Poland Seeking Defence Funding “Outside the Market” [COMMENTARY]

In her interview published by Business Insider, Magdalena Rzeczkowska was outlining the budgetary plans for the year 2023. She emphasized the fact that new expenditures expected to emerge next year would be financed, to a great extent, with the use of sources beyond the state budget alone.

National defence spending would be among the tasks covered by the aforesaid financing scheme. It is expected that the defence expenditure would grow significantly as of 2023.

Noteworthy, the growth is ongoing. Following the year 2022, the defence budget has been defined as 2.2% of GDP for the current year, which translates into an amount of ca. PLN 58 bn. Next year we are expecting a budget of PLN 97 bn., ca. 3% of GDP expected next year. The actual defence spending values would be even higher.

Apart from the 3% of GDP (a part of the state budget), the expenditure would also be happening within the framework of the Armed Forces Support Fund, established via the Act on Homeland Defence. That Fund is replacing the Armed Forces Modernization Fund. It is estimated that the instrument in question could provide 30 to 40 bn. zlotys of financing, being an equivalent of even 1% of GDP.

In the interview, Rzeczkowska stressed that “out-of-the-market financing” is to come primarily from agreements signed with states with whom the equipment procurement contracts would be signed. This may include loan mechanisms developed with the governmental development banks. Issuance of state bonds is treated as a last resort.

The statements made by Rzeczkowska are interesting, as they expose how the government would be willing to finance defence expenditure. The growth scale is unprecedented. Circumstances in which the expenditure share exceeded 2% were rare. Never did the defence expenditure exceed the level of 2.5% of GDP. Now we are dealing with expenditure equivalent to ca. 4% of GDP, or more. The above translates into high financial involvement of the state, via the Armed Forces Support Fund. Realistically, the value of that involvement would largely depend on the cost that Poland would pay for handling the armed forces' modernization debts. The place where Poland finds itself in the financial markets may have an impact on the above.

The declaration made by Rzeczkowska means that Poland may want to "share" the cost and risk with the states where the armament is procured. Financing schemes as such may have a less burdening interest rate, easier to distribute along a longer timeline, as opposed to that available readily on the market. This is the usual code of conduct for development banks. The state that is also the one where the manufacturer resides may also grant a more beneficial set of financing conditions when it comes to investment in the modernization of armed forces belonging to a strategic partner. This is because the money spent would largely be rerouted to that state's economy and industry.

Not only can the Armed Forces Support Fund issue bonds, but it may also borrow money and get funding via loans. And the conditions set by the exporting nations in granting those loans may have a decisive meaning for financing (or for the conclusion of the contracts). Considering the primary defence acquisition trends in Poland, a thesis may be stated, indicating the Republic of Korea, and the US, as the states described here.

For the sake of clarity, it needs to be pointed out that Poland has signed performance contracts with ROK, worth 12 billion dollars this year (K239 Chunmoo MLRS - USD 3.55 bn., K2 gap-filler MBTs - USD 3.43 bn., K9A1 howitzers - USD 2.4 bn., FA-50PL/FA-50 jets - USD 3 bn.). Another large export deal was signed with the US - regarding the M1A2 SEPv3 Abrams main battle tanks, worth USD 4.74 bn. This is an absolute military procurement record. However, the plans for the upcoming year are even more significant. The queue also includes M1A1SA main battle tanks and a giant ammunition package, the second phase of the Wisła programme (at least several billion dollars), Apache helicopters (more than USD 10 bn., if the full scope of procurement is pursued), HIMARS launcher contract, but also the agreements signed with the Republic of Korea, regarding 820 K2PL main battle tanks, and 460 K9PL howitzers.

All of the above means that if the assumptions made by the Polish Ministry of Defence, regarding the contracting processes, throughout the year 2023 contracts worth more than USD 50 bn. may be signed with the US and South Korean industries alone. The South Korean companies work with the Polish defence industry within the framework of consortia, during the second stage of implementation of the performance contracts, for instance in the K2PL programme. And the aforesaid estimates are cautious, to say the least.

This means that the scale of challenges ahead is huge, both when it comes to defence procurement alone, and also in the financial dimension. It is not a surprise then, that the state is seeking instruments that would make it possible to distribute the procurement costs in time, working with the states responsible for manufacturing the procured equipment.

The use of such measures is by no means a novelty, as a similar scheme was adopted for the procurement of the F-16 jets. Back then, half of the programme's value (USD 1.83 bn. out of the whole amount - USD 3.25 bn.) was financed with the so-called B-vouchers. These were ultimately paid for and settled in 2015, 7 years after the delivery of the last of the F-16s. However, the scope of financing needed by Poland now is exponentially more expansive (10-fold). On the other hand, the Polish economy is doing much better than during the period when the F-16s were being procured.

The shape of the programme aimed at accelerating the growth of the Polish Armed Forces would depend on a multitude of factors, financing and state economy foundations beneath that financing included. This is the context in which statements made by the PM should be placed. Morawiecki indicated that there is a necessity to agree with the EU organs when it comes to the State Recovery Plan (KPO - Krajowy Program Odbudowy) - to boost the loan credibility of Poland. This would make the modernization of the Armed Forces smoother, or maybe even allow for financing of some armament procurement via a scheme of low-interest loans within the KPO framework.

Currently one could wish that the programme aimed at the expansion of the capabilities of the Polish Armed Forces was balanced, between needs, and the demographic and financial capacity of the state. All loans need to be paid back someday. Another matter pertains to the involvement of the Polish defence industry in the process. Considering the 3-4 decades-long lifecycles, this plays a relevant part in keeping the equipment usable on the battlefield.

No doubt, however - Poland, given the current political circumstances, needs decisive action aimed at reinforcing the defence potential, also via large-scale, quick defence procurement programmes, to get ready to act with all of the security challenges around, and also to cover the backlog of all governments since 1989. Cooperation with the states manufacturing the armament, within the scope of financing, may be useful here.