Issues Details: 
Vol 9 Issue 4 Sep - Oct 2015
Page No.: 
Sub Title: 
Achieving functional relationships in the Defence Industry
Lt Gen JP Singh, PVSM, AVSM (Retd), Advisor Military Affairs
Sunday, September 20, 2015

India has the 3rd largest armed forces in the world. 40% of budget is spent on capital acquisition, and practically 15% of revenue budget on in- service defense stores and ammunition. 60% of requirement is met by imports. The cumulative budget for 15 years is approximately 50 lakh crore.

Make in India initiative is designed to facilitate investment, foster innovations, protect intellectual property, and build best in class defense industrial base. For the private sector there are beneficial investment opportunities in defense products manufacturing, supply chain sourcing, MRO opportunities and defense offsets. Some of the growth drivers are:

• The DPP 2013 is under revision. The new DPP’s main focus is on higher percentage of indigenization and making the stages of acquisition process more transparent, responsive and uniform for responders. The MAKE  and BUY and MAKE (Indian)procedures, which aim to promote defense R&D and manufacturing processes, are being made more attractive and unambiguous for the private sector.

• The initial validity period of industrial licenses has been enhanced to 3 years from the present 2 years. A guideline for the extension of the validity of industrial licenses has been issued. Defense product list for industrial licensing published in June 2014 has excluded large number of parts/components, casting and forging, etc, from the purview of industrial licensing. The same is available on DIPP website

• The defense security manual for the private sector manufacturing units has been finalized. It is available on Department of Defense Production site. The manual clarifies the security architecture to be put in place by the industry while undertaking sensitive defense manufacturing.

• The FDI policy now permits 49% investment and investments by portfolio investors/FIIs (through portfolio investment) upto 24% under automatic route. On case-to-case basis, the CCS can permit FDI above 49%. The requirement of single largest Indian ownership of 51% of equity has been removed. As also, Minimum Advance Tax (MAT) on FII has been abolished.

• Guidelines for establishing Joint Ventures (JV) between Defense PSUs and Private Defense enterprises as also with foreign OEMs have been defined explicitly.

• Each State in India offers incentives for defense industrial projects. Incentives include subsidized land cost, relaxation in stamp duty, power tariff incentives, concessional rates of interest on loans and special incentives packages on mega projects. Additional incentives are being offered for units in SEZ/NIMZ in special areas such as North East, J&K, Himachal Pradesh and Uttarakhand.

• Export incentives like export promotion capital good scheme, duty remission scheme, focus product scheme, special focus product scheme and focus market scheme.

For Make in India initiative to succeed in defense sector, the government has to review the R&D in defence sector and prevailing mind-set towards indigenous private defence enterprises. The existence of private defense firms is new for India. Following the historic economic reforms in 1991, it took a decade thereafter to permit private sector to participate in defense sector. MoD and other state agencies view the procurement of arms and military from private companies as diversion of public resources from traditional state enterprises and research institutes. State defense orders play an important social role in India and are viewed as a means of providing state support for enterprises that are considered to be strategic, either in terms of technology or the social function they serve. Many state defense enterprises, especially those located far away from urban centres, provide employment and infrastructure for entire communities. In this way private companies are seen as unwanted competition in the battle for significant political and social resources.

Another problem is the view of private sector as highly corrupt in its relations with state structures. As a result, to award a contract to a private company is to risk being seen as taken on its payroll, and to draw to oneself robust audits and other forms of attention on part of law enforcement agencies. This is confirmed by the scandals that erupt on regular basis over defence procurement contracts involving private contractors. Of course, the question of corruption at the intersection of the public and private spheres is a very complex issue that deserves special treatment. Here I would like to simply point the obvious difficulties posed by this problem.

The state’s attitude towards private enterprises in defense sector seems strange especially in light of poor performance of state enterprises when it comes to R&D, production, quality, time lines and cost. Indeed, state enterprises are largely to blame for the fact that India lags so far behind in the development of equipment it requires even low capital outlays like UAVs, MRAP vehicles, ammunition, small arms, NVDs, protective clothing etc. MRO to a very large extent can be taken on by the private sector.

Private R&D is more efficient, in that, it is focused on minimising  costs of the final product, and of the R&D itself. However from the military point of view, this can  also lead to less than fully robust combat performance standards. Indian MoD is also against the use of imported components, which is common among efficiency driven private firms. In the long term, self-reliance is dependent on indigenous R&D. The quality of defense R&D depends on the vitality of fundamental science and basic research that has no prospect of financial reward. Private firms are by disposition inept at doing basic research in a sustained manner. The transfer of knowledge from state owned institutes like DRDO to private firms is often seen as the private sector unfairly exploiting commercial advantage of the results of state funded R&D. The practice of establishing private R&D as annexes to state research institutions, or regular movement of personnel from state to private institutions amounts to little more than state subsidization of private defense enterprises.

The obvious conclusion is that India has not yet established a functional relationship between the public and the private sectors and the DRDO in defense. The private sector has clearly demonstrated its flexibility and efficiency in conducting applied R&D and has attracted the attention of state military and procurement agencies. However, cooperation between the new enterprises and the old, and the public sector is plagued with problems. While the private and public sectors compete among themselves for what is meager funding for defense R&D, the state agencies are inclined to give preference to the public sector. Objectively the private sector has performed better than the public sector. Several of the vertically integrated private defense holdings have new corporate structures that are engaged in innovative and successful defense R&D with little or no support from the state.

Such observations tend to cast a doubt on the current wisdom of rationalization of the defense sector and marginalization of the role of private companies. Self reliance in defense requires common operating picture between all stakeholders. The premier defense R&D organization, DRDO, must have a clear mandate to coordinate and proliferate the basic, applied, transactional and matured technologies on a level play field to all defense sector enterprises. In order to succeed, Make in India initiative has to go beyond the incentives and policies, which are constructive, to transforming the functional correlation between all stakeholders.

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