A chicken-and-egg problem in defence sector for Make in India initiative

Visitors at the Defexpo in Chennai
At the biennial defence exhibition in April at Chennai, Prime Minister Narendra Modi listed out the milestones the government has achieved towards its Make-in-India goal in defence. “Over the last few years, we have made a humble beginning. On defence manufacturing licences, on defence offsets, on defence export clearances, on foreign direct investment in defence manufacturing, and on reforming our defence procurement, we have taken many steps,” he said.

Indeed, the government has made noteworthy progress since relaxing the foreign direct investment (FDI) rules in defence manufacturing. Currently, FDI up to 49 percent is allowed in the sector via the automatic route and beyond that up to 100 percent on a case to case basis. 

“We have seen some encouraging initial results. In May 2014, the total number of defence licence issued stood at 215. In less than four years, we have issued 144 more licences through a much more transparent and predictable process. The total number of defence export permission granted stood at 118, for a total value of $577 million,” the prime minister said while inaugurating the DefExpo 2018.

For foreign companies looking to set up shop in India as minority partners, the opportunities are easy to see. India aims to be among the top five countries in aerospace and defence and plans to increase the value of domestic production nearly three-fold to Rs 1,700 billion by 2025. The draft Defence Procurement Procedure (DPP) targets around Rs 350 billion of exports by 2025 against Rs 19.95 billion today.

Then, there is also the business to be had from the country’s robust internal demand. India is the world’s largest defence importer, and its defence budget for 2018-19 is a whopping $45 billion (Rs 2,842 billion), a 7.8 percent increase over the previous year. Moreover, India’s capex for defence procurement is expected to exceed $250 billion (Rs 1,5792 billion) over the next 10 years.

The procurement policy’s focus, in particular, is on fighter jets, medium lift and utility helicopters, frigates and submarines, land combat vehicles, autonomous weapon systems, missile systems, artillery guns, small arms, ammunition and explosives, surveillance systems, artificial intelligence and cyber-warfare.

Yet in the 187 defence contracts, worth $37 billion (Rs 2,337 billion), signed in the past four years, the FDI flow under the 'Make in India' initiative has been a dismal of $0.18 million (Rs 11 million). 

One of the factors keeping foreign companies away is the cap on FDI via the direct route.  Foreign companies have been pushing for a higher limit. While the government has been deliberating possibilities of increasing the FDI limit to 74 per cent in its new procurement policy, the relaxed norms are likely only for niche technology.

 “I hope the automatic route of 74 percent FDI, will extend beyond the niche technologies and also apply to companies that contribute to jobs, to quality, to complex management practices and to helping out foreign companies that are undertaking commitments and taking risk in doing so,” said Pierre De Bausset, president, Airbus Group.

But relaxed FDI norms alone aren’t enough to guarantee interest from foreign companies. “As long as the investment is into components or supply chain, that gets into big systems embedded into the global supply chain for exports, there are no complaints,” said Pratyush Kumar, president, Boeing India. “But when it comes to a large platform, such as a fighter jet, where the government is the sole buyer, expecting investments just because policy allows up to 100 per cent FDI is not enough.” 

“The original equipment manufacturers are not going to bring FDI unless they have orders to support it. The critical factor in getting FDI into defence is the order,” he added.

In a way, the defence offset policy, too, runs counter-purpose to attracting FDI. Under defence offset, a foreign supplier of equipment is currently required to manufacture 30 percent of its product by value in India. “This policy is actually penalising the FDI, because it doesn’t give any premium to risk investment in equity for FDI,” said Kumar. “From sourcing, I get the same value as from bringing FDI. Therefore, why would I do FDI?”

At the same time, private companies are not happy to compete with government-run Defence Research and Development Organisation (DRDO) for contracts when the latter’s objectives are different from their own goals. Jan Widerstrom, CMD, Saab India Technologies, which has been supplying to the Indian armed forces for over three decades, said unlike DRDO, private companies are oriented towards delivering return on investments and, therefore, the two competing for the same set of projects creates an unequal playing field.

Private players also have to contend with just the scraps  as the meatier projects are nominated by the government to Ordnance Factories Board and Defence Public Sector Undertakings. For instance, in 2017, the Ministry of Defence granted the BMP-2 infantry combat vehicle upgrade programme, worth Rs 23 billion, to Ordnance Factory Board and Bharat Electronics, even though the project was to be initially allotted through a competitive tender, said a report by KPMG-Assocham. 

The lack of predictability in government plans is a big worry. Despite numerous measures to streamline procurement, concerns related to protracted timelines, cancellation of tenders, underutilisation of the defence budget (around 10 percent at the end of each fiscal), tenders awarded based on lowest cost and non-existence of a level-playing field still remain, said the KPMG-Assocham report. The Rafale deal was the latest to be cancelled and revamped; the government scrapped the plan to build the fighters jets in India in 2015, preferring to order ready-to-fly jets from France instead. Likewise, the government stayed large orders for home-made light combat fighter Tejas, only 40 of which have been ordered to date.

Apurva Chandra, director general (acquisition) and additional secretary in the ministry of defence, said that the demand for clarity on orders raises a chicken-and-egg problem; whether it is the order that should come first or the FDI. “Whether we should make FDI a prerequisite to making an order from a global company, I would like to hear from the industry,” said Chandra.

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