing itself from its global economic partners," analysts at Uralsib in Moscow wrote in a note.

"Given the negative impact of recent geopolitical events and the government's tightening of economic policy, we believe that Russia may not be able to achieve its long-term economic growth potential until 2017."

http://www.reuters.com/article/2014/10/07/us-russia-economy-spending-defence-idUSKCN0HW1H420141007

[Ed Anger]

So sad.

[Martinus]

Awww. 

[Tamas]

 

[Syt]

But ... they promised to modernize all their nuclear weapons till 2020.

[derspiess]

Kind of odd that they'd openly admit that.

[Syt]

ITAR-TASS, RT and RIA have nothing about it, so it must be evil imperialist lies!    

[crazy canuck]

Kind of odd that they'd openly admit that.

Setting the stage for diverting a larger percentage of the overall budget to military spending so that the population is willing to take the cuts in services in other areas?

[celedhring]

It's okay, Putin only needs a bow and arrows to shot down NATO planes.

[derspiess]

Kind of odd that they'd openly admit that.

Setting the stage for diverting a larger percentage of the overall budget to military spending so that the population is willing to take the cuts in services in other areas?

Hmm, maybe.  It just seems like something kind of humiliating for a Putin-led government to admit at this point.

[Monoriu]

I for one hope they spend sufficient money on at least making sure that their nuclear weapons don't malfunction 

[Jacob]

Kind of odd that they'd openly admit that.

Setting the stage for diverting a larger percentage of the overall budget to military spending so that the population is willing to take the cuts in services in other areas?

Hmm, maybe.  It just seems like something kind of humiliating for a Putin-led government to admit at this point.

It does seem like it's showing a few cracks, yeah.

[Martinus]

It seems international corporations that invested heavily in Russia are also having a bad spell

Plunging Ruble Pummels Foreign Company Earnings in Russia

By Matthew Campbell and Mathieu Rosemain October 07, 2014


A worker inspects a Lada automobile as it moves along the assembly line at the OAO AvtoVAZ plant, controlled by Renault SA and Nissan Motor Co., in Togliatti, Russia. Photographer: Andrey Rudakov/Bloomberg

Russia's falling ruble is hitting Western European corporate giants such as PSA Peugeot Citroen (UG), Henkel AG and Carlsberg A/S (CARLB) on its way down, further undermining operations under strain because of the country's stagnant economy.

With the currency now at a record low against the euro and dollar, companies that have bet heavily on Russia are finding that the plunge makes it costlier for local factories to import supplies and parts, increases prices for customers, and reduces the foreign-currency value of any profits they manage to generate.

"The weakening of the ruble is a problem," Peugeot Chief Executive Officer Carlos Tavares said at the Paris Motor Show last week. He blamed his company's Russia woes on "the lack of visibility for the customer, and the price increase due" to the ruble's fall.

Story: Here's Who's Getting Hammered By Russia's Falling Ruble

The currency is trading at about 40 rubles to the dollar, its weakest level ever, as the simmering conflict in Ukraine prompts investors to sell Russian holdings. Russia's central bank has spent at least $1.68 billion of its reserves to defend the ruble since Oct. 3, official figures show.

Inflation, meanwhile, has accelerated to the fastest pace in three years. A ban on some imports of food from the European Union and the U.S. -- imposed in retaliation for sanctions on Russia -- has driven consumer prices upward.

Story: Is Russia Desperate Enough to Block Investors From Leaving?

Companies like Peugeot, which owns 70 percent of a car-assembly joint venture based near Moscow, have spent heavily on Russian manufacturing facilities to avoid tariffs and the cost of shipping products from elsewhere in Europe, while benefiting from government incentives for domestic production.

Volga Banks

Siemens AG (SIE) makes locomotives with a local partner in Sverdlovsk, Carlsberg brews beer in a half-dozen Russian cities, and Renault builds cars in Moscow and in Togliatti, on the banks of the Volga. Henkel, which makes Persil detergent and Loctite glue, has eight Russian factories and another on the way -- and says it may see weaker earnings in the second half of the year due in part to the ruble's fall.

To reduce its dependence on imported supplies, Nissan Motor Co. (7201), which operates a plant in St. Petersburg, last month started work on a nearby business park for parts manufacturers. The goal: to supplant components that otherwise would be imported from elsewhere in Europe. Peugeot and other foreign carmakers are similarly seeking local suppliers.

Video: Ruble's Rough Ride Highlights Russian Economic Woes

"We're moving more to making in rubles and selling in rubles, which helps with the autonomy of the business," said Colin Lawther, Nissan's senior vice president for manufacturing and purchasing in Europe.

Beer Declines

Foreign companies looking to sell products to Russia's middle class would be struggling even without the currency drop. To slow inflation, the central bank has hiked the benchmark interest rate to 8 percent, up from 5.5 percent in February. Due to the impact of sanctions and falling oil prices, the economy is nearing recession.

For consumers already nervous about their spending, "weak demand has been compounded by the weak ruble" and the rising price of imported goods, said IHS Inc. (IHS:US) economist Lilit Gevorgyan.

Video: Ruble's Rough Ride Highlights Russian Economic Woes

Carlsberg illustrates how the ruble's nosedive can turn what would otherwise be simply disappointing business conditions into a serious problem. The Copenhagen-based brewer said in August that a 2 percent sales decline in eastern Europe in the second quarter in nominal terms widened to an 18 percent drop after conversion to Danish kroner.

Swedish beauty-products group Oriflame had a similar experience. In August the company said the ruble's weakness would shave about four percentage points off its 2014 operating profit margin, which was 10.1 percent last year. The company gets roughly half its revenue from eastern Europe, and is working on a Russian plant that will be its largest single facility in order to mitigate the impact of currency swings.

Computer Freeze

Companies selling to Russians can choose to maintain sales or profit margins, but not likely both, said Vanessa Rossi, an economist at research firm Oxford Analytica. "Exporters to Russia will find it harder to sell goods at premium prices, and so may either discount or lose volume," Rossi said.

Story: Russia Set Aside $83 Billion for Pensioners. Putin Is Using It to Aid Russia Inc.

To keep Russian customers loyal, Chinese computer manufacturer Lenovo Group Ltd. (992) today said it would freeze its ruble prices until the end of the year. "Lenovo doesn't plan to pass on the currency risks" to customers, the company said in a statement.

Few foreign companies will give up on Russia. With 140 million citizens, vast natural resources, and a growing consumer class in Moscow and St. Petersburg, it's a big opportunity. For example, Ford Motor Co. (F:US), which is postponing its target for returning to profit in Europe, says it plans to keep investing in Russia and will introduce six new models there by the end of 2015.

At the highest end of the car market, the decline of the ruble may even be helping some sales. Rolls-Royce, the U.K. ultra-luxury manufacturer owned by German carmaker Bayerische Motoren Werke AG, is enjoying rising demand as wealthy Russians look to park their cash in expensive cars that historically have maintained their value.

"We are satisfied how Russia developed, particularly in the first half," said Rolls-Royce chief Torsten Mueller-Oetvoes. "That might be due to the case that people invested their rubles into some, what I would call, real assets. And Rolls-Royce is a proper investment."

To contact the reporters on this story: Matthew Campbell in London at [email protected]; Mathieu Rosemain in Paris at [email protected]

To contact the editors responsible for this story: Jacqueline Simmons at [email protected] David Rocks

http://www.businessweek.com/news/2014-10-07/plunging-ruble-pummels-profits-of-foreigners-in-russia#p2

[Maximus]

Well isn't that a shame.

[Martinus]

Kind of odd that they'd openly admit that.

Setting the stage for diverting a larger percentage of the overall budget to military spending so that the population is willing to take the cuts in services in other areas?

Hmm, maybe.  It just seems like something kind of humiliating for a Putin-led government to admit at this point.

As the article says, it does seem to show that there is a rivarly between factions in the Russian government. Obviously, this also means that Putin's hold is not as tight as we would imagine.