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Russian Hawks Win in Failed Warship Deal

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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The saga of the two Mistral helicopter carriers France built for Russia, but refused to hand over because of the conflict in eastern Ukraine, is finally over. The net result is that a French shipyard has been saved at the French taxpayer's expense, while Russian taxpayers will pay to retool the country's wharves so the country can build more of its own warships. 

The Kremlin said Wednesday night that Russian President Vladimir Putin and French President Francois Hollande have agreed to terminate the 2011 contract; that Russia has already received compensation for its expenses; and that it is preparing to dismantle Russian equipment installed on the ships. Russia, according to the statement, considers "the Mistral matter fully settled."

The Kremlin didn't say how much France paid to break its contract, the subject of months of back-and-forth, but the Russian newspaper Kommersant reported that "more than 1.1 billion euros" ($1.2 billion) has landed in the Russian government's account. This fits with French Defense Minister Jean-Yves Le Drian's statement that the compensation was less than the contract's initial 1.2 billion euro price tag.

Russia had so far paid 785 million euros for the warships, one of which was to be delivered last fall and the other later this year. Last September, Hollande suspended the deal under pressure from North Atlantic Treaty Organization allies, as Russia looked increasingly involved in the eastern Ukraine fighting. Russia initially talked of a multi-billion-dollar indemnity prescribed by the contract. In April, however, Putin said he wouldn't demand "any indemnities or over-the-top punitive damages." Instead, Russia asked France to compensate its outlay for new port infrastructure and the upkeep and training of the ships' crews.

If Kommersant's number is correct, France has accepted some of these claims to Moscow's satisfaction, avoiding a diplomatic spat. Moreover, the newspaper reported that the French government did its best to transfer the funds quietly, lest they be arrested by the shareholders of the defunct oil company Yukos, who won a $50 billion verdict against Russia and are hunting for Russian state assets throughout Europe. The deal was struck "in a spirit of partnership," tweeted Dmitry Rogozin, deputy prime minister for Russia's military industrial complex.

Rogozin never liked the Mistral contract. "I have always considered it essentially the private affair of Comrade Serdyukov," he said last year, referring to disgraced former Defense Minister Anatoly Serdyukov, who was fired in the midst of a corruption scandal in 2012. The Defense Ministry has never been able to adequately explain why it needed the Mistrals. In 2009, Admiral Vladimir Vysotsky, then Russian navy commander, said the Mistrals could have been helpful in the brief 2008 war between Russia and Georgia. They would have allowed the Russian Black Sea Fleet to seal off Georgia's sea border in 40 minutes, rather than the 26 hours it actually took, he said. Russia, however, didn't necessarily need to spend 1.2 billion euros on that kind of time gain, especially since the war was already won. 

This doesn't necessarily mean the contract was the result of a kickback. The ships might have been useful for international exercises and to show the Russian flag on the seas. There was also a theory circulating in Moscow that the deal was political payback for then-French President Nicolas Sarkozy's role in settling the 2008 conflict with Georgia. Sarkozy brokered the surrender of Georgia's then President, Mikheil Saakashvili, aiding Russia to avoid international sanctions -- an outcome that may have encouraged Putin to act in Crimea and eastern Ukraine years later. 

The payback idea makes sense. The French shipyard that built the Mistrals -- the former Chantiers de l'Atlantique in Saint-Nazaire -- was in a poor financial state before the huge contract arrived. Its owner, STX France, in which the French government has a significant minority stake, faced growing losses in the years before the Mistral deal was signed. In 2010, the company lost 66.3 million euros on revenue of 538 million euros. Since then, STX France has been breaking even, and in 2014, the French government helped it to line up another big contract (this time for two giant passenger liners), which should keep the shipyard running for the next four years. Now the French government has refunded the Russian payments, the construction of the two helicopter carriers amounts to a taxpayer-funded bailout of the wharf.

France will eventually sell the Mistrals (the government says there are interested buyers). But it will probably take a loss, even if Canada, India or some other country acquires them, because this would be a distressed sale. In Russia, meanwhile, Rogozin succeeded in convincing Putin that the Mistral fiasco proves Russia needs to build its own warships. Russia's new naval doctrine, which Putin signed into effect last month, deems it necessary to ensure "the Russian Federation's technological independence in the areas of shipbuilding and naval equipment in accordance with the state armaments program."

The Russian Finance Ministry has been calling for cuts to the ambitious, 23 trillion ruble ($359 billion) rearmament program Russia has approved until 2020, but the Defense Ministry said last month it didn't expect any drastic reductions this or next year. In its naval part, the program centers on localizing the production of equipment Russia used to buy from Ukraine or the West, such as marine diesel engines.

This won't necessarily be easy. Last month, the navy's commander, Admiral Viktor Chirkov, told a high-level meeting on the rearmament program that so far, import substitution wasn't working in engine production: Local factories cannot build engines and other sensitive equipment without imported parts. "They squandered all the technology," Chirkov said. "You understand that everyone sitting here is spending the government's money, but there's no upshot." Rogozin agreed that billions of rubles had been spent on research and development without obvious results.

That doesn't means billions more won't be spent, despite Russia's recession. The failed Mistral deal will lead to increased investment in Russian shipyards -- just as it did for Saint-Nazaire -- and has already strengthened hawkish proponents of Russian autarky, such as Rogozin. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Marc Champion at mchampion7@bloomberg.net