Future of Defence ETF Monthly Report | December

Defence ETF Key Takeaways | December

Record European defence spending &ndashEU defence spending is expected to reach a record 270 billion euros in 2023 an increase of 12.5% over last year’s 240 billion euro spend with 27 of the EU’s members ratcheting up military spending. The European Defence Agency said six countries had increased their spending by over 10% with NATO new applicant Sweden targeting over 30% more. Sweden’s application is expected to be approved by year end and NATO’s newest member Finland is on track to spend 2.3% of GDP this year. But EU spending in aggregate remains at 1.5% of GDP still below the NATO 2% target.

Germany committed to military spend &ndashGermany’s Cabinet approved a draft 2024 budget that foresees lower spending with defence among the exceptions as Europe’s biggest economy sticks to rules limiting borrowing that were suspended during the coronavirus pandemic. The government’s plan calls for spending of &euro445.7 billion (U.S. $485.7 billion) down nearly 7% from the &euro476.3 billion (U.S. $519 billion) it expects to spend this year. Defence spending is set to rise by &euro1.7 billion to some &euro51.8 billion some way short of what the defence minister initially sought. Germany plans to reach a NATO target of spending 2% of gross domestic product on defence next year a measure on which it has long fallen short with help from a special &euro100 billion fund set up to modernize the German military after Russia’s invasion of Ukraine. Berlin aims to meet the target via its regular budget later this decade.

NATO holds cyber defence exercise as wartime hacking threats rise &ndashNATO countries are taking part in a cyber defence exercise this week set against the backdrop of the continuing conflicts in Ukraine and Israel. The exercises simulate cyberattacks on critical infrastructure including on operational technology systems commonly used in electrical substations energy grids and water-treatment plants. The volume of cyberattacks has increased not only in Ukraine but across NATO nations. Several businesses are also participating. Airbus Italian defence company Leonardo and Spanish defence systems firm Indra provided a platform to test future cyber defence technology alongside the exercise.

Europe ammunition shortages continue &ndashThe EU promised Ukraine millions of rounds of ammunition by March but may not be able to deliver. The lesson is that once defence production capacity atrophies it’s not easy to restore. Ukraine fires some 6000 to 8000 shells a day. Its soldiers need large quantities of the 155mm artillery shells that are a NATO standard and can be used in howitzers from the U.S. France Poland Germany and Slovakia. Yet foreign-policy chief Josep Borrell said on Nov. 14 that the EU had reached only “30% of the overall objective” for ammo deliveries. As of mid-November the EU had provided Ukraine with some 300000 rounds of ammunition but that supply came from existing stocks. The European Defence Agency has also signed at least eight contracts with defence firms to procure an additional 180000 155mm rounds but these haven’t yet been delivered. Europe has also run into supply-chain constraints according to a paper published in June by the International Institute for Strategic Studies (IISS). Chemring a supplier of explosive materials for ammunition producers said some of its customers have asked for output increases of 100%-200%. The good news is that Internal Market Commissioner Thierry Breton said that since February the EU’s ammunition production capacity has increased 20% to 30% according to the European Parliamentary Research Service. But Mr. Borrell said that even if the EU’s defence industry has the capacity to produce 1 million shots a year” that “does not mean that we [will] have 1 million shots ready by March.

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Macro Outlook

Despite recording spending NATO countries are struggling to meet capacity especially for ammunition due to strains caused by simultaneous conflicts involving Ukraine and Israel. NATO countries are also behind on their pledge to meet 2% of GDP targets by 2024 and goals to modernize defence equipment.

The good news for NATO investors is that spending will continue to increase and accelerate as the clock ticks on meeting the 2024 timeline and as new threats persist. New members such as Finland and Sweden will be ramping up spending as well. Included in military spending is the heightened environment for cyber defence spending as the volume of cyberattacks has increased not only against Ukraine but across NATO nations.

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