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ISN Security Watch July 5, 2006

Russian aviation weathering the storm

Russia's aviation military aviation industry is weathering a storm, only just, while the commercial sector is floundering and the government fails to make good on funding promises.

By Eugene Kogan

The year 2005 was a rude awakening for the Russian aviation industry. For the first time since 2000, aviation’s share of Russia’s annual US$5 billion in defense exports fell from 65 percent in 2004 to an estimated 20 percent, and unless creative solutions are found, it could continue to fall.

Despite all, certain sectors of the Russian aviation industry are weathering the storm, even managing to generate some revenue and retain and attract new workforces. These sectors include in particular major aviation companies such as Irkut Corporation, Russian Aircraft Corporation MIG (RAC MIG), Holding Sukhoi, and its associated enterprises, Mil Helicopter Plant, along with several major companies in the engine and avionics sectors.

The military aviation sector has been streamlined, and as a result, has become leaner and meaner, while the commercial aviation sector remains in disarray, non-profitable, and economically non-viable.

Russian Transport Minister Igor Levitin was quoted by Defense News in March of this year as saying that half of the 5,000 civilian aircraft being operated in Russia “are good only for spare parts.” He also said the nation had reached a point in which the crisis in the aviation sector had become "a threat to Russia's security."

When compared to the military aviation sector's accomplishments, the domestic manufacture of civilian aircraft and helicopters has been kept to a bare minimum, while government promises of funding have failed to materialize.

According to Viktor Khristenko, Russian Industry and Energy Minister, in 2005 arms sales generated between $US2 billion and $US2.5 billion in annual sales for the aviation sector, well short of the $US5-$US6 billion envisaged, Russia's Voenno-Promyshlennyi Kur'er, reported in its 2-8 November 2005 issue. According to Defense News, Khristenko also said the new holding company Russian Aerospace Corporation would see annual sales of up to $US8.5 billion by 2015. By 2013, Khristenko said, Russian Aerospace Corporation would increase delivery of civil aircraft from the current 9-12 per year to 120 per year. In addition, Khristenko said the volume of investment into the aviation industry should be about $US20 billion. He neither elaborated on where this investment would come from nor did he specify which sector, civil or military, would be the focus. Most experts agree that these growth figures are not based on reality.

The military-industrial commission headed by Deputy Prime Minister and Defense Minister Sergei Ivanov has approved a draft of a military procurement program for 2007-2015 that promises to buy more than 1,000 new aircraft. In addition, according to Ivanov, the air force’s overall acquisition budget will double for 2006 (no financial figure was disclosed) and nine aircraft will be added to the fleet.

Russian Air Force Commander General Vladimir Mikhailov claims that the fifth-generation fighter-prototype will fly in 2007. Fielding aircraft, however, in meaningful numbers before 2015 (or even later) seems highly unlikely.

As a result, statements by various Russian industry officials - among them Khristenko, Ivanov, and Russian Air Force Commander General Vladimir Mikhailov - should be taken with a pinch of salt.

In February last year, Khristenko suggested a three-tier plan to shore up funding for both civil and military funding. According to Globalsecurity.org, which quoted the Russian daily Ria Novosti, Khristenko speculated that "the aggregate initial [earnings] showing would total US$2.5 billion with the airliner-to-warplane ratio standing at 30 to 70.

In addition, input from President Vladimir Putin, commander-in-chief of the Russian armed forces, has been limited, if not extremely critical. In February 2005, Putin called his country's civilian aircraft "uncompetitive" and said "their attractiveness is falling and they do not meet international levels of comfort," Reuters reported.

Fifth-generation aircraft: national project without financial support

As far back as April 2002, a government commission chaired by Prime Minister Mikhail Kasyanov announced the selection of Aviation Military-Industrial Complex Sukhoi’s offer in the competition for Russia’s fifth-generation fighter. Since then, India has been mentioned time and again as a development partner, while another idea was to bring in aviation companies from Belarus and Ukraine. So far, none of these countries have agreed to participate in the Sukhoi project. China also has made it clear it was not interested in participating.

Sukhoi director-general Mikhail Pogosyan noted last summer that the design bureau had already spent about US$100 million of its own funds on the project. He said the government had promised to boost funding for the fifth-generation aircraft in 2006, but so far that promise has not been fulfilled.

In July last year, Pogosyan invited European companies to participate in the fighter’s development, but their response was muted to say the least, and Sukhoi officials appeared to come to terms with the harsh reality that they would have to go it alone.

So far, the Russian government’s repeated statements that the fifth-generation aircraft is “the national project and of the utmost importance” have not been substantiated.

Interestingly, RAC MIG, the company that lost the bid to develop the fifth-generation aircraft, won backing from India to develop a light fighter similar in size to the MiG-29 with a take-off weight class between 20 and 25 tonnes. In late May, India decided to join the RAC MIG team in developing the light fighter.

Export opportunities and cooperation

So far, export opportunities have cushioned the limited domestic funding for development and manufacture of aircraft and helicopters. However, during the past 18 months, Russia failed to deliver a single Su aircraft despite repeated press reports that Thailand and Venezuela were planning on purchasing Russian Sukhoi fighters. Export opportunities have declined considerably, with traditional Russian customers such as India and China no longer in a rush to buy new aircraft.

At the same time, cooperation between Sukhoi and European Aeronautic Defense and Space Company (EADS), for instance, remains rather limited due to government hurdles about exchanging sensitive information. Furthermore, the financial investments of Airbus, which is held jointly by EADS and BAE Systems, have so far been relatively modest at $US20 million annually. Even a $US70 million purchase of a 10 percent stake in Irkut Corporation is not as large as Russian government officials would like.

The interest of Boeing and EADS in Russia stems largely from a source of raw materials and extensive aerospace engineering talent. In addition, production factors are emerging as important potential pay offs. Russia is considered an increasingly attractive manufacturing site, but doing business in Russia differs in many ways from establishing supplier links in other countries, such as China or South Korea. Russia views ties with Western companies as a way to preserve its existing expertise and keep its workforce abreast of changes and innovations in the aerospace industry. As such, Western companies have been forced to adjust their operations to meet local requirements. Although the extent of cooperative projects with the West is fairly extensive, they are mainly aimed at export markets. The Russian domestic aviation market is for the time being off limits to foreign aviation companies.

EADS has told Russian officials that if all went well, they could become a full partner in the Airbus A320-family cargo conversion program, a potential business proposition valued at more than US$20 billion. Although it is certainly a staggering amount, it does not mean necessarily that Russia would become a full partner, but perhaps a junior partner and a supplier of certain components and raw materials.

There also is a major obstacle standing in the way of such a partnership. Russia’s own MS-21 project would be a competitor, so Russian aerospace industry officials and politicians will have to decide whether to support their indigenous project or cast their lot with Airbus.

Cooperation among the former republics of the Soviet Union so far has been very limited and appears unlikely to expand. This is partly because most of those countries - with the exceptions of Belarus, Georgia, Ukraine and Uzbekistan - possess no extensive aviation industry infrastructure, and partly because many have already turned away from cooperation with Russia, or are slowly doing so.

According to Russian and Western media, Moscow’s decision to consolidate the aviation industry into a single company is the name of the game. The Russian Aerospace Corporation (OAK) is the Russian cure for the industry's ailments. It appears that the merger of Airbus and EADS and the subsequent consolidation of EADS is the formula that the Russian officials wish to emulate.

However, the proposed solution would mean merging, consolidating and downsizing profitable and non-profitable companies and enterprises. However, it makes no sense to involve the latter because their low-quality, non-competitive products would need to be subsidized by the newly created company. In addition, the disparity of funding allocated to research and development in both has been and still is very high.

Furthermore, expectations that such a consolidation would lead to a substantial increase in revenues and shares in the global aviation market are based on forecasts that have little foundation in reality.

Compared with the EU, Russia is capable of holding on to both Sukhoi and Irkut-MIG design houses, though it would have to close down several manufacturing facilities. So far, government officials have been very reluctant to follow this path because of the entrenched interests and fierce resistance that would come from regional governments that benefit from those facilities.

Russia could learn a great deal from the closure and diversification of defense enterprises in the EU and US.

But the industry will continue to decline if new customers and partners are not sought and more efforts are not made to bring in new investors.

Dr. Eugene Kogan is a noted expert in the field of defense technologies. He has held a series of research fellowships at some of Europe's most renowned research institutes, including the Forschungsinstitut der Deutschen Gesellschaft fuer Auswaertige Politik; Stiftung Wissenschaft und Politik; the Swedish Defence National College; and the Swedish Defence Research Agency.


Copyright 2006, ISN, Center for Security Studies (CSS), ETH Zurich, Switzerland