Italian defence spending will continue to stagnate in the near-term, prompting important questions surrounding ongoing procurement programmes. However, industry players will also have new opportunities to shape government demand as Italy faces evolving security threats.
New budget documents have revealed that Italy’s defence procurement spending will drop moderately in 2016.
Renzi’s administration has strived to move past the latest economic recession with a combination of fiscal relief and public spending cuts, while focusing on other legislative issues such as electoral reform. From a top line perspective, defence has become the latest target of these cuts, despite major programmes being underway.
Significantly, the documents have been published shortly before last week’s NATO summit in Warsaw, which took place at a time when the organisation is struggling to ensure its European members maintain prescribed spending levels.
Yet, NATO pressure – paralleled by an evolving threat environment in North Africa and funding requirements posed by existing programmes – has not stopped Renzi from revisiting budgetary resources allocated to platform procurement.
Procurement spending will witness a 3 percent drop to €4.72 billion in the ongoing fiscal year, which may partially threaten the successful and timely execution of key programmes. However, the allocation of existing resources to new initiatives could set the stage for longer-term industrial opportunities, taking place in an evolving European landscape.
A threat to existing commitments?
Italy’s decision to cut its initial F-35 order from 131 to 90 aircraft is driving a sizeable portion of the fall in spending, with MoD documents claiming that over €1 billion will be saved between 2016 and 2019 on the programme. At this moment, it is unclear whether these savings will be the result of the platform number reduction or other changes.
Interestingly, the move came following extensive parliamentary debates out of a proposal of Renzi’s very own Democratic Party (PD), which has been recently divided in its support for its leader.
Renzi has placed a significant amount of political capital into the establishment of a constitutional referendum that will take place in October. As a result, the PM has been more open than ever to accept what are perceived to be secondary requests – like calls by his party’s base to cut defence spending – at the benefit of major political objectives.
Land vehicle programmes will be the ones taking the biggest hit in the near-term. Italy is planning to build a second brigade of Freccia vehicles, which will require at least €2.5 billion. Only €21 million were provided this year, raising concerns over the acquisition’s timeline. Similarly, funding for the Centauro II tank procurement is firm at under €10 million, well below the estimated €160 million required.
While the government has repeatedly stated its long-term commitment to the vehicles, the slowdown may create some uncertainties regarding ground platform procurement over the next years. The delay may potentially cause concerns among the leading platform and subsystem manufacturers, Iveco and Oto Melara, as they see some of their expected revenue slide to the out years.
New initiatives signal new priorities
What is arguably the most significant shift away from original priorities is the insertion of an additional €235 million in the new budget to tackle emerging terrorist threats. The move partially explains the delays to ground platform procurements and was not a surprise given Renzi’s remarks last fall about the Paris attacks and the need for preventive action.
The specific way in which the funds will be allocated is unclear. European Commission President Juncker has already established that terrorism-related expenses will not be considered part of the Stability Pact. This will grant Italy a higher level of independence in setting its own specific priorities.
At the same time, the rise of post-Brexit speculations about increased EU-wide cooperation on defence and intelligence suggests that a concerted effort of some sort will have to take place.
Similarly to intelligence solutions, Italy has committed to cooperating with France on the development of the MBDA-designed Aster missile, which will be a contribution to NATO’s programme for a common anti-ballistic shield.
The new budget also supports a variety of subsystem-level initiatives. On the maritime front, the Italian Navy is considering the procurement of new software technologies to augment platform and combat management systems, which would be installed on ships currently in design and construction phases.
Overall, it seems that Renzi’s budget was engineered in a way that prioritizes services, subsystems, and weapons procurements over major platform acquisitions. Renzi and Defence Minister Pinotti are thus able to cut top line spending, establish new priorities in compliance with EU efforts, while still formally standing by existing programmes.
What lies ahead
Going forward, there are very few realistic political scenarios that would see Italy significantly strengthening its defence spending posture in the near-term. If Renzi manages to survive the October constitutional referendum, he will likely continue to remain more intransigent on domestic political and economic issues compared to military expenditures, especially when facing opposition within his party.
If an early election is called, Italy’s anti-establishment Five Star Movement party is predicted to perform well against the centre-left-led coalition, which may lead to a new administration that would work to cut defence spending further, starting with top programmes.
From an industrial perspective, Italian capabilities will continue to be prioritized, if available, over foreign alternatives, especially at a time when unemployment remains well above pre-recession levels. Yet, room for international participation will continue to exist, particularly for contractors offering innovative products.
Major international ICT companies like IBM have recently fared well as subcontractors to larger defence and public sector tech providers. Similarly, major Unmanned Aerial Vehicle players like General Atomics have developed strong customer ties with the Italian Air Force, targeting Italy’s rising demand for UAV solutions.
On the domestic front, the slowdown in the procurement of ground vehicles may make Leonardo nervous, given its ownership of Oto Melara. However, it is unlikely that any additional drastic change in Italy’s commitment to the F-35 programme will take place in the near-term under Renzi’s tenure, which should reassure Italy’s leading defence contractor given its much larger stakes in the programme.
Overall, the bulk of defence outlays will continue to be captured by Italian firms like Leonardo and Fincantieri, as the MoD’s procurement mechanisms continue to incentivize vendors to maintain a significant local footprint.
Italy continues to face economic stagnation, a fierce debate over the handling and effects of immigration, and domestic political uncertainties. These factors will continue to lead the government to de-prioritize any hikes in defence spending at the benefit of domestic socio-economic relief.
However, opportunities will continue to emerge in the coming years, as Italy juggles with budgetary constraints and new threat types, with a likely emphasis on unmanned vehicles, innovative subsystems, and next-generation services.
UAVs will remain of particular interest, as Italy seeks to maximize its intelligence, surveillance, and reconnaissance capabilities at lower costs. Similarly, software solutions leveraging analytics tied to border control will also be in higher demand as part of EU-wide efforts to curtail terrorist attacks.
Furthermore, industry players able to provide lower-cost subsystems for maritime and airborne platforms will also find a promising customer in the Italian MoD, which will strive to update aircraft and ships approaching the end of their lifecycles without necessarily carrying out new acquisitions.
Overall, players who will successfully shape the way in which Italy tackles emerging challenges, such as migration and terrorism, will be able to establish a stronger footprint in the Italian market, despite a challenging budgetary environment.