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Egozi: FMF and Israel’s Defense Industries

Jun 11, 2020

This post is also available in: עברית (Hebrew)

By Arie Egozi

The Israeli defense industries will have to adapt themselves rapidly to the harsh reality that is being built slowly but with known consequences.

The new foreign military financing (FMF) agreement between the US and Israel will reshape the Israeli defense industries, and among other things, will force them to transfer large chunks of development and production to the US. This is one of the conclusions of a special expert team formed by the Israeli Institute for National Security Studies (INSS).

Some of the Israeli defense industries are already evaluating potential cooperation with US companies in order to get ready for the point where the conversion of FMF funds from US $ to local Israeli currency will be eliminated. Those companies which have US subsidiaries will increase their activity, others are looking for cooperation and acquisitions of US companies.

The current FMF agreement, which Israel had signed with the US in 2017 for 2019-2028, included a formal increase in aid from $ 3.1 billion a year to $ 3.8 billion, the largest one granted by the US to any country, including half a billion dollars a year to fund the Israeli missile defense array, from Iron Dome to Arrow-3.

But according to the US demand, the agreement also eliminated the possibility of converting up to 26% of the FMF money to local Israeli currency.

By 2025, the Israeli Defense Forces (IDF) and industries will begin to feel the change, when the maximum annual amount converted will drop from $ 725 million to $ 450 million. In the next two years it will be $ 250 million, and in the last year of the agreement will be $ 0.

The Israeli defense industries, directly and indirectly, employ some 80,000 people. The Defense establishment estimates that the implementation of the aid agreement could result in the dismissal of 20,000 people, about a quarter of the industries’ workers.

But the problem is much more complicated. The experts say that Israel cannot always rely on external sources of procurement alone.

“The importance of independent production capability is particularly high during a confrontation or other events where the supply chain is damaged or when there are policy restrictions on the use of certain types of weapons. Also on the political level, Israel’s ability to provide advanced military solutions to other countries contributes to their support. Israel’s annual defense exports have ranged from $ 7 billion to $ 9 billion in recent years, with IAI and Elbit exporting about 80 percent of their products and Rafael about 50 percent.

The report calls on the government to prepare for the sharp change in conversions as early as 2025.

While the Israeli defense establishment is once again trying to advance the plan to merge the two major state-owned industries – Israel Aerospace Industries (IAI) and Rafael, the report proposes to examine mergers of small and medium-sized companies with the largest ones, in order to gain an advantage in size. Two such mergers have already taken place in recent years, when Elbit Systems acquired IMI for NIS 1.8 billion, and Rafael acquired Aeronautics for NIS 850 million. Currently, IAI is reportedly leading initial negotiations regarding the acquire of UAV developer and manufacturer BlueBird.

The report proposes prioritizing local funding for survivorship and developing unique security industries, preserving research and development of strategic importance, and retaining key industry personnel. In addition – to assist local companies in increasing exports.

The INSS team says that in order to overcome the need to switch to US dollar aid instead of the NIS, Israeli companies must be incorporated into US purchase orders, encourage cooperation with US companies, and even relocate companies and subsidiaries of Israeli companies to the United States, a process that has already begun, but is far from being sufficient.

A senior expert said that on the one hand, the production of Israeli-developed systems will allow to export them to countries that cannot buy directly from Israel, while on the other hand, systems that will have US technology will be banned for export by Israel to many countries. “The new FMF layout will require many changes. The main one is a growing activity of Israeli defense companies in the US and the merger of some of the Israeli defense companies. This will have to happen, in spite of the fact that some of the workforce will become redundant.”