29 January 2017

Russian Analytical Digest No 196: Russian Security/Defense

By Richard Connolly, Stephen Aris and Bettina Renz

The three articles in this issue of the RAD discuss 1) Russia´s recently-approved 2017–19 budget, which ensures defense spending will remain a priority for the country; 2) the Collective Security Treaty Organization (CSTO), which Moscow is largely neglecting at this time; and 3) how the Putin regime views the utility of military power as an instrument of foreign policy, particularly after its interventions in Ukraine and Syria.

Hard Times? Defence Spending and the Russian Economy


Driven by an ambitious plan to modernize the armed forces and to upgrade the wider defence-industrial base, defence spending in Russia has grown rapidly since 2010. However, nearly two years of recession and bleak growth prospects have caused policy-makers to make some tough choices over how to allocate public resources. The recently-approved budget for the period 2017–19 envisages a reduction in overall public spending and of defence spending. While this suggests that the period of rapid growth in defence spending has ended, closer inspection of the proposed budget shows that the defence industry and the military remain important to the Russian leadership.

Russian defence spending, driven by an ambitious plan to modernize both the equipment used by the Russian armed forces and to upgrade the wider defence-industrial base, has risen sharply in recent years. However, the budget for the period 2017–19 adopted on December 9th suggests that defence spending, as a share of total federal government spending and of gross domestic product (GDP), may well decline in the coming years. Against the backdrop of Russia’s armed intervention in the Syrian civil war, and amidst a wider heightening of tensions between Russia and the West, this relaxation of the defence burden may appear surprising.

In this article, the scale of the planned reduction in defence spending is considered, along with the implications that spending plans are likely to have for the future of Russia’s plan to re-equip and modernise its armed forces, and what this might mean for Russian economic development in the near future.

From Rearmament…

The urgent need to re-equip the armed forces became apparent in the aftermath of the war with Georgia in 2008. In late 2010, the erstwhile president— Dmitry Medvedev—approved a new ten-year state armaments programme (gosudarstvennaia programma vooruzheniia, hereafter the GPV-2020) that was designed to re-equip and modernise the Russian armed forces by 2020. As well as providing substantial—and in the post-Soviet period, unprecedented—funds for re-equipping Russia’s armed forces, it was also envisaged that the GPV-2020 would revitalize the Russian defense industry through investment in the modernization of the industry’s fixed capital stock. As such, the GPV-2020 was an attempt to both modernize the Russian armed forces and to revamp the Russian defence industry. This led President Putin to express the hope that the defence industry would act as a “locomotive” of technological development in the wider economy.

As the rearmament process gathered momentum, total Russian military expenditure grew from 3.8 percent of GDP in 2010 to 5.4 percent in 2015. Within this, the amount allocated to the annual state defense order (gosudarstevennyi oboronnyi zakaz, or GOZ) grew from 1 percent of GDP in 2010 to 2.4 percent of GDP in 2015. This was augmented with state guaranteed credits (SGCs) provided via state-owned banks, as well as additional indirect funding that was channeled through other ministries, such as the Ministry of Industry and Trade, which funded the development of industrial projects with military applications.

This injection of funds into the defence industry caused a reorientation in the overall allocation of federal government spending. In 2010, military expenditure accounted for 15.9 percent of federal government spending; by 2015 it had grown to 25.8 percent. In 2015, the GOZ alone (including SGCs) accounted for nearly 12 percent of federal government spending, up from less than 5 percent in 2010. With total military expenditure estimated by SIPRI to have reached around 5.5 percent of GDP in 2015, the defence burden in Russia was well in excess of the NATO average (1.5 per cent of GDP) and that of the USA (3.3 per cent) and China (1.9 per cent).

For some observers, this reorientation of defence spending was a worrying sign, contributing to the perception of a more militarily capable and threatening Russia. However, it should be understood that the rearmament process embodied in the GPV-2020 drove much of the rise in military expenditure, and this in turn was much-needed after the hiatus in defence procurement and military spending in general that occurred in the aftermath of the disintegration of the Soviet Union. Improved conventional capabilities may, for instance, reduce the emphasis that Russian defence planners place on the use of nuclear weapons in any large-scale conflict. And, lest it be forgotten, the absolute sums allocated to the Russian military remain significantly lower than either NATO to the west and China to the east.

The supplementary amendment to the 2016 budget made in October, which saw an additional RUB 780 billion allocated to the ‘national defence’ chapter of the federal budget, prompted some observers to highlight what appeared to be another sharp increase in defence spending. However, closer inspection revealed that this additional spending was not made to support current spending on operations or procurement, but instead was intended to pay down around RUB 750 billion of the principal outstanding on the SGCs that were used to supplement direct budget funding for the state defence order in previous years (the total stock of which amounted to over RUB 1.2 trillion).

The state decided to intervene before large repayments were due to be made over 2017–18, largely because a number of enterprises would have found the repayment schedule too onerous, raising the prospect of rising non-performing loans affecting the state-owned banks that had provided the loans to defence-industrial enterprises. Soon afterwards, a government decree, prepared by the Ministry of Finance, permitted the state to guarantee up to 100 percent of the debt of strategic enterprises, an increase from the 70 percent that was previously guaranteed by the state.

Both developments—the state intervention to reduce the principal outstanding on previous SGCs and the move to increase the proportion of loans guaranteed by the state— suggest that the financial situation of at least some key defence enterprises is precarious, despite the large increase in defence spending that has taken place in recent years.

…to a Change in Priorities?

After a period where the defence budget grew strongly each year, the new budget for the period 2017–19 suggests that a period of relative austerity lies ahead for the defence industry. Due to the wider, protracted economic slowdown that has afflicted the Russian economy since 2013, tax revenues have declined. Because of the desire in the leadership to reduce the size of the budget deficit, this has resulted in plans for a steady and significant reduction in federal government spending across nearly all spheres of government activity.

In 2015, federal spending amounted to 21.2 percent of GDP. Under the plans outlined in the budget, it is envisaged that the share of federal spending in GDP will decline to 18.7 percent of GDP in 2017, and eventually reach 16.2 percent of GDP in 2019. This reduction in overall spending is intended to reduce the federal budget deficit from what will probably be around 4 per cent in 2016 to just 1.2 per cent in 2019.

Since the recession began in 2015, defence spending has been cushioned from significant cuts, at least compared to most other chapters of budgetary spending (with the exception of social welfare spending). Some accounting sleight of hand has helped. For instance, the 2016 budget as outlined in the budget law envisaged a nominal reduction in spending on the ‘national defence’ budget line of just 1 percent (c. RUB 320 billion), compared to an average of 10 percent in other departments. This would have reduced the share of total (SIPRI-defined) defence expenditure from 5.4 percent of GDP in 2015 to around 4.8 percent. However, the allocation of nearly RUB 200 billion worth of SGCs to help execute the state defence order compensated for this reduction, even before the additional allocation of funds to reduce the stock of outstanding SGCs was made later in the supplementary budget.

The 2017–19 budget appears to portend a more significant reduction in the weight of the defence burden. Spending under the ‘national defence’ chapter is scheduled to decline from nearly a quarter of federal spending in 2016 (19 percent excluding the supplementary allocation of funds to pay off SGCs) to around 17.5 percent over the period 2017–19. If executed to plan, this reduction in spending should bring real (i.e. inflation adjusted) defence spending down to levels last seen around 2013. On the face of it, this halt to the rapid growth in defence spending of recent years appears to be a significant development. After all, if the Kremlin intends to curtail military expenditure, especially in an era of strained relations between Russia and the West, perhaps it will augur well for a future relaxation of tensions. However, closer inspection of the budget reveals that the reduction in funding for the defence industry may not be quite as severe as it is presented.

First, the apparently sharp annual reduction (2016–17) of nearly 30 percent in nominal terms that has been reported in some quarters is misleading. Such a large decline is a result of the inclusion of the additional funds included in the supplementary 2016 budget to reduce the outstanding principal on SGCs. If these additional funds are excluded from the calculation (so, comparing like-for-like expenditure), the reduction in spending committed to ‘national defence’ over the next year is closer to 9 percent in nominal terms.

Second, closer inspection of the planned expenditure reveals significant variation across spending on ‘national defence’. For instance, a large proportion of the proposed reduction in spending looks set to fall on the budget line ‘applied R&D (research and development) in the field of national defence’, where funding should decline from RUB 432 billion in 2016 to RUB 346 in 2017 and even further to RUB 176 billion in 2019, a cumulative decline of nearly 60 percent over three years. Most other budget lines are protected from such severe cuts, with the exception of the budget line ‘other items in the field of national defence’, under which spending on operations in Syria is believed to be funded.

Third, additional funds look likely to be made available elsewhere in the budget to compensate the OPK for cuts made in direct defence spending. For instance, an extra RUB 150 billion is allocated under the classified section of spending on the national economy. This represents a seven-fold increase on spending on the same classified section of the budget in 2016, and includes a nine-fold increase in classified spending on ‘applied R&D’. Given that a new state programme (No.425-8; “Development of the Defence-Industrial Complex”) to increase productivity in the defence-industrial complex was approved in May 2016, it is likely that this will be funded through an increase in spending channeled via the Ministry of Trade and Trade (Minpromtorg). And a further RUB 43.7 billion in SGCs has been made available to help finance the development of the defence-industrial complex. Thus, while the mechanism of funding has changed, the final beneficiary—the defence-industrial complex—remains the same.

Fourth, funding for the annual state defence order (GOZ) is forecast to decline only very slowly in nominal terms. Thus, while around RUB 1.65 trillion was allocated to the GOZ in 2016, modest annual reductions mean that by 2019 it is expected that around RUB 1.55 trillion will still be allocated to the GOZ, a large proportion of which finances procurement. This is quite a mild reduction in funding, even if inflation will erode the real value of this expenditure to bring it down to a level of expenditure last seen in 2013. Indeed, because expenditure on the overall ‘national defence’ line is expected to decline more quickly than spending on the GOZ, the share of the GOZ in ‘national defence’ spending should actually rise from 53.5 percent in 2016 to just under 58 percent in 2018 before declining thereafter.

Finally, there appears to be scope for an increase in defence spending if the wider economic situation improves. In early November the Duma approved a measure that permits the government to reallocate up to 10 percent of federal government spending towards defence and security without seeking agreement from the Duma, although apparently any extra funds cannot be assigned towards fulfillment of the state armaments programme. Because the overall budget is based on a relatively conservative oil price of $40 per barrel (Urals) over the three-year period, it is plausible that tax revenues may turn out to be higher than expected, especially if Russia and OPEC successfully cooperate to support oil prices. Government spending in Russia is highly correlated with oil revenues, so if the price of oil is higher than forecast, we should expect budgetary spending to rise with it.

Implications for the Modernization of the Armed Forces and Economic Development

It is clear that Russia’s protracted and still ongoing economic slowdown is forcing policy-makers in Moscow to make some tough decisions about how to spend increasingly scarce public resources. However, despite the mood of austerity that is reigning across most ministries, the plans for public spending over the next three years do appear designed to reduce, if not eliminate, the impact on both the military and defence industry.

Clearly, as public spending is reined in, the rapid growth rates observed in both procurement (which, including SGCs, rose at a nominal average annual rate of over 30 percent between 2010 and 2015) and military spending more widely have come to an end. As Figure 1 shows, the peak in spending on the GOZ was reached in 2015 and is scheduled to decline over the next three years.

According to the President, the focus for the foreseeable future should be on the ‘optimisation’ of defence spending (i.e. the more efficient use of existing resources) and ‘diversification’ of defence-industrial production (i.e. a shift away from state defence orders as the primary source of sales towards civilian production), so that the defence industry can reduce its dependence on the GOZ for the vast majority of its revenues (estimated by Putin to account for 84% of defence industry revenues in 2016).

Nevertheless, the fact that the government appears to remain committed to rearmament despite the sharp reduction in overall government spending shows that the modernisation of the armed forces, along with social welfare, retains primacy among Kremlin priorities. After all, in real terms, spending on the GOZ looks set to remain at 2013–14 levels for the foreseeable future.

Thus, the re-equipment of the armed forces appears likely to continue, reflecting the political priority that this objective has enjoyed in recent years. While some individual weapon systems, such as the PAK-FA fighter aircraft and the Armata battle tank, may be produced in lower numbers than originally forecast and at a slower pace, it is still likely that significant volumes of new equipment will reach the armed forces over the next few years, enhancing the overall capability of the armed forces.

While this orientation towards defence spending, at the expense of, for instance, education and health, may well appear misguided given the scale of socio-economic challenges confronting Russia’s leaders, there are several reasons to believe that it can nevertheless be maintained.

First, Russia has very real and specific security concerns that mean it is required to bear a greater defence burden than most countries. As a result, both elite and public support for a relatively high volume of defence spending is high. These security concerns are unlikely to disappear soon, so this commitment by both elite and the wider population should be expected to persist.

Second, senior officials, including the President, have stated that once the objective of modernising the equipment used by the armed forces has been met, procurement spending will probably be scaled down to a lower level. Indeed, the statements concerning the likely focus of the new state armaments programme that should be developed by summer 2017—GPV-2025—indicate that attention will switch from large-scale re-equipment to the development of high-technology communication and information systems and new generation weapon systems.

Finally, for all the talk of Russian leaders displaying a preference for ‘guns over butter’, the fact remains that the defence burden remains an order of magnitude lower than that which prevailed during the Soviet era. While defence spending may not prove to be the locomotive of growth and technological development that Putin had hoped for, defence spending is not yet distorting economic development to the extent that it did during the Soviet period.

About the Author

Richard Connolly is director of the Centre for Russian, European and Eurasian Studies at the University of Birmingham. He is also associate fellow on the Russia and Eurasia programme at Chatham House, visiting professor at the Russian Academy of the National Economy, and editor of Post-Communist Economies.

Note: estimates on GOZ spending supplied by Prof. Julian Cooper, University of Birmingham

Additional Reading: 
R. Connolly and C. Senstad. 2016. ‘Russian Rearmament: An Assessment of Defense-Industrial Performance,’ Problems of Post-Communism. 

J. Cooper. 2016. ‘The Military Dimension of a More Militant Russia,’ Russian Journal of Economics, Vol. 2, No. 2, pp. 129–145. 

Figure 1: Spending on Rearmament (Annual State Defence Order, GOZ), Million RUB 2015 Constant Prices, 2010–2019 (2016–2019 Estimates; Prices Adjusted for Inflation Using GDP Deflator).

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