When a Ukrainian media outlet reported in February that people close to then-President Petro Poroshenko were involved in skimming money from the military, it blew the tires off his slowing campaign machine just weeks before his reelection bid.
Bihus.Info's investigation accused Ihor Hladkovskiy, the son of Poroshenko’s business partner Oleh Hladkovskiy, of selling smuggled spare military-equipment parts from Russia at exorbitant prices to Ukroboronprom, the state-owned concern that oversees the defense industry.
The allegations about transactions in 2015 infuriated a public that had been supporting its impoverished military during the more than five-year war against Russia-backed separatists in eastern Ukraine, which has killed some 13,000 combatants and civilians.
Poroshenko, who ran on the patriotic slogan “Army, Language, And Faith,” was subsequently trounced in the April runoff by comic actor Volodymyr Zelenskiy, a political novice who promised to root out systemic corruption and attract foreign investment.
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The 41-year old president now has the power to do just that after July 21 parliamentary elections handed his party a powerful majority – and a clear mandate to install reform-minded officials in key positions in government and state companies.
How thoroughly Zelenskiy cleans up Ukroboronprom, an opaque behemoth that critics say is synonymous with state corruption, will be a litmus test of his commitment to those goals.
The size of what’s at stake for the new president and his country goes far beyond the amount of money allegedly siphoned annually from Ukroboronprom. A transparent defense industry opens the door to foreign investment, economic development, and closer NATO integration -- as well as a stronger military.
Over nearly a decade in existence, Ukroboronprom has botched export deals, driven entrepreneurs to move production outside Ukraine, and kept many potential Western partners away, industry executives and analysts say.
Ukroboronprom is a “serious, serious problem” for Ukraine and the whole military industry is suffering from a “lack of transparency and corruption,” John Herbst, a former U.S. ambassador to Kyiv and now director of the Eurasia Center at the Atlantic Council think tank, told a conference in Washington on July 29.
Zelenskiy’s domestic and Western supporters see cause for optimism.
A month after his May inauguration, Zelenskiy named reformist former Economy Minister Aivaras Abromavicius to Ukroboronprom’s five-member supervisory board, tasking him with carrying out a long-awaited audit of the concern.
But fixing Ukroboronprom -- which oversees about 130 companies employing 80,000 employees who make products from tanks to planes to missiles -- won’t be quick or easy.
It will require shaking up the ministries and agencies overseeing national security, industry analysts say. The U.S. Defense Department has appointed advisers to help Ukraine with the reforms, but analysts say they have yet to see real progress.
“There is no clear armaments development strategy from our Ministry of Defense to drive innovation,” says Denys Hurak, a former deputy director of Ukroboronprom who quit in 2018. “This is essential. Without it, the country will continue to lose its defense capabilities.”
Yanukovych’s Project
Ukroboronprom was created in 2010 by then-President Viktor Yanukovych, who formed it by consolidating the nation’s state-owned military companies under one umbrella shortly after he took office.
He also bestowed upon the concern essentially a monopoly over exports of all military products, making it both a regulator and an industry player.
That conflict of interest -- along with a nontransparent procurement system – would lay the foundation for corruption that would infect the industry and stunt its innovation and growth over the next nine years, according to observers.
Ukroboronprom’s structure closely resembled that of Russian state military conglomerate Rostec and raised suspicions that Yanukovych – who was pushed from power in 2014 by the Euromaidan protests over his bid to bring Ukraine closer to Russia rather than the European Union -- wanted to integrate the Ukrainian concern with the Kremlin-controlled company.
The two countries' military industries had strong ties, a legacy of the Soviet era, with some Russian companies supplying parts to Ukrainian manufacturers and vice versa. Much of that cooperation came to an end after Moscow reacted to Yanukovych’s ouster by seizing Crimea in March 2014 and stoking the separatism that erupted into war in eastern Ukraine that April.
Kickbacks
Denys Kalachov, a board member of the Association of Ukrainian Defense Manufacturers, a lobby group for private companies, says that Yanukovych may have also had ulterior motives for consolidating the state-owned defense companies under one roof.
It gave the president’s team greater control over the billions of hryvnyas that sloshed around the industry, including from exports, says Kalachov. Ukroboronprom takes a fee for international transactions.
When Yanukovych was ousted, his successor -- Poroshenko -- promised to reform the concern. However, his words never materialized into real action, Hurak says.
Poroshenko “didn’t have the political will” to carry out change because it would have hurt the financial interests of his friends, says Hurak, who served at the concern under Poroshenko.
“We lost five years. If we had started the reforms back in 2014, we would now have a transformed industry with strategic Western investment across all aspects of the military industrial complex,” he says.
Ukroboronprom continues to favor state-owned companies to the detriment of private domestic firms, foreign manufacturers, and its own armed forces, says Kalachov, whose association represents about 90 private firms.
The concern hiked prices for imported goods more than 20 percent at times, preventing Ukraine from acquiring needed equipment during wartime, the U.S.-based Rand Corporation think tank wrote in a 2016 report.
The fees private firms pay to export can slice as much as 50 percent from the profit, Kalachov says.
Private defense businesses -- hobbled by Ukroboronprom’s high fees, slow service, and weak export promotion -- are moving to nations such as Lithuania, Bulgaria, and the Czech Republic, depriving Ukraine of jobs and taxes.
"Some smart companies that really have potential are literally shutting down and reregistering in an EU country," says Reuben Johnson, a military analyst based in Kyiv.
Going along with the companies are many of Ukraine’s experienced machinists and design specialists. They are taking their valuable know-how and skills with them, creating a brain drain.
New Strategy
Zelenskiy could quickly tackle much of the corruption in the industry, while jump-starting innovation and growth, by further liberalizing imports and exports and forcing the Defense Ministry to conduct transparent tenders, military analysts say.
But they caution that the future of Ukraine's military industry -- which produces plenty of high-quality weapons and components -- will also depend on its ability to develop a strategy to integrate with NATO now that ties with Russia are severed.
Ukrainian companies could make parts for NATO’s defense industry or incorporate Western technology into their weapons to compete more effectively with Russian products in third markets, says Phil Karber, president of the Potomac Foundation think tank and a specialist on Ukraine's military sector.
But the shift to such products cannot happen unless Ukroboronprom achieves a transparency that meets Western demands.
"If you are not producing stuff that is compatible with allies, you are facing an ever-declining market," Karber says. "If left alone right now, Ukraine’s defense industry will be a shadow of itself.”
