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Defense budgets climb as NATO countries step up spending

A qualification test to earn the maroon beret of the Russian Federal National Guard Troops Service, at the Gorny training centre, Russia.
Kirill Kukhmar | TASS | Getty Images
A qualification test to earn the maroon beret of the Russian Federal National Guard Troops Service, at the Gorny training centre, Russia.

Russian saber rattling and prodding from Washington are spurring more of NATO's European allies to step up their defense spending — and the makers of military hardware stand to benefit.

Since the U.S. presidential election, European members of the North Atlantic Treaty Organization have announced plans to buy everything from surveillance aircraft and drones, to new air defense systems and warships. The announcements come amid U.S. criticism that European countries are not doing enough to uphold their part of the alliance.

As a result, NATO military spending this year is expected to bounce back for the first time since 2010, according to an IHS Jane's Defence Budgets report. Meanwhile, Russia's defense spending is seen falling this year for the first time since the late 1990s, as the low price of oil and Western sanctions batter its economy.

"There's already recognition among leaders in the European Union that countries need to do more [on defense]," said Phil Finnegan, a defense analyst at the Teal Group in Fairfax, Virginia.

NATO has been around since the late 1940s, when the trans-Atlantic military alliance had a dozen founding members. It kept the peace through the Cold War and now has 28 participants, including several countries that were once part of the former Soviet Union's orbit and the communist-led Warsaw Pact.

But during the campaign, President-elect Donald Trump referred to NATO as "obsolete," and suggested the alliance wasn't doing enough on the terrorism front. When asked over the summer whether he would defend the Baltic States in the event of an attack from Russia, Trump said, "If they fulfill their obligations to us, the answer is yes," according to a transcript of the interview from The New York Times.

President Barack Obama also has been critical of NATO members for "free riding" off U.S. protection.

Estonian Special Forces soldiers seen reading a map after raiding the woods during a NATO troop exercise in Estonia.
Dmitri Beliakov | Washington Post | Getty Images
Estonian Special Forces soldiers seen reading a map after raiding the woods during a NATO troop exercise in Estonia.

From a practical standpoint, the U.S. is unlikely to let go of its involvement in the NATO alliance. Yet Trump can use his bully pulpit as the next leader of the free world to get a better deal for American taxpayers, and encourage European allies to step up their spending.

"There's a lot of nervous allies who aren't heeding the warning from the Washington establishment to make a distinction between what to take literally and what to take seriously," said Lisa Samp, an international security analyst at the Center for Strategic and International Studies in Washington.

NATO's rules obligate alliance members to help each other in case of an attack. In 2014, the security partnership produced guidelines for members to spend at least 2 percent of gross domestic product on defense.

Only five of the 28 member countries of the Western alliance — the U.S., U.K., Poland, Greece and Estonia — currently meet the 2 percent of GDP target.

"Spending 2 percent of your gross domestic product on defense comes at the expense of other things," Toomas Hendrik Ilves, a former Estonian president, told CNBC on Sunday. "That's also political risk for any government."

But if the rest of the European NATO members paid the 2 percent target for defense spending set by the trans-Atlantic alliance, it would generate more than $90 billion in additional annual expenditures, according to Jefferies research.

"If Trump is able to get more NATO countries to spend 2 percent of GDP on defense, it would be good for both European and U.S. defense firms," Cowen said in a report last week.

According to the IHS Jane's forecast, concerns about security in Western Europe will boost defense budgets across the region by about $10 billion over the next five years.

U.K. Defense Secretary Michael Fallon recently visited California and announced a development deal worth $125 million for drones from privately held General Atomics. While in the U.S., the British official met with defense giant Boeing, a supplier of NATO's E-3 Sentry surveillance aircraft commonly known as the AWACS.

E-3 AWACS radar aircraft built by Boeing operating from NATO Air Base Geilenkirchen in Germany.
Source: NATO
E-3 AWACS radar aircraft built by Boeing operating from NATO Air Base Geilenkirchen in Germany.

U.K.-based defense manufacturer BAE Systems is mentioned frequently as a defense name to watch due to its exposure to NATO military spending.

"In our view 2016 has seen a marked inflection in the outlook for defense expenditures, and we see BAE as a key beneficiary of this moving forward," said Bank of America Merrill Lynch analyst Benjamin Heelan in a research note last week.

Germany, which spends nearly 1.2 percent of GDP on military outlays, has pledged to meet the NATO target. That could also lead to an uptick in defense spending.

"If Germany were to meet its 2 percent pledge ... it would be a significant increase in overall European defense spending," said Christopher Chivvis, associate director of Rand Corp.'s International Security and Defense Policy Center. "Germany is not going to do that overnight although they are moving in that direction."

Some NATO alliance members are pushing defense modernization plans after Russian military buildups in both the Baltic and Black sea regions.

IHS Jane's forecast sees tensions in the Baltic region pushing defense spending from $981 million in 2014 to more than $2 billion by 2020. That would make it the region with the fastest growth globally.

Earlier this month, Poland announced plans to spend $14.5 billion on its military forces over five years. The country also is getting the Raytheon-made Patriot Air and Missile Defense System from the U.S. as well as drones, helicopters and warships to deal with threats in the Baltic Sea.

Poland's announcement came on the heels of Moscow moving nuclear-capable ballistic missiles into Kaliningrad, a Russian enclave located on the Baltic Sea next to Poland.

"The huge military expansion on the part of the Russians in the last five to six years is not sustainable" -Toomas Hendrik Ilves, Former Estonian president

Meanwhile, Romania is moving ahead with increases in its defense spending and plans to meet the 2 percent NATO target next year. The U.S. and NATO recently installed a missile shield facility in Romania. It comes amid tensions in the Black Sea region after Russia's 2014 annexation of the Crimean Peninsula in the Ukraine.

Russia last year invested more than 5 percent of its GDP in defense, but that figure is expected to drop to just 3 percent due to the country's economic woes.

"The huge military expansion on the part of the Russians in the last five to six years is not sustainable," said Ilves, who served 10 years as the fourth president of Estonia.

IHS Jane's forecast said, "2015 is expected to represent the zenith of Russian defense expenditures for the foreseeable future."

Weak oil prices have cut a major revenue source for the Russian federal government, and there's also been fallout from the ongoing Western sanctions.

"We expect the Russian defense budget to fall again next year and it will sit below France in the No. 7 position by 2020, based on current plans, with a total defense budget of $41.4 billion," said Craig Caffrey, a principal analyst at IHS Jane's.

By comparison, the U.S. defense budget this year is forecast to rise 1 percent to $622 billion, which according to IHS Jane's estimates represents about 40 percent of the world's total defense spending.