Russia’s aggression complicates a deal to buy French-designed military warships.


The Vladivostok warship, a Mistral class LHD amphibious vessel ordered by Russia to the STX France shipyard in Saint-Nazaire, western France, leaves for her first trial on March 5.

FORTUNE — So much for détente. It was almost a year ago when a crowd gathered in Saint Petersburg, Russia, to toast the launching of one half of a French-designed warship, theVladivostok, which had been partially built for the Russian Navy in the city’s shipyard. The giant vessel, as high as a 20-story building, was headed for final construction and assembly in France’s Normandy region — a coastline that bears the scars of World War II. Standing on the dock, a reporter for the Kremlin-run Russia Today TV gushed that the ship represented “the winds of change between Russia and France.”
But just nine months on, the wind has turned chilly. And now a deal worth about $1.65 billion risks being tossed into the seas.
Back in 2011, when former president Nicolas Sarkozy inked a contract to deliver two Mistrals to the Russian Navy, with the possibility of two more, he hailed it as bringing big money into the battered French economy, and 1,000 jobs to the small Normandy community of Saint-Nazaire, where it is being built by the company STX Europe AS, a subsidiary of Korea’s STX Corporation.
It was the biggest military deal for warships anywhere in the world that year. And it was a historical marker, too, as the first military sale to Russia in decades by any NATO member. For Vladimir Putin, it not just filled a military need, but was a not-too-subtle message to the rest of the world, too. “It demonstrates that Russia is not a political outsider, but part of the European family,” Russian military analyst Ruslan Pukhov told Russia Today last year.
For exactly that reason, the Mistrals are now a major conundrum for President François Hollande — as well as a crucial test of how much the West will punish Vladimir Putin for invading and annexing Crimea. President Obama and EU leaders last month slapped travel bans on key Russian officials and froze their overseas assets. They also suspended Russia from the G8 group of industrialized nations, a slap in the face for Putin, who was set to host the G8 summit in June in Sochi. But only one Western business deal — France’s Mistrals — would directly target Russia’s military itself.
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As U.S. and EU officials scramble to react to Russia’s military moves, Hollande’s government have hedged over whether they still intend delivering the Mistrals, loading their responses with qualifying language, so that even French politicians seem clueless about the state of the deal. French officials have suggested that they would wait to see if Putin moves his troops farther into Ukraine, or into other neighboring countries like Moldova or the Baltic states, before scrapping the deal. And they’ve grumbled that it is unfair to demand they lose huge business, while British officials have made it clear that they don’t intend stopping Russian oligarchs from plowing billions into the City of London.
“We would consider canceling the sales,” French Foreign Minister Laurent Fabius said vaguely last month, when reporters asked if the Mistral deliveries would stand. When reporters asked Hollande the same question, shortly before Putin declared Crimea part of Russia, whether the Mistral deliveries would stand, the president said, “Right now, we have no plans to cancel them.”
It’s not hard to understand why. With the French economy predicted to have near-zero growth this year, and unemployment stuck above 10%, France would be obligated to refund Russia much of the cost of the Mistrals if they do not deliver them, a sum worth hundreds of millions of euros. That’s money the government is loath to part with, especially with Hollande’s popularity at record lows; his Socialist Party lost 155 municipalities in last week’s local elections.
But there are other economic reasons, too. In the fiercely competitive defense market, France has failed to find customers for other high-priced defense items, like the Rafale fighter jet, which is made by Dassault Systems. Other European countries have drastically cut their budgets through the Euro-crisis, and aren’t buying. For France, Moscow is a prized client, and officials have spent years cultivating business opportunities with Russia, which is the world’s second-biggest defense spender after the U.S. Putin’s fighter jets, for example, are outfitted with top-of-the-line French avionics, which Russia lacks the ability to engineer itself. “Russia is very good at putting metals together, but not electronics,” says Guy Anderson, editor of the British military publicationJane’s Defense Weekly.
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In recent years, Putin has used his oil wealth to invest heavily in upgrading the Russian arsenal, much of which suffered drastic decline after the collapse of the Soviet Union; Ukraine, ironically, was a major supplier of components to Russia while it was a Soviet state. Putin has been determined to reverse the decline. “They’re throwing billions at developing and catching up on electronics,” Anderson says.
With Russia producing an ever-wider range of products, there is a chance that Putin could retaliate if France scraps the Mistral deal. “France has very clearly moved into the Russian market to getting Russians to buy large number of systems,” says Siemon Wezeman, senior researcher on arms transfers at the Swedish military think tank Sipri. “If France now would say, ‘We’ll stop Mistral,’ the Russians could be pushed to say, ‘We won’t buy electronics.’” That fact seemed clear when Deputy Prime Minister Dmitry Rogozin told reporters last month, “France is starting to undermine confidence it is a reliable provider in the very sensitive sector of military and technical cooperation.”
In truth, however, Putin needs the French warships. And just like Hollande, he would feel their loss. Huge and versatile, the Vladivostok would give Russia the ability to launch a major offensive from its decks. It has six helicopter landing pads and a command-and-control center capable of accommodating hundreds of people. “It’s a highly advanced amphibious platform,” Anderson says. “Russia has nothing comparable.” At least, not yet.