Defence in firing line as Europe begins budget cuts

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For European policymakers desperate to cut spending, the defence budget looks an appealing option. But military chiefs and arms firms will lobby hard, arguing that jobs and geopolitical clout are on the line.

In the early going of the financial crisis, defence budgets were under little pressure and indeed were often seen as part of a wider economic stimulus effort. But with the focus shifting to austerity and rebalancing books, that dynamic will change.
“In the short term, defence is an obvious area to cut,” said Jonathan Wood, global issues analyst for the London-based consultancy Control Risks. “It doesn’t have the same political dangers as cutting social spending.”

Britain’s new government is already pushing through a comprehensive defence review, making it clear that military budgets will come under particular pressure. Other European governments have frozen key decisions, reports Reuters.

Across the continent, the main choice will be whether to scale back or axe major projects — warships, aircraft, and new vehicles — or cut manpower including sometimes bloated conscript or formerly conscript armies.
“My worry is that they do precisely the wrong thing and keep the numbers while cutting the kit we really need, particularly heavy airlift and helicopters,” said Giles Merritt, director of Security and Defence Agenda, a Brussels-based think tank.

That could hit the value of firms such as BAE Systems, Finmeccanica and EADS.
“Valuations for European defence stocks continue to look attractive, (but) this alone will not be enough to drive these stocks upwards,” wrote Morgan Stanley analysts. “Near-term news flow around European defence budgets is likely to be negative.”

But the companies are fighting back.

THREATS OVER JOBS
“At worst, firms like BAE can threaten that they might move their domicile somewhere else — and you know what that would mean for jobs,” said defence analyst and former lobbyist Robin Ashby.

That may mean which projects survive could depend as much on domestic electoral politics as strategic need.

For example, Britain’s junior coalition partner Liberal Democrats are generally cautious on defence spending but enthusiastic about it in their keystone south western constituencies.

Policymakers are also hamstrung by the costs of cancelling pre-committed projects. Short-term costs — payroll, fuel — are easier to cut, but risk leaving costly equipment unused and wasted.

Immediate commitments such as Afghanistan also make it politically dangerous to be seen as cutting support for troops.
“Short-term projects aimed at keeping soldiers safe will get priority,” said Alastair Newton, once a diplomat and civil servant responsible for spending cuts and now a political analyst for Nomura. “Other projects will be more vulnerable. There will be a lot of swapping between budgets.”

Britain’s Foreign Office and Ministry of Defence would particularly look at how they could use funding from the Department for International Development (DFID) that looks to have been ring fenced, he said.

On one level, analysts perceive a drive to high-tech new solutions: drones, satellites, robots and cyber warfare. But powerful vested interests protect the status quo.

Most analysts agree there are multiple savings that could be made. Britain’s Parachute Regiment and Royal Marines could be combined into one elite unit, for example, Ashby suggests. All three services — army, navy, air force — could even be merged into one.

HITTING EUROPE’S CLOUT

But virtually no one expects defence chief to back that idea since they are desperate to protect their key jets, ships and regiments. “They are not only protecting their services, they are protecting career structures,” says former lobbyist Ashby.

A nascent protectionism — at least in the short term — means few expect any drive to set up new multinational projects as governments hunker down to try to protect domestic industry.
“I think it will get worse before it gets better,” said former European Defence Agency chief Nick Witney, now a senior policy fellow at the European Council on Foreign Relations.
“I think after 18 months or so… the logic of pooling effort and resources will reassert itself, I hope.”

That could see France and Britain, the two military powerhouses of the European continent, come together with projects on tanker aircraft.

In the meantime, which projects live or die might also heavily depend on what stage they are at. The A400M cargo aircraft is regarded as sufficiently advanced to be relatively safe, Witney says, while the chances of funding a helicopter program — still at a much earlier stage — are more remote.

Europe might be finding making defence cuts is tough, but the United States — by far the world’s biggest defence spender — is expected to struggle even more as it starts to look at its own military budget as operations in Afghanistan wind down.
“The military-industrial lobby… is much more entrenched in the American political system than in the European so it’s less likely to see as serious a hit,” said Ian Bremmer, president of political risk consultancy Eurasia Group.

That means Europe will be cutting defence spending faster than anywhere else at a time when emerging powers — particularly China and India — are building.

Some argue that short-term policy-making could further reduce the continent’s dwindling global clout.
“This is part of a much larger story,” said Nomura’s Newton. “It’s been a bad year for Europe. They were more or less sidelined in the Copenhagen climate talks and the euro zone crisis has really undermined them. This will play into that.”

Following are some of the military projects that could be affected, defence analysts say:

BRITAIN

The Ministry of Defence says all hardware programmes are under review as part of an effort to reduce its 36.9 billion pound ($56.7 billion) budget by what analysts say could be up to 15 percent,reports Reuters. Programmes under scrutiny include:
— Eurofighter Typhoon combat jets, made by Britain’s BAE Systems together with Italy’s Finmeccanica and European aerospace group EADS.

Britain has ordered 160 of the 70-million-pound planes, but analysts say it may scrap plans to buy an additional 48.
— Britain has already cut its order for the delayed and over-budget EADS-built A400M transport plane to 22 from an original 25. The project will be part of its defence review, but most analysts believe the bulk of orders will be maintained as Britain urgently needs to update its costly and ageing transport fleet to support overseas operations.
— Orders for Lockheed Martin Corp’s F-35 Joint Strike Fighter could be vulnerable. British firms involved in its development include BAE and Rolls Royce.
— Britain could opt to have just one new aircraft carrier, instead of the planned two, in a project involving BAE, Babcock International and Thales. However, contracts have already been placed for 40 percent of the cost of the equipment and materials needed for the ships.

Another option would be to reduce the number of Joint Strike Fighters for the carriers.

Some analysts say that in a radical shift, Britain might opt to buy cheaper French Rafale fighters built by Dassault, perhaps as part of a deal with France on a British air-to-air refueling project. However, the Rafale competes fiercely with Eurofighter. Another alternative to the JSF would be an upgrade of Britain’s Harrier fleet.

Analysts say the Netherlands, Italy and Norway will also look at trimming Joint Strike Fighter orders.
— The British government could opt to reduce its nuclear-armed Trident submarine fleet to three from four, or to extend the life of the current fleet.
— Britain will also have to decide whether to order more armoured vehicles from General Dynamics, after signing a 500-million-pound contract for an initial tranche.

GERMANY

The German Defence Ministry is looking to save up to 9.3 billion euros ($11.9 billion) on procurement projects when it finalises defence cuts this autumn.
— A preliminary report has recommended big cuts in orders for the NH90 transport helicopter and the Tiger combat helicopter manufactured by EADS. Germany has complained about delays and performance problems with both helicopters.
— Germany may also abandon the purchase of the last partial tranche of 37 Eurofighters or resell the planes, and abandon the purchase of the Franco-German-Spanish Talarion EADS drone.

The military is considering reducing its order of 60 A400M planes to 53, negotiators say. However, this and the British cut to 22 planes are designed as mechanisms to fund an agreed price increase in the seven-country plane without putting up new money, and neither move would result in actual cash savings.

Germany may go along with recommendations to stick to plans to buy the MEADS missile defence system as a successor to its Patriot system. Consortium members are Lockheed Martin and EADS, BAE Systems and Finmeccanica.

FRANCE, ITALY

The two countries have decided to buy fewer Fremm Multipurpose Frigates designed by DCNS/Armaris and Fincantieri.

Builders are French state-controlled shipyard DCNS, which is one-quarter owned by defence electronics group Thales and in Italy by Orizzonte Sistemi Navali, a joint venture of shipbuilder Fincantieri and Finmeccanica.

According to a source close to the issue, France plans 3.5 billion euros of savings on its defence budget in 2011-2013. However, the source said the cuts would not affect large contracts or those involving Rafale planes, Fremm frigates, VBCI armoured vehicles, Barracuda submarines, Felin infantry combat systems or France’s programme for the A400M.

NATO

Doubts have been raised about the future of NATO’s biggest joint procurement scheme, the 1.3-billion-euro Alliance Ground Surveillance drone project, after Denmark became the latest of several countries to pull out.



U.S. firm Northrop Grumman ISS International (NOC.N) is the main contractor for the 14-nation project, with the German arm of EADS, Italy’s Galileo Avionica — a unit of Finmeccanica — and the Canadian arm of General Dynamics also involved.