RUSSIA’S DEFENSE ENTERPRISES FACE BIG CHANGES.

Kremlin efforts to reform Russia’s struggling, Soviet-era defense industrial complex picked up speed on October 29, as an unprecedented joint meeting of the country’s State Council and Security Council approved a series of guidelines–or “fundamentals”–aimed at streamlining the sector and improving its performance. This week’s developments are apparently a follow-up to a July 27 meeting in which top government officials first approved a draft plan aimed at restructuring Russia’s defense industrial sector. There were suggestions after that meeting, however, that a number of issues remained unresolved and that work on the draft plan would continue. But if Deputy Prime Minister (and Minister of Industry, Science and Technologies) Ilya Klebanov is to be believed, disagreements between regional leaders and both federal officials and defense industrial directors have been overcome and the country is now prepared to move forward in what is likely to be a painful restructuring effort.

There are believed to be about 1,700 defense enterprises in Russia and, if earlier reports are accurate, approximately one-half of them are to be cut loose to survive on their own. Those enterprises that will continue to receive state defense funding, moreover, are to be consolidated into several dozen “holding” companies, each of which will serve as the conduit for funding to be directed to the companies subordinated to it. Not surprisingly, Russian factory directors and regional leaders have expressed some trepidation over the past year as details of the government’s restructuring plan have become public (see the Monitor, April 3, August 2).

Given the diversity and influence of the various interest groups that will be adversely (or positively) affected by the Kremlin’s defense industrial reform plans, there is some question as to whether the government will be able to translate the decisions taken by this week’s meeting directly into policy. But, at least insofar as media reports were able to describe the semi-secret proceedings, the meeting does appear to have marked a major Kremlin effort to push through substantive defense industrial reform. The format of the October 29 meeting–that is, the decision to convene top defense officials from the Security Council with influential regional leaders from the State Council–was an unprecedented one clearly aimed at getting a broad array of interests on board the defense industrial reform plan.

President Vladimir Putin, moreover, opened the meeting personally with an address that pointedly emphasized both the dire circumstances that prevail in the defense industrial sector and the failure of recent efforts to reform it. Some of Putin’s criticism was remarkably sharp. He told those assembled that some continue “to have the illusion” that the sector’s increasingly obsolete output “would continue to be required by the state like it was before, and that defense industry enterprises can continue [to operate independently of] economic categories like efficiency and competitiveness.” But the structure of military industry, Putin continued, is still “archaic and does not meet the military-political tasks of the state.” As he has recently said on the issue of armed forces reform (see the Monitor, October 29), Putin also used the recently transformed international security environment to argue for changes in the manner in which Russia manufactures, procures and exports military hardware. “One must not forget that today we face new threats” and that we “live and work in conditions which place on the reliability of national defense fundamentally different and higher demands than before.” Given these factors, Putin went on, the only way that Russia’s defense plants can survive is by attracting investments and selling arms abroad. “We need to increase the economic appeal of the military and industrial complex,” he was quoted as saying. “This will allow us to attract not only state investments but also foreign investments, irrespective of how strange this might sound.”

The Russian daily Vremya MN, in reporting on the October 29 meeting, underlined just how significant and potentially radical the reforms Putin announced might turn out to be. The newspaper focused especially on the notion that foreign interests might ultimately be allowed to invest in Russian defense industries–an unprecedented possibility in a sector long characterized by its secrecy and total dependence on state funding–though it also suggested that opposition to investment from abroad remains substantial. More broadly, the newspaper suggested that the president’s speech marked a sea change in attitudes toward defense production in Russia, one in which defense firms would face at least some exposure to market conditions and would be compelled to orient their production toward the needs of clients. Putin, the newspaper observed, had broken Russian (and, by extension, Soviet) tradition by publicly underlining the fact that weapons production around the world has become a profitable business and that defense concerns abroad are not, like their Russian counterparts, entirely dependent on state funding.

If reporting of the October 29 meeting strongly suggested that Putin had advanced some radical concepts on the subject of Russian defense reform, it was nevertheless short of details regarding the nuts and bolts of exactly what had been decided at the meeting. Reports did make clear that the concept approved this week will guide Russian defense reform and production through the year 2010 and beyond. They also quoted Klebanov, whose recently increased responsibilities appear to have given him even more oversight of the defense industrial sector, as saying that it is still planned to organize Russian defense enterprises into some forty to fifty large holding companies. That number is a bit larger than the thirty-six or so holding companies that were mentioned earlier this year, but does not appear to represent a substantive departure from the draft plan approved in July. As a first move in this new effort to consolidate independent defense enterprises into larger holding companies, Putin also signed an order this week to combine five aircraft manufacturing firms into one company under the banner of the well-known Sukhoi firm. This first move is key because Sukhoi’s current accounts for military aircraft sales are said to constitute over 50 percent of Russia’s entire arms export total. Failure to implement consolidation here would likely threaten the success of the entire reform process.

According to Klebanov and other Russian sources, one of the most important results of the October 29 meeting was an agreement regulating taxation of the defense enterprises which are to be consolidated into holdings. Regional leaders had apparently objected to earlier defense reform drafts on the grounds that those plans might have deprived regional governments of tax revenues from what in many cases are among their largest economic concerns. But discord on that count was apparently overcome by guaranteeing that each holding will pay taxes in the region where its constituent plants are located.

Evidence of continuing disagreement did appear on at least two issues, however. One pertains to a reported Kremlin proposal that would create a new commission, one directly subordinated to the president’s office and tasked with overseeing developments in the defense industrial sector. If created, the new agency would, presumably, intrude into Klebanov’s bailiwick. The Russian deputy minister was quick to denounce the proposal. It was unclear, however, how a proposal came to be introduced that appeared to put the Kremlin at odds with one of the government’s most powerful officials and a man whose authority over defense industrial matters had just been strengthened in a recent government restructuring. Moreover, there appeared also to be some dissonance this week over whether private groups would, in fact, be permitted to invest in Russian defense enterprises, as Putin had seemed to suggest. Klebanov himself was quoted by Russian television as giving assurances that not a single share of the soon-to-be-created Sukhoi holding would be allowed to fall into the hands of private investors (AP, Itar-Tass, Russian Public TV, Russia TV, Strana.ru, October 30; Vremya MN, Parlamentskaya Gazeta, October 31).

SERGEI SHOIGU’S ILLNESS MAY BE POLITICAL.