Mid-year defence budget update shows big spending still on track
22 Feb 2021|

The Australian government has released its mid-year budget update in the form of the portfolio additional estimates statements. If you’re looking for screaming headline material in the defence portfolio’s PAES you may be disappointed. But the fact that there’s been little change since the portfolio budget statements were released in October, several months later than normal due to the Covid-19 pandemic, is in itself newsworthy.

Let’s take a step back. The big new news in the past 12 months in the defence budget realm is that the government reaffirmed its 2016 defence white paper commitment to increased defence spending, despite the hit to GDP and the government’s bottom line caused by the pandemic. July’s defence strategic update confirmed the steady increase to funding first presented in the white paper and extended it for a further four years out to 2029–30.

The bulk of that increased funding flows to the Defence Department’s acquisition budget to pay for the government’s ambitious capability program. Over the next few years, the acquisition budget’s share grows to around 40% of the total. To get there, Defence and its industry partners will have to climb some steep steps; the PBS stated that Defence’s planned acquisition spend for 2020–21 is around 27% more than last year, up from $11.2 billion to $14.3 billion. Considering that Defence has only managed annual increases of 5% on average over the past few years, and that Covid-19 is disrupting the global supply chains that feed defence industry both here and abroad, one could be forgiven for thinking that spending that money was going to be a challenge.

So how is Defence going at hitting that number? According to the PAES, it’s on track. The budget top line is virtually unchanged. The PBS estimate for 2020–21 was $41,715 million. That’s decreased by $291 million in the PAES to $41,424 million.

The adjustment can largely be accounted for by three things. The first is a foreign exchange adjustment of $287 million—since the Aussie dollar has recovered marginally against the US dollar and euro, Defence needs less money to buy equipment from overseas. The second is an additional $55.5 million for pay for Operation Covid-19 Assist. And the third is a $32 million decrease in funding for Operation Manitou, Australia’s contribution to maritime security in the Middle East, which the government decided to reduce in October in order to refocus on the near region.

When we dig one level deeper, spending in the three big subcategories of acquisition, sustainment and workforce is largely on track as well. The capital acquisition program is anticipating a reduction of $376.3 million, but a lot of that can be accounted for through the foreign exchange adjustment.

Within that, the military equipment program is looking like it could end up underachieving by $200 million even after that exchange adjustment is factored in, but that’s not bad against a $10.7 billion target, particularly in the middle of a global pandemic. Overall, according to the picture in the PAES, Defence is going to come pretty close to achieving the big increase in acquisition spending set out in the PBS.

That may seem a little counterintuitive when you look at the individual projects in the PAES’ top 30 acquisition projects table (table 66), which states that many of them are going to underachieve, some by a lot. Cumulatively, they amount to a $748 million underspend.

So why isn’t that showing up in the top line? Because Defence always plans on underachieving in its capital program. In Defence’s terminology, it’s called slippage and accounts for the real-world phenomenon that projects never perform as well as their managers hope. In the PBS, Defence built in a margin of $1.2 billion in slippage (page 93). Or, put another way, it budgeted to spend $1.2 billion more than it has on the reasonable assumption that in a $10-billion-plus equipment program, a lot of projects will underspend to the tune of around $1.2 billion and it will all net out. So the $748 million spending shortfall in the top 30 is covered by that. Defence could still underachieve by another half billion or so in the remainder of the financial year and it wouldn’t show up in the top line. You can call it planning for failure, or you can call it astute risk management.

There’s another element that seems counterintuitive. Covid-19 has had a major impact on the air force’s and navy’s flying hours. Cumulatively, their aircraft are predicted to miss their flying-hour targets by more than 17,000 hours, or 17% (page 47). The F-35A fleet is one of the worst hit, predicted to achieve only 5,250 hours—better than last year’s 3,097, but far short of the planned 8,204.

But when we look at sustainment spending on aircraft in the top 30 sustainment products (table 67), Defence is only anticipating a 2.3% reduction in costs despite the big fall in flying hours. Granted, a large part of sustainment budgets is tied up in fixed costs, and you certainly don’t want to lay off a highly skilled maintenance workforce because of a temporary blip in flying tempo. But when the flying hours of the C-27J Spartan fall by over 50%, from a planned 7,500 hours to only 3,360 hours, but its sustainment budget decreases by only 1.2%, from $84 million to $83 million, you wonder whether Defence could structure its sustainment contracts better.

There are the usual ‘the more things change, the more they stay the same’ stories. The recent announcement that Defence would acquire the Apache attack helicopter to replace the Tiger armed reconnaissance helicopter hasn’t solved all of the army’s aviation woes. You wouldn’t know it by looking at the flying hours in the PAES, which says that the army is still planning on flying every one of the 16,550 hours predicted in the PBS for its fleets, including all 7,950 for the MRH-90 utility helicopter and all 4,500 for the Tiger that was so unreliable it had to be replaced ASAP (page 45). That’s hardly credible in light of the air force’s adjusted targets.

In fact, the PAES confirms the MRH-90 is still struggling. Its entry in table 67 says it will underachieve against the target rate of effort and explains that ‘The reduced rate of effort is the result of low availability of serviceable aircraft due to delays in the return of repair parts from European vendors, a complex maintenance system and a lack of responsiveness in engineering support’. That’s a damning assessment of a supply chain that’s had well over a decade to sort out its teething troubles.

And it’s not just sustainment; 16 years after getting second-pass approval in 2004, the original acquisition project still isn’t finished and is planning to spend $100 million this year. It has never been clear to me why the army pushed to replace the Tiger even though most of the effects it sought from it can be delivered either by the Tiger itself or by other, complementary systems, yet it clings on to the MRH-90 despite its underperformance and the lack of other systems that can take up the slack.

That aside, the main takeaway from the numbers presented in the PAES is that Defence is hitting the ambitious numbers in the government’s acquisition program. That should mean that defence industry is absorbing the spend and delivering capability. What we can’t see in the PAES, however, is how much of that is being spent locally and how much overseas.

Despite the government’s defence industry policy, which aims to develop a more robust, sovereign Australian defence industry, the portion of the equipment budget that is spent locally has remained stubbornly stuck at around a third of the total. After seven years of budget certainty, sustained investment increases and substantial policy and spending measures to develop local industry, it would be nice to see whether that share is starting to grow.