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Russia’s attack on Ukraine means more military spending

AS THE TRAGIC human consequences of Russia’s invasion unfold, there is little to celebrate beyond the stoic resistance of outgunned Ukrainian forces and Western unity in facing up to the unprovoked aggressor. One side-effect of the war is a sudden and profound shift in European attitudes to defence spending. Those expectations are behind a surge…

AS THE TRAGIC human consequences of Russia’s invasion unfold, there is little to celebrate beyond the stoic resistance of outgunned Ukrainian forces and Western unity in facing up to the unprovoked aggressor. A side effect of the war is a shift in European attitudes towards defence spending. These expectations have led to a rise in market value for firms that supply weapons (see chart).

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The idiosyncratic nature of the defence industry explains why it was having a good year even before Vladimir Putin sent tanks into Russia’s smaller neighbour. Governments are the main customers of arms makers. Guaranteed sales translate into predictable revenues. Inflation protection is provided by contracts that pass on costs. This sector’s ability to withstand rising costs was a major reason for its outperformance in comparison to the stockmarket overall over the past few months.

McKinsey, a consultancy, notes that defence budgets–and so armsmakers’ revenues–are a function of threats and affordability. Investors believe that the risks will outweigh any costs when calculating the share price after the attack on Ukraine. This is why there has been a spike in share prices. Germany was the first to move, shocking pundits and causing a reversal. On February 27th it said it would spend an extra EUR100bn ($111bn) on defence in 2022, tripling its defence budget for the year. Besides this one-off investment, Germany aims to raise its annual spending from around 1.5% to 2% of GDP by 2024. A slug of the annual increase, equivalent to EUR18bn or so, will go on weapons.

The Russian threat may well encourage other laggards such as Italy, the Netherlands and Spain to meet NATO‘s guidelines for all members to spend 2% of GDP on defence. Citigroup, a bank, reckons that spending will now rise more rapidly and that 2% will become a de facto minimum across NATO. Jefferies, another bank, points out that if all NATO members meet the target, their combined defence budgets (excluding America’s giant one) will go up by 25% to a total of around $400bn a year. Outside NATO, Sweden and Finland, both within striking distance of Russia, are likely to ramp up spending, too.

Defence spending covers an array of costs such as wages and operational expenses. Kit represents between a fifth to a quarter of total spending. Jefferies reckons that procurement budgets in NATO (excluding America) could rise by 40-50% as armed forces gear up to face the Russian threat. European nations favor domestic arms manufacturers. This has led to the largest gains in share prices for European companies. That of Rheinmetall, which makes military vehicles, weapons and ammunition, surged by nearly 70% in a matter of days. Hensoldt (a manufacturer of military sensors), more than doubled the company’s market value. The large business it has with European infantries, Britain’s BAE Systems, was responsible for its 25% increase in share price. Similar advances were made by Thales of France, and Leonardo of Italy.

For once, America’s military-industrial complex has lagged behind its European equivalent. Lockheed Martin, Raytheon and L3Harris sell equipment around the world, but mostly to America’s government. Nearly two-fifths (or almost half) of global spending already goes to the Pentagon. This excludes countries like Russia and China which are not potential markets for American arms. The US military spending will not rise as fast as Europe’s. The renewed threat from Russia will endanger the plan, which was floated by Washington to limit it. Russian revanchism raises the likelihood that Congress will shovel more money to the armed forces in the

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