ANALYSIS-US defense market seen facing rising protectionism

By Andrea Shalal-Esa

WASHINGTON, Nov 3 (Reuters) - Expected Democratic gains in Congress, a tighter defense budget and growing concern about barriers to U.S. weapons sales in some European countries point to a surge in American protectionist sentiment after the Tuesday election.

That is seen resulting in tighter scrutiny of European companies bidding for a stake in billion-dollar U.S. defense contracts. At the same time, a rising dollar and tighter credit markets worldwide may dampen foreign interest in buying smaller American defense companies.

"For a variety of reasons, it's going to be harder to enter this market or sell into it," said defense analyst Loren Thompson of the Virginia-based Lexington Institute.

Defense officials, industry executives and analysts agree that U.S. defense spending is likely to grow much more slowly over the next four years than it did over the past eight, regardless of whether Democrat Barack Obama or Republican John McCain wins the presidential election. One reason: Congress must find a way to pay for the unprecedented $700 billion bailout package for the U.S. financial services industry.

U.S. defense spending has climbed over 60 percent during the Bush administration, and will total at least $612.5 billion in fiscal 2009, including $542.5 billion for the basic defense budget and $70 billion for the wars in Iraq and Afghanistan.

Steve Kosiak, analyst with the Center for Strategic and Budgetary Assessments, said weapons programs could be hit relatively hard as defense spending leveled out. That would create more pressure to protect U.S. manufacturers, especially if the U.S. economy remains weak.

"The next administration may also take a more active role in shaping and protecting the defense industrial base. That, too, could result in some additional protectionism," he said.

Analysts say protectionist rhetoric is already on the rise. They cite campaign statements by both presidential candidates, and anti-foreign comments by Boeing Co supporters during the company's protest against a $35 billion refueling aircraft contract awarded to Northrop Grumman Corp and its European subcontractor, Airbus parent EADS .

"It's probably going to get worse before it gets better," said one defense official, speaking on condition of anonymity.

Richard Aboulafia, analyst with the private Teal Group, agreed. "The sad truth is that both sides of the political aisle have been back-pedaling on globalization."

EXPORTS MAY TEMPER MOOD

Some U.S. industry executives and analysts argue that the prospect of strong overseas sales -- which help maintain production lines and high-paying jobs at home -- should prevent any moves to reverse globalization in the aerospace sector.

Clay Jones, chief executive of Rockwell Collins Inc , a subcontractor to big defense companies, said it was clear that a Democratic-controlled Congress and White House would be more protectionist. But at the same time, efforts to rein in defense spending might actually force the Pentagon to pursue more global development programs like the F-35 Joint Strike Fighter (JSF), he told Reuters in an interview.

Lockheed Martin Corp is developing three variants of the F-35 with eight international partners, including Britain, at a cost of $299 billion.

"If you're trying to control the rate of defense spending, the JSF arrangement makes a lot of sense," Jones said.

Globalization also keeps the aerospace sector competitive and generates good jobs at home, he said.

Some U.S. weapon production lines, including Lockheed's F-16 fighter jet and Boeing's F-18 warplane, were now surviving solely due to foreign sales, said Remy Nathan, an assistant vice president at the Aerospace Industries Association.

"I genuinely don't see some kind of a massive course correction," Nathan said, referring to protectionist worries.

EUROPEAN INROADS

European companies made major inroads to the lucrative U.S. defense market in recent years.

EADS won a contract to build light utility helicopters for the U.S. Army while AgustaWestland, a unit of Italy's Finmeccanica , is designing the next U.S. presidential helicopter. Alenia, another Finmeccanica company, has a big role in an Army contract for cargo planes.

The Northrop-EADS refueling tanker project was the biggest deal by far involving a European supplier.

Pentagon chief arms buyer John Young has denied there was any protectionist sentiment involved in the decision to postpone the tanker competition, and said he remained convinced that open competitions yielded the best results for U.S. troops.

But he said U.S. officials and lawmakers remained concerned about the lack of access that U.S. companies had to some European markets. "I can't explain that to Congress," he said.

Acquisitions have also let several European defense companies increase their footprint in the U.S. market.

Finmeccanica last month won permission to buy military engineering and electronics company DRS Technologies Corp after agreeing to put DRS' sensitive operations into a proxy company that remains out of the control of Finmeccanica's Italian bosses. Even with the condition, some U.S. government officials remained concerned about the deal and nearly blocked its approval, according to two sources.

The Finmeccanica deal may be the last large foreign acquisition of a U.S. weapons company for some time, given tight global credit, the rising dollar, and concerns about maintaining the U.S. industrial base.

"Finmeccanica may prove to be unique. These deals are going to become harder to sell with the U.S. economy in such a perilous condition," said Thompson. (Reporting by Andrea Shalal-Esa; Editing by Tim Dobbyn)