Obstacles eased, yet one remains: Ukrainian defense industry confronts State Audit Service’s demand for refunds

Defense Express reported on the situation.

The controversy erupted from a State Audit Service review in July, identifying "violations" worth UAH 2.5 billion following an audit of the Ministry of Defense. The issue centers on state-owned and private arms manufacturers' profit margins (5-10%) on transferred weapons in 2022, now deemed as needing reimbursement.

The basis for this decision stems from Cabinet of Ministers Resolution No. 335 dated March 20, 2022. Drafted amidst a full-scale Russian invasion, its wording inadvertently led to disallowing the inclusion of manufacturer profits in weapon prices.

“In other words, according to the State Audit Service, Ukrainian arms manufacturers were expected to function with "zero" profit margins. However, this strategy is impractical, given the necessity for supplementary funds to expand arms production, as Poland effectively demonstrates. Poland not only secures substantial orders for its defense firms but also allocates an extra USD 3 billion to ensure their fulfillment,” Defense Express writes.

The Ukrainian Ministry of Defense deemed this formalism "absurd" and detrimental to victory. Moreover, it only applied to domestic arms manufacturers, while foreign counterparts faced no such constraints – an unconventional form of "reverse" protectionism.

Maksym Polyvianyi, the executive director of the National Association of Ukrainian Defense Industries (NAUDI), highlighted that despite the scandal, the issue remains unresolved. The Ministry of Defense is working with both the State Audit Service and arms manufacturers.

A silver lining emerges as this situation pertains exclusively to the preceding period. On November 11, 2022, the Cabinet of Ministers introduced Resolution No. 1275. This resolution overhauls defense procurement processes during martial law, addressing the matter of defense enterprises' profits, which can now extend up to 25%.

"While this problem persists for earlier contracts, new ones are unaffected. Although efforts are underway, the issue remains unresolved," noted NAUDI's executive director.

Although not an outright influx of billions, as Poland employs to boost arms production, this situation avoids further undermining domestic arms manufacturers, Defense Express assesses.

"Currently, the sole source of profit and the pathway to sustaining domestic defense enterprises is the domestic state defense order. Given that all products are exclusively directed towards our military's requirements, it is through this profit that avenues for growth, investment in production modernization, and new advancements become attainable,” said Maksym Polyvianyi.

He highlighted an overall improvement in the landscape of bureaucratic obstacles. Notably, eased control over imports of weaponry and drone components, circumventing arduous customs bureaucracy, is a welcome change.

Throughout 2022, the State Export Control Service mandated permits for drones, components, and electronic warfare equipment. On December 9, 2022, the Cabinet of Ministers eliminated a substantial portion of products from additional state control.

"The government has taken a positive stride by eliminating items from the military list that don't require international reporting from state export control. NAUDI, along with other NGOs, has been developing a draft resolution and gathering data to streamline operations, aiming to ease the challenges faced by manufacturers due to military conditions: missile rocket attacks, logistical disruptions, foreign relations issues, as well as permit and import license complexities," affirmed Maksym Polyvianyi.

Coupled with simplified testing procedures for Armed Forces sample approval, which has shrunk from years to weeks, these initiatives are truly dislodging hindrances obstructing Ukraine's defense industry, Defense Express concludes.