Three Key Factors at Play for Russia's $705 Billion Military Modernization

The Russian government is intent on reviving the nation's arms industry while simultaneously modernizing the armed forces. To this end, the Kremlin has revised its State Armaments Program (SAP) and is now calling for RUB20 trillion ($704.9 billion) to be spent on the military's modernization from 2011-2020. There are three key factors that will determine the extent to which the SAP can be implemented.

First, in order to meet the funding goal of RUB20 trillion, approximately 4.5 percent of the nation's GDP must be directed toward military funding. However, given Russia's current financial position, this may be a bit ambitious.

According to Rebecca Barrett, Eurasian defense analyst at Forecast International, the recent global economic crisis "exposed the structural faults of the Russian economy." She noted, "While equity markets have improved since mid-2009 and capital markets have re-opened, the repair of the financial system is far from complete."

The government is now hoping that the economy will reach pre-crisis levels by the end of 2012, at which time GDP should be on par with the levels achieved in 2008.

At the same time, the crisis has also exposed the financial weaknesses of the Russian aerospace and defense industry. Fortunately for Moscow, the timing could not have been better. The Kremlin leveraged this exposure to consolidate the defense sector under government control and will now use the industry's capabilities to complete the military's modernization plan. However, Barrett points out in the "Market Overview" report on Russia that the government must invest in research and development programs for the defense sector in order to stave off the pending industrial decline. Without the investment, the industry's defense technology base could become a major impediment to the SAP.

The third key factor is the defense budget. The MoD has begun transitioning funding streams to support additional arms procurements through two major reform processes. The first is a cost-saving reform which calls for the reduction of some 200,000 personnel by 2012. The second major reform is the adoption of a new budgetary framework. According to Barrett, "The process is designed to modernize the Kremlin's fiscal practices and provide longer-term price and policy signals to the Russian defense industry."

In order for the SAP to be fully implemented, the government must continue to invest heavily in both the military and the nation's defense industry. Furthermore, because the SAP calls for 11 percent of existing military equipment to be upgraded and a full 70 percent to be replaced with modern weapons, the Russian defense industry needs to stay afloat and the economy must continue to rebound at a steady rate.