New Focus on Arms Industry Expansion in Southeast Asia

By Reuters 14 August 2014

KUALA LUMPUR — Driven by tensions with China, Southeast Asian nations are building up their own military contractors to develop local expertise and reduce their dependence on big American and European arms suppliers.

Although countries like Indonesia, Thailand and Malaysia will not do away with big-ticket imports from giants like the Airbus Group or Lockheed Martin, they are increasing the number of domestic companies to manufacture military hardware locally. With regional military spending forecast to rise to US$40 billion in 2016, 10 percent above last year’s level, some countries are already developing their own exports.

A domestic arms industry is a long-term economic and security goal for the 10 countries in the Association of Southeast Asian Nations (Asean) whose members want to spend more on modernizing equipment, partly to bring military balance to the region. The goal has been given urgency, security analysts say, by China’s recent moves to press disputed claims in waters of the South China Sea, rich in oil and natural gas.

Asean members have stopped short of explicitly citing Beijing as a reason for beefing up military capability. At a meeting in Burma last weekend, Asean foreign ministers appealed, as they have before, for “self-restraint” in the face of heightened tensions, with no mention of China in a formal statement.

“This drive to ensure sovereignty is now at the foremost of all governments’ minds in the region,” said Jon Grevatt, the Asia-Pacific military industry analyst for IHS Jane’s. “Obviously the activity of China has raised the issue of protecting, securing territory.”

China, whose military spending topped $145 billion last year, according to American estimates, claims about nine-tenths of the South China Sea. It has alarmed Southeast Asian diplomats this year with assertive moves like planting a giant, $1 billion oil rig in waters claimed by Vietnam.

A buildup in China’s Coast Guard fleet has also allowed Beijing to expand its maritime presence without deploying warships. Some in the region have sought to counter that like-for-like: In a package that will take effect this month, Vietnam has set aside 11.5 trillion dong, or about $543 million, to be used to buy 32 Coast Guard and surveillance ships.

Southeast Asia’s military spending grew 5 percent, to $35.9 billion, in 2013, data from the Stockholm International Peace Research Institute showed, and is expected to rise to $40 billion by 2016. The region’s arms spending has more than doubled since 1992, according to the institute.

Military procurement in Southeast Asia is still dominated by government purchases of big-ticket items like jets or submarines from Western suppliers like Lockheed Martin in the United States and Airbus and ThyssenKrupp in Europe. Now, though, whether for radar or submarines, governments are tilting purchases to help them develop their own military expertise. While breaking no records in size or scope, recent deals show a growing trend toward embedding local manufacturing in procurement contracts.

In one example, Boustead Heavy Industries in Malaysia is working with the French state-controlled naval contractor DCNS on a 9 billion ringgit, or $2.8 billion, contract for six coastal combat ships for the Malaysian Navy. All will be built locally.

“We expect to achieve well over 60 percent in terms of local content and value, and see considerable transfer of technology to ourselves as well as local vendors and suppliers who we work with and cultivate,” said Ahmad Ramli Mohd Nor, the executive deputy chairman and managing director of Boustead. “Importantly, we will already have I.P. rights for the first generation of offshore patrol vessels, and this can provide a platform to tap the international market,” he added, referring to intellectual property rights.

Known as defense offset deals, these partnerships can enable countries to build up domestic industries over time. Turkey, for example, has successfully used offsets to nurture its domestic industry, whose companies now produce half the country’s military equipment.

Indonesia, which has more than doubled its military spending in the past five years, this year awarded a $164 million air defense system contract to Thales in France. A condition of the deal is that Thales must transfer radar manufacturing skills and knowledge to the state-owned Indonesian electronics company PT LEN Industri.

Similarly, Singapore said late last year it would buy two submarines from ThyssenKrupp Marine Systems in Germany, making the deal conditional on the involvement of local industry in developing combat systems. Singapore has by far the most advanced military industry in the region, as well as its being one of the world’s biggest arms importers.

The wealthy island state has sold military equipment to countries from Nigeria to Brazil since its first overseas arms sales to Malaysia in 1971. Singapore Technologies Engineering, the state’s main arms maker, generated sales of $1.89 billion in 2012 alone, according to the Stockholm research institute.

In a breakthrough, a unit of Singapore Technologies also won a contract for 330 million Singapore dollars, or $264 million at the current exchange rate, in 2008 to supply armored troop carriers to Britain—its first such sale to a major Western arms supplier—showing it could compete in the global arms arena.

Singapore “will not be constrained by lots of regulations and unrealistic expectations,” said Ron Matthews, a professor of military industry economics at Cranfield University in Britain.

Still, for now, the rise of a Southeast Asia arms industry will not deter big global players, analysts said. The region’s rising military spending makes it attractive for weapons makers at a time of tight military budgets in Europe and North America. The regional companies’ lack of advanced capability also means they are not currently competing head-on with the big players for big-ticket orders.

Instead, they can play a more complementary role, focusing on areas like ammunition, small marine vessels and maintenance. But that could change if Southeast Asian firms start to compete for orders on the global market.

“This is a near-term opportunity for global defense firms and a longer-term challenge,” said John Dowdy, a senior partner at McKinsey & Company.