The total F-16 package involves a potential capital cost in excess of $1 billion, some of which comes to charge earlier than was originally contemplated in the 1997 Defence Assessment (DA97). It was approved at a time when the plan itself had already increased from $4.4 billion to $5.6 billion between DA97 and the approval of the F-16 project by Cabinet in November 1998. The DA97 indicative replacement date for the Skyhawks was 2007/2011 at a cost of $653m - based on 1997 dollars and the exchange rates at the time - for 18 second-hand F-16C/D aircraft.

To obtain a clearer picture of the relative impact of the F-16 contracts on other defence priorities, it is necessary to sketch the recent history of the NZDF's fiscal situation. DA97 recorded how Defence had been sharply affected by a series of funding reductions in real terms since 1991. In March 1996 the Chief of Defence Force and Secretary of Defence reported to the Government that expenditure on New Zealand's current defence could not be sustained. Either a review of funding or significant cuts to military capability were required. Doing nothing was not an option, they informed the Government. This advice formed the basis for DA97 and the subsequent White Paper.

DA97/White Paper

DA97 was based on a balanced force, self-reliance in partnership, etc. with minimal increase in funding. It confirmed existing policy and was essentially funding driven.

A 20-year forecast was produced which showed a steadily increasing operating budget. A 20-year capital plan was also produced which showed the intended capability acquisitions needed to maintain a balanced force. Some 45 major projects were included covering the period up to FY 2016/17. An indicative level of extra capital injection was also provided in a 10-year capital plan with $509m needed to FY 2008/09.

Subsequent events have shown the proposed funding regime to be inadequate, with capital injections required, substantially beyond the levels forecast in 1997.

1997 Government Priorities

Following DA97, the Government identified a number of significant high priority projects which were to be "brought forward for separate decision over the next five years". These were:

• upgrading the Army's combat capability including: armoured vehicles, direct fire support weapons, tactical communications and general service vehicles;

• upgrading the Orion aircraft;

• improving the air combat capability of the Skyhawks;

• life extension of the Iroquois helicopter fleet;

• modification of torpedo stocks;

• acquisition of a fifth maritime helicopter;

• modifications to Charles Upham.

There is no mention in this list of replacement C130s, replacement air combat capability or a third frigate as these all fell outside the 5-year window.

1998 Funding Issues

The 1997 capital plan was based on exchange rates of $NZ1 = $US0.69c. By late 1998, primarily because of exchange rate movement, the cost of the 20-year capital estimate had increased from $4.4 billion to over $5.6 billion.

Because of this and a Government instruction to the NZDF to remain within 1997 funding guidelines, all projects were reprioritised in November 1998 in order to arrive at a list of high priority projects that could be financed within the guidelines.

The projects categorised as Priority 1 were those deemed fundamental to restoring the capabilities of front line force elements (e.g. armoured vehicles, replacement combat aircraft, replacement C-130s and a third frigate).

Twenty-seven projects dropped below the indicative funding line and were placed in categories Priority 2 to 5. Many are now said to be more critical but there is currently no funding for them.

Information presented during the review shows that a revised 10-year capital plan was presented to the Cabinet on 30 November 1998 with other papers, including:

• one for the acquisition of the F16 aircraft, which was accepted;

• one for the acquisition of a third ANZAC Frigate, which was rejected.

Among other things, the Cabinet agreed "to maintain the funding envelope as set out in the 1997 Defence White Paper."

Progress to date

• Procurement action is underway for Army direct fire weapons and communications equipment, with these items expected in service by late 2000. Tenders have recently been invited for armoured vehicles and replacement Landrovers, and tenders have been received for upgrading the Orions (Project Sirius). Contracts have been signed for the fifth maritime helicopter and to replace the Skyhawks with F-16s.

• The Iroquois life extension is currently being defined.

• A contract has been signed for the design work associated with the conversion of the Charles Upham. Conversion is currently expected to start in late 2000.

In addition, a study, initially commenced to determine a suitable replacement for the frigate Canterbury, is underway.

Details of individual single-service projects, with their status and priority, follow:

Navy

Priority 1

• Training Simulator - contract signed

• Surface Combatant - study to determine replacement for Canterbury

• Fifth Maritime Helicopter - contract signed

• Charles Upham Conversion - conversion due to commence on completion of charter late 2000

Priority 3

• Torpedo Modifications - under review

• Upgrade Kauri Point - funding not identified

Priority 4

• Remote Minehunting System - funding not identified

• Towed Array Sonar - funding not identified

Priority 5

• Evolved Seasparrow - beyond 5 years

Outside priority list

• ANZAC frigate mid-life upgrade - beyond 10 years

• Minor vessel replacement - beyond 10 years

Army

Priority 1

• Direct Fire Support Weapons ------ tenders issued, contract FY 1999/2000

• Landrover Replacement - tenders issued, some purchased

• Anti-Armour Weapons - tenders issued, contract FY 1999/2000

• Armoured Vehicles - tenders received

• Tactical Communications - negotiations in hand with the United States Foreign Military Sales (USFMS) organisation

• Reconnaissance Vehicles - funding FY 2000/01

Priority 2

• Special Warfare Communications - funding possible FY 1999/2000

Priority 2/4

• Field Engineering Equipment - funding not identified

Priority 4

• Electronic Warfare - funding not identified

• Surveillance and Observation Equipment - funding not identified

• Battle space simulation system - funding not identified

• Unmanned Aerial Vehicle - funding not identified

Priority 5

• Mortar Replacement - beyond 5 years

Outside priority list

• Artillery Replacement - beyond 10 years

• Wheeled Vehicle Replacement - beyond 10 years

• Replacement very low level air defence system - beyond 10 years

• Small Arms Replacement - beyond 10 years

Air

Priority 1

• Skyhawk Replacement - F-16 project underway

• Air Weapon Modernisation - funding in FY 2004/05

• Airborne Laser Designator - funding in FY 2003/04

• Orion Mission Equipment Upgrade (Project Sirius) - tenders received

• Iroquois Helicopter Life Extension - funding in FY 2002/03

• C130 Hercules Replacement - beyond 5 years - project definition; but refurbishment appears best option

• Navigation Systems Upgrade - funding for FY 2000/01

• Orion Auto-Pilot - contract signed

Priority 1/2

• Ohakea and Auckland Runway - the latter being subject to real estate review

Priority 2

• Boeing 727 Replacement - commercial lease being considered

• Airborne Communications - funding not identified

Priority 3

• Anti-Ship Missile - funding not identified

• Helicopter self protection - partially done for East Timor

Outside priority list

• Air-to-Air Missile - beyond 10 years

Current Situation

Since late 1998 there has been further adverse impact on the affordability of the capital plan. Contributing factors are:

• increases in project costs. For example, the naval helicopter project has risen by $45 million due to foreign exchange movement and the ANZAC ship project has increased by over $30 million as a result of exchange-rate changes and contract escalation;

• that the F-16 project is in excess of the original estimate referred to Cabinet in November 1998 and involved significant payments earlier than previously predicted in that document; and

• failure to realise anticipated revenues from the sale of surplus real estate.

Real Estate

A National Real Estate Consolidation Strategy was presented to the previous Minister of Defence in March 1998. It went to the Cabinet in October 1999, but no decisions were taken.

At the time of the real estate review the rationalisation of camps and bases was forecast to eventually save around $20 million in annual operating costs. This was factored into NZDF baselines.

On the capital side, the sale of bases and service housing was expected to net over $140 million. The net proceeds for the first two years of implementation had the potential to reduce the magnitude of the capital injections required to maintain the capital plan. This was also factored into the funding guidelines, but has not eventuated.

Outstanding Priority 1 Projects

There are currently 11 projects that were Priority 1 in November 1998 that have not yet had funds committed. They are:

• The balance of the Army Direct Fire Support Weapons

• Army Anti-Armour Weapons

• Armoured Vehicle Replacement

• Landrover Replacement (some commercial vehicles have been purchased)

• Reconnaissance Vehicles

• Army Communications

• Orion Upgrade (Project Sirius)

• Iroquois Life Extension

• C-130 Replacement/Upgrade

• Replacement of Canterbury, and

• Conversion of Charles Upham

The Ohakea runway upgrade has now been added to Priority 1 to 2 status.

Funding Scenarios

To determine what the future funding requirements might be, the NZDF has developed the following scenarios for Priority 1 projects:

Scenario 1

This covers current commitments and shows the capital injections required to fund those projects where Government approval to commit funds has been given. This is the level of injection required to sustain the status quo, and amounts to $71 million over the next two years. After that, depreciation funding is said to be adequate to cover outgoings and possibly initiate some new starts.

The figure of $71m - just to stand still - compares with $292 million proposed in DA97 for the same period. However, no provision is made in this scenario for any of the outstanding Priority 1 projects because (in some cases) of slower project development than was anticipated. This applies particularly to the Army's APCs and Project Sirius.

Scenario 2

This covers current commitments plus the Army upgrade. This scenario shows the capital injections required if the remaining Priority 1 projects to re-equip the Army are approved. A total of approximately $418 million will be needed over the next three years. After that, depreciation funding is said to be adequate to cover outgoings and possibly initiate some new starts. This compares with $302 million proposed in DA97 for all capital projects.

No provision is made in this scenario for:

• Orion upgrade (Project Sirius)

• C-130 replacement

• Iroquois helicopter life extension

• Replacement of Canterbury

• Conversion of Charles Upham

• Any Priority 2 to 5 projects

Scenario 3

This covers current commitments plus the Army Upgrade and Project Sirius. This takes the level of capital injection to approximately $754 million over the next three years. After that, depreciation funding is again said to be adequate to cover outgoings and possibly initiate some new starts.

No provision is made however in this scenario for: