Why Russia’s Defence Industry Complex Can’t Pay Off Its Debts

July 22, 2019

By Alexander Golts

Enterprises in the defence industry complex (DIC) have two trillion rubles ($31.78 billion) of debt. There is no way they can pay off this debt: they’ll write it off and then hush it up.

Twice the price for the arms race

In June, the Russian deputy prime minister, Yury Borisov, who oversees the defence industry, announced that DIC enterprises have racked up around two trillion rubles of debt. He also acknowledged that the companies are not in the position to pay off the loans they have taken out. This makes the DIC the fourth most heavily indebted economic sector (after financial services, wholesalers, and real estate businesses). A credit bubble in the defence industry is particularly dangerous, as there were only a few banks authorised by the government to hand out the trillions of rubles.

The main issue is not the size of the loans, but that around a third of the entire loan amount is not self-liquidating, it just accrues interest. According to Borisov, companies are spending around 200 billion rubles on repaying interest. Therefore, “the primary loan can never be paid off”, the deputy PM believes. Previously, he has compared the defence industry to spin classes: no matter how many times you turn the pedals, you are still never going to get anywhere.

If this is the case, then the question arises: where is the capital for upgrading production facilities going to come from? And the money to establish civilian production lines, which the president has constantly demanded. Most surprising of all is the that the DIC’s main client – the Russian ministry of defence – has not noted any issues with how manufacturers are operating. The grandiose Army 2019 Forum that has just taken place demonstrated the remarkable successes of the weapon manufacturing sphere. The deputy minister of defence finances, Tatiana Shevtsova, happily talked about how, through a combined effort, [the DIC] managed to fulfil 98 to 99 percent of the defence contracts, which “made it possible to not only manufacture the products that serve our interests, but also modernise [DIC] enterprises, create new jobs and pay decent salaries on time”. We are left trying to work out who is telling the truth. Deputy PM Borisov or Deputy Minister Shevtsova?

Borisov is offering a simple way to get out of this situation: the state should simply write of the some 600-700 billion rubles of debt held by defence companies, to stop them from being “starved”. Accordingly, Russian citizens – or more precisely the tax they pay, which directly or indirectly (through taxation of state companies) makes up the state budget – have to foot the bill twice. First to provide funds for government defence contracts, and then again when the debt is written off in order to finance the arms race started by Russia.

It is likely that this is what will happen. In 2016 the ministry of finance had already provided defence companies with 800 billion rubles to make early loan repayments. An additional 200 billion was provided in 2017. Borisov hasn’t tried to hide the fact that “on a number of occasions” offers have been made to the president “to clear this loan profile”. According to him, the next meeting of the defence industry commission will be dedicated specifically to this issue.

However, government officials interpret the debt overburden of the defence industry as its own kind of natural disaster. No one has even tried to explain how it has happened that, despite seemingly regular and sufficient funding, defence companies have been unable to pay off loans using profits. 

Who is to blame?

First of all, it should be noted that thanks to a thick veil of secrecy there are no reliable statistics about the financial position of the DIC enterprises that consume around 15 percent of the federal budget. Indeed, back in December of last year Borisov named the total amount of interest paid out by the defence industry as 135 billion. That is a third less than today’s figure. The prime minister’s office clarified that in the last half year the figures have been “verified”.

As for the reasons for such irredeemable levels of debt overburden, the deputy PM has wisely chosen not to name them. He said, it is not clear why in 2010 and 2011 “the rate of borrowing was 10, 11 and 12 percent”. However, everyone knows that during those same years a new state armament programme, unprecedented in its scale and worth 23 trillion rubles, was being procured. On the one hand, Russian authorities were unable to let this programme derail, like their predecessors had. After all, this time rearmament was supposed to be the most important aspect of military reform. But on the other, at that exact moment in time, the state, which was struggling to recover fully from the 2008 crisis, did not have the resources to invest in four dozen extremely expensive projects.

At that moment, the then head of government, Vladimir Putin, made a decision that even the most cautious economic experts would call “exotic”. The prime minister decided – either on his own initiative, or upon the suggestion of authoritised state bank chiefs (who chose to seize the moment to secure themselves enormous profit for the next decade) – that the banks financing the federal project will be underwritten by the government; and able to charge criminal interest rates.

Yet if this merely boiled down to a matter of interest rates that are off the scale for cost-effective manufacturing, then the problem would have been resolved by the payments made in 2016 and 2017. However, we can see that this is a recurring issue. Obviously, state banks’ endeavours to make money off high interest rates aren’t the only reason why this keeps happening. It is probably related to poor production efficiency and, as a result, to rising costs of specific weapon systems as well.

It seems that the government has not managed to create a system of industrial cooperation. In the Soviet Union pretty much all industry enterprises had the capacity to contribute to military production and were able to supply the components for military production factories. Understandably, this system had nothing to do with the economy.  The State Planning Committee’s primary function was to strike an artificial balance between the costs of civilian and military outputs. Civilian enterprises could not create revenue through producing components for the DIC. The Soviet non-market model of cooperation failed, but a replacement for it was never created. It appears that now defence enterprises have been forced to manufacture all the required (and extremely diverse) components themselves, which makes the final product extremely expensive. It is probably because of this that project costs have become substantially greater than what was initially claimed. As a result, businesses are forced to take out additional loans, for which the state officially bears no responsibility.

In addition, the secrecy of military manufacturing conceals corruption and other crimes motivated by profit extremely well. Even Shevtsova had to acknowledge that “there was a time, when we sent advances to the general contractors and they did not pass them on further down the production line. They could store them in deposits, issue a loan from them, but not send them on further. Resources intended for weapon production could remain in the business’ account for half a year while [other] businesses and cooperatives were waiting for these advances for production”. Clearly this money was not merely lying around in deposits, but more likely being used for something with the consent of the top DIC managers.

Writing off the debt

And now these non-repayable loans, which demonstrate the corruption in and inefficiency of military manufacturing, will simply disappear. In the view of Finance Minister Anton Siluanov, it would be possible to write off some of the loans, should they be transferred onto the balance sheet of Promsvyazbank. Let’s remember that Promsvyazbank plans on becoming the core “secret” bank for state defence orders and major government contracts because of the threats made by the US to sanction any firm working with the Russian DIC.

For all intents and purposes, [Promsvyazbank] will be a secret office for financing military production. Sperbank, BTB and other authorised banks will be able to transfer debts over specifically [to Promsvyazbank]; debts that will then simply disappear (a separate question is whether or not black holes will appear in these banks’ balance sheets as a result). Thus the issue of DIC debt will, fundamentally, be resolved: we will no longer know anything about them. Similarly, no one in the USSR knew anything about the effect of military production on the country’s economy. Well, pretty much nothing, for as long as the USSR remained in tact.

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