A combination of factors is creating the conditions for a boom in Central and Eastern European defence procurement. But as Poland’s sudden decision on October 4 to scrap a $3.5bn helicopter deal shows, the region remains a tricky place to do business for global defence companies.
One of the main reasons for optimism among global arms companies was highlighted by Republican presidential candidate Donald Trump in September, who questioned America’s commitment to defending other Nato nations under Article 5 of the treaty if they do not comply with the alliance’s rules on defence spending.
Currently, the only European Nato members that meet the defence spending floor of 2% of GDP are the UK, Estonia, Greece and Poland; the other 23 countries fall short of the Nato guideline by roughly 1 percentage point. Nato says the European allies spent $253bn on defence in 2015, or 1.4% of GDP, compared with $618bn by the US, leaving the continent about $100bn a year shy of what they should be spending under the 2% guideline.
That means big scope for increasing budgets, especially in CEE countries such as Hungary and the Czech Republic, which Erste Bank says could increase defence spending without breaching fiscal limits. “The Czech Republic plans a gradual increase of defence spending so that it reaches 1.4% of GDP by 2020, while the general government deficit is expected to remain below 1% of GDP, which provides room for additional increases in spending without violating European fiscal rules,” the CEE bank says in a recent report. “The additional 1pp of expenditure should not be a great problem for the [Hungarian] budget… With some restructuring on the expenditures side, the probability is high that the Nato requirement could be fulfilled without breaching any fiscal rules.”
In Croatia, Slovakia, Slovenia and Romania, by contrast, an immediate need to increase military-related expenditures would likely push deficits above the 3% of GDP limit laid down by the EU, the bank says. Such a situation appears to have been acknowledged by Nato, in that several countries no longer mention the 2% of GDP as a medium-term aim, opting instead to talk of more realistic levels, such as 1.6% by 2020 in the case of Slovakia, up from the 1.16 % GDP in the 2017 budget.
But it’s not just potential rises in spending as a share of GDP that’s enticing. As Krasimira Stoyanova, head of CEE at Saab, a longstanding player in countries across the region, points out, the higher GDP growth rate of the countries in the region compared to their peers in Western Europe will push up defence spending. The European Bank for Reconstruction and Development predicts Central Europe will maintain its steady growth rate at 3.1% this year, while Southeast Europe will see growth rise to 2.9%. “Even if the 2% [of GDP] guideline is not reached, then economic growth will naturally increase the amount of defence spending in the region independent of this external push from Nato,” Stoyanova says.
Poland – one of the few that actually meets its Nato spending commitments – is another factor why global defence firms are so excited about what is happening in the region.
In many ways, Poland exemplifies on a grander scale what is happening elsewhere round the region – both good and bad. Warsaw intends to raise its military spending to 2.5% by 2030 on the back of its multi-billion-euro defence modernisation programme to 2022 – a larger version of the region-wide project to replace old Soviet equipment with modern armaments that can counter the increased threat from Russia as well as deal with modern-day threats like human and drug trafficking, the migration crisis, and terrorism.
Under that modernisation programme, Poland plans to spend at least PLN83bn (€21.7bn) on new weapons and military gear over the next five years. Polish Deputy Defence Minister Bartosz Kownacki, who is responsible for procurement, told parliament’s National Defence Committee on July 19 that the defence ministry will spend about $10bn on new mid-range air- and missile-defence systems, more than $5bn for short-range air-defence systems, $3.3bn to acquire combat helicopters for the Air Force, and $2.5bn to buy submarines for the dilapidated Polish Navy. Other plans include spending “several billion zloty” on military drones (or unmanned aerial vehicles, UAVs).
The programme has four pillars. First is the strengthening of the forces themselves, with a focus on heavy weaponry suitable for both territorial defence and expeditionary tasks. “What the Visegrad countries have in common is the return in their strategic thinking from expeditionary operations to territorial defence,” say analysts at the Centre for Euro-Atlantic Integration and Democracy, adding that while this process started well before the Ukraine crisis, Russian aggression there has certainly speeded it up.
Second, Poland is accelerating its naval modernisation programme, which runs to 2030. The navy is in urgent need of upgrading; 17 of its 41 vessels are due to be decommissioned by 2022. Kownacki told the defence committee that the ministry has reserved a further $2.5bn to buy submarines for the Polish Navy.
“There is a requirement for six surface vessels as well as three diesel-electric submarines, which has been prioritised,” says Jason Howard, Saab’s Poland director, which is looking to sell its A26 submarine, which it says is built for the conditions found in the Baltic Sea and is therefore “well suited” for Poland.
Third is strengthening the most modern section of the armed forces, the air force. As well as the new attack helicopters to replace the old Russian-made Mil Mi-24s currently in service, this will include buying additional multi-role aircraft, as well as what Thales Group, which is looking to sell an armed version of its WatchKeeper drone, describes as an “ambitious procurement programme” to provide UAVs.
Fourth, the Polish government aims to overhaul the local defence industry, which has struggled in the years since the end of communism as it lost the privileged position it had enjoyed, as well as being increasingly unable to fill orders from a military looking to equip itself with modern avionics, electronics and guidance systems. “Is the [Polish modernisation] process defined yet? No. But the current flavour appears to be having Polish industry, led by state holding Polska Grupa Zbrojeniowa, to be mandated to run a competition to see what capability, tech transfer and work packages can be offered by the foreign companies,” says Mark Stevens, director of International Business Development (Europe and Central Asia) at Thales. “It’s up to us in the industry to meet their requirements – and we’re flexible in what we can offer so we’ll have to wait and see.”
Offsets and resets
It is the last pillar that is creating confused thinking among these new Nato members and causing subsequent delays in the procurement, argue some.
Global defence companies put at the heart of their campaigns to win these tenders so-called offset agreements, which are ways for the countries procuring the equipment from foreign manufacturers to gain economically and technically from the deal. A company’s offset obligation is typically worth 50-100% of the value of the contract; the Czech Republic, for example, in the decade since leasing Gripen fighters from Saab in 2004 has gained almost CZK32bn (€1.18bn) thanks to the offset programme.
However, for some this isn’t enough, and there is a tendency among parts of the political establishments in CEE still to push for a homegrown or regional solution that critics say would be better met by purchasing a proven foreign product. Witness the aborted attempt in 2014 by the Visegrad Group (V4) of countries in Central Europe (Czech Republic, Hungary, Poland and Slovakia) to try to build their own mobile air defence radar (MADR) rather than purchase an off-the-shelf system from the likes of Saab, Thales or the Israeli Elta Systems – all three of which have submitted bids in a CZK3.6bn Czech MADR tender that are currently being evaluated by the defence ministry in Prague.
Such flights of fancy inevitably delay further what are already very long processes. There is a private joke in the industry that defence companies in the region search for employees in the kindergartens so that they can complete one defence deal before they go into retirement.
Take Poland’s giant modernisation plan. This was planned to start from 2012 but its final version was delayed yet again in September, with Kownacki in October asking for “patience”. The modernization programme, he explained, is “very complicated and we’re now talking about very minute details”.
Part of the problem is that these countries do not have the experience and know-how to run these hugely complicated tendering processes and mistakes are frequently made, whether down to politics intruding or corruption. “Politics rule the day here and people inherently don’t make decisions always focused on the military outcome,” sighs one foreign manufacturer.
This could be seen in Poland’s sudden decision at the beginning of October to scrap plans that were four years in the making to buy 50 French-made military helicopters from Airbus Helicopters for €3.14bn, and announce just a few days later on October 10 that the government would obtain two helicopters in 2016 from the Polish factory of Sikorsky Aircraft, a unit of Lockheed Martin, and a further eight helicopters from the factory next year.
The reason given for abandoning talks with the French company was that no offset agreement was delivered which “adequately secures the economic and security interests of the Polish state”. President Francois Hollande subsquently cancelled a planned visit to Warsaw in a sign of French displeasure and Airbus is now demanding compensation for the failed Caracal helicopter deal. “We have never been treated by a government client the way we were treated by this government,” Airbus CEO Tom Enders stated. Polish Deputy Defence Minister Kownacki retorted: “the French are people who we taught to eat with cutlery a few centuries ago”.
Bell Helicopter, a division of the giant US conglomerate Textron, may have missed out on Poland, but it is looking to transfer its H1 programme to upgrade the US Marine Corp’s aging fleet of helicopters to the rest of the CEE region. “We have active campaigns in Poland, Czech Republic and Romania, and there are significant opportunities in Croatia and Hungary,” says Joel Best, senior manager of Europe for Bell Helicopter. “All these nations that are flying Mil Helicopters are expressing difficulties in being able to support the aircraft, so anyone owning and operating such Russian helicopters are potential customers for the next-generation helicopters that we produce.” In 2014 the company opened at Prague's Vaclav Havel Airport what will be its centre for customising and delivering all Bell helicopters sold in Europe.
Finally, there is the age-old problem of corruption. Graft has plagued the industry in the region, meaning deals had to be scrapped and halted as lengthy investigations took place – some of which are still going on many years after the event. A 2008 US diplomatic cable obtained by WikiLeaks talks about how, “Czech Defense Ministry (MOD) procurement is plagued by lack of transparency and remains an arena for shady business deals. Successive governments seem to have viewed MOD contracts as a way to reward themselves and their political supporters with lucrative business deals, cheap asset sales, and kick-backs.” The Czechs were heavily criticised by foreign governments for using “middlemen” in arms deals – something that sources say has never entirely gone away.
Winston Churchill once said, “To jaw-jaw always is better than to war-war”, but for many global defence companies perhaps there’s still too much talking in CEE right now.
“We have to be patient, and we are happy to be patient. These contracts need to be well considered so when governments make the decision it remains firm,” says Thales’ Stevens.