The $50 billion question: Is equipment manufacture ready for Defence Sector?

The newly unveiled Defence Production Policy focuses on increasing private participation in defence equipment manufacture. Although not a new practice, the policy could mean a major boost to indigenous equipment manufacture. Payal Khurana explains.

In January 2011, Defence Minister AK Antony released the new Defence Production Policy which opens up to private participation a traditionally government-controlled industry. The policy aims at achieving ‘substantive self-reliance in the design, development and production of defence equipment in as early a time frame as possible’ by creating ‘an ecosystem conducive for the private industry to take an active role, particularly for small and medium enterprises (SMEs)’.

Opportunities for private players

The Defence Procurement Procedure 2011 aims at spending over $50 billion in the next five years on the indigenous manufacture of weapons. Currently 70 per cent of the total military requirement is being met by these imports. “For the first time, we have come out with a standalone production policy, as self-reliance in defence has been a long-standing demand of the country since the Nehru era,” said Antony at the policy release function.

Based on the approved Long Term Integrated Perspective Plan (LTIPP), equipment, weapon system and platforms required 10 years and further down the line would be developed within the country. Sub-systems that are not economically viable or practical to be made within the country may be imported, ensuring their availability at all times. The release also said that efforts would be made to progressively identify and address any issue which could impact the competitiveness of the Indian Defence Industry in comparison to foreign companies. To synergise and enhance the national competence in producing state-of-art defence products within the price lines and time lines that are globally competitive, all viable approaches such as formation of consortia, joint ventures and public private partnerships within the government approved framework would be undertaken. The academia, research and development institutions as well as technical and scientific organisations of repute would be involved towards achieving this objective.

Though the private sector has not been directly involved in the Defence industry so far, it has been playing a significant role as sub-contractors and the ancillary industry. This sector has been involved in the supply of raw materials, semi-finished products, parts and components to Defence PSUs and ordnance factories, fulfilling about 25 per cent of their requirements. It has also been a backup supply-line to several base workshops of army, base repair depots of air force and the dockyards of the navy. The policy sees a fundamental shift in the role of the private sector, from the role of supplier of raw materials, components, sub-systems, they have graduated to become partners in the manufacture of complete advanced equipment and systems.

Activities that have opened up

With the policy change, all the defence-related categories have been removed from the reserved section, and are open to all under the licensed section. This means, after getting the relevant license, the private sector can manufacture all types of defence equipment. The Department of Industrial Policy & Promotion (DIPP) in consultation with Ministry of Defence has issued detailed guidelines for the application for grant of Industrial Licence.

There are huge opportunities for growth within the defence and aerospace industries. According to CII, the current profile of equipment held by the Indian Armed Forces with regards to ‘state-of-the-art’, ‘matured’ and ‘obsolescent’ equipment is 15, 35 and 50 per cent respectively. This suggests that the Government will have to make serious efforts towards upgrading its defence resources which will also provide immense opportunities to the industry. India is one of the largest global military spenders. The defence budget for 2009-10 has increased by 34.19 per cent over the previous year’s budget estimate of Rs 1,056 billion. The huge opportunity has caught the attention of not only the large industrialists but also a large number of micro, small and medium sized enterprises.

An area of major change is the shipbuilding industry in which the government has promised to allow a level-playing field for private shipyards to compete in all future warship tenders of the navy. “Both the defence and private shipyards will have to compete for the tenders in the future,” Antony said. However, the policy has divided procurement into two different sections, one for defence public sector unit (DPSU) shipyards and another for private shipyards. DPSU shipyards will be given shipbuilding contracts on a nominated basis while private shipyards will have to participate through competitive bidding. Therefore we see a limited freedom for private shipbuilders, allowing them to participate in bidding for some projects only, with the government retaining the right to open competitive bids in the first place.

Benefits to private players

The revised DPP has incorporated a few features to benefit the private companies.

• In a bid to provide fair competition between private and public players, the policy has made the exchange rate variation clause applicable to all Indian vendors, which means that private vendors will be now allowed to revise bids for acquiring foreign equipment in line with foreign exchange fluctuations. Earlier only DPSUs were allowed to revise their bids.
• The government has simplified the procedure under the ‘MAKE’ category of DPP in such a manner that it enables indigenous design and development of the required defence products by both public and private industries in a faster time frame.
• The new policy has a performance-cum-warranty bond of five per cent of the total value of the contract rather than two separate bonds of similar value. This will reduce the cost of the bond value by half, easing the financial pressure on private vendors.
• Vendors supplying equipment needed urgently under the fast-track procedure will now be allowed a grace period of 45 days, as opposed to the 15 days time given under the previous policy. The extra time can be used for field trials and technical evaluation. Should the vendor fail to supply on time, he will not be blacklisted as was previously done.
• Finally, the private sector will be encouraged to strengthen their research and development wings so that constant upgradation and improvement in systems under manufacture is possible. The government will set up a separate fund to provide necessary resources to public and private sector including SMEs as well as academic and scientific institutions to support research and development of defence products.

Devil’s advocate

Despite all the grand plans, there have been no definitive targets set. Does this mean that the Ministry of Defence wants to play along and see how it goes? The noncommittal stance is read by the private industry who in turn are cautious about the new policy. Mahindra Defence System’s Chief Executive Khutub Hai says, “As a statement of intent, the new policy is a welcome step. But the government must create an effective framework that will clearly facilitate the private sector in developing and manufacturing defence equipment. The first test case that will define the new policy will be the FICV project.” The plan to indigenously build a Future Infantry Combat Vehicle (FICV) for the army is the first project to be launched under the ‘Make’ category of the DPP. The next ‘Make’ project in the offing is to build a Tactical Communications System.

Industry body, FICCI, also expressed concerns about the actual implementation of the policy because even the existing policies had not been implemented. FICCI expressed concerns about the Ministry providing a level playing field to the private sector by eliminating any price preference for Defence PSUs and doing away with the practice of nomination. The Defence Ministry which has a track record of giving preferential treatment to its public sector units fears labour union protests against equal privileges granted to the private sector. This concern was reflected in Antony’s statements on the opening night function, “We will give more space to the private sector (since) the nine PSUs and 50-odd ordinance factories cannot meet the needs of the services. We will protect the PSUs, strengthen them, and at the same time bring in the private sector by reducing the space for foreign suppliers.”

Deloitte’s Director Nidhi Goyal’s statement, “We need to wait and see how effectively the government works with the private sector to develop indigenous platforms and systems, given the limitations of time and technology that may be available in the country.” Dhiraj Mathur, India Leader (Aerospace and Defence), PricewaterhouseCoopers, summed up by saying that the Defence Ministry has taken the first step towards promoting self reliance in the domestic industry, but the initiative needs to be taken forward. “The production policy seems to be generic in nature and a compilation of stated objectives. The Defence Ministry needs to establish a monitoring system for the implementation of these policies.”

As experts say, the Ministry will face the challenge of balancing the Policy between its key objectives of indigenisation, with keeping the forces supplied with high tech weaponry, little of which is produced in India. The absence of any definitive targets for achievement in the policy is a cause of concern and make the mandatory ‘annual review of self-reliance’ almost a mockery. Unless some clear targets are set, what will the Defence Minister review?