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Q3 2013

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UNITED STATES
DEFENCE & SECURITY REPORT
INCLUDES 5-YEAR FORECASTS TO 2017

ISSN 2042-423X
Published by:Business Monitor International

United States Defence & Security Report Q3 2013


INCLUDES 5-YEAR FORECASTS TO 2017

Part of BMIs Industry Report & Forecasts Series


Published by: Business Monitor International Copy deadline: June 2013

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United States Defence & Security Report Q3 2013

CONTENTS
BMI Industry View ............................................................................................................... 7 SWOT .................................................................................................................................... 9
United States Defence SWOT ....................................................................................................................... 9 United States Security SWOT ..................................................................................................................... 10 Political ................................................................................................................................................. 11 Economic ............................................................................................................................................... 12 Business Environment .............................................................................................................................. 13

Industry Forecast .............................................................................................................. 14


Defence Expenditure ............................................................................................................................... 14
Table: Defence Expenditure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15 Table: Defence Expenditure Scenario - Changing % Of GDP (US$mn) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16

Armed Forces ........................................................................................................................................ 16


Table: Armed Forces ('000 personnel, unless otherwise stated) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17 Table: Manpower Available For Military Service, 2010-2017 (aged 16-49 unless otherwise stated) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

Defence Trade ....................................................................................................................................... 18


Table: Defence Trade Balance (US$mn) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 20

Imports ................................................................................................................................................ 21
Table: Defence Imports (US$mn) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 22

Exports ................................................................................................................................................ 23
Table: Defence Exports (US$mn) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24

Macroeconomic Forecasts ............................................................................................... 25


Macroeconomic Forecast .......................................................................................................................... 25
Table: US - Growth Revisions (%) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 25 Table: UNITED STATES - GDP BY EXPENDITURE, REAL GROWTH % . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 33

Industry Risk Reward Ratings .......................................................................................... 34


Developed States Risk/Reward Ratings ........................................................................................................ 34
Table: Developed States Security Risk Ratings (scores out of 100, with 100 the best) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 34 Table: Developed States Vulnerability To Terrorism Index (scores out of 100, with 100 the best . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35

United States Risk Ratings ......................................................................................................................... 35

Market Overview ............................................................................................................... 36


United States Defence Market Overview ...................................................................................................... 36 Armed Forces and Government Spending ................................................................................................... 36
Table: Foreign Deployments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51

Industry Trends and Developments ............................................................................................................ Arms Trade Overview ............................................................................................................................. United States Security Overview ................................................................................................................. Domestic Threats ...................................................................................................................................

53 57 61 61

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United States Defence & Security Report Q3 2013 Regional Threats .................................................................................................................................... 64 International Threats .............................................................................................................................. 64 Political Risk Analysis .............................................................................................................................. 75

Company Profile ................................................................................................................ 80


Boeing ................................................................................................................................................... L-3 Communications ................................................................................................................................ Lockheed Martin ..................................................................................................................................... Northrop Grumman ................................................................................................................................. Raytheon ................................................................................................................................................ 80 82 84 87 89

Global Industry Overview .................................................................................................. 91


Global Political Outlook ........................................................................................................................... 91

Methodology ...................................................................................................................... 94
Defence Industry .................................................................................................................................... 95 Sources ................................................................................................................................................ 96

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BMI Industry View


The United States is planning to withdraw from its decade-long military presence in Afghanistan from 2014. As the US reduces its footprint in the country, it will hand over an increasing share of the security burden to the Afghan National Army and police force.

The eventual withdrawal of US forces from Afghanistan is expected to yield significant savings to the Department of Defense budget. For fiscal year (FY) 2013, President Obama has requested US$525.4bn. During the next decade, the Pentagon is expected to make budget savings of up to US$487bn, which will be achieved, in part, by the cessation of military operations in Afghanistan. That said, the defence budget is also threatened with significant contraction via a process known as sequestration which has already cut this year's budget by US$46bn, and is set to trigger a further US$500bn of reductions over the next decade.

Over the long term, the US will make a major reduction in the size of its strategic nuclear weapons inventory. Currently, around 5,000 operational and reserve nuclear warheads are in the possession of the US armed forces, including around 200 tactical nuclear weapons. The New START (Strategic Arms Reduction Treaty) agreement between Russia and the US will see the Department of Defense reduce its air-launched and sea-launched nuclear weapons delivery systems.

Although ballistic missile defence efforts proved highly controversial during the administration of President George W. Bush, they have continued, albeit in a different form, under President Obama's administration. The Missile Defence Agency, the branch of the Pentagon supervising ballistic missile defence initiatives, is currently pursuing several programmes aimed at destroying ballistic missiles during their boost, ascent, midcourse and terminal phases of flight.

Missile defence technology is only one area that the Pentagon is pouring significant funds. The Department of Defense continues to pursue several major defence acquisition projects, not least of which is the Lockheed Martin F-35 Lightning-II Joint Strike Fighter family of combat aircraft. This is in addition to scores of other programmes across all five US armed services. The abiding raison d'tre of many of these initiatives is to make the force more agile and deployable, while at the same time improving the connectivity between soldiers, vehicles, weapons and command and control systems.

Since Q213, BMI has made some changes to the United States Defence and Security Report. These include

An update regarding likely effects of sequestration on the country's defence budget and defence posture. Details regarding expected personnel downsizing in the US armed forces, particularly in the US Army.

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Updated news regarding existing US defence procurement programmes, and new programmes which have been launched in the last quarter.

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SWOT
United States Defence SWOT
SWOT Analysis

Strengths

World's most sophisticated armed forces. Significant combat experience across full spectrum of military operations. Noticable weakness in post-conflict stabilisation missions. Force structures still cumbersome which, to an extent, limits the ease with which large formations can be deployed for out-of-area operations.

Weaknesses

Opportunities

Despite the budgetary squeeze regarding the United States' defence budget, the armed forces still boast significant procurement opportunities.

US defence companies retain their global presence, and participation in a number of foreign defence procurement campaigns.

Threats

The rising military power of China, and the country's occasionally difficult relationship with Russia.

The contraction of the US defence budget could have an adverse effect on the country's military posture.

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United States Security SWOT


SWOT Analysis

Strengths

The world's richest and most influential nation, with unrivalled military power. United Nations Security Council Permanent Member; founder NATO member state; boasts one of the world's largest nuclear arsenals.

Weaknesses

The United States has little security and defence presence and influence in subSaharan Africa, although this is changing.

The country has little experience and performing and sustaining peacekeeping operations.

Opportunities

The United States is keen to operate with other countries around the world in an attempt to enhance regional security in various areas.

The United States is revitalising security relationships with several actors in Asia in an attempt to reduce the strategic influence of China.

Threats

Emerging Chinese military power could become a major threat to US power and influence in the Asia-Pacific region.

Washington's occasionally difficult relationship with Russia continues to cause significant diplomatic difficulties.

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Political
Political SWOT Analysis

Strengths

The US is an undisputed superpower and therefore occupies centre stage in most international diplomacy.

A long-standing democracy with vigorous and open political debate, the US continues to attract large numbers of immigrants committed to citizenship and selfadvancement.

Weaknesses

Political debate between Republicans and Democrats has historically been polarised and divisive.

As today's superpower, the US attracts the enmity of a wide range of political groups opposed to the current international status quo.

Opportunities

The widespread dissatisfaction of the voting public with the performance of Congress may encourage both major parties to experiment with more consensual approaches to certain policy areas. Though we are not optimistic, ongoing budget debates will provide a pertinent test of the degree to which bipartisan cooperation is possible.

Threats

The perception of inflexibility and bias in US foreign policy, particularly in the Middle East, may stiffen opposition and at worst provide fertile recruiting ground for radical anti-US groups such as al-Qaeda. Partly as a reaction to foreign policy difficulties, US public opinion may return to an isolationist and protectionist mode.

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Economic
Economic SWOT Analysis

Strengths

The world's largest economy with an impressive record of entrepreneurial dynamism, innovation and high research and development spending.

Despite some threats to its reserve status, the US dollar is treated as an international currency, meaning that investors around the world are prepared to hold US debt. Because of this, the US is uniquely able to run large fiscal and current account deficits.

Weaknesses

Despite the dollar's role as an international currency, excessive US debt levels are a risk. A decision by the Japanese and Chinese central banks to reduce their larger dollar holdings could cause sharp falls in the value of the US currency.

A low savings rate by US households on a historic basis, although this has begun to reverse.

Opportunities

Further liberalisation of international trade through the WTO, coupled with a more competitive dollar exchange rate, could boost export growth and help restore balance to the US's external imbalances.

Threats

Intensified competition from China and other low-wage economies could accelerate the loss of manufacturing jobs.

Large growth in public spending, coupled with tax cuts, will worsen the fiscal deficit, eventually forcing more restrictive monetary policy and slower growth.

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Business Environment
SWOT Analysis

Strengths

The US boasts the world's largest single internal consumer market, which presents tremendous opportunities for businesses of all types and sizes.

Few countries offer a better environment for entrepreneurial activity, with a highly flexible labour force, a legal system that is friendly to business, and significant centres of technological innovation (such as California's Silicon Valley).

Weaknesses

Much of the country's physical infrastructure is in need of improvement, with congested roads and airways.

US corporate tax is, on average, among the highest in the OECD (though effective taxes are much lower).

Opportunities

The US has often been the origin of new drivers of economic growth booms, and sectors ranging from biotechnology to alternative energy are being discussed as possible catalysts.

Threats

The US's fiscal crisis may force the federal government to find ways to raise effective corporate tax rates, following a multi-decade downtrend.

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Industry Forecast
Defence Expenditure
The exact figure for defence spending for fiscal year 2013/14 remains in flux following political uncertainty regarding the extent of defence cuts which could come into play as a result of congressionally mandated cuts to the Department of Defence's budget. Currently, President Obama's budget request for the Department of Defense (DoD) stands at US$525.4bn for 2013. This is a reduction of around US$5.0bn compared to the defence budget for 2012.

However, at best, this reduction may be only temporary as the defence budget is expected to rise in 2014 to US$533.6bn; equating to an increase of around 2%. Of the US$525.4bn requested for the 2013 defence budget, up to US$88bn of this is will pay for ongoing military operations in Afghanistan. This is significantly less than the US$115.1bn for overseas contingency operations requested in the 2012 budget, the US$158.8bn requested in 2011 and the US$162.2bn earmarked for these operations in 2010.

The reduction of the 2013 budget request for overseas contingency operations reflects the cessation of US military operations in Iraq. Over the long term, defence spending is expected to experience a significant reduction. Under the terms of the 2011 Budget Control Act, Pentagon expenditure must reduce by 2021 by US$487bn. This will require the annual defence budget to reduce by around US$55bn per annum by 2021 if this target is to be achieved.

However, the effect of government spending cuts on the US defence industry can often be heavily overplayed. Alternative views see the reductions as cyclical over the long-term and only significantly impacting the country's dominant prime contractors - Lockheed Martin, Northrop Grumman and Raytheon which rely on the government for the vast majority of their projects and sales. In a sector as large as US defence, it is questionable whether the cuts would operationally hamper companies outside of the leading 10, where international markets and commercial variants of military-grade equipment are often more strongly pursued. Indeed, a cursory look at the US' catalogue of wars over the past few decades shows that DoD spending usually slides significantly after a drawdown.

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Downward Trend?
US Defence Spending in US$mn and Percentage Change Year-on-Year

750,000

0 500,000

-25 250,000 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009e 2010e 2011e 2012e 2013f 2014f 2015f 2016f 2017f Defence expenditure, US$mn (LHS) Defence expenditure, US$ % change y-o-y (RHS)
Notes: 1 "SIPRI, BMI calculation" 2 "SIPRI, BMI calculation" Table: Defence Expenditure

2010 US$mn - % change y-o-y - % of GDP - US$ per capita US$mn - % change y-o-y - US$ per capita EURmn - % change y-o-y - EUR per capita US$mn, constant prices - % change y-o-y 493,111.0 -25.4 3.4 1,588.7 493,111.0 -25.4 1,588.7 371,748.5 -21.3 1,197.7 485,471.0 -26.8

2011 505,517.4 2.5 3.4 1,614.6 505,517.4 2.5 1,614.6 363,681.6 -2.2 1,161.6 483,266.7 -0.5

2012e 525,961.9 4.0 3.3 1,665.5 525,961.9 4.0 1,665.5 414,143.2 13.9 1,311.4 494,112.5 2.2

2013f 543,806.4 3.4 3.3 1,707.4 543,806.4 3.4 1,707.4 435,045.1 5.0 1,365.9 500,005.9 1.2

2014f 561,665.6 3.3 3.2 1,748.7 561,665.6 3.3 1,748.7 468,054.7 7.6 1,457.2 505,426.6 1.1

2015f 594,286.6 5.8 3.3 1,834.9 594,286.6 5.8 1,834.9 495,238.8 5.8 1,529.1 524,167.3 3.7

2016f 609,019.8 2.5 3.2 1,865.0 609,019.8 2.5 1,865.0 507,516.5 2.5 1,554.1 526,154.7 0.4

2017f 624,986.5 2.6 3.1 1,898.4 624,986.5 2.6 1,898.4 520,822.1 2.6 1,582.0 528,899.6 0.5

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Defence Expenditure - Continued

2010 - constant US$ per capita 1,564.1

2011 1,543.6

2012e 1,564.7

2013f 1,569.9

2014f 1,573.6

2015f 1,618.4

2016f 1,611.2

2017f 1,606.5

Source: SIPRI/BMI

Table: Defence Expenditure Scenario - Changing % Of GDP (US$mn)

2010 Core scenario Spending +0.2pp of GDP Spending +0.5pp of GDP Spending +1.0pp of GDP Spending -0.2pp of GDP Spending -0.5pp of GDP Spending -1.0pp of GDP

2011

2012e

2013f

2014f

2015f

2016f

2017f

493,111 505,517 525,962 543,806 561,666 594,287 609,020 624,987 522,164 535,693 557,776 577,144 596,569 630,785 647,069 664,720 565,743 580,956 605,497 627,149 648,924 685,532 704,143 724,321 638,376 656,394 685,031 710,493 736,182 776,776 799,267 823,656 464,058 475,342 494,148 510,469 526,762 557,789 570,970 585,253 420,478 430,079 446,427 460,463 474,408 503,042 513,896 525,652 347,846 354,640 366,892 377,120 387,150 411,797 418,773 426,317

Source: BMI

Armed Forces

Cuts to the personnel strength of the US armed forces, in particular the United States Army, are planned for the coming hears. In February 2013, it was reported that the US Army could reduce to around 490,000 from circa 570,000. This is a direct result of the Budget Control act, also known as ''sequestration", which is aiming to effect US$487bn of defence cost savings over the next 10 years. Other cost-cutting measures being considered by the Pentagon include a 1% pay rise for members of the armed forces, as opposed to the 1.7% rise originally planned for in 2014. Needless to say, there are major concerns regarding the impact of these cuts on the readiness levels of the US Army, and its ability to project force around the world. A cut of 80,000 personnel is extremely significant and equates to several regiments-worth of troops. Any emerging future crisis which has a need to deploy ''boots on the ground'' en masse could prove difficult to manage if there are insufficient forces to meet the needs of commanders. It also puts into question how similar ''surge'' operations akin to this performed in Iraq at the height of the country's violence last decade could be performed during future deployments if the army has insufficient numbers.

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Smaller Numbers
US Armed Force in '000s and Armed Forces Size as Percentage of Population 2,000 0.6

1,500 0.4 1,000 0.2 500

0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 PERSONNEL: Total armed forces, '000s (LHS) PERSONNEL: Total armed forces, % of population (RHS)
Notes: 1 "IISS/BMI calculation" 2 "IISS/BMI calculation" Table: Armed Forces ('000 personnel, unless otherwise stated)

2000 Army Navy Air force Paramilitary force Total armed forces --- % of population --- % of manpower available for military services --- % of manpower fit 655.00 373.00 356.00 65.00

2001 654.00 378.00 354.00 65.00

2002 661.00 383.00 368.00 66.00

2003 677.00 382.00 375.00 66.00

2004 678.00 373.00 377.00 66.00

2005 672.00 362.00 352.00 69.00

2006 685.00 350.00 349.00 71.00

2007 708.00 338.00 333.00 72.00

2008 669.00 328.00 329.00 76.00

2009 662.23 335.82 334.34

1,449.00 1,451.00 1,478.00 1,500.00 1,494.00 1,455.00 1,455.00 1,451.00 1,402.00 0.51 1.03 0.51 1.02 0.51 1.04 0.51 1.05 0.51 1.04 0.49 1.01 0.49 1.01 0.48 1.00 0.46 0.97

0.00 0.00 0.00

1.33

1.18

0.00

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Armed Forces ('000 personnel, unless otherwise stated) - Continued

2000 for military services

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: BMI

Table: Manpower Available For Military Service, 2010-2017 (aged 16-49 unless otherwise stated)

2010 Males Females Total --- % of population --- % change on 10 years previously 73,464,257 71,435,343

2011 73,476,972 71,322,969

2012e 73,464,526 71,158,134

2013f 73,468,765 70,991,621

2014f 73,546,007 70,893,956

2015f 73,721,550 70,902,485

2016f 73,963,147 71,014,599

2017f 74,278,987 71,209,976

144,899,601 144,799,941 144,622,660 144,460,386 144,439,962 144,624,035 144,977,746 145,488,962 46.7 2.9 46.2 2.1 45.8 1.3 45.4 0.7 45.0 0.3 44.7 0.0 44.4 0.2 44.2 0.4

Source: BMI

Defence Trade
BMI estimates that US defence spending totalled US$493.11bn in 2010, by some way the biggest defence budget in the world. However, defence outlay fell 25% from 2009 in nominal terms and 27% in constant price terms, although it should be noted that spending rose 7% in 2009 and 11% in 2008 as stimulus measures took effect and the demands of the military 'surge' in Iraq were felt. Defence expenditure equalled US$1,589 per head in 2010, and 3.4% of GDP, well above the 2% target recommended by NATO, the military alliance of which the US is the leading member, and accounted for 13.9% of government expenditure, considerably down from 18.8% in 2009 but still a high proportion for a developed country.

There are both upside and downside factors that could affect this outlook. Although for the time-being spending cuts remain in place, defence expenditure could still rise in the future if the US becomes embroiled in another overseas conflict, for example, with Iran or North Korea, although Washington would be loath to become involved in another bloody ground war abroad. Furthermore, a serious terrorist attack could lead to higher security spending and potential involvement abroad. If the US perceives China as

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becoming more belligerent, it might increase its military presence in East Asia, for example in South Korea and in the seas around, and perhaps in Central Asia.

Should the US economic recovery be reversed - a possibility that cannot be ruled out - there would be fewer resources to invest in the military. The US (and indeed much of the world) is arguably over-dependent on Chinese economic growth and China's willingness to buy US Treasuries and should these pillars of support prove fragile, the outcome for the US economy could be serious.

Impact On Procurement

Having enjoyed strong earnings in the period 2001-08, the large US defence companies were expected to be able to withstand a deceleration in government defence expenditure. These profits have helped to restore balance sheets and to improve company operations. Most notably in the US, the companies have a very varied customer base of several contract-awarding military services and intelligence agencies. Major programmes use a large number of diverse contractors, spreading the burden of cuts in the defence budget or programme delays to smaller firms - the ones that will suffer most.

A likely scenario as a result of the multi-year spending cuts is a shift in procurement towards unmanned systems. US-based Unmanned Aerial Vehicle (UAV) manufacturers - including General Atomics, Boeing or AeroVironment to name a few - are producing units that offer greater propulsion, endurance and larger payload capacities that increasingly include munitions. The greater uptake of UAVs seen in the US in recent years was largely driven by the more advanced sensors that these larger payloads can carry, enabling them to carry out intelligence, surveillance, reconnaissance, target acquisition and even attack missions that were previously confined to manned aircraft. Operating Northrop Grumman's Global Hawk UAV can cost more than US$200mn less a year than deploying Lockheed Martin's manned U-2. The confluence of technological advances in the UAV space, their markedly lower cost compared to manned aircraft and severe budget constraints is therefore serving as a boon for UAV manufactures.

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Defence Trade Balance


US Arms and Ammunition Trade Balance in US$mn and Percentage Change Year-on-Year 2,000

1,000

Notes: 1 "UN Comtrade/BMI calculation" 2 "UN Comtrade/BMI calculation"

Table: Defence Trade Balance (US$mn)

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010e 2011e 2012e 2013f 2014f 2015f 2016f 2017f Arms, ammunition trade balance US$mn Arms, ammunition trade balance, % change y-o-y 2010 2011 2,990.5 7.5 55.6 8.6 504.3 9.8 1,101.5 9.4 2012e 3,199.9 7.0 60.0 7.9 549.5 9.0 1,196.4 8.6 2013f 3,409.4 6.5 64.4 7.3 594.7 8.2 1,291.3 7.9 2014f 3,618.8 6.1 68.8 6.8 639.9 7.6 1,386.2 7.3 2015f 3,927.2 8.5 73.2 6.4 685.1 7.1 1,481.0 6.8 2016f

-1000

2017f

Arms and ammunition --- value % change y-o-y --- % world imports Military weapon imports excluding guns and swords --- value % change y-o-y --- % world imports Revolvers and pistols --- value % change y-o-y --- value % world imports Bombs, grenades, mines, missiles, ammunition --- value % change y-o-y

2,781.1 -2.6 0.0 51.2 21.5 0.0 459.1 -9.1 0.0 1,006.6 4.4

1,326.1 4,382.8 11.4 157.8 -3.3 -625.5 6.2 2,083.6 7.2 1,326.1 11.4 157.8 5.5 82.1 5.7 775.5 6.2 1,670.8 6.0

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Defence Trade Balance (US$mn) - Continued

2010 --- % world imports 0.0

2011 -

2012e -

2013f -

2014f -

2015f -

2016f -3.3

2017f -

Source: BMI/UN Comtrade

Imports
The significant technological lead enjoyed by US defence companies, plus the country's ability to manufacturer complex ground, air and sea systems essentially makes it, to all intents and purposes, selfsufficient when it comes to imports of defence materiel. As the Department of Defense can essentially source nearly all its defence requirements domestically, it has little need to look overseas for materiel. Allied to this is the fact that the Pentagon is under significant domestic pressure to ensure that its ''buys American''. There are some isolated examples of the Department of Defense purchasing nonAmerican equipment; the McDonnell Douglas/ Boeing AV-6B Harrier-II Vertical/Short-Take Off and Landing (V/STOL) aircraft which is based on the British Hawker Siddeley/BAE Systems Harrier V/STOL aircraft is one notably example, as is the new Eurocopter UH-72A Lakota utility helicopter which is equipping the United States Army and National Guard. Moreover, traditionally the United States Coast Guard has been a major consumer of foreign materiel.
Notes: 1 "UN Comtrade"
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010e 2011e 2012e 2013f 2014f 2015f 2016f 2017f 0 1,000 3,000 5,000

Upward Swing?
US Arms and Ammunition Imports US$mn

4,000

2,000

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Table: Defence Imports (US$mn)

2010 Arms and ammunition --- value % change y-o-y --- % world imports Military weapon imports excluding guns and swords --- value % change y-o-y --- % world imports Revolvers and pistols --- value % change y-o-y --- value % world imports Bombs, grenades, mines, missiles, ammunition --- value % change y-o-y --- % world imports 2,781.1 -2.6 0.0 51.2 21.5 0.0 459.1 -9.1 0.0 1,006.6 4.4 0.0

2011 2,990.5 7.5 55.6 8.6 504.3 9.8 1,101.5 9.4 -

2012e 3,199.9 7.0 60.0 7.9 549.5 9.0 1,196.4 8.6 -

2013f 3,409.4 6.5 64.4 7.3 594.7 8.2

2014f 3,618.8 6.1 68.8 6.8 639.9 7.6 -

2015f 3,927.2 8.5 73.2 6.4 685.1 7.1 1,481.0 6.8 -

2016f

2017f

4,155.0 4,382.8 5.8 5.5

77.6 6.0

82.1 5.7

730.3 6.6

775.5 6.2

1,291.3 7.9 -

1,386.2 7.3 -

1,575.9 6.4

1,670.8 6.0

Source: BMI/UN Comtrade

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Exports
The United States is a major exporter of military equipment. Its materiel is in high demand around the world, especially in the air domain where the United States has the rare distinction of being able to build large numbers of highly technologically sophisticated aircraft which are comparatively inexpensive to purchase. This is because of the sheer numbers of aircraft the United States purchases for its Army, Air Force, Navy, Marine Corps and Coast Guard. That said, whether this trend will continue into the future, given the spending cuts likely to take hold it the Pentagon in the future as sequestration (see above) takes hold. This will invariably result in reductions to the quantities of equipment that the Pentagon will purchase, possibly resulting in increased unit prices for equipment in the future. Another trend being observed as far as defence exports in the air domain are concerned is the trend for involving non-US defence companies in the development of complex weapons systems to save costs; witness the manufacturing programme for the forthcoming Lockheed Martin F-35A/B/C Lightning-II Joint Strike Fighter.
Notes: 1 "UN Comtrade"
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010e 2011e 2012e 2013f 2014f 2015f 2016f 2017f 1,000 4,000 3,000 2,000 7,000 6,000 5,000

In Demand
US Arms and Ammunition Exports in US$mn

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Table: Defence Exports (US$mn)

2010 Arms and ammunition --- value % change y-o-y Military weapon exports excluding guns and swords --- value % change y-o-y Revolver and pistol exports --- value % change y-o-y Bombs, grenades, mines, missiles, ammunition --- value % change y-o-y 3,448.4 0.4 241.4 8.6 54.6 -15.9 2,348.0 -6.3

2011 3,866.9 12.1 240.1 -0.5 65.2 19.4 2,616.9 11.5

2012e 4,088.9 5.7 239.5 -0.3 70.8 8.6 2,759.6 5.5

2013f 4,404.4 7.7 238.5 -0.4 78.8 11.3 2,962.3 7.3

2014f 4,749.8 7.8 237.5 -0.4 87.5 11.1 3,184.2 7.5

2015f 5,117.8 7.7 236.5 -0.4 95.8 9.5 3,425.0 7.6

2016f 5,481.2 7.1 235.4 -0.4 104.7 9.3 3,659.6 6.8

2017f 5,871.8 7.1 234.3 -0.5 114.3 9.1 3,911.7 6.9

Source: BMI/UN Comtrade

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Macroeconomic Forecasts
Macroeconomic Forecast
BMI View: We have downgraded our US real GDP growth forecast for 2013 to 2.1% from 2.3%, owing mainly to base effects from late 2012 and the decision to maintain the 'sequester' cuts to federal spending. Our core view on the US economy is that the recovery is becoming increasingly entrenched, and that by 2014 many of the headwinds to growth will be dissipating.

The near-term US economic outlook will be shaped in large part by fiscal retrenchment, above and beyond the 'fiscal cliff' deal reached in January that we wrote about in our previous economic activity update. The implementation of the 'sequester' spending cuts in March will amount to US$1.2trn over a decade, and more immediately, US$85bn in the 2013 fiscal year. BMI's core forecast was for about US$55bn in sequester reductions in 2013, which is half of the US$110bn originally scheduled, predicated upon a compromise to reduce the sequester impact (see our online service, March 6, 'Sequester Impact To Be Relatively Modest'). The final sequester figure is about US$30bn more than that assumption, which is about a 0.2-0.3% of GDP difference from our baseline. Added to poor base effects from weak growth in Q412 (just 0.4% quarter-onquarter annualised), we have revised down our real growth forecast for 2013 to 2.1% from 2.3%. Nonetheless, our core view remains the same, which is that US economic activity is likely to pick up as the year progresses, led by business and residential investment. Our 2014 growth forecast of 2.7% represents a major bounce from 2013 and is an upgrade from our previous projection of 2.5%.

Table: US - Growth Revisions (%)

2012 Old GDP Private Consumption Fixed Investment Government Consumption Exports Imports Inventories (% of GDP) 2.2 1.9 8.5 -0.8 3.3 3.0 0.3 2.3 2.2 8.1 -0.1 5.8 4.6 0.4

2013 New 2.1 2.2 6.8 -1.5 3.5 2.8 0.3 Old 2.5 2.3 5.7 0.7 5.1 5.0 0.4

2014 New 2.7 2.5 7.0 0.0 5.2 5.0 0.4

Source: BMI

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The spending cuts come at a bad but not necessarily a disastrous time. The tax increases that came into effect at the beginning of 2013 will take their toll, but we still believe that the economy is due to pick up steam in the second half of the year. That outlook is somewhat more restrained now that the sequester is in place, but an improvement in the private sector will very likely be more than enough to fend off downside risks to growth from the sequester. The spending reductions also are unlikely to come all at once, but it is unclear how they will be distributed over the course of the rest of the fiscal year, meaning the impact on economic growth as a whole is difficult to measure.

A Rising Tide
US - Real GDP & Components 3

2011

2012e

2013f

2014f

Real GDP growth, % change y-o-y Private final consumption, contrib. to real GDP growth (pp) Fixed capital formation, contrib. to real GDP growth (pp)

e/f = BMI estimate/forecast. Source: BEA, BMI

For now, the jury is still out, but we think that on balance, the data indicate an increasingly firm recovery, particularly within the private sector. Data in the opening months of 2013 have generally been positive, with the first really negative blip coming in the first week of April, when non-farm payroll jobs were estimated to have grown by only 88,000 in March, well below the average of 150,000 over the previous three months. The unemployment rate decreased to 7.6% from 7.7% in February, but only because of a sharp decline in the labour force participation rate to the lowest level since 1979.

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Employment Data Points To Flattening Growth


US - Non-Farm Payrolls & Real GDP Growth

Source: Macrobond, BLS, BMI

The ISM manufacturing purchasing managers' index indicated expansion in March at 51.3%, down from 54.2% in February. Taken together with the non-farm payroll figures, and a tick up in initial jobless claims, it is possible that we are seeing the first signs of the sequester spending cuts taking hold.

Then again, the economy's recovery appears to be increasingly cemented. For one thing, private credit markets - which collapsed in 2008 - have been healing slowly, and we have begun to see a consistent rise in year-on-year credit growth to households and businesses.

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Credit Market Continues To Heal


US - Credit Market Debt Outstanding By Sector, % chg y-o-y

Source: Federal Reserve, BMI

For another thing, we maintain our upbeat outlook on major cyclical sectors of the economy, such as residential investment, and increasingly believe that business investment will pick up as well. In the earliest stages of the recovery (2009-2010), our biggest reason for refuting the likelihood of a double-dip recession was that many key components of GDP were at or near such low levels that it was difficult to see how they would make significant negative contributions in future quarters. The accompanying chart shows the aggregate level of three key cyclical elements of GDP - equipment and software investment, durable goods consumption, and residential construction - as a percentage of GDP. Growth in these categories of GDP have typically helped lead the US out of recession, and have done so since 2009, rising from 16% of GDP to 18% as of Q412, around the lowest levels in the post-World War II period. The prospect of a continued rebound in these cyclical areas underpins our thesis for continued growth in residential construction and business investment as 2013 and 2014 proceed.

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Plenty of Room For Recovery


US - Cyclical Components Of GDP, % Of GDP

Note: Includes residential construction, business investment and consumer durables consumption. Source: BEA, BMI

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Consumption Holding Up Despite Headwinds


US - Private Consumption, % chg annualised, q-o-q & m-o-m

Source: Macrobond, BMI

Our forecast for improving yet below-trend consumption is predicated upon several factors. The increase in payroll tax beginning in 2013, which will take a US$1,000 chunk out of annual income for workers making the median annual income of around US$50,000, will be a headwind. However, recent data show that despite this decline, real disposable income has been rising slowly in year-on-year terms, and given the weak inflation picture in the US, we see potential for additional strength. Household balance sheets continue to recover following a steep contraction during the recession. While the total net worth of households and non-profit organisations remains below the pre-crisis peak of 2007, it has been growing very strongly in recent quarters. Furthermore, with interest rates set to remain low for the next few years, consumer credit growth could pick up further as the cost of borrowing remains low. Given the improved economic outlook, consumers will be more willing and able to take on credit, while banks, with improved cash buffers and increased stability, will be more willing to lend. Already, monthly consumption figures to February suggest that the Q113 figure could come in above 2.0% quarter-on-quarter annualised, which would be an improvement from 1.8% in Q412.

Fixed Investment: Owing largely to weak base effects from Q412, we have downgraded our 2013 real fixed investment growth projection to 6.8% from 8.1%. However, due to our belief that residential

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construction will remain strong and business investment will pick up following a period of major policy uncertainty, we have raised our 2014 investment forecast to 7.0%, from 5.7%. Core durable goods orders to March 2013 imply increasingly strong equipment and software investment going into 2013, following the contraction in Q312. We believe that with corporate profits around record levels, and with a significant amount of uncertainty now in the past following the fiscal cliff deal at the turn of the year, businesses will have an increasing propensity to invest.

Business Investment Likely To Pick Up


US - Core Durable Goods Orders & Real Business Investment

Source: Macrobond, BMI

The US residential construction sector returned to growth in 2012, with a 15.6% increase in spending driving 11% growth in overall construction spending. Housing starts and building permits have both hit multi-year highs, with February housing starts coming in at 917,000, the highest rate since mid-2008. Despite this, the sector remains significantly below trend, implying further upside over the medium term. With new order bookings from US homebuilders continuing to post strong growth, residential construction is likely to continue to support growth through 2013.

Net Exports: We have revised down our 2013 growth forecasts for exports and imports of goods and services, in large part due to base effects from 2012. Our 2013 export growth forecast is 3.5% (down from

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5.8% previously), and our import growth forecast is now 2.8% (down from 4.6% previously). That said, the changes mostly offset each other, and we now forecast net exports will make no contribution to real GDP growth, up slightly from our previous forecast for net exports to subtract 0.1 percentage points from real growth. However, these forecast revisions somewhat obscure the trends we see developing in the US economy. Our Shipping team highlights the increased throughput at the Port of Los Angeles in the first months of the year as evidence that both exports and imports are accelerating relative to last year. We expect these dynamics to persist throughout 2013 and into 2014 as a strengthening consumer boosts imports and the external environment gradually improves.

Trade Growth Is Strengthening


Port Of Los Angeles Container Throughput, % chg y-o-y (Jan-Feb 2012 & Jan-Feb 2013)

Source: Port Authority, BMI

Government Consumption: We have revised down our 2013 government consumption growth forecast to -1.5% from -0.1% previously, owing almost entirely to the implementation of the sequester spending cuts in March. It is entirely possible that the Republicans and Democrats come up with a compromise to push back some of the cuts, perhaps by rearranging some of them to ensure that some areas of spending are fully funded while keeping the overall reduction at current levels. Crucially, a government shutdown - which could have resulted from impasse over the 'continuing resolution' - has been averted by an agreement

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reached in March, meaning that from a federal standpoint at least, this year is likely to represent the trough for government consumption. From a state and local spending standpoint, we expect the worst is over and that the consistent drag on US growth from this category will flatten out as 2013 proceeds.

Table: UNITED STATES - GDP BY EXPENDITURE, REAL GROWTH %

2009 Real GDP growth, % change y-o-y 1 Private final consumption, real growth % y-o-y 1 Government final consumption, real growth % y-o-y 1 Fixed capital formation, real growth % y-o-y 1 Exports of goods and services, real growth % y-o-y 1 Imports of goods and services, real growth % y-o-y 1 Net exports of goods & services, real growth % y-o-y 1 -3.1 -1.9 3.7 -19.0 -9.1 -13.5 -28.2

2010 2.4 1.8 0.6 -0.2 11.1 12.5 18.2

2011 1.8 2.5 -3.1 6.6 6.7 4.8 -2.8

2012e 2.1 1.9 -0.8 8.5 3.4 2.4 -1.8

2013f 2.2 2.2 -1.5 6.5 3.5 2.8 -0.4

2014f 2.7 2.5 0.0 7.2 5.2 5.1 4.6

2015f 2.6 2.2 0.7 5.3 5.1 4.2 -0.1

2016f 2.4 2.0 0.5 5.3 5.0 4.0 -1.0

2017f 2.4 2.0 0.5 5.3 5.0 4.0 -1.3

Notes: e BMI estimates. f BMI forecasts. Sources: 1 BEA/BMI.

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Industry Risk Reward Ratings


Developed States Risk/Reward Ratings
Security Risk Analysis

Table: Developed States Security Risk Ratings (scores out of 100, with 100 the best)

Interstate risk Canada Australia United States Japan Germany UK France Italy Spain 97 98 91 88 100 95 96 98 97

Terrorism risk 90 83 90 92 82 75 77 78 65

Criminal risk 99 92 91 91 84 95 89 71 85

Composite domestic risk 94 88 90 91 83 85 83 75 75

Regional rank 1 2 3 4 5 6 7 8 9

Composite security rating 95 91 91 90 89 88 87 82 82

Ranking 1 2 3 4 5 6 7 8 9

The 'Composite security risk rating' is the main rating. It comprises 'Inter-state' - risk of becoming a primary party to an inter-state conflict that threatens significant damage to homeland; 'Terrorism' - risk of terrorist groups (domestic or international) being able to launch major attack/sustained campaign; and 'Criminal' - risk of (politically motivated) violence against expatriate workers. Each of the three has equal weighting. The 'Composite domestic security risk rating' comprises 'Terrorism' and 'Criminal', each of which has equal weighting. Each rating is assessed subjectively by our analysts in a clearly defined methodology, incorporating a minimum of six distinct elements. Source: BMI

BMI's Security Ratings service, which integrates closely with our Country Risk service, offers a comprehensive comparative analysis of security risk in three key areas - inter-state conflict, terrorism and physical safety for expatriate workers - across major states in each region. The ratings are combined to form a composite security rating to provide an overall guide to long-term trends and risks.

We integrate our short-term political and economic ratings with the terrorism rating, to indicate a state's vulnerability to a sustained terrorist campaign or major terrorist attack. In all instances, the rated period is two years, with each country assigned a score out of 100, with a low score indicating a high level of risk.

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Table: Developed States Vulnerability To Terrorism Index (scores out of 100, with 100 the best

Terrorism Canada Australia United States Japan Germany UK France Italy Spain 90 83 90 92 82 75 77 78 65

Short-term political 92 86 81 80 85 81 81 73 69

Short-term economic 72 71 70 65 73 68 68 67 57

Composite 86 81 83 82 80 75 76 74 64

Regional rank 1 2 3 4 5 6 7 8 9

Scores out of 100, with 100 the best; The 'State vulnerability to terrorism index (SVT)' is the principal rating. It comprises the 'Terrorism' and BMI's country risk 'Short-term political' and 'Short-term economic' ratings, which are given equal weighting. The SVT quantifies the exposure of a state to a successful major terrorist attack/campaign, evaluating first how likely one is (Terrorism) before considering the vulnerability of the political and economic environment to a sudden shock. As such, it incorporates subjective analysis of 15 conceptually separate analytical elements, as well as 13 separate objective data points. Source: BMI

United States Risk Ratings


The US has a low risk from becoming directly threatened by major international conflict. As such, its average risk rating for interstate conflict during the forecast period is 92. Its most recent award is 91. The country has sustained this figure since June 2011, when it fell one point from the 92 awarded in January 2011.

While the country has a low risk of involvement in international conflict, it has a correspondingly low risk from terrorist action. The United States' average terrorism risk rating during the forecast period is 85. Its most recent rating is 90, a figure which the country has sustained since March 2010.

Finally, the US also has a low risk regarding criminal activity. As such, its risk rating for criminal activity has averaged 84 over the forecast period, its latest figure being 91. This figure has been sustained by the US since February 2007.

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Market Overview
United States Defence Market Overview
Of significance to the near- and medium-term prospects for procurement and the defence industry is the core concept in the QDR (Quadrennial Defense Review) and defence budget that the former and current missions in Iraq and Afghanistan are open-ended, and are actually a model for future engagements.

Long delays in the US procurement system (contrasted with introduced measures in the United Kingdom to speed up the process) and shortfalls in funding for procurements increase costs. The product bought at the end is not necessarily of the same standard as it was when it began on the drawing board.

Some programmes have been cancelled, including Future Combat Systems Manned Ground Vehicles (MGV) for the Army, the VH-71 presidential helicopter, and CSAR-X search-and-rescue helicopter.

The MGVs were cancelled before production began because of their vulnerability to roadside IEDs - the main threat facing troops in the Afghan theatre. Military chiefs are said to have wanted to avoid spending extra funds on modifications to the MGVs to enable them to survive hits by IEDs.

Other sizeable weapons programmes are being cut back, such as the 'Zumwalt' class destroyer for the Navy. The USAF also originally wanted to buy up to 800 Lockheed Martin F-22A Raptor air superiority fighters, but this was cut to 442, then 381, and then cut again to just over 180, less than a quarter of the total sought when the programme began during the Cold War.

Armed Forces and Government Spending


Defence Decision Making

The President of the United States of America is the Commander-in-Chief of the country's armed forces. Administrative authority of the armed forces is exercised by the Secretary of Defence, who also acts as the principle defence advisor to the President.

The armed forces are commanded by the Joint Chiefs of Staff (JCS). The JSC is headed by a Chairman and Vice Chairman, who preside over the respective service chiefs. The Chairman and Vice Chairman also act as the senior military advisors to the President and to the National Security Council (NSC).

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The role of the NSC is to act as a forum in which national security issues which require a Presidential decision can be discussed. The NSC includes the President, Vice President, Secretary of State, and Secretary of Defence.

Alongside its military command, each of the United States' armed forces has its own Secretary, with the exception of the United States Marine Corps over which the Secretary of the Navy has jurisdiction, and the United States Coast Guard which falls under the responsibility of the Department of Homeland Security.

Grand Strategy

The most recent articulation of the United States grand strategy was the 2010 National Security Strategy Document, published in May of that year. The document specified the following focuses for US Strategy:

To ensure that the citizens of the United States, of its allies and of its partners are secure. To foster an open international economic system promoting opportunity and prosperity; ensure that US economy remains strong, innovative and growing. To respect values at home and abroad. To promote peace, security, opportunity and cooperation in the international arena. The 2010 National Security Strategy Document identified the country's security priorities as: Enhancing domestic security and resilience. To disrupt, degrade, dismantle and defeat al-Qaeda in Afghanistan, Pakistan and throughout the world. Counter the proliferation of weapons of mass destruction and to ensure that such weapons are secure. Promote peace and security in the Middle East. Invest in US international partnerships and alliances. Securing cyberspace.

To achieve these aims, the National Security Strategy Document called for:

A strengthening of the US military to ensure that it can meet these above commitments. The deterrence and prevention of threats to the United States, to its interests and to the security and interest of its allies around the world. Prepare the United States to meet contingencies perpetrated by state and non-state actors.

In addition to the 2010 National Security Strategy Document, the National Military Strategy published in February 2011 stipulates the methods by which the US military will advance the priorities outlined in the aforementioned document. The National Military Strategy states that:

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US military power is most effective when employed alongside other instruments of national power such as foreign policy via the so-called 'whole of nation' approach. That the US military will continue to counter violent extremism, deter aggression, strengthen international peace and security. The US will continue to maintain a nuclear deterrence as long as other weapons of mass destruction exist. The US armed forces will counter anti-access strategies and ensure the defence of space and cyberspace.

Both the key points of the National Military Strategy and the 2010 National Security Strategy Document were distilled into the publication Sustaining US Global Leadership Priorities For 21st Century Defence, published in January 2012. The document is intended to provide principles which will help to guide the development of the future US Joint Force 2020. The key points of the publication stipulate:

A renewed strategic emphasis towards the Asia-Pacific region. The ability of the US armed forces to maintain one large-scale regional operational deployment, while being able to protect and safeguard a second region from opportunistic aggression by inflicting unacceptable costs on an aggressor. The employment of non-military and military-to-military cooperation as a means of addressing instability.

Order of Battle

With a combined land, sea and air force of about 1.4mn active-duty personnel, the US armed forces are among the world's largest, and the US government spends more than any other country on defence, which has resulted in the worlds' most technologically sophisticated armed forces. In 2012 the total personnel strength of the US armed forces numbered 1,408,000 active personnel and 847,100 selected reservists and 464,900 National Guard members.

The US Army has 562,000 active members, 205,000 reservists and 358,000 National Guard members. The US Air Force has 332,200 active personnel, 71,400 reservists and 106,700 Air National Guard members. The US Navy has 325,700 active personnel, plus 66,200 reservists. The United States Marine Corps has 202,100 active members and 39,600 reservists. The United States Coast Guard has 38,100 active personnel and 20,000 reservists.

The main strategic change is that in the post-Cold War, post-9/11 age, US forces are involved in major expeditionary operations far from the country and beyond the traditional Cold War central European theatre of operations. This strategic shift has necessitated the procurement of increasing numbers and types of mobile equipment, and the establishment of new political alliances, most notably with countries in the

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former Soviet Union, primarily located in Central Asia, to secure basing for US forces close to their operational theatres, most notably Afghanistan.

United States Marine CorpsThe United States Marine Corps (USMC) has a personnel strength encompassing 202,100 active-duty members, plus 39,600 reservists. This latter figure is set to diminish to between 150,000 and 20,000 active and reserve members respectively by 2015.

Active and reserve personnel populate the three Marine Expeditionary Forces (MEFs) and four Marine Expeditionary Brigades (MEBs). These include the following formations and subunits:

11th Marine Expeditionary Unit (MEU) 13th MEU 15th MEU 22nd MEU 24th MEU 26th MEU 31st MEU 1st MEF 2nd MEF

3rd MEF 1st MEB 2nd MEB 3rd MED 4th MEB Reserve Force Three Marines Prepositioning Forces Marine Special Operations Command Marine Corps Africa (MARFORAF) Seven fighter-bomber squadrons Six all-weather fighter-bomber squadrons Seven attack squadrons Four EW squadrons

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Three transport squadrons One Presidential Transport Squadron Seven tilt-rotor squadrons Eight medium-lift helicopter squadrons Ten heavy lift helicopters squadrons Six light attack helicopter squadrons United States Coast GuardThe United States Coast Guard (USCG) is the smallest of America's armed forces, comprising 38,100 personnel and 20,000 reservists.

The USCG comprises 10 Districts; four of which fall under the control of the Commander Pacific Area, with six under the control of the Commander Atlantic Area. The composition of the USCG fleet is as follows:

12 'Hamilton' class high endurance cutters One 'Tamaroa' class medium endurance cutter One 'Storts' class medium endurance cutter 13 'Bear' class medium endurance cutters Three 'Diver' class medium endurance cutters 16 'Reliance' class medium endurance cutters 40 'Island' class patrol boats Three 'Seabird' class patrol boats Five 'Cyclone' class patrol boats Two 'Polar' class icebreakers One training cutter 40 Sea-going buoy tenders 40 river, inland and construction buoy tenders. Nine icebreaking tugs 15 medium and small harbour tugs 2,000 boats of under 20m length. 13 HC-144A Maritime Patrol/Search and Rescue (MP/SAR) aircraft 41 HC-130 MP/SAR aircraft

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Nine HU-25C MP/SAR aircraft. 103 HH-65A/C rotorcraft 32 HH-60J rotorcraft An unknown number of VC-11, VC-4, E-2C and RG-8A platforms Four land-based aerostats

Defence Modernisation

United States Army

The United States Army is currently involved in the following modernisation programmes:

Order of battle

Brigade Structure Introduction: By late 2013, the US Army will have completed its shift from a divisionbased structure to a brigade-orientated force. This is intended to yield operational formations which are easier to deploy, and which can perform all-arms battle more readily than larger division-sized units. Brigade Combat Teams (BCTs) will be reorganised into Heavy, Infantry, Airborne/Air Assault, Mountain, Infantry and Stryker formations and the Battalion structures of the BCTs will be retained. Joint Task Force: The deployment of one Army-sized component in each US geographical joint command. The headquarters element of this component will be capable of commanding a Joint Task Force (JTF) or a Joint Forces Land Component Command (JFLCC). Corps- and division-sized headquarters will remain numbering between 800-1,000 personnel. They will be capable of assuming the command of a JTF or JFLCC.

Equipment

Armoured Personnel Carrier/Infantry Fighting Vehicle

Armoured Multi-Purpose Vehicle (ARMV): The APMV programme will procure a replacement to the BAE Systems M113 family of armoured personnel carriers in five variants specifically a command and control vehicle, two ambulance variants, a general purpose vehicle and a mortar carrier. The unit cost of each vehicle will be capped at US$1.8mn. The APMV programme may call for up to 3,800 vehicles to be purchased. BAE Systems are expected to offer a version of the firm's Bradley Infantry Fighting Vehicle (IFV) for the requirement, with General Dynamics scheduled to offer both wheeled and tracked versions of its Stryker IFV. The ARMV programme is focused on procuring an existing vehicle, rather than designing a new platform. Joint Light Tactical Vehicle (JLTV): The JLTV initiative involves the US Army and the US Marine Corps in the procurement of circa 55,000 vehicles to equip the two servics. Four companies have been downselected to develop 22 prototype vehicles namely Lockheed Martin, AM General, Oshkosh and Hardwire. The army will acquire 49,000 of the vehicles with the Marine Corps obtaining 5,500. The JLTV is being procured as a replacement for the AM General High Mobility Multipurpose Wheeled Vehicle, better known as the HUMVEE. In early May 2013, it was reported that the JLTV initiative could

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experience delays to its testing schedule which could see this being moved back by four months. The potential delay to the testing programme is thought to be the result of budget cuts currently being experienced by the Pentagon. This could see a delay to the original plans to award a contract for low-rate initial production in circa 2015.

Mine Resistant-Ambush Protected (MRAP) vehicles: The US Army is taking delivery of up to 6,219 MRAP platforms. Ground Combat Vehicle (GCV): The US Army's ground combat vehicle programme is designed to provide a new tracked or wheeled platform to replace the force's existing M2 Bradley infantry fighting vehicles. Both BAE Systems and General Dynamics are pursuing development work on the initiative, with the final go-ahead for the programme expected to be given in circa-2019.

Artillery

M-109PIM Upgrade: The US Army is upgrading 580 M-109A6 self-propelled howitzers to M-109PIM (Paladin Integrated Management) configuration. M224A1: The US Army is taking delivery of the M224A1 lightweight 60mm mortar to replace the legacy M244 design. Ground-Based Air Defence MIM-104F PAC-3 Upgrade: The US Army is upgrading all of its MIM-104 Patriot medium/high altitude surface-to-air missile systems to MIM-104F PAC-3 (Patriot Advanced Capability-3) status.

Command and Control

Joint Tactical Radio System (JTRS): The JTRS programme is an ambitious US Department of Defense (DoD) undertaking to roll out new fixed site, vehicular, manpack and handheld radios across the US Army, air force, navy and Marine Corps. The systems being procured include General Dynamics AN/ PRC-155 manpack systems.

Aviation

AN-64A Upgrade: A redelivery of 621 AH-64A Apache helicopter gunships upgraded to the AN-64D Longbow Apache configuration is ongoing. Armed Aerial Scout: This programme covers the eventual replacement of the OH-58D Kiowa Warrior armed reconnaissance and scout helicopter with a new rotorcraft. It is not thought that the US Army will decide to move ahead with the aircraft's replacement before the end of 2013. CH-47F: The US Army is acquiring 391 CH-47F Chinook heavylift helicopters which includes the delivery of 61 CH-47G Chinook special forces heavylift helicopters. OH-58D Upgrade: The US Army is upgrading its OH-58D Kiowa reconnaissance helicopters to OH-58F status. The first upgraded aircraft performed its maiden flight on 26th April 2013. The upgrade adds new optronics, avionics and a new cockpit, together with improvements to the aircraft's survivability. Low rate initial production of the OH-58F is expected to commence in 2015, with deliveries then commencing in 2016. The US Army is expected to take delivery of up to 368 upgraded OH-58Fs. UH-60M: The force is procuring additional UH-60M Black Hawk medium lift helicopters.

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UH-72A: The US Army is taking delivery of 345 UH-72A Lakota light utility helicopters. EMARSS: The Enhanced Medium Altitude Reconnaissance and Surveillance System (EMARSS) will replace the US Army's Hawker Beechraft RC-12 turboprop intelligence, surveillance and reconnaissance aircraft. Boeing is the prime contractor on the programme and will deliver the first fully-equipped airframe in September 2013. Four prototype aircraft are being built by the company. JMR-TD: The Joint Multi-Role Technology Demonstrator (JMR-TD) helicopter programme is intended to eventually replace the UH-60 Black Hawk series of utility helicopters, and possibly the AH-64 Apache family of attack helicopters in the 2030 timeframe. Bell and a joint Sikorsky/Boeing team are involved in the AVX programme. Bell is offering its V-280 Valor tilt-rotor design to fulfil the requirement. Sikorsky and Boeing are offering a design based on the former company's X2 compound helicopter design. Prototype contracts for the JMR-TD programme are expected to be launched in September 2013, which maiden flights following in 2017.

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Air Force

The United States Air Force is currently involved in the following modernisation programmes:

Combat aircraft

F-16A/B/C/D Upgrade: The USAF is expected to commence the upgrade of its existing legacy F-16A/B/ C/D multirole combat aircraft with a new electronic warfare system, radar and structural enhancements to continue the aircraft in air force service prior to the arrival of the F-35A (see above). F-35A Lightning-II Joint Strike Fighter: Several hundred F-35A Lightning-II Joint Strike Fighter (JSF) multirole combat aircraft will be supplied to the United States Air Force under the terms of what is, to date, the largest defence procurement programme in history. In addition, the United States Navy and the United States Marine Corps (USMC) will receive JSFs in the form of the F-34B Short-Take Off/Vertical Landing (STOVL) for the USMC and the F-35C catapult-launched and arrested recovery aircraft for the USN. The USMC is expected to take delivery of up to 340 F-35Bs with the navy receiving 480 F-35Cs. B-2A Spirit: The USAF is planning a major modification of its Northrop Grumman B-2A Spirit stealth bombers. The upgrade will improve the aircraft's communications and targeting systems, while reducing its maintenance burden. New weapons may also be integrated onto the aircraft. Long Range Strike Bomber (LRS-B): The United States Air Force LRS-B programme will outfit the service with a new bomber to replace the existing Northrop Grumman B-2A Spirit and Boeing/Rockwell International B-1B Lancer strategic bombers. So far, development funds for the LRS-B are forecast at around US$6.3bn, although the entire cost of the aircraft could be in the region of US$60bn. The aircraft is scheduled to enter operational service in circa 2025.

Helicopter

Combat Rescue Helicopter (CRH) Programme: The United States Air Force has an outstanding requirement for up to 112 new helicopters to replace the Sikorsky HH-60 Pave Hawk helicopters which perform the Combat Search And Rescue (CSAR) mission. The value of the contract is capped at US $6.8mn. The award of the CRH contract is expected by the end of 2013.

Tanker

KC-46A: The US Air Force is taking delivery of up to 179 KC-46A tankers under the terms of the service's KCX programme. A second tanker acquisition is expected to be launched in the future as part of the KCY initiative. Boeing expects to commence the construction of the first aircraft in 2013, with the first flight of the type to occur in 2015. The first operational aircraft will be delivered in 2016.

Transport

C-5A Galaxy Upgrade: 52 of the USAF's C-5A strategic freighters are being upgraded to the C-5M modernisation. C-130J Hercules: The USAF is taking delivery of 80 C-130J Hercules turboprop freighters.

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Special Missions

HC-130J: The USAF Special Operations force is taking delivery of eleven HC-130J Combat King special operations turboprop freighters. These aircraft are utilised for the covert infiltration, exfiltration and support of special forces commandoes.

Rotorcraft

CV-22B Osprey: The USAF is taking delivery of 50 CV-22B Osprey tilt-rotors and retaining options on an additional 26 aircraft. These platforms are being acquired to support special operations missions and are outfitted with a terrain-following radar and additional fuel tanks to extend their range and payload.

Unmanned Aerial Vehicle

RQ-4B Global Hawk Unmanned Aerial Vehicle: The US Air Force is involved in the acquisition of 66 RQ-4B Global Hawk Unmanned Aerial Vehicles (UAVs). MQ-9 Reaper UAV: Up to 288 MQ-9 Reaper Medium-Altitude Long-Endurance (MALE) UAVs are being acquired by the US Air Force.

Electronic Warfare

MALD-J: The USAF is ordering Miniature Air Launched Decoy-Jammer (MALD-J) aircraft selfprotection systems from manufacturer Raytheon. A total of 202 of the MALD-J systems are expected to be delivered at a cost of US$81mn. Deliveries are expected to commence in the 2015/16 timeframe.

United States Navy

The United States Air Force is currently involved in the following modernisation programmes:

Aircraft Carrier

'Gerald Ford' class: Two 'Gerald ford' class aircraft carriers are being constructed for the US Navy. The first ship in the class will be named the USS Gerald R. Ford. It will be followed by the USS John F. Kennedy. A third, as yet unmanned, vessel is also planned.

Surface Combatants

'Freedom' class: Six 'Freedom' class Littoral Combat Ships (LCS) will be delivered to the US Navy. So far, a single example, the USS Freedom, has been commissioned, a second, the USS Fort Worth, is undertaking trials with the USS Milwaukee, USS Detroit, USS Little Rock and USS Sioux City all under construction. A further ten examples may be purchased in the future. 'Independence' class: Alongside the 'Freedom' class (see above), the US Navy is taking delivery of six 'Independence' class Littoral Combat Ships (LCS). The first ship in the series, the USS Independence, has been delivered, with the USS Coronado under construction, and a further four examples planned; the

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United States Defence & Security Report Q3 2013 USS Jackson, USS Montgomery, USS Gabrielle Giffords and USS Omaha. Beyond these vessels, the US Navy may take delivery of a further six 'Independence' class vessels.

'Zumwalt' class: The US Navy is taking delivery of two 'Zumwalt' class destroyers, in addition to the lead ship, the USS Zumwalt, which has already been delivered. The two ships will be named USS Michael Monsoor and USS Lyndon B. Johnson. 'Arleigh-Burke' class: The navy has ordered nine DDG-51 'Arleigh Burke' class destroyers and has options for a tenth ship. These are being constructed by General Dynamics and Huntington Ingalls. Each company will build one ship each between 2015 and 2017. In addition, two destroyers are already under construction.

Amphibious Support

'America' class: Four 'America' class amphibious support vessels are being acquired by the US Navy. The first example will commence construction in 2013, with a further four vessels planned. 'Spearhead' class: Ten 'Spearhead' class Joint High Speed Support vessels are being purchased by the US Navy. So far, the USNS Spearhead has been completed, with the USNS Choctaw and USNS Millinocket under construction, with the USNS Fall River and USNS Resolute planned. LX(R) Amphibious Support Ship Requirement: The US Navy has a requirement to replace its existing fleet of Landing Ship Docks (LSDs) with a new amphibious support ship known as the LX(R). The first of eleven of these new vessels will be ordered in 2019 with a design based closely upon the navy's existing 'Whidbey Island' and 'Harper's Ferry' class amphibious support ships. Mobile Landing Platform: The US Navy is procuring the Mobile Landing Platform (MLP). The MLP is designed to carry personnel, equipment, vehicles and small craft as a key part of the US Navy's Sea Basing concept. 'San Antonio' class: The US Navy is acquiring eleven 'San Antonio' class Landing Platform Dock ships. So far, the USS San Antonio has been delivered, along with the USS New Orleans, USS Mesa Verde, USS Green Bay, USS New York and USS San Diego. The USS Anchorage, USS Arlington, USS Somerset and USS John P. Murtha under construction, with long lead time items being purchased for an additional, as yet unnamed, ship.

Submarine

'Ohio' class: The US Navy is currently planning the eventual replacement of its 'Ohio' class nuclearpowered ballistic missile submarines (SSBN) with a new class of SSBN. 'Virginia' class: A number of 'Virginia' class nuclear-powered attack submarines are expected to enter service with the US Navy. These include the USS Minnesota which is expected to be commissioned in 2015, the USS North Dakota scheduled for delivery in 2014 with the USS John Warner to be delivered a year later. Construction is ongoing of the USS Illinois and the USS Washington. Several additional boats are planned including the USS Colorado, USS Indiana, USS South Dakota and USS Delaware. An addition ten as yet unnamed boats will be procured under the 'Virginia' class Block IV programme, scheduled to commence in 2014, with a further four Block V boats to be procured after this date.

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Aviation

Broad Area Maritime Surveillance (BAMS) programme. The US Navy is advancing the BAMS programme which will see the procurement of MQ-4C Triton Unmanned Aerial Vehicles to perform long-range, wide-area maritime patrol. C-2A Greyhound Replacement: The US Navy is contemplating the replacement of its Northrop Grumman C-2A Greyhound carrier-on board delivery aircraft. Bell-Boeing is promoting the CV-22 Osprey tiltrotor for this role. Northrop Grumman, meanwhile, is promoting a modernised version of its C-2A aircraft. The navy could issue a request for proposals in 2014. E-2D Advanced Hawkeye Upgrade: The US Navy is purchasing four AN/APY-9 Airborne Early Warning (AEW) radars to equip E-2D Advanced Hawkeye Airborne Early Warning aircraft. E/A-18G: 114 E/A-18G Growler electronic warfare aircraft are being delivered to the US Navy to perform electronic warfare and suppression/destruction of enemy air defence missions. F/A-18E/F: The US Navy is currently taking delivery of up to 515 F/A-18E/F Super Hornet Multi-Role Combat Aircraft (MRCA). F-35C Lightning-II Joint Strike Fighter: The US Navy will be supplied with up to 260 F-35C LightningII Joint Strike Fighter multi-role combat aircraft (see above) MH-60R/S: Deliveries to the US Navy are underway of 300 MH-60R and 145 MH-60S maritime support helicopters. P-8A Poseidon: The US Navy is taking delivery of an initial seven P-8A Poseidon Maritime Patrol Aircraft (MPA) which will eventually replace the service's P-3 Orion family of MPAs. T-6A Texan-II: Several T-6A Texan-II turboprop aircraft are being delivered to the US Navy to support pilot training. Unmanned Combat Aerial Vehicle: The US Navy plans an eventual procurement of a an aircraft carrierbased Unmanned Combat Aerial Vehicle. MQ-8C: The US Navy is acquiring up to 30 MQ-8C Fire Scout unmanned aerial vehicles following the award to the aircraft's manufacturers Northrop Grumman in 2012. The initial operating capability for the aircraft is expected to be reached by late 2014. MQ-4C: Plans are afoot for the US Navy to purchase up to 65 MQ-4C long-range surveillance Ummanned Aerial Vehicles from Northrop Grumman. RQ-21A: The US Navy is also procuring the RQ-21A Unmanned Aerial Vehicle to support US Special Forces missions. A total of five RQ-21A Systems will be obtained, each of which includes five aircraft and a ground control station. VXX: The US Navy has released a Request for Proposals regarding a new Presidential helicopter, known as the VXX, to replace the Sikorsky VH-3D and VH-60N helicopters which are currently used in this role. AgustaWestland is expected to offer its AW101 medium-lift helicopter design, with Sikorsky offering the S-92 and Bell-Boeing promoting the V-22 Osprey tilt-rotor. The successful bidder will be expected to deliver nine low-rate initial production aircraft, six developmental helicopters and eight production aircraft over an eight-year period.

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United States Marine Corps

The US Marine Corps is engaged in the following procurement programmes:

The delivery of 310 LAV-C2A2 wheeled armoured fighting vehicles. The acquisition of the Joint Land Tactical Vehicle (alongside the US Marine Corps). The supply of the Internally Transportable Vehicle. The purchase of 45 HIMARS artillery rocket launchers. The acquisition of a new amphibious armoured vehicle. The supply of 420 F-35B/C Lightning-II Joint Strike Fighters. The delivery of 360 MV-22 Osprey tiltrotors. The acquisition of 123 UH-1Y Venom medium-lift helicopters. The supply of 226 AN-1Z Viper gunships. The supply of 156 CH-53K heavylift rotorcraft. The first flight of this aircraft is expected to occur in 2014, with low-rate initial production commencing in 2015, and full production in 2022 at the latest.

United States Coast Guard

The US Coast Guard is engaged in the following procurement programmes:

The procurement of eight 'Bertholf' class National Security Cutters. The delivery of 25 Offshore Patrol Cutters The acquisition of 58 'Bernard C. Weber' class Fast Response Cutters.

The delivery of 34 HC-144A fixed-wing maritime patrol/search and rescue aircraft.

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International Deployment and Joint Exercises

The United States, along with its NATO partners deployed in Afghanistan, is looking ahead to the eventual withdrawal of the bulk of its forces from the troubled country, which is expected to begin in 2014/2015. The prevailing strategy of NATO is to hand over an increasingly large share of the internal security burden to the Afghan National Army and Police force, as NATO begins to draw down its forces. This is intended to facilitate a relatively smooth exit from the country without a corresponding increase in Taliban violence. Prior to the expected withdrawal of NATO forces in the 2014/15 timeframe, American and British troops will reduce their lead combat roll from 2013.

The relationship between the administration of President Barack Obama, and the government of Afghan President Hamid Karzai is increasingly strained, and arguably characterised by profound distrust on both sides. Karzai has been unhappy with the level of force that NATO has employed during its campaign against the Taliban, particularly when Afghan civilians have been killed and injured as a result of NATO actions. For its part, Washington is said to believe that Karzai is corrupt and ineffective. Relations were further soured on March 11 2012 following a massacre of 16 Afghans, including nine Afghan children, after a US Army sergeant went on a killing spree outside the southern Afghan city of Kandahar. The murders occurred just weeks after several copies of the Qur'an were inadvertently burned in a rubbish pit, and the emergence of videos showing American soldiers urinating on the corpses of Taliban fighters. These incidents, excluding the Qur'an burnings, which appear to be accidental, maybe indicative of a growing frustration in some isolated quarters of the US military that the overall campaign against the Taliban is losing momentum and handing the initiative to the enemy. Moreover, support for America's continual involvement in the conflict appears to be ebbing. A poll for the Washington Post, taken in March noted that 54% of Americans want US forces immediately withdrawn from the country, regardless of Afghanistan's internal security.

The occasionally difficult relationship existing between the United States and Afghanistan experienced strain towards late February 2012 when Afghan President Hamid Karzai asked US special forces to leave Wardak province, south of the Afghan capital Kabul. Karzai's rhetoric against the US-led International Security Assistance Force has become increasingly bellicose throughout early 2013, as the NATO operation winds down ahead of the withdrawal of the bulk of the combat forces present in the country in circa-2014/15.

In February 2012, during President Obama's State of the Union address, he stated that 34,000 of the 68,000 American personnel in Afghanistan will leave the country by the end of 2014. Obama had planned to reduce

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troop figures more drastically in 2013, although this has in effect now been postponed for a year. Some political figures in the United States have criticised the president's actions arguing reducing the troop levels sooner would place more of an emphasis on Afghan army and police units absorbing more of the country's security burden.

Away from Afghanistan, the size of the United States Army's deployment to Europe will reduce to 30,000 by 2015; the lowest figure since the end of the Second World War. The force will retain a rotation of brigades to bolster NATO's rapid reaction capabilities, with a planned to rotations per year to this end. Some units will be moved from Germany to Italy, while the 10th Special Forces Group will be deployed to Europe to provide a rapid reaction capability for Africa Command (ARFICOM) which is headquartered in Germany.

In January 2013, the United States announced that it was supporting French-led military efforts to rid northern regions of the West African country of Mali of Islamist elements that have taken control of this territory. To this end, the United States Air Force is supplying refuelling aircraft and intelligence, surveillance and reconnaissance assistance to the French operation.

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Table: Foreign Deployments

Country Afghanistan

Strength 109,200

Mission To defeat the Taliban and other insurgents, to bolster the Afghan army and police to give the country its own capabilities. Combat mission in towns and cities concluded.

Iraq

49,700

Maintain and support government and democratic processes. Remaining troops until 2012 will train, advise and equip Iraqi forces, support civilian operations, and conduct counterterrorism (CT) operations. Some combat expected for CT missions.

US and US territories North Africa, Near East and South Asia Europe

1,113,207 In Africa, peacekeeping within US AFRICOM, CT operations, training of force. 5,800 Enhanced intelligence and counterterrorism assistance to raids on al-Qaeda based in Yemen, including US-sponsored and directed air raids on AQAP camps. Within NATO, trains for, conducts and supports training and contingency operations. Japan: US-Japan alliance main focus of security role in East Asia. 53,000 US troops are stationed in Japan to provide bulwark against China and North Korea. Korea: 30,000 US troops stationed on edge of Demilitarised Zone to deter North Korean invasion of South.

82,460

East Asia and Pacific

68,812

High alert May 2009 over North Korean nuclear and missile tests and threats to South Korean ships. Mission includes naval searches of North Korean ships under Proliferation Security Initiative. Joint military exercises in Pacific.

Sub-Saharan Africa

2,082

Peacekeeping within AFRICOM, CT operations, training of forces.

Source: BMI; US Department of Defense (active duty military personnel strengths by regional area and by country (309a) September 30 2008); Figures for Iraq and Afghanistan from US press reports.

The Department of Defense must reduce its budget by US$46bn by September under a process known as sequestration as enshrined by the 2011 Budget Control Act. This figure amounts to around 10% of the Pentagon's budget, although military personnel funding are exempt from the reductions. However, the costs of ongoing military operations are included in the reductions. This is causing particular anxiety as the funding required for combat operations in Afghanistan is higher in 2013 than for the previous year due to Pakistan authorities levying an increased transit costs for US military supplies crossing their territory, and an increased tempo in combat operations.

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These cuts will have an impact across the board. In early March 2012, it was announced that the Pentagon could see a reduction of US$35bn in its operations and maintenance budget as a result of the reductions. The DoD is currently operating under what is known as Continuing Resolution (CR) under which its funding has been frozen at 2012 levels. As well as affecting the operations and maintenance budget, the reductions have caused the cessation of all army training, with the exception of units heading to Afghansitan, the air force has ceased training for non-deploying squadrons with the navy grounding four aviation wings. Up to 2,500 procurement programmes will be affected by the US$46bn cut, although military units tasked with the nuclear deterrence mission will be except.

In particular, to save funds, the navy plans to reduce some ship deployments, and to return other vessels to their home ports. Some procurement programmes may also be slowed, including the purchase of new submarines, and aircraft carriers, along with the deferral of several maintenance, overhaul and upgrade initiatives. Furthermore, the navy has also downsized the Carrier Battle Group presence in the Persian Gulft from two to one. The air force, meanwhile has delayed elements of the Lockheed Martin F-35 Lightning-II Joint Strike Fighter multi-role combat aircraft, Space-Based Infra-Red System satellite programme and the Lockheed Martin AC-130J gunship acquisition. The army has expressed concerns that a time-lag will threaten programmes which are stopped and have to be subsequently restarted as a result of sequestration, and also the possibility of having to renegotiate contracts which could also cause programme costs to increase.

In the middle of March 2012, the Pentagon commenced a strategy review vis-a-vis how these anticipated spending reductions could affect current and future US military operations.

Notably, the review will take the planning assumptions of the 2011 Defense Strategy Guidance and examine the extent to which these still can be performed in light of the US$46bn cut, and planned cutbacks of up to US$487bn over the next decade. Once drafted, the review will act as the foundation for the next Quadrennial Defence Review which is expected in February 2014.

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Industry Trends and Developments


Procurement Trends and Developments

Army

Aviation

CH-47F: Boeing has been awarded a contract to supply 177 additional CH-47F Chinook heavylift helicopters. The deal is worth up to US$4bn to the company and goes some way to achieving the 464 CH-47F airframes which the US Army wishes to procure. Deliveries will commence in 2015.

Air Force

Combat Aircraft

F-35A Lightning-II: In late May 2013 it was reported that the US Air Force will receive its first Lockheed Martin F-35A Lightning-II Joint Strike Fighter in December 2016.

Navy

Combat Aircraft

F-35C Lightning-II: In late May 2013 it was reported that the US Navy will receive its first Lockheed Martin F-35C Lightning-II Joint Strike Fighter in February 2019.

Marine Corps

Combat Aircraft

F-35B Lightning-II: In late May 2013 it was reported that the US Marine Corps will receive its first Lockheed Martin F-35A Lightning-II Joint Strike Fighter in December 2015.

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Q113

Army

Armoured Personnel Carriers/Infantry Fighting Vehicles

Armoured Multi-Purpose Vehicle (ARMV): The US Army has released a draft Request for Proposals (RfP) for its ARMV programme. A final RfP is expected to be published by the end of 2013. Both BAE Systems and General Dynamics are strongly expected to offer bids for the ARMV contract.

Modernized Expanded Capacity Vehicle (MECV) Modernisation: A programme has been launched by the US Army to modernise its High Mobility Wheeled Multipurpose Vehicle (HUMVEE) wheeled multipurpose vehicles. The programme is aimed at improving the vehicles' survivability, and is expected to be rolled across 60,000 HUMVEEs.

Command and Control

Joint Tactical Radio System (JTRS): General Dynamics has been awarded a contract worth US$250mn for the supply of 3,726 AN/PRC-155 Manpack radios as part of the JTRS programme. These radios will begin equipping US Army units from 2013.

Air Force

Helicopter

Combat Rescue Helicopter Programme: The United States Air Force has reissued a Request for Proposals (RfP) regarding the procurement of helicopters to perform the Combat Search And Rescue (CSAR) mission. The issue of the RfP represents a revitalisation of an earlier competition to procure replacement aircraft for the Sikorsky HH-60 Pave Hawk helicopters used in this role. Bids are expected to be offered from a number of teams including Lockheed Martin and Sikorsky, AgustaWestland and Northrop Grumman, Eurocopter and Boeing.

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Navy

Amphibious Support

'San Antonio' class: The US Navy has taken delivery of the USS Anchorage, the latest vessel in the 'San Antonio' class of amphibious support ships. She will be commissioned by mid-2013.

Weapons of Mass Destruction

The US possesses around 5,000 nuclear warheads. This includes an inventory of around 2,150 operational nuclear warheads, comprising 1,950, which equip 798 strategic delivery systems, and 200 non-strategic freefall B61 family nuclear bombs deployed to Europe, and made available to NATO. These 2,850 operational nuclear warheads are supplemented by a further 2,850 strategic nuclear warheads kept in reserve. In addition around 3,500 warheads have been struck off the US armed forces inventory and are awaiting dismantling.

In terms of the country's strategic nuclear forces, around 420 Intercontinental Ballistic Missiles (ICBMs) are deployed, each of which carries a single warhead. All of these weapons are LGM-30 Minuteman-III ICBMs. These weapons are deployed in silos at FE Warren Air Force Base (AFB), Wyoming; Malmstrom AFB, Montana; and Minot AFB, North Dakota. Each of these weapons carries a single W87 warhead believed to have a yield of up to 475 kilotons. The at-sea strategic nuclear deterrent includes up to 336 UGM-133 Trident-II/D5 missiles equipped with a total of 1,747 warheads. Each missile can accommodate between four and eight warheads, which can either include 100 kiloton W76 or 300-450 kiloton W88 warheads. These missiles are carried on 14 Ohio class nuclear ballistic missile submarines (SSBNs).

Finally, the air launched component of the US nuclear triad includes B61 and B83 family freefall nuclear bombs that equip 20 B-2A Spirit and 74 B-52H Stratofortress strategic bombers. The New START (Strategic Arms Reduction Treaty) agreement signed by Russia and the US on April 8 2010 calls for the US to reduce its strategic nuclear weapons stockpile. These reductions will see the country maintaining the present inventory of 420 LGM-30 Minuteman-III ICBMs, reducing the fleet of 94 strategic bombers to 60 aircraft, with the balance of 34 airframes being converted to conventional missions. The fleet of 14 Ohio class SSBNs will be maintained, although each boat will accommodate 20 UGM-113 Trident-II/D5 missiles, rather than the 24 that they currently accommodate. The four launch tubes on the boats no longer required for the additional missiles will be permanently disabled.

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There are no standing chemical weapons (CW) or biological weapons (BW) programmes in the US. The original CW facilities have been dismantled and the arsenals are being disposed of at various locations. BW expertise remains within the existing research and development (R&D) facilities, such as USAMRIID at Fort Detrick, in order to produce medical countermeasures (drugs, vaccines, antidotes) to bioterrorist-related diseases.

On September 18 2009 President Obama suspended several elements of the multibillion-dollar, 'son of Star Wars' ballistic missile programme (BMD) orchestrated by the Bush administration as a protective 'shield' against missiles launched by nations that could threaten the continental US, its allies, and overseas interests.

Nevertheless, President Obama's decision did not see the US completely abandoning Ballistic Missile Defence (BMD) initiatives. The Missile Defence Agency (MDA), which is part of the US DoD, continues to pursue a number of efforts aimed at enhancing BMD efforts. The agency's mission is to 'develop, test and prepare for deployment of a missile defence system. Using complementary interceptors, land-, sea-, air- and space-based sensors, and battle management command and control systems.'

The efforts of the MDA are divided into several strands, according to the 'phase' of a missile's trajectory. These include efforts to intercept ballistic missiles during the boost phase of their trajectory, ie between the missiles' launch before it reaches an altitude of around 200km such as the Network Centric Airborne Defense Element (NCADE). Raytheon was awarded a contract worth US$10mn on September 18 2008 to develop an air-to-air weapon, which would use technology developed for the company's AIM-120 Advanced Medium-Range Air-to-Air Missile that would intercept a ballistic missile with a hit-to-kill warhead.

The MDA is also examining efforts to intercept a ballistic missile during its ascent phase, which follows the missile's attainment of an altitude of around 200km, before it reaches its mid-course. Details regarding the research and development efforts vis--vis ascent phase missile defence remain classified. More information is available regarding the efforts the MDA is pursuing for ballistic missile interception in the mid-course phase. The mid-course phase follows the ascent phase, prior to the missile's warhead re-entering the atmosphere. Three distinct programmes are continuing in this regard, notably the Ground-Based Midcourse Defence initiative. This is developing a ground-based Surface-to-Air Missile (SAM) interceptor armed with a hit-to-kill Exoatmospheric Kill Vehicle (EKV). Fire control for the missile is provided by the systems' Battle Management Command, Control and Communications (BMC3) system. Acquisition of incoming ballistic missiles is performed using PAVE PAWS early warning radars, of which three are maintained in an operational condition on the east and west coasts of the Continental United States. These radars hand off

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information regarding the incoming ballistic missiles to Ground Based Radars, which guide the Ground Based Interceptor SAMs to their targets. Ground Based Interceptor bases are located at Vandenburg AFB, California, and Fort Greely, Alaska.

Additional mid-course missile defence projects include the Aegis BMD (Ballistic Missile Defence) Combat Management System, which equips five US Navy Ticonderoga class cruisers and 16 Arleigh Burke class destroyers. The Aegis BMD CMS is used to provide target acquisition and fire control for the Raytheon RIM-161 SM-2/3 SAMs carried by these vessels.

Finally, terminal phase defence, which intercepts a missile's warhead once it re-enters the atmosphere, before it reaches its target, is being pursued by four distinct programmes. These include the Terminal High Altitude Area Defense (THAAD) initiative, which is a US Army hit-to-kill SAM system currently being deployed with the force's 32nd Air and Missile Defence Command. Other efforts encompass the MIM-104F Patriot PAC-3 upgrade to the standard MIM-104 Patriot SAM system, and the US-Italian-German MediumRange Extended Air Defense System (MEADS), which uses Lockheed Martin's PAC-3 SAM as its primary weapon. All three countries have agreed to continue funding MEADS research and development, although they have not committed themselves to the systems' purchase. The US is also collaborating with Israel under the auspices of the MDA's terminal phase missile defence programme via the development of the Arrow family of SAMs.

In March 2012, the United States said that it would consider abandoning Phase Four of the European Phased Adaptive Approach (EPAA) Ballistic Missile Defence (BMD) scheme which would see the installation of Raytheon SM-3 Block-IIB surface-to-air missiles in Poland and Romania. Phase Four of the programme is currently under review, and any cancellation or reduction in scope in this phase could be welcomed by Russia which has, in the past, raised significant objections to the EPAA initiative. Washington's move has been seen as a mechanism by which the costs of the EPAA programme could be reduced, rather than as a straightforward signal to Moscow. Moreover, there is also technical uncertainty as to whether the missiles would be capable of engaging and destroying a ballistic missile target.

Arms Trade Overview

The global defence industry has so far been greatly cushioned from the credit crunch and recession due both to the long-term character of the contracts and the US and other countries' continuing large government spending budgets.

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However, cost overruns in key programmes, particularly in Europe, continue to plague the industry, but this is providing some opportunities for increased competition from smaller companies, which are more inventive and innovative particularly with regard to creating new technologies.

The most promising areas of the US defence industry, for much of the current decade and set to dominate the scene in years to come, are IT; communications - requiring advanced software systems; and high-tech equipment for field operations. Recent acquisitions of defence IT companies reflect this trend: General Dynamics has acquired Anteon International and Lockheed Martin has acquired Aspen Systems among others. This has partly been driven by US government procurement policies. Smaller specialist companies then arise again from set-asides, which in turn get acquired, and so on.

Big US defence companies have also merged - most notably Northrop with Grumman in 1994 and Boeing with McDonnell-Douglas in 1997. This is to bring about economies of scale in the face of rapidly rising R&D costs of high-tech weapons systems, the demand for which has largely overtaken previous Cold War needs for military equipment.

Of the big companies, Raytheon, which makes missiles, will receive an increase in funding for orders of its surveillance systems and reconnaissance units. Northrop Grumman's share value increased following the DoD announced request for more navy destroyers.

Lockheed Martin and the US Navy have looked into opportunities to sell the company's Littoral Combat Ship (LCS) abroad to their mutual benefit, after the Navy confirmed that it would be buying both classes of the vessel, DodBuzz reported in January 2011.

Sales abroad could potentially reduce costs of the programme, which has been beset with various technical and cost problems. Both the Saudi Arabian and Israeli navies are said to be interested in the LCS, which has been described as 'an attractive platform for the international market' by Lockheed Martin officials, who assert that construction of the vessels in the US for export should provide benefits for the US Navy through cost savings.

Even with recent increases in defence procurement within the US, defence firms are far from immune to the downturn, and as US military spending growth is reined in, some will feel the bite in what is a competitive market. As a result, many are looking abroad for growth.

Demand is increasing for more effective Countermeasures against Improvised Explosive Devices (C-IEDs), particularly in the Afghan theatre, where the continuing, relentless use of roadside bombs by the Taliban

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removes the need for these insurgency forces to maintain complex logistical support, thereby making the targeting of them infinitely difficult.

Many of the technologies were first pioneered in the 1970s in the UK to counter the extensive used of IEDs in Northern Ireland, and are now greatly advanced and in wide use by US forces. Robotics is particularly useful for reconnaissance and surveillance, target acquisition and identification. Leading American companies in this sub-sector are iRobot, Qinetiq and Allen Vanguard.

Developments include the race to develop rapidly installed robots with multiple modular adaptations to detect and handle large, deep-buried IEDs. Parts can be attached for excavation of the device. An example is Qinetiq's Bobcat loaders, which can be used remotely to render safe land mines.

Companies making detection, protection and decontamination equipment are part of a small sector that depends both on Homeland Security and DoD funding, and on how threat levels and events drive the industry onto further R&D. For example, 9/11 and the anthrax 2001 attacks kick started and went on to spawn a burgeoning biodefence protection, detection and therapeutics industry which has receivedbns of US dollars in funding for new vaccines and drugs. Further and constant requirements for scanning and monitoring equipment at airports, ports and high-profile locations to counter explosives - including novel explosives home-made from common compounds - as well as CBRN countermeasures equipment, continue to maintain buoyancy in this sector.

Exports

The US remains the world's number one defence exporter. The major contractors to the US DoD have yearly revenues in excess of US$8bn. US military expenditure is 41.5% of the world total. Many developing countries rely on arms imports and provide a rising market.

The US reserves the right to ensure its weapons sold overseas are used for their intended purpose and that defence technology is not passed on or leaked to third-party countries. This has delayed some deals such as the sale to India of new fighter aircraft and ships. This follows on from the Indian proposal that production is initiated in American shipyards and is then transferred to Indian shipyards.

Former US Defence Secretary Robert Gates said in April 2010 that the country's export controls ought to be overhauled. Gates said that the controls were more suited to the Cold War environment and now served only to constrain supplies to allies while easing market penetration by foreign defence companies.

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The notoriously cumbersome International Traffic in Arms Regulations (ITAR), backed by the Arms Export Control Act, spreads the export process over a number of agencies goods lists. The result is a far more opaque and laborious trade environment than exists in comparable countries. Enacted in 1976, the importexport regulations helped impede the proliferation of advanced technology produced in the US, helping the country far surpass rivals in technological sophistication.

Canada has been largely exempted from the ITAR for some time but other allies, most notably Australia and the UK, have become increasingly frustrated over restrictions. Both countries each have bilateral draft treaties that would reform trade between the parties, although these are still waiting to be ratified in the US. Gates' comments show that there continues to be fairly strong political will to reform ITAR or at least legislate bilateral exemptions at executive level, which has been the case since the Clinton administration. Such efforts continue to founder at the legislator level, however, with both the Senate and Congress stymieing ratification largely on security concerns.

Nonetheless, under pressure from the domestic defence industry, as well as foreign governments, Gates built on efforts by the previous two administrations in April 2010 by announcing the most comprehensive ITAR reform programme yet. However, concern has grown that Canadian authorities are not sufficiently controlling the movement of military-grade goods from US defence firms. Such concerns were heightened when it emerged that military-grade parts made by Connecticut-based Pratt & Whitney had been used for China's first domestically produced combat helicopters.

In March 2011 the Washington Post reported that the US government was still looking into reforming regulations on defence exports in order to boost sales overseas while protecting strategically important technology. The changes would seek to consolidate the multi-layered bureaucracy associated with defence exports, and the move has been strongly supported by the defence industry and advocates of the sector, who wish to see export growth to offset losses from reined in domestic spending.

Gates said that he was working with the State, Commerce and Homeland Security Departments to address export rules and to move the consolidation process forward. The goal, according to Gates, is to produce a single-text list for export control, a single licensing agency, a single IT data management system and a single enforcement agency to replace the tangle of responsibilities that exists at present, thereby simplifying and streamlining the export process. A single programme licence is also expected to be introduced, replacing licensing for each component.

The reforms also seek to control fewer parts and components, distinguishing between specialised military equipment and basic materiel. This would also allow the authorities to concentrate on controlling and

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protecting 'critical technologies...that are the basis for maintaining our military technology advantage,' said Gates.

Industry figures are concerned that export restrictions have led to foreign countries introducing their own versions of US military technology, rather than buying the originals, harming exports but not strengthening security. Some suggest that regulation has also disincentivised investment and innovation by US firms, which know they cannot currently export some of their technology.

It remains to be seen to what extent exports can take up the slack caused by constrained domestic spending exports have averaged an equivalent of 23% of US military procurement since 1970 - foreign sales are seen as increasingly important. While critics point out that many other countries are scaling back spending, emerging markets, particularly in Africa, the Middle East and Asia, are investing heavily in defence, creating opportunities that are readily being seized by other major defence exporters such as France, the UK and China.

United States Security Overview


Domestic Threats

Domestic Politics - 2013: The Year Of The Deal?

BMI View: There is a growing likelihood that the US government will avoid a major showdown over the debt ceiling or federal spending, and that a compromise is within reach on immigration reform. President Barack Obama has shown an openness to compromise on entitlement reform, and there are bipartisan working groups in the Senate tackling many of the key issues for this year. That said, we acknowledge the potential for gridlock to return if deals fail to materialise in the near term.

Whereas US President Barack Obama pursued sweeping changes in the first two years of his first term such as the Dodd-Frank financial reforms and his landmark healthcare plan - a Republican majority in the US House of Representatives since the 2010 midterm elections put an end to far-reaching legislation. The White House and Congress stumbled from crisis to crisis in 2011 and 2012, unable to make progress on major legislation. That said, we see preliminary indications that this year may be an inflection point. If both sides are ready to make sacrifices, then 2013 may see deals done on a number of fronts, including the debt ceiling, a budget compromise and immigration reform.

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No Position Of Strength

Our initial interpretation of the November 2012 presidential and congressional elections seems to be playing out. Despite winning the White House and adding seats in the US Senate, Democrats do not enjoy a broad governing mandate that would allow them to push through their policies. Indeed, with Republicans still firmly in control of the House, all federal legislation must come with at least the acquiescence - if not the outright support - of House Speaker John Boehner and some of his fellow Republicans.

Moreover, after enjoying a brief surge in support immediately before and after the November 2012 election, Obama has seen his poll numbers soften. According to Gallup, his approval rating in mid-April had fallen to 49%, roughly equal to his average approval rating since his first inauguration in January 2009.

Similarly, Gallup reports that Congress has seen its approval rating fall from a recent high of 21% in October 2012 to just 15% in April, with a disapproval rating of 79%. As a result, we believe neither the executive nor the legislature will be able to consistently mobilise public opinion to force through sweeping changes. If major legislation goes through in 2013, it will almost by necessity be the result of deal-making and compromise.

Issues On the Table

Debt Ceiling Must Be Raised: As the result of a short-term measure passed earlier this year, the US debt limit was suspended until May 18, at which point either Congress must pass and Obama must sign legislation to increase the debt limit, or the US government would move closer to default. Media reports indicate that the US Treasury can forestall a default without a deal for roughly two months, but after that point, action must be taken or the government will be unable to pay its bills. We see it as highly unlikely that the government will default on its debt, but recent comments by the White House and Republicans in Congress indicate the potential for conflict over the final terms of any deal. Obama has stated he will not negotiate over the debt ceiling and is demanding a clean bill to raise the limit. However, some Republicans have said that the debt limit should be used as leverage to extract spending cuts from the White House, potentially setting up a showdown similar to the summer 2011 debt ceiling fight that led to the downgrade of US sovereign debt and a sell-off in financial markets.

A Budget Deal On The Table? The White House and Congress struck a deal in March to avoid a government shutdown by passing a continuing resolution to fund the government through September 30, the end of the fiscal year. Since then, the US Senate has produced a budget blueprint for next year, the first time

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it has done so since 2009, and the House also has a budget document. While the two budget plans are ideologically irreconcilable, Obama has since released his budget plan for next year, which we see as the beginning of a compromise document. Among other things, the White House budget proposal includes changes to Social Security entitlements, a clear signal that Obama is willing to compromise on some areas important to his base in order to make progress on tax and spending policy. A budget deal for fiscal year 2014 could be the precursor to a longer-term 'grand bargain', one that includes significant changes to taxes, entitlements and discretionary spending; however, we think this is less likely at this juncture.

Immigration Reform On Its Way: Media reports indicate that a group of Senate Democrats and Republicans has made progress on the outline of a comprehensive deal - one that addresses guest worker programmes and that includes some method for illegal immigrants to normalise their status - and we believe there will be strong pressure for a compromise bill to pass. There has long been broad support for sweeping immigration reform on the left. On the right, the business lobby has been in favour of modernising guest worker programmes for quite some time, and those who have opposed any leniency towards illegal immigrants are increasingly being drowned out by those who are concerned by the severe underperformance of Republican candidates among Latinos and other voters that are sympathetic to the immigrant community.

Gun Control Moving Forward? Any gun control legislation that passes this year is likely to only see marginal changes to the status quo, but we see it as a key barometer for the willingness of members of both parties to work together. After the deaths of 28 people, including 20 children, at a mass shooting at an elementary school in Connecticut in December 2012, gun control took centre stage as a policy priority for the Obama administration. Although the gun lobby has successfully defeated all but the most watered-down proposals - enhanced background checks on those who purchase firearms - we maintain that passage of a gun control bill would provide a precedent for deal-making on other issues and, importantly, empower those senators who are looking to find common ground.

The Senate Will Start, But The House Remains The Hurdle

As noted above, progress thus far on many of these issues has started in the Senate, and we expect that this pattern will hold. Generally speaking, there is more precedent for substantive bipartisan deal-making in the Senate, and the Republican-controlled House is unlikely to meet much success in initiating broad compromise measures owing to the highly politicized nature of that chamber and the large number of far right-wing Republicans who hold seats. As such, even if a deal on any of the issues described above were to

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pass the Senate, it must still pass the House, meaning that Boehner will very likely have to bring measures to the floor that are opposed by many in his caucus.

We note that Boehner will have a difficult task balancing the views of ideological hard-liners in his caucus and any compromise measures, and one risk to our outlook is the possibility of Boehner losing control of the chamber to a more conservative speaker. If such a scenario were to develop, we would see much greater risk of serious conflict over raising the debt ceiling or reaching a deal on a budget for next year.

Regional Threats
The United States does not face any major traditional security threats in its immediate locale. The country does share some outstanding disputes regarding the sovereignty of the Arctic Ocean off Canada's northwest coast, although these disputes are extremely unlikely to be resolved through the use of military force.

Beyond this, the United States does face some non-traditional security threats from narcotics and peopletrafficking from Mexico and Latin America. Moreover, the country is also on the frontline as regards blowback from the increasingly violent internal situation which is gripping Mexico.

International Threats
Iran

Iran's nuclear programme will remain a key priority for the US. Although we expect rumours of an impending US/Israeli strike on Iranian nuclear facilities to pervade the international media from time to time, we still believe that an actual strike is unlikely in the foreseeable future. Although a US attack would differ from the Afghan and Iraq wars in that it would consist largely of an intensive bombing campaign rather than a ground invasion and occupation, its consequences would still be substantial. Iranian retaliation would be expected, most probably via proxies in Lebanon, Iraq and Afghanistan, in the Strait of Hormuz, and possibly far beyond the region.

In addition, the air campaign could not be a guaranteed success. Thus, Washington will instead hope that tighter sanctions on Iran will strangle its economy, thereby turning up the internal pressure on President Mahmoud Ahmadinejad with a view to forcing his replacement by a more compromising figure, or at least moderating his behaviour. Even if Ahmadinejad were replaced, though, we believe that Tehran will retain its nuclear programme.

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Iran continues to obfuscate on its uranium enrichment programme, with the revelation in late September of yet another secret plant (at Qom), and heavy water project in development at Arak (which has the potential to produce plutonium). While the programme is not running sufficiently to produce a nuclear weapon in the next two years, the Iranians are proceeding apace with little opposition other than the possibility of a longheralded Israeli air strike.

The Iranians have broadcast footage of missile silos in the country, as part of its publicity war against Israel and the US. The missiles located in the silos are capable of hitting Israel and US bases in the region, according to the Iranian governments. The revelation comes as the country begins a 10-day long war game as tensions continue to slowly ratchet up between Iran and the international community. Colonel Asghar Qelichkhani said that the missiles were located in silos as a 'swift-reaction unit' against any possible strike. The US recently expanded its sanctions regime to Iran to include a major logistics firm, raising worries that food imports into the country will be severely affected.

In January 2012 tensions across the Middle East rose once more following repeated claims by the Iranian regime that they will seek to close the Strait of Hormuz in retaliation for the latest round of economic sanctions that were imposed on the central bank by the US government. Combined with announcements out of Tehran that they would be conducting new military exercises in the Strait, fears of an armed conflict between the Islamic Republic and Western powers began to build. This served to push oil prices higher, with Brent crude trading at US$113.18/bbl at the time.

Despite current tensions, we continue to believe that Iran will refrain from closing the Strait. Apart from the extremely provocative nature of such a move vis--vis the Western world and Iran's neighbours, this would also raise the ire of China and India, countries that the Islamic Republic generally has good relations with, and which import much of their oil from the Middle East.

According to a US Office of Naval Intelligence report published in November 2009 (Iran's Naval Forces: from Guerrilla Warfare to a Modern Naval Strategy) operational control of Iran's official navy in the Strait of Hormuz and surrounding waters has been handed over to the Islamic Revolutionary Guard Corps Navy (IRGCN) - the Revolutionary Guard Corps' naval component - as such, a paramilitary naval force using insurgency tactics.

If the IRGCN was to close or mine the narrow Strait of Hormuz, Iran could potentially cut off almost a third of the world's oil supply. Iran has deployed Chinese-supplied cruise missiles in the Persian Gulf and Gulf of Oman, as well as numerous small, high-speed vessels armed with missiles and torpedoes. US ships have allegedly been harassed by such vessels to the extent that they have been on the brink of firing on them.

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In December 2009 a secret document was obtained by The Times and the International Atomic Energy Agency that contained evidence that, not only had Iran been working on building nuclear weapons as recently as 2007, but also described efforts to 'research and test' a component - a neutron initiator - which is only used for nuclear weapons. A neutron initiator is placed at the centre of a fission bomb to flood the uranium core with neutrons and initiate the chain reaction.

The Iranian missile programme was stepped up in 2009, further provoking the US administration. Several tests were conducted in 2009, including the launch in December of an upgraded version of the Sajjil-2, which the Iranian Minister of Defence Ahmad Vahidi said would act as 'a strong deterrent' against possible foreign (ie: US or Israeli) attack. Iran said the Sajjil-2, first tested earlier in 2009, is more accurate than the Shahab missile and has a longer range: 3,200km, compared with the Shahab's 2,000km.

Iran also carried out two long-range Shahab-3 missile tests in September 2009. One was solid-fuel and therefore able to be launched at short notice. Both could reach Israeli territory or US bases in the Gulf. The combination of missile testing and increased intransigence of the Iranians is leading to the US switching its testing against missile attacks from North Korea to Iran.

US 'Energy Independence': Geopolitical Consequences

BMI View: The US shale gas 'revolution' has led to speculation that Washington could gradually abandon the Middle East. Although we believe that such suggestions are misplaced, we nevertheless examine the consequences of a US shift in military priorities. Over the past year or two, there has been considerable speculation that the US can achieve 'energy independence' over the coming years as a result of the development of unconventional oil and gas resources (the shale gas revolution) in North America. Some proponents of US energy independence argue that Washington would no longer need to involve itself in the affairs of the Middle East, and could reduce or completely withdraw its military presence in Kuwait, Bahrain, and Qatar. However, we believe that this is a false argument. There is indeed a case for US energy independence, but this would not necessarily lead to a reduction of the American military presence in the Middle East.

American military involvement in the region stretches back decades, and during the Cold War this was aimed at preventing a Soviet takeover of the region. The Carter Doctrine of 1980 explicitly stated that 'an attempt by any outside force to gain control of the Persian Gulf region will be regarded as an assault on the vital interests of the United States of America, and such an assault will be repelled by any means necessary, including military force.' During the 1980s, the US ensured the safe passage of shipping in the Persian Gulf at the height of the Iran-Iraq war. The US presence really increased from the 1990s, after it went to war

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against Iraq following that country's invasion of Kuwait. Thereafter, Washington maintained a policy of dual containment against Iran and Iraq, before invading Iraq in 2003.

Three Reasons For Continued US Involvement In The Middle East

Global oil supplies: Firstly, the US is not in the Middle East solely because America needs its oil. The US in fact imports less than 10% of its oil from the region. Rather, the US is expected to guarantee the security of oil shipments (especially through the Strait of Hormuz) to friendly states, namely Europe, Japan, South Korea, and several other Asian countries. This role augments the United States' importance in global affairs. If Washington relinquished these perceived responsibilities, then other countries dependent on Middle Eastern oil imports, such as China and India, could be expected to expand their naval capabilities and more actively project their influence in the Middle East. Given that China is already a geopolitical competitor of both India and Japan in Asia, their rivalry could be carried into the Middle East. Of course, it is highly likely that Beijing and New Delhi (and possibly even Tokyo and Seoul) will seek greater involvement in the Middle East regardless of what the US does, but Washington will probably not take any conscious action to hasten this eventuality.

Furthermore, even if the US substantially reduced its imports of Middle Eastern oil, oil prices would still be determined by international markets, and thus respond to global events, including instability in the Middle East. Therefore, the US would feel compelled to retain a military presence in the Gulf region for the purpose of mitigating shock events that could cause the oil price to surge.

Protection of Israel: The second major reason that the US is heavily involved in Middle Eastern affairs is the protection of Israel from external threats. In the past, these have come from Egypt and Syria (until the 1970s), and Iraq (until 2003). At present, the threat mainly stems from Iran and its proxies. If the US were seen to be reducing its commitment to Israel's security, this could embolden the Jewish state's enemies into provocations against it. Israel would become increasingly alarmed, potentially prompting it to strengthen its already powerful military capabilities or even carry out military action against real or imagined threats more frequently. This would be negative for regional stability. In our view, the strong pro-Israel lobby in the US means that Washington will not abandon Israel.

Regional balance of power: The third major reason for US involvement in the Middle East is to maintain a balance of power between the region's most powerful states, namely Iran, Saudi Arabia, Turkey, and Iraq (pre-2003). During the 1980s, the US carefully acted to ensure that neither Iran nor Iraq emerged overwhelmingly victorious in their eight-year war (1980-1988). The US went to war in the Gulf in 1991 because Iraq, which at the time had the fourth-largest military in the world, invaded a small sovereign state,

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Kuwait, thus threatening to control a huge proportion of Arab oil resources and overturn the regional order. The US went to war against Iraq again in 2003 on the basis that the latter's alleged weapons of mass destruction made it a regional threat. Now, there is speculation that the US and/or Israel may eventually attack Iran, because if the latter acquires nuclear weapons, it would become the hegemonic power in the region. Overall, it is difficult to see the US withdrawing from the Gulf region while Iran remains hostile to key American allies.

US Involvement In The Middle East Comes At A Price

Overall, the United States' involvement in the Middle East has come at a price. Washington's long-term support for Israel and authoritarian Arab regimes in the region (prior to the Arab Spring of 2011), its deployment of troops in Saudi Arabia in the 1990s and early 2000s, its repeated military actions against and subsequent occupation of Iraq, and drone strikes in Yemen have all fuelled anti-Americanism. This helped fuel the rise of al-Qaeda and led to the 9/11 terror attacks that claimed almost 3,000 lives in the US. America also suffered the loss of 4,500 troops in Iraq during its eight-year occupation of that country.

Arguably, a powerful new external player in the Middle East such as China could begin with a clean slate and attempt to portray itself as an 'honest broker', in contrast to the US, which is seen as biased in favour of Israel and against Iran. Beijing would also be less likely than Washington to interfere in the internal affairs of regional states. However, if China were to pick sides in the region or pursue hegemonic policies, then it too could generate resentment and 'anti-Chinese-ism' over the long run.

What If The US Abandoned The Middle East?

Nonetheless, let us suppose that the US decided to substantially reduce its commitments to the region. We see several consequences:

Iran would almost certainly emerge as the major power, even if it did not possess nuclear weapons, for it has a large military and very active external intelligence service. Tehran may be tempted to increase its support for oppressed Shi'a Muslims in eastern Saudi Arabia and Bahrain, as well as anti-Israeli groups in the Levant - all of which would prove destabilising. Turkey and Saudi Arabia, both Sunni Muslim countries, would emerge as the main competitors to Iran, and we would expect to see a three-way arms race between them. This might also entail a nuclear buildup. That said, if the US energy revolution led to substantially lower oil prices, then Iran and other Gulf states would suffer economically, thus reducing their ability to spend heavily on armaments. Israel would find itself more isolated in the region, and could become more aggressive as a result. The Jewish state could also be expected to search for a new 'big brother', but it is unclear which country can fulfil this role. No major emerging power (e.g. China) is likely to share America's knee-jerk commitment to Israel.

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China would almost certainly seek to expand its involvement in the Middle East, and could even establish a military presence in the region. India could eventually be expected to follow suit. Beijing's choice of security partners could radically transform the region's geopolitics. World oil prices would probably be subject to greater volatility, reflecting the geopolitical power vacuum left by the US.

Most of the above trends are already in motion, but these processes would accelerate if the US departed the Middle Eastern scene.

Implications Beyond The Middle East

If the US did indeed reduce its military presence in the Middle East, then it would be able to devote more attention and resources to the Asia-Pacific region, in line with its stated 'pivot' towards the area. Although Washington does not publicly admit it, the 'pivot' is mainly to counterbalance China's rising power, which is of concern to Japan, Vietnam, the Philippines, and India. The downside risk is that greater US involvement in Asia could strain its relations with China.

The geopolitics of Europe could also see notable changes. The US retains tens of thousands of troops in Germany, Italy, and the UK, in part because they are NATO allies but also because they serve as military logistical hubs for US actions in the Middle East and North Africa. The importance of these facilities could thus decline. So too could Russia's geopolitical power, if global energy prices fell substantially. A weaker Russian economy as a result of reduced external demand for its energy could force the Kremlin to focus more on domestic matters, especially if public discontent increased as a result of weaker economic growth.

More broadly, if US energy independence led to lower global oil prices, then the geopolitical influence of other petro-states such as Venezuela and the Gulf monarchies could also decline. Reduced oil revenues could undermine political stability, as governments would have less means to 'buy' social stability. Furthermore, countries hoping for a massive energy bonanza as a result of relatively new oil discoveries, such as Brazil and Ghana, could see some of their expectations dashed.

No Dramatic Changes Soon

Overall, it will probably be several years before the US energy bonanza has a substantial impact on global energy prices. In the meantime, although the US is undoubtedly tired of fighting long wars in Afghanistan and Iraq, it will retain its current security commitments in the Middle East for the foreseeable future. Meanwhile, although China in 2012 began testing its first aircraft carrier, it lacks a 'blue water' (ie. oceangoing) navy and foreign naval bases. Furthermore, any increased Chinese naval activity would initially be

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focused on the East China Sea and South China Sea, and thence Indian Ocean rather than the Persian Gulf. Therefore, it will be many years - probably at least a generation - before China is capable of displacing the US as the main external power in the Gulf.

North Korea

The Korean Peninsula will remain a potential flashpoint following the transition of power from the late Kim Jong Il to his third son Kim Jong Un. This means that Pyongyang will be prone to potentially provocative behaviour, such as more naval skirmishes, missile tests, or even a third nuclear test, as Jong Un seeks to prove his credentials. Owing to North Korea's substantial military (numbering 1.1mn), artillery forces, and weapons of mass destruction, a US strike on the country is virtually unthinkable. Tighter sanctions have been introduced, but China continues to support Pyongyang.

Washington faces a great challenge in moving away from the previous administration's failure to offer the North Koreans security guarantees and to achieve normalised relations with the world's most isolated and unpredictable state, which in 2009 pushed forward its nuclear and missile programme most evidently to enhance its bargaining power in future negotiations. North Korea oscillates between sabre-rattling - through missile and two low-yield nuclear tests and threats to South Korea on land and at sea - and agreeing to bargain.

In April 2012, despite international disapproval, North Korea launched a rocket that flew for only a short time before breaking up and crashing into waters surrounding the Korean peninsula. Pyongyang claims that the aim of the launch was to send a satellite into orbit as part of the country's centennial celebrations marking the anniversary of the birth of the nation's founder Kim Il Sung. The US and other nations have, however, claimed that the launch was a disguised long-range ballistic missile test, which North Korea has been banned from performing under UN resolutions.

After testing its Taepodong-2 long-range ballistic missile in April 2009 and detonating its second nuclear weapon later in May of the same year, North Korea carried out several short-range missile tests in July and October of 2009. It also reactivated the Yongbyon plutonium production plant in April and said it had restarted its uranium enrichment programme. Following the collapse of the six party talks in May 2009, preliminary negotiations were restarted in November with the visit of the US envoy to Pyongyang.

As on previous occasions, North Korea continues to provoke the US administration by rattling sabres and then indicating a desire to return to the talks in order to get moved further up the list of priorities for the new US administration. Given North Korea's history of offering concessions only to subsequently break them, it

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can be seen as having forced the Obama administration to engage with North Korea according to the latter's terms and timetable.

The US is concerned about North Korea spreading its nuclear and missile technologies while furthering its own capabilities. The two controversial underground nuclear tests were below explosive yield expectations, but any such device exploded in or on a city would still dwarf any conventional explosion since 1945. Following the May 25 2009 test, as reported by Global Security Newswire on May 28 2009, senior security advisor General James Jones warned that the US concern is 'not just that [North Korea] have a nuclear weapon, it's what they're going to do with the technology and where it's going to go' - that is, to terrorist groups or other near-failed states. Much of the initiatives launched by the US to stop maritime transportation of nuclear and other WMD materials are based on attempts to stop North Korean proliferation.

However, North Korea's weapons exports and proliferation activities have been curtailed somewhat by tougher UN sanctions following the passing of UN Resolution 1874. As in the past, it remains to be seen if the US or other powers, faced with continuing Chinese shielding of North Korea, will be able to effect the denuclearisation of the pariah state during 2010 and beyond.

Afghanistan

As a result of the US troop surge in Afghanistan and the concomitant reduction from Iraq, the former country is now the US' main military theatre, with Washington contributing 100,000 troops out of the 150,000 Western soldiers deployed there. This force now exceeds the Soviet Union's peak of 120,000 troops during its occupation of Afghanistan in the 1980s, which ended in defeat. Nonetheless, Afghanistan's population has doubled since then, and the US and its allies have found themselves unable to defeat the Taliban insurgency and allow the pro-Western government in Kabul to consolidate its control over the country.

The Obama administration announced in June 2011 that it intends to withdraw 33,000 troops by mid-2012. Admiral Mike Mullen, chairman of the Joint Chiefs of Staff, said that he was initially unprepared to back such a large withdrawal, describing it as 'aggressive' and likely to 'incur more risk'. Nevertheless, he described maintaining large force levels as the safest course but not necessarily the 'best course'.

Some 10,000 troops were withdrawn by the end of 2011 and a further 23,000 by the beginning of summer 2012. US troop levels in Afghanistan had been increased significantly by a 'surge', hoping to replicate the success seen in Iraq using a similar strategy. Despite this, many observers note that success in Afghanistan

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has proven to be even more elusive than it had been in Iraq, despite higher troop levels. The Afghan government has welcomed the decision, saying that the protection of the Afghan populace is a job for their government. The Obama administration has resisted the temptation to escalate the conflict further and it is likely that momentum towards securing a political solution to the conflict will grow over the coming 12-18 months.

However, according to a report in late 2011, Washington and Kabul are moving closer towards securing a strategic pact that would see a US military presence in Afghanistan until at least 2024. In our view, given the apparent lack of progress in the training of Afghan forces and the US' wider geostrategic interests, a full withdrawal by 2014 appears increasingly unlikely. Having said that, an extension of the US military presence could delay a lasting political resolution.

Following President Obama's decision to withdraw approximately 33,000 US troops from Afghanistan by the summer of 2012, we hinted at the possibility of a limited permanent active US military presence in the country, even after security is handed over to the Afghan authorities in 2014. There are increasing signs that the US will stay beyond its 2014 commitment to fully withdraw from the country.

A report by UK-based Daily Telegraph on August 19 2011 stated that the two countries were edging closer towards signing a strategic pact, allowing US troops to stay in Afghanistan until at least 2024 - a full decade after the 2014 withdrawal deadline Obama set in December 2009. According to the report, the pact would allow military trainers to build up the Afghan National Army (ANA) and the Afghan National Police (ANP). Officials from both sides are hoping to finalise the pact before the Bonn Conference on Afghanistan scheduled to be held in December 2011, where topics such as the 2014 handover, post-handover international commitments, and the overall domestic political process of reconciliation and integration are expected to be discussed.

Perhaps the most vital non-geostrategic imperative the US has to extend its stay beyond 2014 are the deficiencies of Afghanistan's own security apparatus, which if left unresolved would make a handover of responsibilities ineffectual. In a recent report, the International Crisis Group stated that despite the training provided so far by the US and the NATO-led International Security Assistance Force (ISAF), Afghan forces have 'thus far proved unable to enforce law, counter the insurgency or even secure the seven regions'.

For instance, the 142,000-strong ANP, which for all intents and purposes serves as paramilitary units as the spread of insurgency takes the police to the front lines, is lacking in credibility. Police violence, corruption, high desertion rates, drug abuse, and gang rapes have all led to a deterioration of international and (perhaps more importantly) domestic confidence in the overall ability of the police to uphold law and order.

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According to Lieutenant-General Mohammad Rahim Hanifi, the head of the Attorney-General's statistics and analysis department, more than 4,600 policemen were accused of crimes in 3,000 separate cases between March 2010 and March 2011. While the proportion of those accused appears small compared with the entire police force, the damage may have already been done. A survey conducted by the UN in late 2010 found that 60% of Afghans see the police as corrupt, and a majority believe that filing a complaint against misconduct would be futile.

Should these circumstances prevail until 2014, the US (and most probably its key NATO allies) will be unlikely to want to risk losing any security gains by handing over complete control to still ineffectual domestic security institutions. A complete withdrawal without rapid and considerable improvement of domestic capabilities would leave a country that cannot afford to be alone with very fragile armed forces. Crucially, the Afghan government is aware of the country's shortcomings. Rangin Dadfar Spanta, President Hamid Karzai's top security adviser, stated that a longer-term US presence was vital to build Afghan forces and continue the fight against terrorism.

Besides Afghanistan's domestic factors that may bind international forces to the country longer than previously expected, geostrategic motivations may force Washington to extend its stay in the country past 2014. While the US publicly denies any interest in creating a permanent presence to project its influence in the region, the rising concerns of Afghanistan's neighbours suggest otherwise. Pakistan, India, Russia, China, and Iran all oppose a permanent US military presence in Afghanistan, which they feel would impede their regional ambitions. Aside from securing a US foothold in the region, a permanent American military presence would allow Washington to more effectively manage or hedge against the volatility of some of the region's unstable states (ie Iran and Pakistan).

While the US may well deem the prolonging of its military presence in Afghanistan to be in its national interests, the biggest risk of extension would be the consequent reduction in all parties' (including the Taliban) motivation to finding a permanent political solution to the country's conflict. Further signals that Washington and Kabul are reaching for a long-term agreement may upset any effort to bring the Taliban to the negotiating table. The Taliban may well choose to continue attacking US troops. A senior member of Karzai's peace council has already echoed such concerns. In our view, an extension of the US military presence post 2014 would almost certainly be tantamount to 'kicking the geopolitical can down the road'. It could also prove unpopular with the American public, especially if casualties rise over the coming years.

Most US deaths and injuries are from Taliban IED attacks, which are growing in sophistication. Roadside IEDs account for at least 70% of US casualties. Other weapons used by the insurgents include RPGs

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(rocket-propelled grenades) and explosively formed penetrators (EFPs), which penetrate all but the most upto-date, heavily armoured vehicles.

As a seasoned military leader, General David Petraeus's selection as a replacement for McChyrstal (who was abruptly dismissed as Commander of US Forces in Afghanistan as a result of comments made to Rolling Stone Magazine) was a natural choice for Obama. The general was formerly the US Central Command (Centcom) commander and as such had a hand in Obama's reworked policy on the Afghan campaign revealed in late-2009. However, Petraeus has been known to be critical of a drawdown of US forces from July 2011. He stepped down from his post in July 2011 and became director of the CIA, only to resign following a personal scandal in 2012. Many military commentators believe the US is losing the war in Afghanistan, a country where no occupying or intervening power has ever succeeded militarily. This was exacerbated by McChrystal's dismissal as attention was refocused on the overall campaign. Not only is the conflict a classic example of asymmetric warfare and in danger of sinking into a stalemate, but defining success in the war has changed.

Iraq

The US officially ended combat operations in Iraq at the end of August 2010, by which time it had reduced its troop presence there to 50,000 from a peak of 170,000 in 2007. After September 1 2010, the US military formally assumed an advisory (as opposed to combat) role, training and supporting Iraq's army and police.

The remaining 50,000 troops were withdrawn on schedule in December 2011, as per the Status of Forces Agreement (SOFA) signed between Baghdad and Washington in 2007. The final convoy of US soldiers from the Army's Third Brigade First Cavalry Division - crossed into Kuwait on December 18, and in the process officially ended the US military commitment in Iraq, barring a few hundred military advisers still stationed in the country at the time of writing.

Concerns remain high that the Iraqi security forces do not have the wherewithal to maintain law and order in the country. In August 2011 Iraqi armed forces chief of staff Lt-Gen Babakar Zebari publicly stated that the military would not be ready to ensure security until at least 2020. Zebari's views are believed to be shared by Iraqi and American generals. However, Baghdad and Washington were unable to conclude an agreement on extending the presence of US troops in Iraq beyond 2011, with the two sides falling out over the issue of immunity for US troops from prosecution in Iraq.

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Yemen

Before Abdulmutallab's Christmas Day airline bomb attempt in 2009, Yemen was a close ally to the US in the 'war on terror'. US military aid for the country increased in 2010 to US$66mn, including more support for counterinsurgency and antipiracy efforts, and for coast guard training and development.

According to US and foreign government officials, the threat from further incursions into Yemen by alQaeda was heightened in 2009 before the December bomb attempt. Abdulmutallab said the explosives had been supplied to him in Yemen, where he had lived for several months and been trained by AQAP.

US military operations - primarily using weaponised unmanned aerial vehicles (UAVs) - inside Yemen are likely to continue despite the 'Arab Spring' of widespread anti-government unrest that spread across the Middle East and North Africa in late 2010 and early 2011. Unrest continued in a number of countries, including Yemen, and remained as of September 2011 leading to the ousting of now-deposed president, Ali Abdullah Saleh.

Political Risk Analysis


BMI View: The 'crises' in Turkey, Syria, Iran, and the Korean Peninsula are all connected in a complex geopolitical matrix. For now, the informal Damascus-Tehran-Pyongyang anti-Western 'axis' appears firm, but it rests on shaky foundations. Meanwhile, the US setbacks in the Middle East are being offset by the cultivation of new allies in East Asia.

Several recent developments highlight the interconnectedness of events in Eurasia, and suggest that the informal anti-Western 'axis' comprising Syria, Iran, and North Korea is making geopolitical gains. This will cause further complications for the US's foreign policy.

By early June, it was being widely reported that the Syrian regime of President Bashar al-Assad had made significant military gains against rebel forces, and appeared to have retaken control of the crucial town of Qusayr. At the same time, World Tribune, a US-based national security affairs website, citing Middle East Newsline, reported that Assad was winning the battle for the hearts and minds of Syrians, with many of his countrymen hitherto opposed to his rule having changed their minds over the past six months. World Tribune cited an unpublished study by NATO alleging that 70% of Syrians now back Assad. (BMI could not verify these claims, or find an alternative news source on this.) Also noteworthy were reports that around a dozen North Korean military officers are on the ground in Syria, providing logistical and tactical

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advice to the regime. Meanwhile, Turkish Prime Minister Recep Tayyip Erdogan faced massive protests against his leadership in multiple cities across the country, which, if sustained, could damage Turkey's appeal as an investment destination and complicate Erdogan's ability to govern effectively.

Anti-Western Axis Appears To Be Strengthening

The above developments would appear to indicate the strengthening position of an informal anti-Western axis comprising Syria, Lebanese Shi'a militant group Hizbullah, Iran, and North Korea, which has open backing from Russia and more quiet support from China. The 'axis' between Syria, Iran, and North Korea has existed for decades, mainly involving co-operation in matters such as missile and nuclear energy technologies. All three oppose the US in particular, and the West in general, and particularly Western efforts to increase its influence in their respective regions. Syria has long been Iran's closest ally in the Arab world, while North Korea is Iran's closest partner in East Asia. Syria and North Korea have also had close ties for decades. Hizbullah, meanwhile, is Iran's main proxy in the Levant, and Tehran has been seeking to consolidate a Shi'a belt stretching through Shi'a majority Iraq and Syria (which is ruled by a Shi'a sect, the Alawites) to Lebanon (and thus the Mediterranean). Russia, for its part, has given the Assad regime strong diplomatic and military backing, while retaining cordial ties with Iran and North Korea - countries that China also supports in various forms.

The Syrian angle: When Syria's rebels made strong gains last year, speculation was rife that Assad would fall, thereby breaking the Middle Eastern part of the axis by cutting off Iran's main conduit to the Mediterranean Sea. However, the apparent recovery of Assad's military fortunes has prompted a reassessment of the eventual 'inevitable collapse' of his regime. Although the EU and now the US have lifted their arms embargo on Syria's rebels, the West will still face considerable doubts about the wisdom of intervention. Not only are the rebels on the back foot, but there are reports of infighting between Sunni radical Islamist factions and more moderate nationalist ones. In addition, there have been multiple reports of atrocities by the rebels. Furthermore, if reports that more Syrians are switching their allegiance back to Assad are true, then this would beg the question of why the West should risk political capital in arming a seemingly unpopular (and in parts, anti-Western) rebellion. Nonetheless, even if Assad regains control of the majority of Syrian territory, he would rule over a weakened state and face extended diplomatic isolation. Some form of insurgency would continue, especially as arms flows from the West increase.

The Iranian angle: The Iranian government will take comfort from Syrian rebel losses, for Tehran has provided military support to the Damascus regime. The overthrow of Assad would be a clear geopolitical reversal for Iran, which seeks to uphold and expand Shi'a influence in the Middle East. The Syrian civil war

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has from an early stage been a proxy conflict between Shi'a Iran on the side of Assad and Sunni nations Turkey, Saudi Arabia, and Qatar on the side of the rebels. If Assad defeats the rebels, Iran would feel vindicated.

However, Iran can hardly afford to feel comfortable, as its economy continues to suffer under sanctions. The June 14 presidential election resulted in a relatively moderate figure, Hassan Rouhani, being elected president, suggesting that Tehran could soon seek a partial rapprochement with the West. However, it is far from clear if Rouhani will have the authority to pursue such a move. He is also unlikely to have much say over Iran's Syria policy. Matters of foreign affairs and national security lie with the Supreme Leader, who is less keen on compromise. Over the coming months, Western leaders, and probably Israel, will adopt a 'wait and see' attitude towards Rouhani. Yet, if Rouhani fails to reduce tensions over the nuclear programme, we cannot preclude eventual Israeli airstrikes on Iran. An all-out Israel-Iran war, possibly drawing in US support, could boost the clerical regime in the short term, but weaken it over the longer term, especially if it results in economic devastation. For example, years of sanctions and military defeats in the former Yugoslavia eventually led to a popular uprising against former Serbian leader Slobodan Milosevic in 2000.

The North Korean angle: Reports that North Korea has sent military advisers to Syria are unsurprising in view of Pyongyang's longstanding ties with Damascus. The officers are apparently there both to assist the Syrians and to gain tactical experience for the North Korean armed forces. Kim Jong Un's regime has meanwhile calmed down somewhat after a period of hyper-aggressive rhetoric against the US, South Korea, and Japan in March and April, during which Pyongyang threatened nuclear strikes against its enemies. North Korea now appears to be taking steps to reduce its isolation by reaching out to Japan, China, potentially Russia, and even the US. Pyongyang hosted a key adviser to the Japanese prime minister in midMay and sent a special envoy to China later that month. Beijing is Pyongyang's closest ally, but has shown frustration with the Kim regime's provocations in recent months.

However, North Korea's government, although seemingly secure, has not gained anything from its February nuclear test and subsequent extreme rhetoric. If the Assad regime were to weaken or collapse, this would alarm Kim, who could one day face his own uprising. Nonetheless, Pyongyang can at least take comfort from the fact that its nuclear arsenal makes airstrikes against North Korea very unlikely.

Turkish Unrest Could Weaken Erdogan's Hand

The recent unrest in Turkey could weaken Erdogan's hand and Turkish influence in the region. Firstly, rising opposition to the prime minister will force him to focus more on domestic matters, especially since one poll showed that 70% of Turks are against Erdogan's support for Syrian rebels. He could, of course,

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seek to distract public attention with some sort of foreign policy foray, such as by increasing his criticism of Israel, but this could backfire. Secondly, the instability in Turkey resulting from public concerns about creeping authoritarianism and Islamism is raising doubts elsewhere in the region about the desirability of the 'Turkish model' of Islamist democracy, which has been promoted widely after the 'Arab Spring'. Erdogan's harsh crackdown on protestors has rekindled memories of the 2011 uprisings across the region.

Furthermore, if Erdogan's position weakens significantly, he will be less capable of finalising a peace deal with the separatist Kurdistan Workers' Party (PKK) or enshrining Kurdish rights in a new constitution. This could result in further unrest among the Kurdish minority. Finally, Erdogan has also offended Turkey's minority Alevis (a Shi'a sect which comprises around 20% of the population) by naming a new bridge currently under construction in Istanbul after a sixteenth century ruler who massacred thousands of Alevis.

Geopolitically speaking, Turkey's 'zero problems with neighbours' foreign policy is now discredited, for the country has found itself at loggerheads with Syria, Iraq, Iran, and Israel (despite the latter's recent attempt at rapprochement). The main geopolitical gain that Turkey has made in recent years is its deepening ties with the Kurdistan Regional Government (KRG) of northern Iraq - although this has come at the expense of good relations with Baghdad.

US Facing Mounting Risks Across Eurasia

As the US surveys Eurasia, it faces considerable risks. The Obama administration is committed to a 'pivot' towards the Asia-Pacific region, with the unstated intention of counterbalancing China. However, the instability in the Middle East is requiring the US to focus considerable diplomatic energies on that region. As noted, Syrian and thus Iranian gains in the Levant would challenge the US's Sunni allies, Turkey, Saudi Arabia, and Qatar. Meanwhile, the US faces the prospect that the withdrawal of the majority of its troops from Afghanistan in 2014 will leave a security vacuum in Central Asia, which Islamist militant groups will seek to exploit. The risks are especially high for the US's ally, Pakistan. Meanwhile, the US's closest ally in East Asia, Japan, remains locked in a maritime territorial dispute with China, which could conceivably result in skirmishes. This would severely complicate Washington's relationship with Beijing (President Obama met his new Chinese counterpart, Xi Jinping, on June 7-8).

Nonetheless, US geopolitical setbacks in the Middle East and South Asia could be partly compensated by gains in the Asia-Pacific region. President Obama hosted Myanmar President Thein Sein in the White House on May 20, 2013, marking a very significant step in Naypyidaw's emergence from isolation and its rebalancing of foreign policy priorities away from China. For the US, cultivating a South East Asian nation of 60mn people located at the crossroads of China, India, and the Indian Ocean would be a strategic

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gain. Meanwhile, rising concerns about Beijing's territorial claims in the South China Sea are pushing the Philippines and even Vietnam into closer military cooperation with the US. Editor's note: This is an updated version of an article originally published on June 6. The update reflects the outcome of Iran's presidential election and the US's decision to arm Syria's rebels.

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Company Profile
Boeing
SWOT Analysis

Strengths

Long and illustrious history of aerospace design, production and innovation. Market leader in integrated military platforms, network-centric systems. Integrated defence systems sector involves coordination with Lockheed Martin on R&D for the anticipated US Air Force 2018 Bomber programme.

Operates in more than 90 countries and is among the biggest US exporters in terms of sales - eg the F-15 Strike Eagle is in service in Israel, Japan, Saudi Arabia, Singapore and South Korea. Weaknesses

Controversy still surrounds accusations of bid-rigging and corruption, following the 2003 case which involved a Pentagon official.

Pressure on cost and quality testing of composite materials for commercial aircraft manufacture (the 787 Dreamliner).

The 787 delays coming to production The company's exports are restrained by the US' International Traffic in Arms Regulations.

Was surpassed by BAE Systems in 2010, which became the world's largest defence company by sales.

Opportunities

Boeing is looking increasingly to the Asia Pacific market for their commercial aircraft, particularly India, which it projects will become the world's biggest.

Despite economic problems, the company expects to benefit from rapid growth of air travel in emerging economies in the 'developing world'.

Company estimates air cargo traffic will increase on average by 5.4% per annum. Civilian airline business threatened by economic downturns.

Threats

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SWOT Analysis - Continued

Northrop Grumman may continue to take some military business: in March 2008, Northrop was chosen over Boeing (plus rival Airbus) by the navy to replace fleet of ageing air-refuelling tankers.

As with other defence companies, possible reduced demand due to government budget cutbacks threatening specific large programmes.

Strategy

Boeing struggled through the 2008-09 recession, facing lower demand for freighters and passenger aircraft. Like the rest of the defence industry, Boeing needs international markets as it faces multiple challenges in the domestic US defence sector. The company faces stiff competition from Lockheed Martin and EADS, which are also making inroads into emerging markets, notably India. Over the next five to 10 years, Boeing's competitive fate will depend on whether its vision of the future of aviation - one in which airlines will require smaller, speedier aircraft that fly point-to-point more frequently, is correct. It is gearing its product range to this scenario, now focusing on the 747, a 200-250 seat plane built of lightweight carbon fibre, and designed to be 20% more fuel efficient, with a 10% overall reduction in operating costs. Boeing expects to generate about half its total international defence revenue from the Middle East by 2013 as it continues to reposition itself to win overseas contracts amid slowing defence spending growth. Brazil is also a key market for Boeing, with its local unit there reporting some of the fastest growth across the company. The company expects growth in defence revenue as a share of total income, however, to 25-30% by 2013, against an existing 18%.

Financial Data

Boeing generated US$68.7bn in revenue for 2011, with US$4.0bn in profits for the year.

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L-3 Communications
SWOT Analysis

Strengths

Leads in developing and producing largest range of state-of-the-art high-tech Command, Control and Communications, Intelligence, Surveillance and Reconnaissance (C3ISR) systems.

Moving up with increasingly lucrative military technologies for the modern battlefield advanced electronics, electro-optical/infrared sensors, precision engagement aviation, telemetry, microwave systems, SATCOM and antenna, simulation and training.

Fastest growing big defence contractor in the US.

Broad and mostly expanding customer base - as well as the DoD, the DHS, US intelligence agencies, other federal agencies, state and local government, allied foreign defence ministries, US aerospace and defence contractors, commercial clients. Weaknesses

The company's exports are restrained by the US' International Traffic in Arms Regulations (ITAR).

Opportunities

Will benefit from growing emphasis on C3ISR requirements. Homeland security as an expanding sector will need more scanning equipment as the threat of smuggling and weapons proliferation grows.

Need for aircraft modernisation, advanced avionics, enhanced air defence. For homeland security, providing deepwater and port security systems and border protection - of increasing importance in smuggling and terrorism prevention and further expansion into airport detection technologies market.

Threats

L-3 was under criminal investigation in 2010 after it emerged that one of its units was monitoring emails of workers, other firms and government employees.

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Company Overview

Prime contractor in the up-and-coming area of defence - C3ISR - including secure networked communications and communication products, mobile SATCOM, information security systems, missiles and munitions, shipboard communications, naval power systems, telemetry and instrumentation. An array of defence systems, providing signals intelligence (SIGINT), communications intelligence (COMINT). Avionics, antennas and microwave products, data links, electro optics, encryption products, guidance and navigation products and systems, propulsion systems, sensors, scanners, satellite communications, signal intelligence. Supplies emergency management systems and training. Supplying systems integration and life-cycle support services to aircraft manufacturers at home and abroad. Major contributor to future programmes - including DD(X), MMA, FCA, MHP, Combat Search and Rescue-X (CSAR-X), WIN-T, FAB-T, LHA-R and the F-22. Providing logistics support and life-cycle maintenance for 4,000 government aircraft, including 1,600 military training aircraft. Developing and supplying maritime radars and monitoring systems, mine detectors, video surveillance systems, thermal imaging cameras, weapon sights for law enforcement and infrared defence systems. US homeland security: providing deepwater and port security systems and border protection, plus protection of US airspace, supporting law enforcement and first responders; crisis management and exercise planning. An important player in the burgeoning explosives detection market for airports and port cargo scanners, using multi-view tomography technology.

Recent Developments

Fitch Ratings argued that the company's steady operating margins, significant free cash flows and strong defence spending justified maintaining its issuer default rating at 'BBB-' in September 2011. The agency also said that it viewed L-3 Communication's products and services as in line with the US DoD's requirements. However, Fitch criticised the company's cash deployment strategy concentration on acquisitions and share repurchases, while describing the DoD's drawdowns in Iraq and Afghanistan as modest concerns. The company secured a US$48.8mn contract to provide engineering and maintenance of depot-level, organisational and support equipment services to the US Navy in September 2011. The contract will provide the support to 55 C-12 aircraft held by the Navy and 11 more held by the Marine Corps within 12 months.

Financial Data

L-3 Communications generated US$15.6bn in revenue in 2011. The company's net income for 2011 was US$15.4bn in 2011.

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Lockheed Martin
SWOT Analysis

Strengths

Lockheed Martin is a major global defence company with a full range of defence technologies and 3,000 individual programmes.

The company operates in 75 markets. Lockheed Martin is a world pioneer in aircraft technologies - fighters, transport airlifters (the famous C-5 Galaxy), high-altitude reconnaissance and simulation systems.

Major missile manufacturer, full range of strategic and precision strike systems. Also has full range of missile defence systems. Delivery systems include the F-16, F/A-22 and the F-35 Joint Strike Fighter, which are capable of delivering precision weapons.

World leader in R&D and production of radars in operation in 38 countries. Five main DoD-defined network centric capabilities: integrated communications links, focused logistics, battle space/situational awareness, force application, command and control, protection.

The company's A-issuer default rating was affirmed by Fitch Ratings. Weaknesses

Cancellation and curtailment of orders such as the presidential fleet of VH-71 helicopters.

No planned increase in ground-based missile interceptors for Alaskan deployment. The company's exports are restrained by the US' International Traffic in Arms Regulations (ITAR).

Opportunities

Although the future of the F-35 fighter jet is unclear, the US is expected to eventually buy the lion's share of Lockheed's expected production of the aircraft.

Increased order for Littoral Combat Ships (LCS) from 2-3 in FY10 to 55.

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SWOT Analysis - Continued

Increasing funding for Terminal High Altitude Area Defense (THAAD) System as part of the BMD programme.

Threats

Possible decline in contracts due to volatile economic situation and possible temporary decline in government spending on defence means cancellation of programmes.

Possible decline in contracts for missile defence due to President Obama's intention to scale back the BMD programme.

Longer timescales for programme development.

Company Overview

The most promising areas of the US defence industry, for much of the current decade and set to dominate the scene in years to come, are IT and communications - requiring advanced software systems and high-tech equipment for field operations with acquisitive strategy affirming this trend. Lockheed Martin has had to endure the cancellation of important programmes: the TSAT Mission Operations System (TMOS) contract, F-22 Raptor fighter and the VH-71 Presidential Helicopter (VH-71) programme. Lockheed Martin's high-cost platform programmes have been the prime targets of the Obama administration's budget cuts.

Recent Developments

For missile defence, Lockheed Martin is developing boosters, targets and countermeasures, infrared seekers, precision pointing and tracking optics, radars and signal processing. But sizeable weapons programmes are being cut back, such as the DDG-1000 Zumwalt-class destroyer for the Navy and Lockheed's F-22 Raptor fifthgeneration fighter. The F-22 fleet was capped at a total of 187 fighters, which is just one-quarter the total sought when the programme begun during the Cold War, but Lockheed Martin is fiercely campaigning to keep production lines open with 95,000 US jobs at stake. Much of Lockheed Martin's revenue levels in the two decades to 2030 will be determined by the completion and sale of the F-35 Joint Strike Fighter. With 11 countries expected to acquire the plane Lockheed has been working hard to sustain enthusiasm and commitment for the unit amid severe budgetary pressures. The DoD was considering delaying the production of 100 F-35s to slash costs as required under the Budget Control Act in September 2011, according to reports. The company estimates that global F-35 Joint Strike Fighter sales could make up over 20% of its total revenue. The production of 2,447 F-35 aircraft is expected to cost US$382bn, up

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significantly from the original US$231bn estimate for 2,866 aircraft (GAO data). The company also had its involvement in the delivery of the US Navy's Mark 41 Vertical (Missile) Launching System cut in October 2011 amid a drive to reduce costs. The Navy instead effectively made UK rival BAE Systems the integrator for the project, with Lockheed supplying and installing electronics. Lockheed is attempting to revive sales in its Information Systems & Global Solutions division, which saw sales decline by 6% in Q211. The company completed the acquisition of California-based medical evaluation services firm QTC Holdings in September 2011, picking up a company that is the largest provider of medical evaluation services to the US government and US Department of Veterans Affairs.

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Northrop Grumman
SWOT Analysis

Strengths

Vastly experienced and varied high-tech R&D expertise and production facilities. Covers all burgeoning areas of defence technology from submarine systems to missiles, space systems and cyber systems.

Develops and provides many advanced IT systems, which comprise one of the fastest growing sectors within defence.

Products include intelligence, surveillance and reconnaissance systems. Main strengths are cyber security, intelligence, global reach, precision strike and missile defence systems.

For missile defence, it can provide full range of technologies for BMD: sensors; shooters; integration and battle management, command, control and communications (BMC3). Weaknesses

Has to keep up with major competitor Boeing to secure bids. The company's exports are restrained by the US' International Traffic in Arms Regulations (ITAR).

Opportunities

Significant competitive wins of further contracts for the company's leading-edge electronics technologies.

Continues to focus on unmanned aerial vehicles and C3ISR. Cyber security and cyber warfare systems - recent lapses in cyber security will attract lucrative contracts and cyber warfare is a rapidly rising aspect of defence, which will instigate a race for companies to secure big contracts and attract the best skills.

Threats

Possible decline in contracts, due to volatile economic situations and decline in government spending on defence particularly regarding contracts for missile defence, due to President Obama's announced intention to scale back the US' BMD programme.

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SWOT Analysis - Continued

Possible large-scale problems with pensions as plan returns are connected to stock market performance. Drop in 2009 means higher pension costs and earnings may also be affected.

Company Overview

Northrop Grumman produces systems and products in aerospace, electronics, information systems, shipbuilding and technical services. Northrop merged with Grumman in 1994. This was to bring about economies of scale in the face of rapidly rising R&D costs of high-tech weapons systems, the demand for which has largely overtaken previous Cold War needs for military equipment. In the period 1994-2002, Northrop Grumman made six acquisitions. The company relocated its headquarters to Falls Church, Fairfax County in Virginia in September 2011 Northrop Grumman's revenues for 2011 were US$15bn. The company's operating income for the same year was US$3.2bn and its profit was US$2.1bn.

Financial Data

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Raytheon
SWOT Analysis

Strengths

Continues to make substantial profits in its missile, space, network centric, integrated defence systems.

A very long history - nearly 90 years of experience in defence innovation and manufacturing.

Dominates missile and missile defence market - makes full range, air-to-air, strike, naval, land combat, guided projectiles as well as exoatmospheric kill vehicles (EKVs) and directed energy weapons. Weaknesses

Although the company sells to commercial clients, some 85% of sales are from US government accounts. It is expected to continue at strength, but this may vary according to current government policy.

Raytheon has been criticised for its close links with government at all levels and charges of 'influence peddling'.

The company's exports are restrained by the US' International Traffic in Arms Regulations (ITAR).

Opportunities

Able to meet further demand for enhanced interoperability and mission control systems, as well as a host of hi-tech systems.

Threats

A possible decline in contracts due to the volatile economic situation and possible temporary decline in government spending on defence.

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Company Overview

Raytheon's products and services span: electronics, missiles, mission systems integration, sensing and effects, C3ISR, targeting, navigation systems, radars, early warning systems and mission support services. Raytheon is also the world's largest producer of guided missiles. The company ranks high among the Department of Defense's 10 main defence contractors and is the world's fifth-biggest defence company. Raytheon generated US$24.8bn in revenue in 2011.

Financial Data

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Global Industry Overview


Global Political Outlook
BMI View: As we progress through 2013, there is no shortage of 'big' geopolitical risks, namely tensions on the Korean Peninsula, Iran, and Syria, but most of these appear to be contained, at least for the time being.

As we move through the second quarter of 2013, the immediate political risks facing the world are renewed concerns about the eurozone in light of Italy's political deadlock and Cyprus's financial crisis, and a possible clash on the Korean Peninsula. As the year progresses, we expect attention to turn to several key elections, with September being an especially busy month due to voting in Australia, Germany, and Austria in quick succession. Other countries holding important elections include Iran (presidential), Japan (Upper House), Argentina (legislative), and Azerbaijan and Georgia (presidential). As regards international conflict risks, we remain vigilant towards the possibility of an Israeli attack on Iran in the second half of 2013 if Iranians elect a hardliner as president in June and if Tehran shows no flexibility over restraining its nuclear programme. We are also keeping a close eye on the Sino-Japanese territorial dispute over the Diaoyu/ Senkaku islands in the East China Sea, the situation in Mali, and of course the civil war in Syria, which could intensify as the rebels close in on Damascus.

Global Hotspots: Koreas, Iran, Syria, Asia Maritime Disputes

Korean Peninsula at risk of new clash: Tensions will remain high on the Korean Peninsula following the North's February 12, 2013 nuclear test and its sharp increase in rhetoric against the South and the US. Although apocalyptic propaganda statements from Pyongyang are not that unusual, the tone has been fiercer of late, and should not be entirely discounted. We see a realistic risk of a clash between North and South, as Northern leader Kim Jong Un appears to wish to test the resolve of the South's new president, Park Geunhye. Provocations by Pyongyang could take the form of a renewed confrontation in the West Sea region, where the North does not recognise the Northern Limit Line (NLL) maritime border; an incident in or barrage across the Demilitarised Zone (DMZ) that separates the two Koreas; a series of short-range missile tests; a long-range missile test or new nuclear test; and a cyber attack (both Koreas have experienced cyber attacks recently).

If North Korea does carry out a provocation, the South will certainly be tempted to respond. One Southern general has warned that it would retaliate against the North's 'command', which is believed to refer to its corp commanders or even its leadership. Now that the South has given a strong warning, it may have to follow up on its rhetoric in the face of a Northern provocation. There is thus the risk of a skirmish that costs

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dozens of lives. The current period of tensions could last at least until July 27, 2013, which marks the 60th anniversary of the end of the Korean War. Pyongyang traditionally uses key anniversaries to make grand gestures such as missile or nuclear tests.

As for North Korea's internal politics, although Kim Jong Un appears to have consolidated his power, we remain vigilant towards possible internal dissent within the powerful military, which has seen an unusual amount of reshuffling of its top positions over the past year. In addition, any attempt by Kim to shift more economic resources towards the civilian sector could be met by resistance from the generals.

Iran war risks rising, but not inevitable: Although speculation about Israeli airstrikes against Iran's nuclear facilities has waned somewhat lately, we believe the risk could rise in the second half of 2013, as Israel loses patience with Tehran and could conclude that it has a 'now or never' opportunity to prevent the Islamic Republic from going nuclear.

That said, we still see several constraints on Israeli action. Firstly, we believe that US President Barack Obama is reluctant to see a new conflagration in the Middle East which could cause oil prices to surge, potentially triggering a new global economic downturn. He will thus seek to dissuade Israel from war. Secondly, negotiations between Iran and the 'Great Powers' (China, France, Germany, Russia, the UK, and the US) have been under way, and Israel is unlikely to act while these are in progress. That said, we believe that Iran is unlikely to offer major concessions until its June presidential election is out of the way, as its main political leaders are busy jockeying to succeed Mahmoud Ahmadinejad or to manoeuvre their preferred candidate into the ranks of the front-runners. This leads to our third point, namely Iran has presidential elections on June 14, 2013, and the US and Israel will be hoping that deteriorating economic conditions in Iran as a result of sanctions could give the Iranian opposition, which has largely been sequestered since challenging the outcome of the 2009 election, a new lease of life. In our view, any military action against Iran ahead of that country's election would only end up boosting the ultra-hardliners, as the public rallied around the regime amid patriotic fervor. This would quash the opposition's hopes for a revival.

If negotiations with Iran fail and a hardliner is elected president in June, then the probability of Israeli military strikes would rise substantially. BMI has conducted a scenario for an Israel-Iran conflict, which would last several weeks and cause a spike in oil prices (see our online service, November 23, 2012 'Scenario: What Would An Israel-Iran War Look Like?'). That said, we do not believe that airstrikes against Iran are inevitable in 2013. Firstly, Iran's probable retaliatory moves (such as blocking the Strait of Hormuz, launching missile attacks on Israel and other US allies, and possibly carrying out terrorist attacks against

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Israeli and Western interests) are still a powerful deterrent. Secondly, Iran may refrain from crossing any visible nuclear threshold, leaving sufficient ambiguity over its nuclear programme that reduces the sense of urgency in the US and Israel.

Syria set for long war: Syria's civil war remains in deadlock, and there is no telling how long this will last. Deadlocks can end suddenly, as was the case in Libya's conflict in the late summer of 2011. Possible gamechangers include assassinations of major figures, defections, rebel gains in a key city or region, and the use of chemical weapons. The rebel forces have made considerable advances and are closing in on the capital, Damascus. President Bashar al-Assad long ago lost the means to reassert full control over the country, and his best chance of survival probably rests with fortifying Damascus or fleeing to the north-western coastal region, where his Alawite supporters are reportedly preparing to create a mini-state. If the latter scenario does transpire, the war will go on even after Damascus falls. Even if Assad is killed or overthrown and the Alawite state fails to materialise, we believe Syria's conflict will continue. Syria's minorities, including Christians and Kurds, are fearful of the possibility that a Sunni majority Islamist regime would persecute them, and they could take up arms against the country's new rulers. Meanwhile, the Syrian opposition is itself diverse, comprising secular nationalists and Islamist militants supportive of al-Qaeda. The only thing unifying them is their desire to see regime change. Once the Alawite regime is out of power, the rebels could turn on one another. Overall, we reiterate that even if Assad falls from power, the war would not end.

Asia maritime disputes will remain unresolved: Sino-Japanese tensions over the disputed Diaoyu/ Senkaku islands have cooled somewhat, but the issue remains unresolved, and we continue to highlight the risk of an aerial or naval 'incident' or skirmish that leads to fatalities. This would dramatically raise the emotiveness of the dispute in both countries and could lead to retaliation. We doubt that either new Chinese President Xi Jinping or new Japanese Prime Minister Shinzo Abe favours conflict, but neither feels that they can concede ground. That said, we do not preclude an early summit between Xi and Abe to at least deescalate recent tensions. The dispute between China on the one hand and Vietnam and the Philippines on the other in the South China Sea will also merit attention.

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Methodology
How We Generate Our Industry Forecasts

BMI's industry forecasts are generated using the best-practice techniques of time-series modelling. The precise form of time-series model we use varies from industry to industry, in each case being determined, as per standard practice, by the prevailing features of the industry data being examined. For example, data for some industries may be particularly prone to seasonality, meaning seasonal trends. In other industries, there may be pronounced non-linearity, whereby large recessions, for example, may occur more frequently than cyclical booms.

Common to our analysis of every industry, however, is the use of vector autoregressions. Vector autoregressions allow us to forecast a variable using more than the variable's own history as explanatory information. For example, when forecasting oil prices, we can include information about oil consumption, supply and capacity.

When forecasting for some of our industry sub-component variables, however, using a variable's own history is often the most desirable method of analysis. Such single-variable analysis is called univariate modelling. We use the most common and versatile form of univariate models: the autoregressive moving average model (ARMA).

In some cases, ARMA techniques are inappropriate because there is insufficient historic data or data quality is poor. In such cases, we use either traditional decomposition methods or smoothing methods as a basis for analysis and forecasting.

It must be remembered that human intervention plays a necessary and desirable part of all our industry forecasting techniques. Intimate knowledge of the data and industry ensures we spot structural breaks, anomalous data, turning points and seasonal features where a purely mechanical forecasting process would not.

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Defence Industry
There are a number of principal criteria that drive our forecasts for each defence variable.

Defence Budget And Expenditure

Figures for the defence budget (but not expenditure) are based, where possible, on primary government/ ministry sources and official data. Where these are unavailable, defence budget/expenditure forecasts are based on a range of variables including:

Stated expenditure and procurement plans; Likely increases to expenditure owing to security threats; Political factors (likely government changes, influence of the military); Readiness of the military; and, Commitments of the armed forces.

Expenditure per capita / % of GDP / % of fiscal budget are calculated using BMI's own macroeconomic and demographic forecasts.

Employment In Arms Production

Forecasted based on the following criteria:

The growth or otherwise of the defence industry; and, Company results and expansion plans.

Arms Imports/Exports

Forecasted based on the following criteria:

Arms ordered and not yet delivered; Stated procurement plans; Military needs (based on the security situation and the readiness of the military); and, Occasionally realpolitik (orders from major allies, foreign military sales from the US, etc).

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Sources
Sources used in defence reports include local defence ministries, officially released company results and figures, established think-tanks and institutes, such as the Stockholm International Peace Research Institute (SIPRI), the International Institute for Strategic Studies (IISS) and the Royal United Services Institute (RUSI), and international and national news agencies.

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