Funding for the Defense Industry Reforms

President Putin outlined his plan for Russia's defense reform during his annual address to the Federal Assembly of the Russian Federation on 10 May 2006. In that speech, and over the course of the next two months, Putin and Minister of Defense Sergei Ivanov enacted a series of changes to the economic and political framework of Russian that would produce added revenue to fund the overhaul of the defense sector.

One of the state's primary goals was to augment its control over the entire industry; but it also intended to make domestic investment opportunities more readily available to private and foreign investors. This would be accomplished by introducing Public Private Partnership (PPP) principles that are intended to facilitate private investment within the defense industry. This would aid the country immensely in rebuilding and reforming its industry and defense complex. In the meantime, the government prepared to allocate funding for the modernization of the armed forces from a variety of alternate sources.

In May 2006 President Putin ordered the Ministry of Economic Development and Trade to reintroduce the direct control of customs, a practice that had been disbanded in 2004. Many officials believed this would become a major channel for increasing state revenues, and it was anticipated customs and new tax regulations would comprise the principal flow of assets into the national budget during 2007-2009. The funds would not be transferred directly into the national defense budget, however. Instead, specific economic and development programs would be launched in order to reinforce and enhance the general environment in preparation for the implementation of the state defense order.

The country also altered the method in which it exported weapons and munitions, which, throughout the course of the 1990s and as of early 2007, represented a majority of the defense industry's activities. Defense Minister Ivanov announced the country had abandoned the practice of selling military hardware on credit or in exchange for promised future incentives and paybacks. In the past the Russians were quite often burned by such agreements and received little for their exports. In its place Moscow adopted the practice of prepaid agreements for future arms exports deals, a policy that guaranteed returns and dividends.

The government revealed plans associated with increasing its role in sectors of the economy associated with national resources. Some of the proposed measures included the creation of a ruble denominated commodity exchange for oil, gas, and gold. This would increase state revenues significantly according to Russian experts, who claim their companies lose $5-6 billion per year on the sale of oil from the Urals because of pricing mechanisms and commodity exchanges. The changes were expected to become fully operational in the oil industry by the start of 2007 and in the gas industry by mid-2006.

Overall the country was prepared to depend on arms sales, the creation of further vertically integrated holdings in the economy, and the establishment of ruble denominated commodity exchanges for oil, gas, and gold to serve as its main sources of defense funding.