Will Sanctions Alone Undermine Russia’s Defence Industry?

Hlib Kanievskyi

Contributor

Monday, 18 July, 2022

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Russia’s massive defence industry has long been a symbol of patriotism as well as a key source of revenue. More than 1,300 facilities currently produce weaponry, and state officials like to boast about the hundreds of missiles, aircraft and tanks being produced alongside military innovations such as Iskander missiles and Armata tanks.

It came as no surprise that, following Russia’s full-scale invasion of Ukraine in February, defence businesses were one of the first subject to Western sanctions. One would assume that such international actions would certainly amount to a serious blow to Russia’s industrial potential and result in shortages of tanks and missiles for its army.

However, sanctions against Russia’s vast military industrial complex are nothing new. The EU and US introduced them after the annexation of Crimea and war in the Donbas in 2014, but this clearly did not prevent Russia from fulfilling defence orders, the results of which are now maneuvering in Ukrainian fields.

The sanctions may have annoyed the Kremlin, but have failed to disrupt its predatory plans.

Data from the Stockholm Peace Research Institute shows that between 2013 and 2020, a dozen companies from the Russian Federation were regularly found in the top 100 defence corporations in the world.

The Kremlin began its new arms race in 2010, when oil prices were on the rise for several years. Russian economists say that between 2011 and 2016 the scope of their defence industry grew by one and-a-half times.

Despite sanctions and general sectoral restrictions, the largest Russian companies continued to produce weaponry. In 2017, three years after sanctions were imposed, sales of weapons even grew. There were budget injections in the form of several successful export contracts with India and China, traditional buyers of Russian weapons, as well as Moscow’s move to cancel the debts of the defence companies that facilitated such growth.

In 2018, Russia adopted an ambitious ten-year rearmament programme. By 2027, the Kremlin plans to spend on average 20-24 billion US dollars annually, depending on currency rate fluctuations, on its new deadly vehicles. These are astronomical amounts. In comparison, during the pre-war period Ukraine spent around one billion dollars a year to modernise its army and buy new weaponry.

Large budget orders under classified contracts are the foundation of the success of the Russian defence industrial complex; local companies are characterised by large-scale corruption, nepotism and cronyism.

This is illustrated by the case of Kurganmashzavod JSC, which until recently belonged to businessman Albert Bakov, son-in-law of the filmmaker Nikita Mikhalkov.

At the beginning of the 2000s, Bakov, together with his partners, managed to privatise Kurganmashzavod JSC along with many other defense assets, being guided by the-then logic of wild capitalism.

“Everything was first bought and only later assessed,” he told Russian Forbes magazine.

However, after privatisation the ministry of defence refused to buy Kurganmashzavod JSC infantry combat vehicles due to their poor quality. Kurganmashzavod JSC could not compete with foreign offers, so Bakov and his partners took exorbitant loans secured with the defence company’s assets - which they failed to pay off.

In 2018, the state-owned Rostekh Corporation bought out the factory debts and returned it to public ownership within the structure of the subsidiary High-Precision Systems corporation. The Russian ministry of defence signed contracts with both the new and old state factory on the supply and modernisation of combat infantry vehicles. This allowed Kurganmashzavod JSC to return to economic activity. According to media reports, around 300 million dollars were spent just to initially stabilise Kurganmashzavod JSC.

The most recent estimates put the arrears of Russian defence companies at some 30 billion US dollars. A few years ago, the Kremlin allocated 13 billion dollars to pay off such credit. In order to save defence companies from collapsing, the Kremlin empowered the state Promsvyazbank to ensure preferential credit and refinancing. In fact, a bank system was assigned to the military and industrial sector that was only placed under sanctions this year, after Russia recognised the sovereignty of the so-called DPR and LPR.

"Western partners need to cooperate to limit Russia’s lucrative weapons trade with its current customers."

Export contracts constitute a safety cushion for the Russian defence industrial complex. Russia produces and sells at least a third of its production under such contracts each year. Since 2013, the income from selling Russian weapons abroad came to 15 billion dollars a year.

Moscow has sold weapons to dozens of countries all over the world since Soviet times, with China and India standing out due to the scope of contracts. In 2019, for instance, Delhi and Moscow signed a colossal contract for 14.5 billion dollars in 2019.

Their interest in this cooperation is pragmatic rather than ideological. The Russian defence industry modernises Soviet-era military equipment in India, takes part in joint projects in the Indian territory and supplies weapons which are cheaper than Western analogies.

The partnership between Moscow and Beijing is of a very different nature. Though these countries have not created a direct military alliance, they have tight connections in the armed forces and industrial spheres, which both country’s state-controlled media spins as an alternative to American hegemony in the world.

The stand out contracts entered into after the offensive against Ukraine in 2014 include an order of Russian fighter jets for around 2.5 billion dollars and six divisions of S-400 missile defence systems for over three billion dollars. According to Russian officials, the portfolio of Chinese orders amounts to up to seven billion dollars a year.

This makes it clear that the West’s sanctions policy has failed to achieve its purpose. Though the restrictions have bothered the Kremlin, they have been far from fatal for the Russian defence industrial complex. Amid the full-scale invasion of Ukraine, when tanks produced just last year are seen in occupied Ukrainian cities, it is important to make sure such mistakes are not repeated.

Putin will continue to have the resources to obtain deadly new weapons until the Western countries stop paying enormous amounts of money for oil, gas and other goods. So weapons sanctions need to be accompanied with an energy embargo.

The modernisation of the Russian industrial base also has to stall. As early as 2014, the EU and US banned the sale of goods which could be used in military production. However, this did not prevent Western businesses from supplying modern machines, electronics and software to Russia for non-military production purposes. In reality, these industrial goods were resold through intermediaries to companies within the defence industry.

Western partners need to cooperate to limit Russia’s lucrative weapons trade with India, Turkey and other current customers.

One could be bolder and suggest that the ongoing conflict has shown some Ukrainian weaponry, such as the naval Neptun missile or anti-tank Stugna system, to be wold-class and decisive on the battlefield.

With Western investment, perhaps the Ukrainian military industry can itself contribute to pushing Russian companies out of foreign markets.

Hlib Kanievskyi is an analyst with Trap Aggressor, a civil society group and IWPR partner that is researching the Russian military industrial complex.