The Collapsing Russian Defense Budget and Other Fairy Tales

Posted today on Russia Matters, a project by Harvard Kennedy School’s Belfer Center for Science and International Affairs.  Below is my latest piece in response to the headlines generated by SIRPI’s trends in military expenditure report alleging a 20% reduction in Russian military expenditure in 2017.

One can only observe with bemusement the growth in size, readiness and modernization of Russia’s armed forces when juxtaposed against recent news stories reporting a 20-percent decline in Russian defense spending from 2016 to 2017, described as the first notable cut since 1998. It is seemingly impossible for both trends to be real. Indeed, Russian defense spending is alive and well, with cuts limited to single digits. The announcement about its steep decline by the Stockholm International Peace Research Institute, or SIPRI, was erroneous. Changes in Russia’s handling of defense funding have led SIPRI and, before it, IHS Jane’s Defense Weekly to misreport the reduction. Now, for the second time in as many years, the miscalculation is proliferating across major media outlets.

The main source of the error is readily identifiable, arcane though it may be: In 2016 the Russian government started paying off defense-sector debt that had piled up over the years, which created the illusion of much higher spending on national defense and, accordingly, a subsequent decline the following year. Before this, the Defense Ministry (MoD) had managed to rack up close to a trillion rubles in debt to defense contractors, who had been producing equipment on credit borrowed from various banks. The MoD was paying the interest on these loans and the Russian leadership was none too happy about it. After the government decided to pay down the debt, the Finance Ministry provided 792 billion rubles for this purpose, a figure that seemed to boost 2016 defense spending from its actual 3.09 trillion rubles to 3.8 trillion. (Subsequently another 186 billion rubles was spent in 2017 on paying down debt, making the spending appear higher for that year as well.) According to the MoD, this measure saved 130 billion rubles in interest alone.

Another change disrupting the continuity of Russian defense-spending data, adopted by the government in 2017, was to tighten up controls on funding left over in the hands of the defense sector when it was unable to deliver weapons on time. Prior to this, the defense industry was allowed to build up stockpiles of money advanced for armaments that had not been produced as scheduled. Furthermore, some defense enterprises were clever enough to collect interest on these large advances, which sat in their accounts. At the end of the year, about 250-300 billion rubles ended up trapped in this manner, and the MoD had a hard choice to make: either further finance incomplete orders, and therefore reward delinquency, or return the money to the government budget and potentially lose it. To solve the matter, the MoD will now pull unspent funding back to the government budget under the condition that it will be reissued, and roll over payments into the following year. This means that some portion of each year’s budget (perhaps 5 percent or so) will flow into the next year.

In making its calculations SIPRI also converted the outsized budget figures from 2016 into U.S. dollars, which exacerbated the impression of a dramatic decline in defense spending in 2017. Measuring Russia’s defense budget in dollars is analytically unhelpful, since Russia’s defense sector doesn’t buy much of anything in dollars. Thus, the resulting figures are distorted by changes in currency exchange rates, and they are not adjusted for purchasing power parity. Ultimately, several percentage points in SIPRI’s alleged decline were likely due to currency devaluation, which is almost completely irrelevant to the matter in question.

While we are in fact witnessing a steady decline of Russian defense spending as a percentage of GDP, defense cuts in absolute terms have been modest at best. Official spending on defense dropped by about 8 percent from 2016 to 2017, from 3.09 trillion rubles to 2.84 trillion, and the defense budget was only scheduled for cuts averaging 5-6 percent over the three-year period of 2017-2019. (The numbers in this article reflect official defense spending, not total military expenditure, which might include funding for other militarized services like the border guards and Interior Ministry troops, or military pensions, which could add another trillion rubles to the bottom line.) Actual reductions in military spending began in 2015, by about 5 percent. Economic factors certainly played a role—primarily Russia’s recession and the drop in oil prices—but perhaps more important were the geopolitical factors: loss of access to certain defense articles imported from the West and the messy divorce from Ukraine’s defense sector. Due to the war with Ukraine, Russia’s defense industry could not buy components from its long-time partner across the border; this, in turn, delayed production and left the Russian Defense Ministry with less materiel to buy, while the funds to pay for it sat in government coffers instead of getting spent.

Russia’s defense expenditures are not a coherent data set and have become easy to get lost in given the changes that have taken place. Nonetheless, it is especially frustrating to see the narrative of “slashed military spending due to economic woes” resurface now, since the same miscalculation was made last year by Jane’s, which reported a 25-percent reduction in Russian defense spending from 2016 to 2017 based on Moscow’s advance announcement of planned expenditures. Jane’s later acknowledged the mistake and took down its original story, but by that time the sensational figure had already been reported widely in the news media.

Although it is impossible to know in advance how much will be spent in 2018, it is already looking like this year’s anticipated 5 percent reduction is unlikely to materialize. Instead of the planned 2.768 trillion rubles, the Russian budget’s defense chapter has already been amended to 2.953, a 6.7-percent increase; this higher 2018 figure likely includes carryover payments for armament procurement in 2017. Hence defense spending in 2018 is unlikely to decline, but the Russian leadership still intends to see military expenditure reduced as a share of GDP. Planned spending on national defense was envisioned at 2.815 trillion for 2019 and 2.807 trillion for 2020—also hardly a steep cut, and current performance suggests actual numbers will prove higher.

Moreover, despite a reduction in Russia’s purchasing power, the new state armament program for 2018-2027 is quite substantial for the defense sector, especially considering the amount of modernization and procurement of new equipment already accomplished under the previous one. The latest program allocates considerable resources for additional procurement. It is configured in a 19+1+3 formula, with 19 trillion rubles for the armed forces, 1 trillion in infrastructure spending and another 3 trillion for other security services, such as the National Guard. The previous program of 2011-2020 was valued at close to 19 trillion rubles (plus infrastructure investment), about half of which was spent by 2017, at a rate that might average 1.35 trillion per year.

Thus, Russian defense spending and procurement is in for a sustained trim, but the reductions are fairly minor in comparison to the sensational headlines. Moscow has long declared its intentions to halt the growth in defense spending and reduce military expenditure as a share of GDP over time. Given the complexity of Russia’s defense budget, and a data set that lacks continuity, the best thing one can do is tread with care when it comes to pronouncements.

Because budget work is kind of lackluster and doesn’t offer much in terms of photos, I’m attaching this picture of Ivan, our lead analyst of budget analytics and kibble.

Ivan director of budget analytics and kibble

6 thoughts on “The Collapsing Russian Defense Budget and Other Fairy Tales

  1. Mike, I like the picture in this version better than the one Harvard used. Traveling a lot, but will hope to catch you at some point before the summer really gets goin. Best, Bill

    On Tue, May 22, 2018 at 10:30 PM, Russia Military Analysis wrote:

    > Michael Kofman posted: “Posted today on Russia Matters, a project > by Harvard Kennedy School’s Belfer Center for Science and International > Affairs. Below is my latest piece in response to the headlines generated > by SIRPI’s trends in military expenditure report alleging a 20% red” >

    Like

  2. If I might offer my layman’s view, the Russian ecomonic potential does include what is now the world’s #1 agricultural production and she possesses an enviable reserve of fresh water. In the future this may well prove more valuable than oil… In addition, mineral resources are aplenty; if Russia could find a way to improve their substandard productivity, there is great potenial to exceed projections. All this taken into account, Russia’s biggest issue remains her lack of geopoltical allies. The situation of last century remains unchanged in this sense: Russia has only two viable allies, Germany and the US. China will never be more than a marriage of conveince. As long as the US can keep Russia on an island, they retain the upper hand.

    Like

  3. From a pro Russian point of view concerning production efficiency.

    Russias production efficiency is pretty heterogenous. Labor productivity in Peter and Moscow is mostly on par with the EU average (below Germany and the Scandinavians though), but this is not the case for non first/second tier cities.

    Much of the production inefficiency comes from single factory towns. There is a bit of a catch 22, since these industries can get state subsidies (on account for the town collapsing if they go bankrupt) to make up for inefficiency, while there are also solid reasons why modernizing these things is much harder as there is less money and it is hard to convince talent to move there.
    The central authorities are trying to utilize pretty young technocrats to fix these things. The understanding is that a young technocrat who proves himself there gets better rewarded tasks in the centre in the future.
    What I find kind of hilarious is I do not see any intention on the official Russian side to claim “we are so peaceful, look how we decreased our military budget”.

    My understanding is that people in the west who are pro Russian want to belive this because it reinforces their understanding of “peaceful defensive Russia” (Russia is defensive, but not peaceful) while the “Russia will collapse” crowd sees this as “ZOMG OUR SANCTIONS WORK! GLORY TO US!!! USA USA!!!”.

    In reality, its just the central administration being reasonably business savy.

    Like

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

w

Connecting to %s