The development of Ukraine’s defence sector is key to its victory

Joint piece written with Haluk Bayraktar

The development of the defence sector is crucial for Ukraine’s victory in the war and also its long-term economic development.

By Haluk Bayraktar and Timothy Ash

The resilience of the Ukrainian people in resisting Russian invasion and aggression has been truly inspiring. They are at the forefront of Europe's defense and we must all thank them for their valour. Recent events in the US Congress, however, have underscored the importance of Ukraine's long-term self-reliance in defense, reducing its dependence on others. To this end, President Zelensky convened a defense forum in Kyiv last week, gathering hundreds of Western defense industry executives. The objective was to engage all stakeholders, both domestic and foreign, in enhancing Ukraine's defense industries to achieve significant self-sufficiency in defense equipment production. Such an approach is undoubtedly the most effective way to address the enduring threat from Russia. The development of a robust, efficient, large-scale, and competitive defense industry is of critical importance. It is worth noting that Ukraine, not by choice, is now compelled to allocate tens of billions of dollars to defense spending, a situation likely to persist for many years to come. Nevertheless, the experience gained through conflict and the forced advancement of the aerospace and defense industry presents an opportunity for broader economic and scientific development and innovation. It is imperative for Ukraine's defense and long-term progress that this process is executed effectively and expeditiously.

Ukraine sought to learn from others during the recent conference, but we believe this event has also illuminated areas where Ukraine can and indeed must improve on its own.

Baykar was among the participants in the conference, reflecting the long-standing and unwavering strategic cooperation between Ukraine and Turkiye. This collaboration dates back well before the recent full-scale aggression and continues to thrive despite various challenges. On February 3, 2022, just 21 days before the invasion, the Turkish and Ukrainian governments signed an intergovernmental Framework Agreement for cooperation in high technologies and aviation. This agreement paved the way for a remarkable commitment by Baykar to invest in research and development (R&D) and manufacturing activities related to Unmanned Aerial Vehicles (UAVs) in Ukraine, for the benefit of Ukraine. Baykar's dedication is evident in substantial investments, including the acquisition of land for a new factory and essential infrastructure development, such as electricity supply. Construction officially commenced on June 1, 2023, and is currently progressing swiftly. We anticipate the completion of this state-of-the-art facility within just 1.5 years, representing a fixed investment estimated at an impressive $100 million USD. What makes this partnership even more remarkable is the strategic objective it achieves for Ukraine. Upon completion, Ukraine will possess all the necessary manufacturing and research and development capabilities for the in-house production of the entire Bayraktar series of UAVs. This means that highly skilled Ukrainian personnel, including engineers and technicians, initially numbering no less than 300 individuals, will play a central role in this remarkable achievement. It is worth emphasizing that despite the full-scale war and the associated risks, Baykar has not only remained steadfast in its commitment but has also expanded its investments and efforts. The commitment of Baykar exemplifies the power of collaboration in the face of adversity and demonstrates what the international defense sector can achieve when working in tandem with Ukraine.

So, what steps can Ukraine take to attract more companies like Baykar? After engaging with conference participants this week, many of whom possess extensive experience working in Ukraine, we have identified several essential reforms:

1. **Establish Ukrinvest as a One-Stop Solution**

We recommend that Ukrinvest, Ukraine's investment agency, act as a comprehensive “one stop shop solution” for investors in defence and aerospace industries, serving as an honest intermediary between investors and the government. It should also establish key performance indicators, undergo regular audits and, given its importance, should report directly to the President. This would send a great signal to investors - a similar agency in Turkey (Invest in Turkiye) also reports directly to the presidency.

2. **Streamline Import and Export Licensing**

We recommend a simplification of the import and export licensing system for defense-related industries. Currently, only a few select Ukrainian companies are authorized to handle these items, and the licensing process can be protracted, even during wartime. Streamlining this process is vital to facilitate the rapid development of aerospace and defense sectors.

3. **Offer Comprehensive Investment Incentives**

To attract more investments, it is advisable to provide comprehensive investment incentives, including import tax waivers, corporate income tax reductions, VAT exemptions, and personal income tax exemptions for employees in the sector. A straightforward approach could include a tax-free period of five years for investments, followed by a unified tax structure accessible through a single window.

4. **Finalize Industrial Zone By-Law**

The prompt finalization of the industrial zone by-law, similar to the Turkish model, where industrial parks are directly managed by the Ministry of Industry Technology, can simplify the process for investors and grant them direct access to central government ministries.

5. **Government Support for Infrastructure**

The government is encouraged to directly cover a significant share of costs related to electricity, gas, and sewage connections for a specified period to attract investments.

6. **Align Investments with Procurement Plans**

Investments in aerospace and defense should align with a comprehensive five-year procurement plan, in coordination with the Ministry of Defense's acquisitions. Contracts should mandate local investments within the country, with a clear and straightforward offset mechanism tied to the contracted items.

7. **Digitalize License Mechanisms**

We advise transitioning import and export license mechanisms to a digital platform, which would allow applicants to monitor and expedite applications online. This will enhance efficiency and reduce opportunities for corruption.

8. **Efficient Surplus Land Allocation**

We would suggest the allocation of surplus land owned by the Ministry of Defense's for high-tech defense investments with clear terms spanning 30 to 50 years and to streamline the process, ensuring it does not exceed six months.

9. **Simplified Work and Residence Permits**

It is advisable to simplify the process for investor and foreign personnel to receive work and residence permits, making them more accessible.

10. **Exemption from Mobilization**

We would recommend simplifying the application process for exempting defense company staff from mobilization, ensuring continuity in defense production.

11. **Establish a Dedicated Agency for International Promotion**

We would recommend the establishment of a dedicated agency, or department, to actively promote Ukrainian aerospace and defense products internationally. Additionally, consideration should be given to providing financial and administrative support to defense industry companies engaged in local production and exports.

12. **Preferred Status for Local Suppliers**

We recommend the adoption of legal regulations that grant preferred status to companies involved in local production and after-sale support activities as suppliers in tenders. Incentives can be offered to such companies through multipliers to create advantages.

13. **Transparent Procurement**

We recommend measures to enhance the transparency of the procurement system, such as facilitating access to information on short-term, urgent purchases, and long-term supply plans. This can help limit opportunities for corruption.

14. **Market Pricing and Reduced Government Control**

Consideration should be given to moving towards market pricing and reducing government control over local contractors to avoid their relocation outside Ukraine, which often results in delays and complications in manufacturing processes.

Implementing these reforms, as advised above, will require collaborative efforts from the Ukrainian government, industry stakeholders, and international partners. However, these steps can lead to a more self-reliant and economically developed Ukraine with a robust defense sector capable of addressing long-term threats effectively.

Haluk Bayraktar is CEO of Baykar, the largest and most succesful drone company in Europe. 

Timothy Ash is an Associate Fellow at Chatham House on its Russia and Eurasia Programme.