* Ukraine puts moratorium on arms export to Russia
* State-owned Yuzhmash defies ban, fulfills contracts
* Firms try to balance between Moscow, Kiev and rebels
By Thomas Grove
KRAMATORSK, Ukraine, May 27 In quiet defiance of
a promise by Kiev's pro-European government to cut arms ties
with Moscow, a state-owned defence firm in eastern Ukraine has
vowed to work around the clock to fill every Russian order it
As for many of Ukraine's defence firms, the stakes are high
for Yuzhmash, an industrial behemoth that was so jealously
guarded by the Soviet Union that the nearby city of
Dnipropetrovsk was closed to foreigners until the bloc split
Now, in the face of the Ukrainian crisis and greater
economic hardship, Yuzhmash faces a difficult balancing act
between its political masters in Kiev, its biggest customer in
Russia and the threat from pro-Russia separatists in eastern
Ukraine who have tried raiding factory stockpiles.
The plight of Yuzhmash, whose full name is the Southern
Machine-building Plant, highlights the importance of defence
ties between Moscow and Kiev for both sides.
Not only are companies like Yuzhmash dependent on contracts
with Russia, but their cooperation has also been key to Russia's
own multi-billion dollar military modernisation - and Russian
President Vladimir Putin is loath to lose this.
"Whether it likes it or not, Russia's defence industry is
wedded to Ukraine. The interconnection is very deep rooted, and
the divorce can only be messy," said Ruslan Pukhov, director of
Moscow-based defence think-tank CAST.
"We're not talking about hundreds and hundreds of
components, systems and so on. We're talking about thousands and
thousands," he said.
Yuzhmash, which produces rockets for some of Russia's most
powerful missiles, including intercontinental ballistic missile
Satan, said it was keeping its contracts with Russia solely for
"Due to the situation that has occurred regarding Russia,
some projects and contracts have been on the verge of a
breakdown," said a statement on the company's website.
"However, the situation has now stabilised. The company will
honour all old contracts and will start talks about new projects
in the nearest future."
Ukraine's top state arms conglomerate, Ukroboronprom, which
sold 14.7 billion hryvnia ($1.24 billion) of arms last year, cut
ties with Russia after First Deputy Prime Minister Vitaly Yarema
said Kiev would end military cooperation with Moscow following
Russia's annexation of the Crimea peninsula in March.
"It is complete madness to manufacture products for the
Russian Federation which will later be used against us, and the
prime minister has already decided that we are stopping military
cooperation with Russia," Yarema said in April.
It was unclear whether the call was meant only to prevent
future contracts or also to stop the fulfilment of contracts
that had already been concluded.
Pukhov said that before the moratorium, around 70 percent of
Ukraine's arms exports were traditionally shipped to Russia -
everything from rockets for missiles to engines for helicopters
- making Russia a crucial market for Ukrainian industry.
THREAT TO RUSSIA'S MODERNISATION
The Ukrainian defence industry is so important that Russian
lawmakers sent a suggestion to Deputy Prime Minister Dmitry
Rogozin, who is responsible for Russia's arms industry, that
Russia write off Ukraine's $3.5 billion debt for natural gas in
exchange for giving Moscow shares in its defence industries.
The deputy chairman of the parliament's committee on budget
and taxes, Oksana Dmitrieva, said she had not yet received an
answer from Rogozin, but expected to by the end of the month.
The moratorium on Ukraine's exports to Russia has thrown a
wrench into Russia's plans to spend more than $600 billion on
new arms and equipment to modernise its military by 2020.
Russia announced in 2012 that its defence budget would rise
by about 25 percent, pushing spending above that of France and
Britain. Moscow says it hopes to equip at least 70 percent of
active-duty personnel with modern weapons.
That will include 2,300 new tanks, 1,200 new helicopters, 15
new ships and 28 submarines.
Russia's defence industry has been forced to look at various
options to recoup the losses it will suffer by being cut off
from Ukraine's defence industry, including turning to China for
more parts and components.
"Ukraine has been an important partner in Russia's military
modernisation, and there is not yet a clear picture on the part
of the Russian government on how to deal with that," said Pavel
Baev, a defence analyst at Peace Research Institute Norway.
Putin has also said Russia's arms industry should be
entirely self sufficient, a goal that he said would take a
little more than two years to complete.
A trade pact between Putin and former Moscow-backed
Ukrainian president Viktor Yanukovich included a provision to
ensure cooperation between Russian and Ukrainian defence firms.
The agreement would have been likely to employ thousands
more workers across Ukraine and particularly in the eastern part
of the country, where unemployment is as high as 8.2 percent in
Donetsk, above the national average of 7.7 percent.
Yuzhmash, like many other defence firms, has seen capacity
usage plummet, while the number of workers employed at the
factory is a fraction of what it was a year ago, as a
cash-strapped Ukrainian government slashed spending.
The moratorium on arms for Russia is expected to cut output
further, despite increased orders from Kiev for Ukroboronprom,
including 100 new armoured personnel carriers for Ukraine's
National Guard, which is fighting separatists in eastern
"Right now Yuzhmash is at only 20 percent of its potential.
Once, around 70,000 people worked at Yuzhmash. Now there are
only 10-15,000 people left," said Boris Braginsky, an adviser to
Igor Kolomoisky, the governor of Dnipropetrovsk, where Yuzhmash
TARGETS FOR REBELS
As violence in eastern Ukraine has risen, with armed
pro-Russian separatists taking over public buildings, the
numerous factories that produced arms during the Soviet Union
and after independence in 1991 have become easy targets for
separatists seeking to boost their arsenals.
In late April, separatists forced their way into the
Novokramatorsk Machine-building Factory (NMF), which produced
parts for tanks during Soviet times and lies a few kilometres
from the rebel stronghold of Slaviansk, to demand a modified
tank. NMF said the rebels left empty-handed.
With police loyal to Kiev unable or unwilling to maintain
order in eastern Ukraine, Yuzhmash, like other defence firms,
has managed to find its own ways of maintaining security.
In an agreement signed between Yuzhmash's General Director
Sergei Voit and regional governor and powerful businessman Igor
Kolomoisky, the governor promised to protect Yuzhmash, its
facilities and workers from "unauthorised entry".
Kolomoisky, one of Ukraine's richest businessmen, has
sponsored an increase in the number of soldiers and police
officers across Dnipropetrovsk, paying their salaries and
providing body armour and ammunition.
"The province is taking all measures for security, even if
those measures aren't outlined in the constitution and not
outlined in the functional duties of the governor," said
"These are extreme times."
(Reporting by Thomas Grove, Editing by Timothy Heritage and