Why Some Ukrainian Defense Contractors Are Still Doing Business With Russia

By Katherine Jacobsen
Bloomberg Businessweek | June 03, 2014

While officials in Kiev worry about a full-on military invasion from Russia, some Ukrainian defense manufacturers are still selling military parts—from helicopter motors to intercontinental ballistic missile components—to the Russians.

After Vladimir Putin’s annexation of Crimea, the director of Ukroboronprom, Ukraine’s state-owned conglomerate of defense manufacturers, banned the export of all weapons and military equipment to Russia. Private companies, however, faced with the possibility of losing billions of dollars in defense contracts, have continued to do business with Russia.

“The overall portfolio of Ukraine’s defense contracts from Russia is more than $15 billion,” says Alexei Arbatov, of the Carnegie Endowment for International Peace in Moscow. That’s more than the aggregated amount of aid that the West has pledged. Plus, Arbatov adds, the aid money has to be paid back, whereas the money from selling exports to Russia is a profit.

At a time when the Ukrainian economy is already sputtering, cutting off these contracts would cause factory shutdowns and the loss of several thousand jobs, at minimum, says Arbatov.

Although Ukraine’s sales to Russia come to only about 10 percent of its total military exports, the goods produced for the country are highly specialized for that market: The helicopter motors made in Ukraine for sale in Russia, for example, are only compatible with Russian helicopters. Attracting foreign trade partners in this case is almost impossible.

Alternatively, turning factories around to manufacture different parts would require money and time, neither of which are abundant in the Ukrainian economy.

There’s been talk about the Ukrainian military purchasing arms from its own companies, but its army is in need of basic gear rather than the high-tech equipment the Russians have been purchasing.

This interdependence of the Russian and Ukrainian military industrial complexes dates back to Soviet times, when Ukraine was part of the U.S.S.R. and was a vital player in the arms race against the U.S. By the 1980s, Ukraine housed roughly 30 percent of the Soviet defense industry, according to Arbatov. After the fall of the Soviet Union, military armament companies in the two countries, both the newly privatized and those still under government control, continued to collaborate.

Although Russia would continue to occupy an important niche in the Ukrainian arms market, the demand from Moscow began to wane after the end of the Cold War, and Ukrainian military manufacturers began to diversify their list of trading partners to include India, Iraq, China, and Thailand.

In 2012, Moscow set off on a military modernization plan to build up Russia’s armed forces. President Putin pledged $755 billion to restore the nation’s military might.

“Ukraine figures very prominently into this plan,” says Omar Lamrani, a military analyst with Stratfor, a geopolitical intelligence firm. “While eventually Russia would like to move away from the Ukrainians and build their own independent arms industry, that doesn’t mean that they can do this in a short period of time, especially during this modernization period,” he says.

While Putin estimated that Russia will be able to make up for the loss of Ukrainian exports within two and a half years, this seems a bit optimistic, says Lamrani.

Russia has been domesticating most of its arms manufacturing for the past several years, says Vasily Kashin, a senior analyst at the Center for Analysis of Strategies and Technologies, a Moscow-based defense industry think tank. “Russian collaboration with Ukraine has been a matter of saving money,” Kashin says. Instead of buying new intercontinental ballistic missiles, for example, Russia is able to do maintenance on its Soviet-era missiles, using parts and experts from Ukraine.

Russia will, of course, suffer a financial setback if all Ukrainian military companies stop selling to the country. But in the end, according to Kashin, Russia has the upper hand.



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