Tuesday, September 15, 2009

U.S. Arms Buyers Await Price Hikes



U.S. Arms Buyers Await Price Hikes
Sales Decline Spurs FMS Fee Increase

By William Matthews

Starting Aug. 1, foreign governments will pay a little more when they buy U.S. weapons through the Pentagon’s Foreign Military Sales (FMS) program.

The 2.5 percent fee levied on each purchase, intended to cover the cost of operating the program, will rise to 3.8 percent.

In 2005, the Pentagon sold $10.6 billion worth of arms to other countries, from aircraft parts to Argentina to trucks to Turkey. That was $2 billion less than the program sold in 2004, and therein lies the problem. Sales have been declining in recent years.

Foreign military sales fluctuate from year to year, said a spokesman with the U.S. Defense Security Cooperation Agency (DSCA). While U.S. weapon sales decreased from $13.2 billion in 2004 to $10.6 billion in 2005, they are expected to reach $12.9 billion this year, he said.

Sometimes increased sales are associated with world events. There was a spike in weapon sales after the first Persian Gulf War. But sometimes increases and decreases appear unrelated to what’s happening in the world, he said.

“Income and expenses are out of balance, necessitating a combination of reduced expenses and increased income,” the DSCA wrote in a memo this spring.

The FMS program is a government-to-government method for selling U.S. defense equipment, services and training to foreign countries. A benefit to the buyers is that they get U.S. military help in learning how to operate and maintain equipment. A benefit to the U.S. government is that friends and allies operate compatible equipment.

Another is that sales improve the U.S. trade balance. The program is required by U.S. law to recover its costs through fees on weapon sales. When sales are brisk, program fees have been lowered. In 1999, for example, the fee was reduced from 3 percent to 2.5 percent. But now sales are slackening and the fees must go up.

So far, customers have been understanding, a DSCA spokesman said.

“In March, we met with stakeholders, including international customers” and announced the rate hike, he said. “While customers are concerned about the impact on their budgets and planning, they understand the business decisions that necessitated these changes and have responded favorably.”

And in fact, not all DSCA fees are going up.

The agency has decided to eliminate a 5 percent fee levied on “non-standard items” and a 3.1 percent logistics support charge for certain sales.

The spokesman said these changes might mean the cost of some FMS purchases will drop.

The higher fees are bound to “irritate some customers,” possibly enough to convince some to buy commercially rather than through the Pentagon, said Joel Johnson, vice president for international affairs at the Teal Group consulting firm in Arlington, Va.

Bigger customers, such as the Saudis, the British and the Canadians, are likely to be more upset than the smaller ones, because 3.8 percent of a multibillion-dollar deal is a lot more than the same fee on a purchase worth a few hundred thousand dollars, Johnson said.

Johnson said part of the FMS program’s problem is that it has not shuttered offices in countries where FMS deals are dwindling, and overhead is eating earnings.

DSCA officials said they have cut the agency’s overseas staff “to the lowest in history” and further cuts are not feasible. But expenses are likely to continue to rise. DSCA warns that “aging legacy data systems will likely require major investments in the coming years.”

Foreign Reaction

Despite the rosy optimism out of DSCA, Taiwan and Israel are bracing for the changes.

In Israel, whose military is heavily dependent on FMS sales, officials said the surcharge hike is especially ill-suited because it adds costs for services rarely used.

“The FMS program offers essentially two types of deals: a standard deal for which they now take 2.5 percent; and a nonstandard deal, where the extra work required to manage non-standard items warranted a large fee of 5 percent,” an Israeli Ministry of Defense official said. “Their decision to go for a flat rate of 3.8 percent — regardless of whether the contract is standard or nonstandard — is particularly burdensome for us, since 90 percent of our FMS contracts are standard.”

The MoD official said about 60 percent of Israel’s defense purchases of U.S. equipment are made through direct contracts with the U.S. provider. Of the remaining 40 percent, which are administered through the FMS program, only 10 percent are considered non-standard and have required the higher 5 percent surcharge.

“We realize this is an across-the-board decision made from the macro-perspective,” the official said. “We also recognize and are grateful for the generous [U.S. foreign military financing] aid that allows us to enter into these contracts. But if you ask how this decision will affect us, the answer is simple: The price for entering into FMS contracts will be a lot more expensive.”

Israel receives nearly $2.5 billion each year in military aid grants, the bulk of which is managed by the DSCA, regardless of whether Israel opts for FMS contracts or direct commercial sales with U.S. firms.

Taiwan, a nation of 23 million people, has long complained about the high price of U.S. arms. Taiwan’s legislature has been entangled in an unprecedented 24-month battle over a $15 billion purchase of arms promised by the Bush administration in 2001, including eight submarines, three Patriot PAC-3 air defense batteries and 12 P-3 Orion maritime patrol aircraft. The legislature has blocked the purchase an unprecedented 56 times since June 2004.

Legislators have accused the United States of attempting to force Taiwan to purchase unwanted arms at inflated prices. To make matters worse, there is limited legislative oversight for FMS programs in Taiwan.

“FMS is supposed to eliminate corruption, but it has actually obfuscated the level of accountability in Taiwan,” said a former U.S. defense official with intimate knowledge of Taiwan’s FMS program. “The FMS is hid behind a veil of secrecy [in Taiwan], and it results in Taiwan being overcharged by hidden commissions, offsets and vague administration fees that could allow military officials to abuse the system.

“Taiwan defense officials hide behind the screen of the FMS program to make it appear they are avoiding impropriety,” the former official added. “There is no transparency in Taiwan’s FMS program. The U.S. government allows this to happen by telling Taiwan to keep everything classified. About 16 percent of Taiwan’s defense budget is classified.”

Turkey also may face problems with the FMS rate hikes, a procurement official said.

“As a general rule, we could conclude that the extra cost will have to be shared by the Turkish government and the U.S. contender. The new situation also will encourage commercial deals and discourage FMS-backed deals,” he said.

Burak Ege Bekdil, in Ankara, Riad Kahwaji in Dubai, Wendell Minnick in Taipei and Barbara Opall-Rome in Tel Aviv contributed to this report.