Pentagon needs an extra $42 billion due to soaring inflation -industry group

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FILE PHOTO: The Pentagon building is seen in Arlington, Virginia, U.S.

By Abhijith Ganapavaram and Mike Stone

(Reuters) - The U.S. Department of Defense will need an extra $42 billion in the next fiscal year to make up for a shortfall in how much it can buy as rising prices eat in to its procurement budget, a defense industry group said in a report coming out this week.

"Significant inflation is a major challenge" for the Pentagon and its thousands of contractors, compounding the challenge from COVID-19 and dealing with the supply-chain crisis, said the National Defense Industrial Association report, which was reviewed by Reuters ahead of publication.

From fiscal years 2021 to 2023, the total loss of buying power to the Pentagon from inflation will exceed $110 billion, the report said.

The drop in supply from the defense industrial base, which is bleeding money due to higher costs, risks slowing the pace of U.S. defense modernization at a time of rising confrontation with China and the war in Ukraine.

The NDIA called on the U.S. Congress, which is set to vote on a resolution later this month to keep the government funded, to provide inflationary relief to companies that hold long-term fixed price contracts, while suggesting future contracts automatically account for price rises.

The call for relief comes as smaller U.S. defense companies holding contracts that cannot be renegotiated complain they are losing money on them due to a shortage of workers and spiking raw material prices.

Small companies are important to the health of the defense industrial base, as they compete with each other and help the Pentagon drive down costs of contracts. They also help nurture and provide a steady pool of talent, essential in maintaining the United States' cutting edge in weapons.

To be sure, inflation has affected contracts in every other sector. But given the rigid nature of DoD contracts and the fact that there is one buyer, firms are unable to negotiate prices with the Pentagon, leading to calls by some companies to reassess fixed-price contracts.

"Re-evaluation of fixed price contracts is essential in this environment for mission success," Parsons Corp Vice President Jai Spivey told Reuters.

However, industry sources warned that any inflation relief may not be in the offing.

"I am skeptical that a sector-oriented solution will be passed this year which fully makes up for the inflation numbers due to competing interests and election season," said Pawel Chudzicki, leader of Aerospace and Defense practice at Miller Canfield law firm.

The Pentagon released a memo on Monday evening signed by pricing and contracting director John Tenaglia on Sept. 9 stating that schedule relief could be granted to contractors impacted by inflation. It said, however, that only in "extraordinary circumstances" would existing firm-fixed-price contracts get "upward adjustment to the price."

(Reporting by Abhijith Ganapavaram in Bengaluru and Mike Stone in Washington; Editing by Matthew Lewis)