JP/6/ANDI

JP/6/ANDI

Defense Procurement and Military-Related Debt

Andi Widjajanto
Jakarta

Weapons systems procurement should be driven by military
strategies developed by the defense ministry to respond to
current and potential threats. Defense procurement should also be
confirmed by the finance ministry in order to make sure that
military spending is legitimate.

The main questions for strategic planners and acquisition
officers to decide on weapons procurement are: What and how much
should we buy? How should the ministry buy it? From whom should
we buy? Should we develop more a reliable defense industry and
buy our equipment from domestic sources? Even when guided by an
official strategy (e.g., the National Defense Strategy or Force
Development Program (Probangkuat)), forecasting defense
procurement is no longer a simple linear process from threat
(demand) to equipment (supply), but a more dynamic, interactive
process that cannot be captured by a simple method.

Defense contractors take into account both the new weapons
systems that recently have been made available on the
international market and the cost of obtaining those systems. The
acquisition officers in Asrena (Planning Assistant) or Asrenum
(General planning assistant) office take these signals into
account in drawing up long-term plans and mid-term military
expenditure framework.

However, the internationalization of the defense industry as
well as liberalized defense exports can easily alter the defense
requirements. To complicate matters, defense acquisition is
closely scrutinized because many stakeholders have a valid
interest in ensuring that acquisition preferences are made
correctly. Such stakeholders include the defense contractors who
hope to make a handsome profit and maintain access to the
ministry's procurement system; the armed services that engage in
inter-service rivalry to decide which system should be made the
highest priority; and the Ministry of Finance which must find
suitable foreign loans to fund the procurement.

Importing military equipment that is financed via foreign
loans increases the economic burden on the country. By taking out
a foreign loan, a debt is incurred, for which interest payments
must be made and amortization paid. For the purpose of arms
imports, Indonesia uses the Credit Export Facility (CEF). The CEF
is a loan with medium requirements provided by industrialized
countries to finance their exports.

The problem with the CEF lies primarily on its interest, which
is relatively high, its grace period that is relatively short and
its premium charge. At present, the Credit Export Institution --
which provides a rating to debtor countries based on the analysis
on its risk in trading and investment -- views Indonesia as a
high-risk country in that respect.

In terms of the purchase of weapons, export loans are given to
the military industry by the country from whence the weapons are
produced. In 2002, the government provided the CEF for weapons
systems procurement of Rp. 1.44 trillion.

In 2002-2003 a 44.94 percent increased occurred in 2002-2003
in the credit export for defense procurement. In 2003, the
government provided export loans amounting to Rp 3.36 trillion
(approximately US$353 million) to be used for defense
acquisitions.

It is difficult to make an assessment of the size of the
military-related debt. The official debt statistics do not
provide any indication as to how much of the total debt was
incurred for the purpose of arms imports. However, we can make
estimates based on rough assumptions of the allocation of Credit
Export since 2000.

Directorate for Bilateral Foreign Financing of National
Planning Development Agency (BAPPENAS) stated that from 2000-
2004, the amount of foreign debts of the government in the form
of credit export was more that 20 percent of all the debt stock
of the government. Since all the approved allocations for credit
export issued by the government from 2000-2004 were mostly
allotted to the defense and security sector, the military-related
debt consumed 15 percent to 20 percent of all foreign debt in the
form of credit export.

Arms imports can be used to estimate what percentages of
capital expenditure are spent domestically and abroad. For
Indonesia, since we are not substituting domestically produced
arms for imported ones, the consequences are threefold:

First, we spent a higher proportion of our military
expenditures on arms imports; second, we lose a relatively larger
amount of scarce foreign exchange; and third, we give up a
significant amount of foreign exchange earned through exports for
the arms imports.

One policy alternative to reduce our dependency on such
imports is by developing an advanced and genuine military
industry. The measure is to incrementally increase the percentage
of total defense-sector research and development (R&D)
expenditure allocated for the materiel industry. The capital
expenditures for such an industry are of particular interest.

They signify the portion of overall defense-related spending
that is invented domestically. The Ministry of Defense currently
spends less than 1 percent of its military spending for R&D, this
figure should be gradually increased and hopefully by 2009, the
ministry will spend at least 7 percent on R&D, and eventually by
2015, 15-20 percent of defense expenditure will be allocated to
build a more advanced, domestic arms-producing industry.

A good portion of these invested resources is expected to stay
within the domestic economy rather than being sent abroad as
foreign exchange payments for arms imports. Theoretically, the
capital expenditures in the military industry will interact with
other sectors in the economy and function as an accelerator that
will have multiplier effects on other sectors. The indigenous
arms industry can even be deliberately planned is such a way so
as to fulfill dual-production purposes (military and civilian) so
that capacity-utilization functions in our national economy can
be taken up in either direction.

In order to mitigate the negative effect of arms imports, the
financial management of the ministry's procurement budget must
ensure that the future of defense procurement is consistent and
well-synchronized with the strategic plan to develop our defense
industry. Since the advancement of this industry will not be
achieved instantly, the ministry must focus on at least a mid-
term solution (5-10 years) and budgeting system that will enable
the ministry to forecast their modernization trajectory as well
as to develop domestic arms-production facilities.

The writer is a lecturer at the School of Social and Political
Sciences at the University of Indonesia. He can be reached at
andi_widjajanto@yahoo.com.