Mitsubishi Heavy warns survival of Japan’s defence industry at stake

Mitsubishi Heavy Industries, Japan’s biggest defence contractor, has warned that the survival of the country’s struggling defence sector is at stake as the government debates a historic increase in military spending to counter the threat from China.

Naohiko Abe, who heads the sprawling conglomerate’s defence and space business, told the Financial Times that Russia’s invasion of Ukraine has crystallised the security risks to Japan posed by China and North Korea, creating more public support for a bigger defence budget. Recent polls have shown that a majority of the Japanese public is in favour of an increase.

“It was a big factor that everyone including the general public started to feel that something similar to Ukraine could happen around Japan. Putting aside the actual figure of how much the defence budget will increase in terms of percentage, action needs to be taken,” Abe said.

But beyond a straightforward increase in military spending, Abe argued a wider shake-up was needed, saying the country’s defence industry was not sustainable if it could only generate razor-thin margins from defence ministry contracts.

“More companies are withdrawing from the defence sector because they are chronically losing money,” he said. “Industry players all say that they need more profitability, continuity as well as predictability. We must do something to sustain the industry because companies are withdrawing in the last five years.”

He even warned that additional military spending would not necessarily provide a bigger business opportunity for MHI’s defence business, which accounts for about 10 per cent of the group’s revenue which was ¥3.8tn ($29bn) in the year to March.

But he added that the situation could improve now that the defence ministry is in the process of reviewing contracts to improve profitability for companies.

While companies can theoretically expect up to a 7 per cent profit margin from supplying the government with military equipment, the actual margin has often been zero or even negative given the sporadic nature of contracts as well as other cost factors. Increased reliance on imports from the US has also led to a drop in procurement of homemade equipment.

As a result, Japanese companies have retreated from the defence business in recent years. Last year, Mitsui E&S withdrew from naval and government shipbuilding operations, selling the division to MHI. In 2018, Komatsu announced it would stop development of wheeled armoured personnel carriers shipped to Japan’s Ground Self-Defense Force.

Japan’s biggest business lobby Keidanren warned in April of “a crisis” in the domestic defence supply chain and urged the government to “position the defence industry as an important partner for national defence”.

Scrutiny of the country’s defence industry comes in a pivotal year for Japan. By the end of December, Prime Minister Fumio Kishida is expected to release a new national security strategy, guidelines for the national defence programme and a five-year procurement plan that will form the basis of the defence strategy.

In the wake of the war in Ukraine, the ruling Liberal Democratic party has said Japan should boost its military spending in line with Nato’s commitment for member countries to spend 2 per cent of gross domestic product. For about half a century, Japan has capped its defence budget at 1 per cent of its GDP. In the current fiscal year, this amounts to ¥5.4tn.

Japan is expected to increase its military budget but analysts are divided over how far Kishida can go given the fiscal pressures the economy faces from rising healthcare costs for its elderly population.