TITLE:                   DEFENSE INDUSTRY










NUMBER OF PAGES:         14



The Russian defense industry is undergoing changes, which
a shift from production of military to commercial goods;
the restructuring of firms into a mixture of holding companies,
joint ventures, and small spin-offs;
a shift towards integration into the world economy.
The defense budget dropped to below four percent of GDP, which
is insufficient to support more than 1700 existing defense
industry firms, 1.2 million armed forces and defend 22,000 km of
borders. Opportunities for American business lie mostly in joint
production at enterprises included in the defense conversion
program or in dual-use technologies. The following IMI is based
on the FCS and Embassy report oDiversification and Defense Trade


The Russian defense industry remains in a state of disarray.
Traditional sources of support u the defense budget and orders
from former Soviet satellites and allies u have almost
evaporated over the past 10 years, and very few new sources of
income have emerged.  Most defense plants reside in old,
deteriorated buildings and rely on obsolescent and often worn
equipment.  Defense industry pay is in arrears by up to 10
months in some cases.  When paid, it has not kept up with
inflation and many engineers and production workers have left
defense firms for small technology firms or the private sector.
Many are working in the retail sector, operate kiosks, or drive

Arms Exports

Russia currently is the world's fourth largest arms exporter,
behind the United States, Britain and France. Back in 1980's,
the Soviet Union's arms exports amounted to $20 billion a year.
In 1998, the nation's main arms trader, the Rosvooruzheniye
company, exported only $2 billion in arms. The sales primarily
focused on a new generation of Sukhoi (Su) planes, upgrades of
MiG fighters, and air defense missile complexes.

Market Prospects

The Russian economy is plagued by a serious non-payments
problem, and inefficient and decaying infrastructure, severe
environmental problems, inadequate housing, and poor quality
consumer goods.  These were compounded by the financial crisis
that developed in 1998.

As long ago as the Brezhnev era, the Russian government turned
to its defense plants for production of needed civilian
products.  During the Gorbachev era, specific defense sectors
were directed to focus on commercial sectors.  For example,
biological weapons plants were told to focus on medicines, and
enterprises of the space complex started producing sailboats,
microwaves and other consumer goods.

The Primakov government places a high priority on reviving the
defense industry and ensuring that it gets more resources.
However, the financial crisis worsened an already existing wage
arrears and tax revenue problem, and it is doubtful that the
government will have the resources to meet its obligations to
the defense plants for past years, to fund any conversion plans,
or even to place significant new orders for defense equipment.
Russian defense firms, while strong in engineering and
manufacturing, still lack expertise in marketing, management,
and financial analysis. U.S. firms could work with spin-off
enterprises of Russian defense firms to jointly produce goods
for Russian and regional markets.  Although short-term barriers
are numerous, several factors may make joint ventures attractive
in the long run.

Low Manufacturing Costs:  Russian defense enterprises operate
at lower costs than Western ones, although the recurring
problems related to non-payments throughout the economy make it
difficult to know or predict real costs.

- Pockets of superior technology and expertise:  Russian defense
plants usually appear poorly maintained and obsolete.  However,
Russian scientists developed unique approaches and capabilities
often unrecognized in the West.  In 1990, an interagency
technology assessment group identified Russian sectors with
advanced military technology, which include:

Chemical/allied products
Rubber and plastic products
Small nuclear power reactors
Industrial/commercial machinery
Electronic components
Transportation equipment
Photographic, medical, and optical instruments
Space launch and payload services
Metallurgy, primary metals
Aerospace, rocket engine design
Lasers and optics
Software design

Defense Budget Information

This year's federal budget allocates only 3.2 percent of the GDP
for defense u the lowest in the post-Soviet history of Russia.
Historically, Russia spent an estimated 20-plus percent of its
gross domestic product on defense.  In more recent years, this
figure has dipped below 4 percent of a smaller domestic
product.  Furthermore, from1993, the government began to
withhold a large part of the budgeted amount.  In 1996,
allocations for the entire year were one-third short of the
budgeted amount, while in 1997, MOD sources claimed to have
received only 55.6 percent of their budget.

Russian defense figures are easily misinterpreted and have
become less transparent with renewed concealment of the budget
in 1998.  Much defense budget money actually goes for civilian
production and social services for defense workers.  Many
defense plants and defense bases receive hidden subsidies from
regional and city governments in the form of free land,
electricity, food supplies, and other services.

In 1998, the military budget continued to shrink both in percent
of GDP and percent of overall expenditures, despite Government
statements about committing 3.5 percent GDP to military funding.
Out of the budgeted amount of 7.00 billion dollars (for three
quarters of 1998) only 4.66 billion dollars or 66.5 percent of
the budgeted amount was fulfilled.  The planned 1999
expenditure, based upon debate in the Duma, has increased from
an original figure of 2.3 percent to up to 3.2 percent of GDP.

Brief Description of Domestic Industry Structure

The Russian defense industry consists of over 1,700 firms and in
1997 employed some 2.5 million workers.  While defense
enterprises are found throughout the country, a significant
portion is concentrated in twelve cities and regions, where over
one-third of the labor force works in defense.  The industry
needs modernization and many defense enterprise managers are
eager to learn about the basics of marketing, finance, and
modern business practices.

A Russian defense plant is also, in some ways, a throw-back to a
U.S. factory-town.  The defense plant is really a mini-city in
itself, with its own apartments, doctors, clinics, restaurants,
and power plants.  Outside of Moscow and St. Petersburg, defense
plant employees usually live in company apartments, shop in
company stores, and eat in company cafeterias.  Up to 80 percent
of a defense plant's budget goes to maintaining these social
services.  The plant manager is often as concerned with making
deals to bring in potatoes and bread to feed his people as with
joint venture agreements, and these and other transactions are
often conducted on a barter-basis.

Most Russian defense enterprises would be considered bankrupt in
Western terms, and the situation has been worsened by the
financial collapse of 1998.  The Ministry of Economy reports
that 400 defense enterprises are unable to pay their debts.
Russian defense plants have lost nearly 80 percent of their
funding from the Russian government in the past ten years.
Defense orders have almost disappeared in the last two years.
At the same time, defense plants have lost export earnings due
to loss of traditional Soviet bloc markets and the general
decline in the world arms market.

Plant managers have often attempted to maintain production even
without budget authority to keep workers busy.  This has led to
an excess inventory of weapons, which plant managers try to
sell, even as the downsizing armed forces also sought to sell
off now surplus military equipment. Many defense plants have
reduced operations to only a few days per week at most.  Russian
defense industry wage increases have not kept pace with
inflation, meaning that most Russian defense enterprises have
steadily lost their best workers (estimates range from 800,000
to 1 million lost per year) to Western companies or the emerging
Russian private sector.

Restructuring the Industry

By November 1, 1997, the core of the defense industrial sector
(not counting those organizations affiliated with the Ministry
of Nuclear Energy) comprised 1,700 institutions and enterprises
employing nearly 2.5 million individuals in eight defense
related industrial sectors spread across 72 locations in Russia.

Currently, the Ministry of Science and Technology, the Ministry
of Defense, and the Ministry for the State Property are working
to identify 670 strategically important enterprises that will
form the basis of the reformed defense core by 2005. Government
priorities will be given to those industries that produce
dual-use technologies, especially in aerospace, electronics, and
communication markets. The Government intends to auction off
state-owned blocks of shares in the remaining enterprises, which
are often small and difficult to manage.

At present, the preliminary institutional break-down is as
follows: between 1999 and 2000, the share of state-owned
enterprises in the defense industrial sector will decrease from
forty to thirty percent; the share of joint stock companies with
participation of the state will increase from thirty to sixty
percent; and the share of fully private enterprises will
decrease from thirty to ten percent.

The Russian government goal has been to target limited budget
funds and Western assistance to a small number of key,
technology-rich research and design institutes.  Last year,
President Yeltsin overturned a government decision that would
have allowed unprofitable firms to go bankrupt.  Meanwhile,
Deputy Prime Minister Maslyukov has tried to act on behalf of
those in the Duma who press for government action to preserve
defense industry firms and retain government control if not
ownership of many of these "strategic enterprises."

Traditional Suppliers of Defense Equipment

Nearly all Russian defense equipment is produced by domestic
firms.  In the recent past, Russia was a part of the Soviet bloc
military-industrial complex, with interrelated units throughout
Eastern Europe and the former Soviet Union.  Today, most
supplies and equipment are produced within Russia, with limited
purchases from its former partners.  Historically, Russian
defense firms have always sought and managed to acquire Western
military and dual-use technology.  This interest can be expected
to continue, with limited commercial purchases sometimes
substituting for espionage.  The Department of Commerce, through
the Bureau of Export Administration has published several
editions of the Russian Defense Business Directory, which
provides more detailed information on major Russian defense and
aerospace firms.


Pure defense industry opportunities in Russia for U.S. firms are
very limited, even without technology transfer concerns.  The
Russian government intends to use limited defense funds to
maintain Russian defense capabilities and is unlikely to invest
in weapons systems from the West.  Some opportunities exist
through U.S. Government aid programs that help the Russian
military and government to safely dispose of nuclear, chemical,
and biological weapons and prevent proliferation of Russian
weapons technology.  There is some U.S. Government money
available to help in this effort.  Specific activities include:

- Destruction of nuclear weapons;
- Improvements in nuclear weapon security and accountability
- Safeguards against weapons proliferation.

Another potential service is education and training.  Russian
industrial managers and military leaders are anxious to learn
about the management and manufacturing methods of the West.

1. New Defense-Related Commercial Projects:

Many of the Russian Ministry of Defense's major new initiatives
are commercial, not military and might offer potential upgrade,
replacement or spare parts, maintenance, logistics, service
opportunities for military equipment converted for civilian
purposes.  Major projects within the Russian defense sector are
listed below:

- Next generation commercial airliners: Ilyushin and Tupolev are
developing a new generation of commercial airliners for NIS and
global markets.

- Merchant Marine: Russian shipyards are re-equipping the
Russian oil tanker and cargo vessel fleet.

- Telecommunications: Russian defense firms are building
equipment for a major upgrade of Russian telecommunications

- Global Navigation System: The Russian Space Agency is
overseeing the Russian work on the GLONASS global satellite
system to improve aircraft navigation across Asia.  The system,
which is run by the Strategic Rocket Forces, is a rival of the
U.S. Global Positioning System (GPS).  The Government intends to
enforce its use in new telecommunications in Russia.

- The U.S.-Russia space station: Russian aerospace firms are
working with American partners on the international space

2. New Systems Development

Under severe budgetary constraints, government defense
procurements have been drastically cut.  A further constraint
has been significant surplus of used military equipment on hand
as a result of efforts to downsize the armed services. It has
been reported publicly that in 1998 no major equipment items
were procured.  Plans for future procurements are reportedly
focused on minimal replacements of existing inventory when
needed, possible procurement of "one-of-a-kind" prototypes, and
eventual re-equipping of the services with new systems after
2005 at the earliest.  To date, the attention of the MOD remains
focused on traditional suppliers (such as MiG, Sukhoi, Mil,
Tupolev, and Kamov) for aircraft, as well as the other Russian
manufacturers of various types of ground and naval equipment.

3. Military Operations

As of 1 January 1999, the authorized peacetime strength of the
Russian Armed Forces is 1.2 million, following massive personnel
cuts and reduction of peacetime billets over the past two years.
Strength accounting is complicated by the fact that Russia
maintains several militarized formations subordinate to
non-Defense security services, such as the Ministry of Interior,
the Federal Border Guards Service, the Ministry of Emergency
Situations (EMERCOM), the Federal Security Service, the Federal
Agency of Government Communications and Information (FAPSI), the
Federal Service of Railroad Troops, and the Presidential
Security Regiment.

Russia's current economic crisis and predicted fiscal austerity
programs has put most reform projects within the Armed Forces on
hold and aggravated what was already a dismal fiscal situation
for the Armed Forces.  It was estimated that Russia's present
economy can adequately support only 550,000 servicemen out of
its present 1.2 million.

Combat training has become virtually non-financed, with the
military receiving only 6 percent of the resources required for
combat training in 1998.  Even this amount was apportioned only
for maintaining infrastructure, forcing the military to finance
fuel, ammunition, and training equipment costs from other
sources.  The Russian Armed Forces' living standards remain at
the low end of the country's socioeconomic scale.  Throughout
1998, the government remained 3-4 months' delinquent in paying
service members' wages, although many units were finally current
on pay by the end of the year.

4. Country efforts to reduce and restructure military spending

Over the past year, Minister of Defense Sergeyev has continued
to move forward with implementing reform and restructuring to
develop a force that can be manned, equipped, and sustained at a
high level of combat readiness under existing and projected
funding limits.  As a result of the military's financial
restrictions, both force modernization (acquisition and
procurement of new equipment) and plans to transition from
conscript to all-contract Armed Forces have been deferred until
well into the next decade.  The Ministry of Defense estimates
that, even if fully funded, defense orders will meet only the
most urgent requirements (foremost, in the Strategic Rocket
Forces).  Consequently, it is focusing on upgrading and
repairing the Armed Forces' current inventory to extend the life
of existing systems.

5. Identification of Key Ministries, Bid Procedures

The Russian Defense Ministry has procurement procedures similar
to the United States.  Information about procurement is becoming
more readily available, especially public tenders for food,
uniforms, etc.  With many Russian defense factories idle, the
Russian Ministry of Defense is unlikely to give major defense
contracts to non-Russian firms.  However, this may not rule out
bidders with Russian partners or participation, depending upon
the commodity.


Despite a challenging economic and political environment, the
Russian market offers a variety of trade opportunities for U.S.
firms.  Working with a Russian defense firm is one way U.S.
firms can attempt to gain toe-hold in Russian and NIS markets.
Defense firms are becoming more adept at marketing and they have
access to vast networks of suppliers and sub-contractors within
the Russian defense establishment.  Many also have political
connections and clout that can help to reduce barriers to trade
and eliminate government obstruction.

On paper, the Russian government has developed a defense
conversion plan identifying up to 14 areas for conversion
efforts.  However, the government has thus far allocated a mere
3 billion dollars to stimulate this conversion process.  In
these areas, Russian defense firms will need Western products
and technology to succeed in conversion efforts even though
mutual technology transfer concerns and issues may complicate
such contacts. Some of the most potentially fruitful areas

- Civil Aviation: Russian manufacturers need Western engines and
avionics to bring the Russian civil fleet up to world standards.

- Civil Shipbuilding: Russian shipyards need to build oil
tankers, fishing trawlers, cargo ships, and pleasure craft.

- Oil and gas industry equipment: Russian missile equipment and
tank plants are now building oil drilling pumps, excavation
equipment, air compressors, and gas liquefies.

- Housing: The Russian defense sector may begin to address
Russia's severe housing shortages through producing homes,
apartment buildings, internal equipment, and appliances.

- Consumer goods: The Russian defense sector produces nearly all
of Russia's televisions, video cassette recorders, and cameras,
plus most washing machines and vacuum cleaners.

- Medicine and Medical Equipment: Defense plants produce 80
percent of medical equipment produced in Russia.  Biological
weapon plants are now converting to produce vaccines and

Other high priority industry sectors include the following:

Food processing
Textile industry equipment
Communications and information equipment
Timber industry equipment
Pollution control equipment

1. Opportunities Arising from the Privatization

Many Russian defense enterprises recognize the need for Western
investment and partners.  The Russian government at one time
planned to privatize about three-fourths of its more than 2000
defense enterprises by the end of 1994.  About 700 of Russia's
defense enterprises have already to some degree been privatized
although the government retains a significant if not controlling
interest.  About 450, mainly research institutes and design
bureaus, will remain government-owned.  Many talented Russian
scientists and engineers are setting up spin-off companies to
market commercial applications of defense and other
technologies.  To survive as privatized firms, most Russian
defense enterprises will need Western management help,
investment, and cooperation.

2. Opportunities in Dual Use or Related Technology Fields

Telecommunications Equipment

The Russian telecommunications market suffers from a lack of
installed lines, outmoded switching equipment, and inadequate
revenues to finance investment.  As an example, only 15 percent
of the local networks' total access lines are digital.  Upgrades
of the Russian network over the next few years are estimated to
be worth around 2 billion dollars.

The current strategy of the State Committee for Communications
and Informatization (Goskomsvyaz) is construction of new digital
trunk lines, network digitalization, expanding the range of
services, introducing new management technologies, and
re-organization of the accounting and billing systems in keeping
with international standards.  Goskomsvyaz is dedicated to
bringing the telecommunications infrastructure up to
international norms, and many multinational firms are looking
for the opportunity to help in this undertaking.  The issue of
financing is critical in the implementation of existing projects
in the field of telecommunications.

According to the experience of telecommunications companies in
Russia, there are a number of issues that need to be resolved,
including legal and regulatory instability and uncertainty of
enforcement; improvement of the process of certification of
telecommunications equipment and services; improvement of
licensing procedures for provision of telecommunications'
services in Russia; improvement of availability to user of the
frequency spectrum and transparency in allocations; and legal
protection of investments in the Russian telecommunications

Medical Equipment

Because domestic medical equipment production can meet only 30
percent of total demand, imports play a significant role in the
market.  Government purchases of foreign medical equipment are
usually financed by foreign loans, foreign credit lines, and
internationally-sponsored development projects.  The Ministry of
Health no longer makes centralized purchases.  Instead, regional
health authorities, or hospitals whose funding is at least
partially provided by local companies, are the principal buyers.
Large manufacturing enterprises which opened up their hospitals
and medical units have become the most active purchasers of
medical equipment.

The most promising medical subsectors include:

diagnostic equipment;
ultrasound equipment;
electro-cardiographic equipment;
laboratory equipment;
dental equipment;
test kits.

Under the current crisis, though, the majority of buyers of
medical equipment cannot afford new and expensive high-tech
items.  After the devaluation of the ruble, they will most
likely be able to buy only small devices and disposable products
like test kits, laboratory devices, and syringes.  Many Russian
medical equipment manufacturers are interested in buying modern
manufacturing equipment to produce disposable and hygienic
products.  Distributors of medical equipment are forced to
widely use barter arrangements and clearing operations to keep
their business afloat.


With abundant highly educated manpower and natural resources,
Russia offers large-scale business opportunities in an
environment of limited competition.  This must be
counterbalanced against some negative factors that include:

High operating costs;
Weak business infrastructure, poor roads and transport;
Poor accounting and standardization in Russian firms;
Political system prone to corruption;
Undeveloped legal framework and unclear property rights.

The major political barrier is the lack of consensus within the
Russian government on the path of economic reform toward an
open, market economic system.  There are serious misconceptions
and a deep ambivalence about whether and how to attract Western
investment.  While the government is generally pro-reform, many
political and bureaucratic leaders are reluctant to assist in
what they perceive to be the selling off of their country to the
West.  Many promising Western investments are sidetracked by
long delays in government approval, sudden changes in
regulations, or unexpected charges of illegal actions on the
part of Western companies.  Russian contract, property, and
intellectual property protection laws are still undeveloped and
enforcement of existing laws is uneven.

U.S. firms generally find success by choosing their sales
targets carefully.  Because a lack of capital and poor cash flow
are typical of Russian businesses, many firms find it expedient
to rank potential customers based on their ability to pay.
Possible candidates for export sales include:

     Russian enterprises that export for hard currency;
     Development projects financed by Western sources;
     Russian enterprises with good domestic cash flow;
     Regional governments in natural resource rich areas;
     Russian federal government;
     Major modernization projects by Russian enterprises;
     General Russian consumer market; and
     Upscale (albeit narrow) "new Russian" market.

Export Controls

In the defense sector, U.S. companies must consider both Russian
and U.S. regulations.  The Russian export control system
provides for export control oversight over materials, equipment,
and technology to produce weapons, and civilian dual-use
materials and technology that can contribute to missiles,
nuclear, chemical, and other weapons of mass destruction.

The Department of State maintains a U.S. Munitions List that
identifies defense articles and services.  U.S. firms
participating in defense trade must register with the State
Department Office of Defense Trade Control, and seek approval
for the export of any items on the Munitions List.  The Commerce
Department's Bureau of Export Administration administers export
controls on dual-use technologies.  U.S. exporters are now
permitted to ship some low-level dual use goods to civilian
end-users in Russia, under a license exception, without prior
approval, but companies should check with Commerce as this list
is subject to change.

Other goods and technical data still require a license, or are
not eligible for export due to their potential use in nuclear,
biological, chemical, and other weapons.  Controlled items
include chemical weapons precursors, super computers, high-end
computers capable of over 7 billion operations per second, and
electronic equipment with potential military applications.  U.S.
exporters should consult the Bureau of Export Administration
before engaging in consultations or business transactions
involving the export of controlled commodities or technical data.

VII: U.S. Government of Points of Contact

The following is a list of useful contacts for firms interested
in the Russian market.

U.S.  Government Contacts:

U.S. and FCS Moscow
Edgar Fulton, Senior Commercial Officer
Bolshaya Molchanovka, 23/28
121069 Moscow
Tel: (095) 737-5030
Fax: (095) 737-5033

Office of the Secretary of Defense
Strategy and Threat Reduction Policy
Cooperative Threat Reduction Policy
Mark Palevitz, Action Officer
Tel: (703) 693-0289
Fax: (703) 614-4365

Useful Russian Government contacts:

Ministry of Defense
Committee for Military Technical Policy
General Major Viktor Mironov, Deputy Chief
Tel: (095) 296-6535
Fax: (095) 202-5615

Ministry of Defense
Department of Defense Industry Conversion
Dr. Gennady Kuzin, Director
Tel: (095) 292-2012
Fax: (095) 202-5615

Special Equipment Research Institute
Ministry of Internal Affairs
Viktor Andreyevich Khimichev, Director
Malaya Lubyanka Ulitsa, 16/4
10100, Moscow, Russia
Tel: (095) 222-6253
Fax: (095) 924-2714

Russian Space Agency
Yury Nikolayevich Koptev,
General Director
Tel: (095) 975-4632
Fax: (095) 288-9063
Boris Dimitriyevich Ostroumov,
Deputy General Director
Tel: (095) 971-9141

Ministry of Emergency Situations
Department of Certification of Rescue Equipment
Abay S. Maurin, Head
Tel: (095) 443-8305
Fax: (095) 449-9004

Ministry of Nuclear Energy (MinAtom)
International Nuclear Safety Center
Sergey Ye. Bugaenko, Director
Tel: (095) 263-7309
Fax: (095) 264-4010

Rosvooruzheniye company
Yevgeny Ananiev, General Director
Tel: (095) 202-4590
Fax: (095) 202-4594

Source: U. S. Department of Commerce - National Trade Data Bank, June 21, 2000