Coming to Ukraine’s Defense: Leveraging the European Investment Bank for Ukrainian Drone Manufacturers
Enhancing support for Ukraine’s military and defense industrial base is top of mind at the NATO Summit last week, especially if the United States should step back after the presidential election. Despite challenges, there are also opportunities for Europe to unlock and catalyze investment in Ukraine’s defense sector through the European Investment Bank.
July 15, 2024 6:46 pm (EST)
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Dual-Use Investment Rule Change Can Unlock New Funds
As Russia’s invasion of Ukraine continues into its third year, the fast-evolving landscape of modern warfare presents the European Union with a unique strategic opportunity to harness the capabilities and financial resources of the European Investment Bank (EIB) to bolster not only Ukraine’s military capabilities but also enhance Europe’s defense industrial complex. By investing in innovative Ukrainian drone manufacturers today, the European Union can leverage global financial markets through the EIB to facilitate significant advancements in defense technologies that serve both Ukraine’s immediate and Europe’s long-term security interests.
As the financing institution of the European Union and the world’s largest multilateral lender and borrower in international capital markets, the EIB is well positioned to support loans to and investments in dual-use companies (those that produce products for civilian and military use). The recent approval of the EIB’s new Security and Defense Action Plan now permits the bank to lend to dual-use companies primarily for military purpose and extends this financing policy to small- and medium-size enterprises (SMEs) and innovative startups in security and defense, specifically referencing drones as a sector for potential investment. The EIB is now a powerful financing arrow in the quiver that Russia cannot match.
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The EIB already targets financing for Ukrainian SMEs under its existing development framework. This mandate could extend to financing dual-use SMEs active in supporting Ukraine’s defense industrial base, in particular, to scale cutting-edge drone manufacturers to meet increased demand. Ukraine produces domestically more than 90 percent of the drones it uses on the battlefield, overwhelmingly by private SMEs. The need to rapidly scale was a critical takeaway from the recent conference between the U.S. Defense Department’s Defense Innovation Unit (DIU) and Ukraine’s equivalent, Brave1, on the Future of Drones in Ukraine. Mykhailo Fedorov, Ukraine’s minister for digital transformation, said Ukraine could double its rate of drone production but needs further Western financial support given Ukraine’s inability to finance the industry’s full production capacity. Other potential sources of financing for Ukraine’s drone companies include the EIB’s recently launched €175 million Defence Equity Facility, which could support private equity and venture capital funds investing in Ukraine’s drone sector, again leveraging private capital, and potentially include the EIB’s European Investment Fund (EIF), which partnered last week with NATO’s Innovation Fund. Over time, many of those Ukrainian drone companies could prove highly valuable—future Anduril-style unicorns. For now, however, Ukraine needs to scale them to survive.
At NATO’s seventy-fifth anniversary in Washington, DC, EU member states celebrated the record number of countries meeting the 2 percent of gross domestic product (GDP) defense-spending threshold. They touted Europe’s increased capacity to burden-share and individual countries’ long-term bilateral security agreements signed with Ukraine. Missing on the list was the opportunity to invest in Ukraine’s defense directly through a powerful collective EU institution: the EIB. The EIB’s current mission to support Ukraine in its candidacy for EU membership, strengthen its economy, preserve existing jobs, and create new jobs is consistent with financing Ukraine’s defense industrial complex. The commencement of EU members’ bilateral spending on military equipment made in Ukraine—soon to include the proceeds from Russian frozen assets—shows the way forward. The EIB will be lending and investing into a process already supported by EU taxpayers to scale up Ukraine’s domestic defense industrial complex. Over time, building high-tech weapons in Ukraine will further its integration with Europe and anchor its valuable role in the future of European security, regardless of when Ukraine crosses the bridge to NATO membership.
Scaling Ukraine’s Drone Capabilities: A Low-Cost, High-Tech Win
Ukraine has demonstrated remarkable resilience and ingenuity in its battle against Russia, particularly in the development of advanced drone technologies. These home-grown capabilities and fast innovation cycles are critical in the ongoing war and provide Ukraine with a strategic—and cost-effective—edge in prosecuting the war. Ukraine’s use of drones on the battlefield is redefining the nature of warfare itself, demonstrating the critical importance of technological superiority and adaptability. Ukrainian forces have successfully countered Russia using unmanned systems for surveillance, targeted strikes, and intelligence gathering.
For example, Ukraine has used naval drones to dramatically alter the strategic dynamics in the Black Sea against Russia’s substantial navy, without Ukraine actually having a traditional naval fleet. According to the Wall Street Journal, Ukrainian naval drones were instrumental in pushing back the Russian navy by striking Russian vessels, pushing the bulk of Russia’s Black Sea fleet far from Sevastopol, and giving Ukraine a tactical advantage. This allowed Ukraine to reopen channels in the Black Sea to crucial Ukrainian exports supporting the Ukrainian economy and providing agricultural exports, among others, to the world. This revolution in naval warfare underscores the transformative potential of relatively inexpensive naval drone technology to level the playing field against a much more powerful aggressor.
Hundreds of private Ukrainian artisanal drone factories, which have sprung up in response to the conflict, require urgent resources to scale production. With adequate support and investment, those small-scale manufacturers can expand their operations, produce more advanced longer-range drones, and maintain Ukraine’s competitive edge on the battlefield. This will be increasingly crucial to counter Russia’s overwhelming manpower and traditional military advantage, not to mention Russia’s increased access to Iran’s arsenal of Shahed drones and other supplies, as well as China’s suspected support for Russia in developing its own Shahed-like drone arsenal.
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Strengthening Europe’s Defense Industrial Base
Beyond the immediate benefits to Ukraine in its battle for survival, the EIB’s ability to support investment in dual-use technologies has profound implications for Europe’s own defense industrial complex. European defense manufacturers can integrate certain cutting-edge technologies into their own capabilities to create a more competitive and innovative European defense sector alongside Ukrainian companies.
The integration of advanced, highly innovative Ukrainian technologies into Europe’s defense supply chain will create and support high-tech jobs and enhance Europe’s ability to burden-share in a highly cost-effective manner. Investing in and working with Ukraine’s drone innovators in real time would also promote greater interoperability within future EU defense frameworks, ensuring that European forces are equipped with the latest and most effective technologies. As it moves toward EU membership, Ukraine itself would likely become a hub for EU defense manufacturing due to its low military production costs and could have an overall integrative effect on an otherwise atomized EU defense industry.
The EIB in Ukraine: Strong Support to Build On
The EIB already works closely with Ukraine on infrastructure, energy, housing, humanitarian aid, and reconstruction, and has mobilized and distributed more than €2 billion since Russia’s 2022 invasion. It manages the EU for Ukraine Fund for recovery and investment and so much more. Expanding resources to include dual-use SME investments in drones would unlock critical financial resources for Ukraine’s defense sector, making it more likely there will still be a Ukraine to reconstruct.
Time is not Ukraine’s friend. It needs the investment now to rapidly deploy new unmanned military innovations as they are developed. Rapid extension of the EIB’s new dual-use financing capacity to include Ukraine would allow the EIB to mobilize resources and SME expertise to support Ukraine’s defense sector today. Concurrently, it would lay the groundwork for long-term enhancements to Europe’s own defense industrial base tomorrow.
Special thanks to Jacob Funk Kirkegaard, nonresident senior fellow, Peterson Institute for International Economics, for his thoughtful comments and review.