Ukraine's weapon production plans face problematic hurdles

On Thursday, May 4, the Cabinet of Ministers finally published a resolution on the establishment of the Ukrainian Defense Industry joint-stock company to replace the state-owned defense concern Ukroboronprom.

"This is not merely a change of sign. This is a reform that has been in the works for a long time, even before Russia's great invasion," Prime Minister Denys Shmyhal said on March 21, reporting on the reorganization of Ukroboronprom into the Ukrainian Defense Industry JSC.

More than a month has passed, and even the signage change mentioned by the Prime Minister has not happened: even the resolution on the reform of the concern has only just appeared on the government portal, so the reform has once again been stalled. 

As LIGA.net has learned, the decision is not due to wartime peculiarities or technical problems, but to a different vision of Ukroboronprom's tasks by the minister in charge, Alexander Kamyshin.

"Kamyshin is the senior supervisor in this area, he has a political mandate from the president," the leadership of the Servant of the People faction told LIGA.net.

LIGA.net looked into what awaits Ukroboronprom. 

RESOLUTION MISSING

On March 21, a few hours before the government meeting, the parliament appointed Alexander Kamyshin as the new Minister for Strategic Industries. Reforming Ukroboronprom to provide the Armed Forces with weapons is one of the key tasks in his new position.

It was Kamyshin, who probably hadn't even seen his own office yet, who presented the draft resolution on the reorganization of Ukroboronprom. However, during his speech in parliament before his appointment, he did not even mention the corporatization of Ukroboronprom among his priorities.

"Kamyshin put [the resolution] on hold for a bit to get his head round it," David Arakhamia, head of the Servant of the People faction in the Rada and a former member of Ukroboronprom's supervisory board, tells LIGA.net. "It's unlikely that there will be any major changes. It's too late to make them, because there is a law according to which we are moving."

The law on the corporatization of Ukroboronprom was adopted in July 2021 and stipulates that the joint-stock company will become the successor to the state concern from the date of state registration.

To do this, the resolution agreed with all beneficiaries must be certified by the Ministry of Justice. Until this happens, it is too early to talk about the de facto start of Ukroboronprom reform, Hlib Kanievskyy, head of the StateWatch expert organization, tells LIGA.net.

The Ministry of Strategic Industries seems to have a different opinion. Two government sources told LIGA.net that the resolution was still pending approval by Kamyshin's department, and it is not known when it will be returned.

But the reform law was passed almost two years ago. The Defense Committee of the Verkhovna Rada raised the issue of reorganizing Ukroboronprom back in May-June 2022, Committee Chairman Oleksandr Zavitnevych (Servant of the People faction) told LIGA.net. So why has the resolution on the actual start of the reform been adopted only now?

"Not only Kamyshin, but also all his predecessors had their own vision of the future of Ukroboronprom. Back in 2021, Ukroboronprom CEO Yuriy Husiev mentioned in an interview with LIGA.net that he had "discrepancies" about the document with the first minister in charge, Oleh Uruskyi.

"After the full-scale invasion, Ukroboronprom was repairing armored vehicles from morning to night. What corporatization?" a government source explains to LIGA.net, "And [Pavlo] Ryabikin (Kamyshin's predecessor as minister – ed.) was not particularly interested [in the reform].

Under Ryabikin, State Secretary Olena Spirina was responsible for the reform at the Ministry of Strategic Industries, says a government source: "This is a clear sign of disinterest in the reform."

The parliamentary committee on economic development even joked that they had forgotten what Minister Pavlo Ryabikin looked like, since he had hardly reported to the Verkhovna Rada.

Defense Committee Chairman Zavitnevych denies the allegations about Ryabikin's attitude and assures that he did contribute to the reform: "In May [2022], Ukroboronprom prepared everything, and the Ministry of Strategic Industries submitted documents to the Cabinet of Ministers. There were several submissions, and they kept coming back, because they had to get approval from all the ministries. Of course, we would like it to be faster."

LIGA.net asked Kamyshin about his position on the reform of Ukroboronprom and plans to improve the efficiency of the defense concern's enterprises, in particular, about the option of direct subordination to the ministry. At the time of publication, we had not received a response. We will add it as soon as we receive it.

WHY REFORM IS NEEDED

The government made its first commitments to introduce corporate governance in the defense sector back in the 1990s. Today, it is part of Ukraine's international commitments, in particular, to join the European Union. 

The main goal of the reform is to transform the state concern Ukroboronprom into a joint-stock company, which, like Ukrzaliznytsia or Naftogaz, will be managed by a supervisory board. The newly created companies will be able to raise direct investments, including foreign ones, to manufacture modern weapons and military equipment.

The full-scale war has put the state concern at an extreme disadvantage, Kanievskyy explains. "On the one hand, Ukroboronprom is overburdened with inefficient enterprises and excess property. On the other hand, it lacks the funds to increase production of what the Armed Forces currently need. Exports, which used to bring in the lion's share of revenue, are now banned, and the Defense Ministry wants to buy weapons and ammunition "as if in a supermarket," not a year after the funds were allocated, Minister Oleksii Reznikov explained in an interview. 

As a result, it is easier for the Ministry of Defense to buy imported ammunition in wartime than to invest in the development of Ukrainian production of the same ammunition, Kanievskyy says. And this carries its own risks.

"If we stop receiving equipment and do not have our own production, we will depend on the political will of our [foreign] partners," Roman Bondar, Deputy Director General of Ukroboronprom in 2019-2021, explains the risks to LIGA.net. Not to mention the loss of jobs and part of GDP.

Instead, now is a good time to attract funds from international players to Ukraine's defense sector, Zavitnevych believes.

Ukroboronprom enterprises are actively involved in the repair of Western equipment. "This is step one, which precedes production," Bondar explains. 

But it is impossible to move on to steps two and three without reform, Olena Tregub, secretary general of the Independent Defense Anti-Corruption Commission (NAKO), tells LIGA.net. "Ukroboronprom should quickly launch a transformation to become a Western transparent structure and try to attract Western investment funds and, possibly, aid funds from NATO countries," she says.

Tregub explains that the legal form of a "state concern," a kind of hybrid between a ministry and a company, does not exist in countries that are ready to invest in Ukraine's defense industry. Therefore, this format is incomprehensible to them. 

As soon as the concern becomes a joint-stock company, this will be possible. The transformation will give Ukroboronprom "opportunities, levers and tools that private companies have," which are mostly many times more effective, Zavitnevych told LIGA.net: "The only difference is that the owner will not be a private company, but the state represented by the Cabinet of Ministers." 

POINT ZERO

The Cabinet of Ministers' resolution on the transformation of Ukroboronprom is "not some kind of feat," LIGA.net's source at the concern stresses.

"This is part of a long process, point zero, from which we are just starting the reform of the concern. And we will do it for at least three more years at best. To fully reform, it is necessary to form a supervisory board, a risk management system, a compliance system, and undergo international audits," the concern's press service says.

But it seems that the Ministry of Strategic Industries is not ready to wait that long. "No one asks about the legal structure of Ukroboronprom. Everyone is interested in efficiency, how much and what is produced," a government source explains to LIGA.net. According to him, no one was equally concerned about the completion of the reform of Ukrzaliznytsia, because during the great war the company "fulfilled all state functions."

It is because of Kamyshin's success at Ukrzaliznytsia that President Volodymyr Zelenskyy trusts him and believes that as a minister he will be able to achieve the results the country needs in the war, one of the top officials in the President’s Office tells LIGA.net.

The new minister will not be able to radically reverse the reform of Ukroboronprom, as this would require amendments to the law through the Rada. The only way to do that is to "creatively rethink it," Tregub believes.

This is theoretically possible only by incorporating Ukrainian know-how called "handbrake," Tregub says. That is, by transferring the company's key production of equipment and ammunition to hands-on management.

Two of LIGA.net's sources admit that for greater "efficiency" a number of the concern's enterprises may indeed be subordinated directly to the ministry.

A government source recalls that in March 2022, the Cabinet of Ministers transferred three special export companies from the concern to the Ministry of Defense: "Nothing prevents us from directly subordinating other companies."

Will this increase production capacity or make it easier to manage? Bondar is convinced that it will not. "The state, with state salaries, simply does not have enough professionals to manage complex production cycles," he argues. 

The president's team is generally convinced that government decisions are not a prerequisite for Kamyshin to show the necessary results.

As things stand, the government has no clear answer as to what to do with Ukroboronprom: Kamyshin has been given time to figure it out, and international partners are not putting pressure yet, three sources in the Defense Ministry and the government told LIGA.net.

"I can't say that any decision has been made," one of the senior representatives of the President’s Office admits to LIGA.net, "but everything will be done to make [Ukroboronprom] more efficient.

While the government is looking for alternative scenarios, Ukroboronprom is running out of money, Ukraine is falling in the ranking of arms manufacturers, and is essentially at a standstill, Tregub warns. Without reform, the defense industry infrastructure is being destroyed and property is being devalued.

"We may come to a point where there is almost nothing left," she concludes. "The longer this decline continues, the harder it will be for us to attract investors and create joint ventures with NATO states.