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No Fire In Damp

In her budget proposals, the Union Finance Minister has attempted to revive investment, especially foreign direct investment in building infrastructure and manufacturing.

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Not too long ago, BW Businessworld had predicted that defence production in India could be the ‘next big thing’ in manufacturing. Now that India aspires to be a $5 trillion economy by 2024 and the government of the day woos investors (including foreign investors) into infrastructure building and manufacturing, what are the odds that the desired participation of the private sector and multinationals in defence production will take off at last? We take stock of whether or not the untapped potentials of manufacturing military hardware within India could be unleashed in the prevailing policy framework. 

In her budget proposals, the Union Finance Minister has attempted to revive investment, especially foreign direct investment in building infrastructure and manufacturing. She has also tried to incentivise exports and create new jobs in the private sector. The defence production industry has the potential to meet the government’s twin objectives of invigorating manufacturing industries and creating jobs. 

Make in India   
In May 2001, the Indian government opened up the defence industry, till then reserved solely for the public sector, offering 100 per cent private sector participation. Up to 26 per cent equity investment in foreign direct investment (FDI) was allowed, subject to licensing. The FDI policy was further liberalised and up to 49 per cent equity investment has been allowed under the automatic route. Equity beyond 49 per cent is permissible should it lead to access to modern technology or other specified factors.

The government reserves the right to quality control as the major stakeholder an issue often interpreted as an ambiguous investment barrier. Original equipment manufacturers (OEMs), who usually have decades of research and technological breakthrough ploughed into their products, are not comfortable with the control issues. As former Army Chief, General Ved Malik says, “I believe 49 per cent foreign ownership is a bit flexible. Now that India is working to exploit foreign markets for its defence products, we can be more liberal with foreign ownership of OEM companies in India.”   

As many as 42 proposals for FDI and joint ventures have been approved in the defence sector for manufacturing defence equipment in both the public sector and the private sector. Yet, foreign direct investment in defence-related industries is negligible. Between April 2000 and March 2019,  a meager FDI of Rs 41.54 crores ($7.31 million) has trickled into India. In 2018-19, FDI in defence-related industries in India was a mere $2.18 million.  

As one of the world’s biggest purchasers of defence equipment, India is keen to acquire a strategic advantage in manufacturing military hardware and even turn into a hotbed of investment. Somewhere down the line though, and despite the uptick in policy changes and rules favourable to investment, defence production is stuck in a quagmire. As General Malik says, “The most important step would be to change the mindset in the MoD: break the nexus with defence PSUs and the Ordnance Factory Board (OFB), loosen bureaucratic red tape in our systems, and give a level playing field to the private sector.”

While some OEMs have increased their footprints in India, none have enabled the process that could qualify them as System of Systems or Systems Integrators, which in aerospace terminology are companies that specialise in bringing together component subsystems into a whole to ensure that the subsystems function together. The multiple joint ventures that have cropped up in the defence sector are a good sign but are still a million miles away from resembling a defence cluster or an aerospace ecosystem. 

As on date for reasons of security, India’s defence forces continue to rely on the ordnance factories and defence public sector undertakings (DPSUs) for their supplies. Many of these government entities now lag behind and are not in step with technological developments and in their delivery schedules. As General Malik points out, “the Ministry of Defence (MoD) must realise that foreign OEMs are not comfortable with the work culture of our ministry, the OFB and PSUs. They would prefer to work with our private sector companies.”   

BW Busiinessworld picked the minds of the world’s top five global original equipment manufacturers and integrators of the System of Systems. Many said they were definitely looking at India and hopeful of a few concrete orders. At the Paris Air Show, Boeing Chairman and CEO, Dennis Muilenburg, said the aviation multinational’s investments in India were to the tune of $1 billion, but an order book the size of India’s MMRCA (Medium Multi-Role Combat Aircraft) deal could lead to aerospace clusters in India. 

Similarly, the world’s leading engine maker, Pratt & Whitney would have to be wooed with incentives if it was found fit to collaborate with the Advanced Medium Combat Aircraft (AMCA) project of the public sector Hindustan Aeronautics Limited (HAL). After all, at the end of the day, the nomenclature “indigenous aircraft” refers to a plane with a locally made engine. 

Laxman Behera, a research fellow at the Institute for Defence Studies and Analyses (ISDA), has done an extensive analysis of the status of the defence industry in India. “FDI in defence is unlike FDI in other sectors,” points out Behera. “Since there is only one buyer in defence, the inward investment would only be feasible if there is minimum order assurance from the government. No foreign company will bring in investment in defence just to make India an export hub.”

Behera says, “If the government wants big FDI, it has to give a commitment to buy.” General Malik corroborates the viewpoint. “After weapons and equipment trials, all companies finally want firm orders. We should be willing to do so taking into account our own requirements and capacity to sell abroad.”

A defensive budget   
In her Budget proposals, Union Finance Minister, Nirmala Sitharaman, allocated Rs 4,31,011 crore to the Ministry of Defence, apportioning 71 per cent of it, or Rs 3,05,296 crore, to the three Armed Forces and the Defence Research and Development Organisation (DRDO). The rest of the defence budget comprises allocation toward expenses like pensions of defence personnel. The budgetary allocation for the MoD is 15.5 per cent of government expenditure, but a mere 2.04 per cent of India’s estimated GDP.    

The capital account of the defence budget, or the portion earmarked for procuring new equipment for the Armed  Forces, is  Rs 1,08,248 crore. The  Defence Acquisition Council under the MoD has cleared contracts worth over Rs 1,70,000 crore since the beginning of 2018-19, exceeding allocations made in the budget. According to Behera, the contracts would entail an outflow of at least Rs 17,500 crore a year over the next several years.  The Armed Forces had a combined shortfall of nearly Rs 1,12,000 crore, which remained a whopping Rs 67,363 crore in FY19. “A substantial increase in the capital part of the defence budget is absolutely essential to make up the deficiencies, catch up with modernisation and to send the right signal to foreign vendors and OEMs,” says General Malik.    

The revenue expenditure, which includes salaries and maintenance of establishments, has been pegged at Rs 2,10,682 crore in FY20, against Rs 1,88,118 crore in the 2018-19 financial year.  

The revenue part has shot up to nearly 60 per cent of the MoD’s budget, from roughly 45 per cent in 2011-12, jeopardising the modernisation plans of the Armed Forces. Their revenue expenditure now sustains 31 lakh pensioners, 14 lakh uniformed personnel and four lakh defence civilians. When the Armed Forces start rightsizing their manpower, it goes without saying that the axe will fall first on their civilian manpower.  

Unlocked assets  
Investment in defence indirectly related to the sector being given norms prevalent in the industry. The MoD has an impressive pool of landmass comprising 1.73 million acres of land, some of which are unused, which may be used for defence manufacturing in partnership with the private sector. 

Defence production is now broadly confined to 41 odd ordnance factories, nine defence PSUs and 50 DRDO establishments. Union minister of state for defence, Shripad Naik, has divulged that 15 proposals worth Rs 861 crores had been granted for capital up-gradation and modernisation of ordnance factories in FY 19. Accelerating the disinvestment process in the ordnance factories will not only improve their productivity but also generate resources for the MoD.

General Malik also suggests special economic zones (SEZs) for OEMs, with adequate infrastructure and tax concessions. A great deal of investment could also be attracted into defence production through the procurement route. Projects identified for execution under Strategic Partnership guidelines could act as catalysts for both domestic and foreign investment. “It is too early to say that,” cautions Behera, however. “As far as defence policies for planning, procurement and industry are concerned the Modi government 1.0 had taken a host of initiatives. Those initiatives need to be implemented in a time-bound manner by the new government,” suggests the defence analyst.  

So, to cut an enormously long story short, India offers a policy framework for manufacturing a good deal of the defence equipment it imports. India needs investment in defence production and in manufacturing industries in general. Global titans in the business of defence are keen to test the waters here too - yet somewhere, something does not quite click. Will the new avatar of the Narendra Modi-led coalition that has returned to power for a second term be able to fix the jinx?

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