Global defence spending falls, even as commercial aircraft production zooms

A breakdown of the world's top 50 defence spenders (courtesy DTTL)

By Ajai Shukla

Business Standard, 4th Jan 14

Early growth projections for 2014 in the keenly-watched aerospace and defence sector forecast a continuation of the trend of the past two years --- record profits in the commercial aerospace sector, alongside continuing decline in global defence spending.

A report from Deloitte, Touche Tomhatsu Ltd (hereafter Deloitte), entitled “2014 Global Aerospace and Defense Outlook”, projects that commercial airliner production will set a new record this year, as airlines replenish obsolete fleets with new, fuel-efficient aircraft, especially in the Middle East and Asia Pacific.

Meanwhile, revenue and earnings in the defence sector will face further decline as traditional high spenders, America and Europe, trim defence spending at the end of the Afghanistan conflict. Global defence spending fell 1.9 per cent in 2011, 1.3 per cent in 2012 and the 2013 fall will be about 2.5 per cent.

Leading this decline is United States, which accounts for 40 per cent of global defence spending. On March 1, 2013, the US Budget Control Act sequestration took effect, lopping $37 billion off US defence spending last year. For the next nine years, sequestration will trim $52 billion annually from Washington’s defence budget. US defence companies will be hardest hit, with the 20 largest contractors experiencing a revenue decline of 3.3 percent in 2012 and a similar figure expected for 2013.

“For the overall global aerospace and defense (A&D) industry, revenue growth in the 5 per cent range is expected for 2014. This would be similar to the growth experienced in 2012, and likely in 2013, all of it and more due to the rising fortunes of the commercial aerospace sector”, predicts the report.

Commercial aircraft production presents a rosy picture, says Deloitte. Annual production of airliners, which rose from 858 in 2008 to 1,267 last year, will reach 1,724 deliveries annually by 2032. Over the next 20 years, 29,000-34,000 commercial airliners will be built, with at least one more manufacturer joining the traditional duopoly of Boeing and Airbus, says the report.

A key question for the defence industry is: what will be the effect of America’s “pivot to Asia” from land wars like Iraq and Afghanistan? Deloitte identifies the new US challenge as: “conduct(ing) operations over a vast area of the globe without direct access to land bases and airfields, a large part of it over the Pacific Ocean.” These shifts from land power to “air-sea power”, forecasts the report, will change the defence industry focus to “aircraft carriers, littoral combat ships, and long-endurance unmanned aerial vehicles equipped with sophisticated cameras and sensors.”

The report recommends that the defence industry should focus on affordability, rather than the expensive cutting edge. It quotes former US Defence Secretary Robert Gates, who said, “We cannot afford exquisite solutions anymore when 80 per cent functionality at 20 per cent of the cost may be good enough.”

The report notes that India, along with China, Russia, South Korea, Brazil and Japan, continues to increase defence spending. While the Defence Procurement Procedure of 2013 is acknowledged as an “impetus to indigenization”, Deloitte notes that international defence vendors remain unwilling to share technology with India, or transfer operations here. The reasons: a foreign direct investment (FDI) cap of just 26 per cent; unfriendly tax policies; bureaucratic red tape; and lack of clarity on offset requirements.