Central Europe's Defense Surge: Geopolitical Exposure and Hidden Supply Chain Winners

The European Union's defense spending has entered a new era, driven by geopolitical volatility and a strategic pivot toward self-reliance. With total defense expenditures hitting €343 billion in 2024 and projected to rise to €381 billion in 2025, Central Europe is emerging as a critical battleground for capitalizing on this surge. According to a report by Defense News, the EU's 1.9% GDP allocation to defense in 2024—a 19% year-over-year increase—reflects a shift from post-Cold War complacency to a war-driven urgencyBoosting European defence expenditure^[1]. Poland's 3.8% GDP defense budget in 2023 and Germany's commitment to meet NATO's 2% target underscore this regional transformationMilitary spending in Western and Central Europe higher than end of Cold War data shows^[4]. For investors, the question is no longer if to bet on European defense, but how to identify the most compelling opportunities.

The ReArm Europe Plan: A Catalyst for Supply Chain Winners

At the heart of this transformation is the EU's ReArm Europe initiative, a €800 billion investment plan aimed at bolstering defense capabilities and industrial sovereignty. A key component, the Security Action for Europe (SAFE) instrument, provides up to €150 billion in loans for joint procurement, prioritizing interoperability and cost efficiencyBoosting European defence expenditure^[1]. This shift toward common procurement is reshaping supply chains, favoring firms that can scale production and integrate with cross-border projects.

Central European companies are already reaping the rewards. Rheinmetall (Germany), for instance, is expanding its air defense and armored vehicle production to meet surging demandBoosting European defence expenditure^[1]. Similarly, Leonardo (Italy) is leveraging its partnership with Turkey's Baykar to produce drones under the EU's urgent needs frameworkBoosting European defence expenditure^[1]. Smaller players like Saab (Sweden) are modernizing submarine fleets and supplying advanced radar systems, positioning themselves as critical nodes in the EU's rearmament networkBoosting European defence expenditure^[1].

Geopolitical Exposure: A Double-Edged Sword

The EU's push for strategic autonomy is not just about numbers—it's about geopolitics. As tensions with Russia persist and U.S. foreign policy shifts under new administrations, European governments are prioritizing domestic solutions. For example, Germany's 2025 defense budget of $110 billion is explicitly tied to reducing reliance on non-EU suppliersEurope is pouring money into defense. Can US firms reap the reward?^[3]. This trend favors companies like BAE Systems and Thales, which are expanding their Central European operations to align with EU procurement goalsBoosting European defence expenditure^[1].

However, this focus on self-reliance also introduces risks. Fragmentation remains a challenge, as national governments often prioritize domestic suppliers over cross-border collaborationSeizing the moment: how can SMEs thrive in Europe’s new defence landscape^[2]. Additionally, Europe's reliance on non-EU technologies for AI, quantum computing, and cyber defense could create vulnerabilitiesSeizing the moment: how can SMEs thrive in Europe’s new defence landscape^[2]. Investors must weigh these risks against the long-term tailwinds of a €800 billion spending spree.

Underappreciated SMEs: The Hidden Gems

While giants like Rheinmetall dominate headlines, smaller firms are quietly becoming linchpins of the EU's defense industrial base. The European Defence Industry Programme (EDIP), with €1.5 billion allocated for R&D and procurement, is a lifeline for SMEsSeizing the moment: how can SMEs thrive in Europe’s new defence landscape^[2]. For instance, Fincantieri (Italy) is expanding its naval shipbuilding capabilities, including multipurpose combat ships, to meet EU and NATO demandsBoosting European defence expenditure^[1]. Similarly, Safran (France) is pivoting toward next-gen propulsion systems for fighter jets, a sector expected to grow as the EU ramps up its air defense investmentsBoosting European defence expenditure^[1].

These companies benefit from the EU's relaxed fiscal rules, which allow member states to exceed deficit targets for defense spending by up to 1.5% of GDP until 2028Boosting European defence expenditure^[1]. This flexibility is particularly advantageous for Central European economies like Poland and the Czech Republic, where defense budgets are expanding at double-digit ratesMilitary spending in Western and Central Europe higher than end of Cold War data shows^[4].

Conclusion: A High-Conviction Play

The Central European defense sector is a high-conviction investment opportunity, driven by geopolitical urgency, policy tailwinds, and a restructured supply chain. While risks like fragmentation and technological dependence persist, the scale of EU spending—projected to grow at 6.8% annually until 2035Seizing the moment: how can SMEs thrive in Europe’s new defence landscape^[2]—creates a compelling case for long-term investors. For those seeking exposure, a diversified portfolio of large-cap defense contractors and high-growth SMEs offers the best balance of upside and resilience.

As the EU races to close capability gaps in air defense, cyber, and AI, the winners will be those firms that can scale production, innovate rapidly, and navigate the complex interplay of national and EU-level priorities. The time to act is now—before the next round of procurement contracts is finalized.