Russian Ministry of Defense seeks safety in Parliament

09.06.2012 — Analysis

At the beginning of June the bill "On Defense Procurement" will have its second reading at the RF State Duma. The instrument masterminded by the Military and Industry Commission is meant to put an end to the war between the Ministry of Defense and manufacturers and to their suspicions of fishing in troubled waters. The first reading showed that peace had a long way to go: The special-purpose committee of the parliament turned down the amendments that were critical to industrialists. As the RusBusinessNews columnist has found it out, officials practice dual standards: On the one hand, they demand that the defense manufacturers should make their costs transparent; on the other hand, they lobby the controversial framework law that is not intended to make budget expenditures more transparent.

The conflict between the RF Ministry of Defense and manufacturers started a long time ago. Anatoly Serdyukov, appointed head of the defense department in 2007, was deeply concerned about the armament quality and cost, setting his mind on taking care of it. It hampered defense procurement and resulted in a few months' delays in reaching agreement on product prices and remittance of money to manufacturers. In addition to the red tape, manufacturers were annoyed by the new policy of the Ministry of Defense: the minimum price combined with the maximum responsibility of manufacturers. Exorbitant punitive penalties, piles of requested documentation, curtailment of the apparent costs - all these turned into a catalysis sparking the discontent on the part of defense manufacturers.

The defense department tried to find excuses, arguing that the Russian legislation has no detailed provisions regarding the principles of cost accounting, which extremely complicated control over employment of physical, human and financial resources. Being unable to control business economics, the Ministry of Defense turned to cutting rates.

In addition to problems with pricing, A. Serdyukov ran into absence of clear-cut laws that would govern defense procurement. It was also unclear how decisions on purchases of products were made. The attempts to get this inheritance straightened out resulted in wrecking the defense procurement program for 2011 and further aggravation of relationships with defense companies.

The law "On Defense Procurement" was chosen as a tool to harmonize the conflicting parties. In April 2012, its draft was discussed by deputies of the RF State Duma. In his introductory speech, Vladimir Komoyedov, the chairman of the defense committee, shared his hope that accurate and timely information about costs will facilitate more efficient application of budgetary funds allocated for purchasing of arms and military hardware.

Having analyzed the draft bill, experts concurred that it would not put clarity either into pricing or into the relationship between the military and manufacturers. According to Vladimir Gutenev, the first vice president of the Engineering Union of Russia, most of the basic provisions and concepts of the document are very vague. The drafters of the law decided to leave the explanation of the framework theses to the executive branch, i.e. to the government and to the Ministry of Defense. There is not the slightest hint of the equitable relationship between the customer and the contractor in the draft bill.

The attempts of manufacturers to establish disciplinary, civil, and administrative liability or criminal responsibility for delays in signing contracts and payments went down the drain: The industry committee, as the co-author of the bill "On Defense Procurement", voted down the amendments - in the same way as it did with other proposals regarding defense procurements for the next year to be scheduled not later than for February, setting of the rate of return and suggestion on all of the manufacturing costs to be included in the price structure, including insurance, logistics costs, etc.

Andrei Frolov, an expert of the Center for Analysis of Strategies and Technologies, thinks that voting down the amendments offered by such "monsters" of the military industrial complex as the United Aircraft Building Corporation, OJSC, Rostechnologies State Corporation, United Shipbuilding Corporation, OJSC, proves that the Ministry of Defense does not want to assume any definite legal obligations. In practice it will mean that financing of defense procurements will continue to be a total mess.

Igor Korotchenko, the chairman of the Public Council of the Defense Ministry, thinks that the defense department does not try to avoid responsibility. The ministry performs successfully its functions in financing of defense procurement and defining performance characteristic of weapon. The headache that the military have is caused by transparency of contracts and quality of products. The customer wants to see the pricing algorithm along the whole production chain - up to the suppliers of the fourth level. The expert realizes that it will be not easy: non-transparency of prices gives the possibility to defense manufacturers to collude and to drive up contract prices by 200-300% due to components. To break down this practice amidst egregious corruption is rather difficult.

The military, in the opinion of I. Korotchenko, set their mind on the requirement that profitability of the end product manufacturer should not exceed the limit of 15-20%. The expert thinks that regardless of manufacturers' likes or dislikes, they will have to accept transparency of prices for defense products in Russia in the same way it is in the USA. Therefore, the parties should reach agreement as soon as possible.

In the meantime, manufacturers do not like the idea that all agreements must be reached at their expense. However, that is how it goes so far: According to Vladimir Kukarskikh, the executive director of the Union of Defense Enterprises of the Sverdlovsk Region, only manufacturers are held liable for defense procurement. Their financial interests are also neglected: The expert states that the governmental customer is persistent in its unwillingness to include social infrastructure expenses of defense manufacturers in the price of the contract. Dual standards are obvious: The Ministry of Defense agrees to keep sport facilities and health resorts as its assets, but denies this right of industrial enterprises working for the state.

The problems with defense procurement can cost Anatoly Serdyukov his minister office. Yes, that's right, he came to the new Russian government; however, settlement of conflict relationships between the customer and contractors is in responsibility of vice prime-minister Dmitry Rogozin. He is considered the most likely candidate for the office of the Russian Defense Minister in the near future.

Vladimir Terletsky