Wednesday, 19 February 2020

Bolstering India’s Military Industry Capability Challenges And Prospects

By Prof. (Dr.) S.N. Misra
Updated: February 12, 2020 11:55 am

India has a large defence manufacturing base of nine defence PSUs, 40 ordnance factories and 52 Defence Research and Development laboratories. India’s self reliance index, i.e. ‘per cent’ of imports in value to total defence acquisition, is at a stagnant level of 30 ‘per cent’. This paper seeks to bring out the military industry capability, both in terms of manufacturing, research & development and the impact of liberalization that has wafted through the private & public sector. It brings out the major policy changes in FDI, leveraging big acquisition to gain key technology and the need to usher in further structural changes to bring up military industry capability, design and research based in best global practices. India is uniquely perched to become a global manufacturing hub, should it embrace these global lessons and put in place the structural changes.

Before we examine the footprint and value addition by the captive defence PSUs and ordinance factories, it would be useful to take an overview of defence expenditure over the years to look at the trend at both revenue and capital expenditure and their relationship with India’s GDP.

It would be seen from the above that around 2% of GDP is spent for defence services. Capital outlay for acquiring weapon systems and platform constitute 30% of India’s defence budget. The allocation for research and development is around 6% of defence expenditure.

A look at the trend of military expenditure in a few other countries and its relationship to GDP is as under-

It would be seen from the above that major power like USA and Russia spend more than 3% of their GDP on military expenditure.

 

India’s Defence PSUs/OFs

They account for nearly $8.3 billion in terms of value of production. The details of Value of Production, profit after tax and value addition by each entity is represented below.

It would be seen from the above, that the VOP of the defence PSUs and ordnance factories has gone up by 14 ‘per cent’ and the profit after tax is around 8.9 ‘per cent’. However, it must be added that the profit earned by them is due to their monopolistic character and lack of competition from the private sector. The other point to be noted is in regard to value addition. While in case of shipbuilding and aircrafts, the value addition is around 35 ‘per cent’, it’s very high in case of strategic material and missiles produced by Midhani & BDL respectively. The high level of value addition in OFs (85 ‘per cent’) is predominantly due to their low technology content and complete ToT absorption. In contrast, in case of fighter aircrafts, frigates and submarines, the DPSUs are still assemblers of sub system, without significant value addition from the component stage.

Liberalization in Defence Manufacturing

India embarked upon economic liberalization in 1991 by freeing the economy from the shackles of licence, quota and permit raj. This unleashed high momentum of growth in terms of increase in GDP, saving, exports and FE reserves. It also freed the financial sector from the monopoly of public sector banks and brought in a whiff of fresh air in banking services. The impact of economic liberalization is tabulated below.

The monopoly of defence PSUs and OFs was done away with in 2001, when 100 ‘per cent’ participation by the private sector and 26 ‘per cent’ FDI was allowed. The Kelkar Committee (2005) was a major watershed, as it championed the cause of private sector participation, public private partnership, level playing field for the private sector and joint participation in R&D projects. This Committee also mooted the idea of an offset policy practiced by many countries where it could leverage big ticket acquisitions to get critical technology, FDI & outsourcing orders from the OEMs. Subsequently the Prabir Sengupta Committee (2006) coined the concept of Rakhya Utpadan Ratnas (RUR), as per which 12 companies were identified to have the same status as Navratna PSUs like the HAL & BEL. This was to provide level playing field to major private sector players like Tatas, L&T, M&M, Godrej & Boyce, Pipavav Shipyard, who are active in the defence sector, with significant investments.

However, this laudable initiative could not be progressed further as there was a perception that many large IT companies have been overlooked and a few have been favoured. The proposal of strategic partnership model of Dhirendra Singh Committee (2015) drew its inspiration for the ‘RUR’ model of 2006 of Prabir Sengupta. The Dhirendra Singh’s model, has not received the kind of enthusiasm from the Indians industry as it should have. This is because it has proposed to limit the SP to one segment only. This will limit the potential of major conglomerates like Tatas & L&T who can operate in several segments like aircrafts, warship, command control and communication to one sector only. The VK Aatre Committee (2016) also has not received enthusiastic response, as it has restricted participation of private players to one segment only. Many private players want to operate in several synergistic sectors. Any policy that preempts such opportunity would be self defeating.

 

Major Policy Changes

(a) FDI Policy

To the credit of the present NDA government, it has liberalized 87 rules cutting across many sectors to spur economic growth. Some of the sectors where it has been radically overhauled are construction, retail trading and food processing. In the defence sector the present government has tried to unshackle the FDI limit by increasing it to 49 ‘per cent’ from the earlier 26 ‘per cent’. However, a close look at the total FDI inflow into all the sectors and inflow into the defence sector clearly underlines the urgent imperative to unshackle our FDI policy in defence sector further. The inflow is really a trickle and that too from three countries viz. UK, France and Israel.

It may be recalled that India’s telecom sector got a real boost due to 100 ‘per cent’ FDI being allowed. The increase the FDI limit to 49 ‘per cent’ in defence is ineffective. The inflow into the defence sector has been tepid so far and there is a need to increase it beyond 50 ‘per cent’, so that OEMs and design houses will like to have long term investment in India and make India a preferred destination as a manufacturing hub with major stockholding. They will pass on critical state of art technology. The experience of countries like China, which has become the manufacturing hub for aircrafts like Boeing, is a testimony to the realism of Chinese as they have increased the FDI limit for foreign players beyond 50 ‘per cent’. The fear that increasing FDI limit beyond 50 ‘per cent’ will affect India’s sovereignty is misplaced as suitable legal safeguards can be put to preempt flight of capital, repatriation of profits etc.

 

(a) Offset Policy

A major defence policy (Offset policy) was announced in 2005 for leveraging India’s big ticket acquisitions to get critical technology and outsourcing orders from the OEMs who have bagged the export orders. This policy has been subsequently amplified in its scope by including multipliers for critical technology, incentivizing SMEs and allowing products having dual use in paramilitary and the defence sector the benefit of offset. However, such policy changes have not brought in critical technology except orders for outsourcing low-tech work by the OEMs. The offset policy to be effective has to be complemented by a liberal FDI policy, where the OEMs can be major stakeholders. Brazil’s experiment of building Embraer aircraft through technology transfer by USA became successful as the government provided full support in terms of galvanizing the scientific pool of the country and providing tax holidays. The mosaic should be widened to include ‘indirect’ offsets, which will include other social sectors like education, health and infrastructure instead of being defence specific only. Many countries allow indirect offsets to improve their education and health footprint. India must adopt best global practices in offset policy to build state of art systems and platforms, as countries like Brazil have done, by availing of state of art technology and fostering long term partnership with OEMs.

(b) Need for Structural Changes

There is a need to make significant changes in the organizational structure of MoD, based on best global practices in France and USA.

Director General of Armaments (DGA)

It was created in 1961 in France with a view to providing a collaborative platform, in which research, design, manufacture and maintenance by different stakeholders are monitored by the DGA. It has been able to provide unique solution for maintaining combat worthiness of the French defence, while ensuring competitiveness, quality and safety of defence platforms.

In India, the different stakeholders like the services, production organizations, DRDO and the private sector player’s work in silos. The ministry of defence which should provide a coordinating platform to the different agencies is unable to provide the leadership which DGA provides. The ministry of defence is run by civilians who do not have the requisite specialised professional expertise in the defence sector and are unable to provide the much needed strategic thinking and professional expertise required at the apex level.

 

Challenges of Strategic Partnership

The Dhirendra Singh Committee had rightly underscored the importance of Strategic Partnership where a Private sector player would be identified as the Production Agency  for a particular deliverable/platform, either in Aeronautics, Ship Building, Armoured Vehicles, Missiles, Materials  etc  in tandem with an OEM & design house. This would take away monopoly of the defence PSUs as nominated agencies for the platform without competition. The Raksha Udyog Ratna (RUR) concept of Prabir Sengupta Committee was on the same lines, though it seemed to favour a few private sector players and   excluded the major players in IT.

In the existing structure of MOD, the Department of Defence Production overtly patronizes the defence PSUs, despite myriad promises of providing a level playing field to the private sector players. The PM Nair Committee had strongly pitched for corporatization of our ordnance factories in the 1980s. The government could not make the entrenched opposition of the trade unions. The concept of SP likeable but unfeasible, given the structural constraints and intransigence of the present government to give Big Push in defence manufacturing.

 

Build to Print or Print to Build

The TOT route of India since the 1969s undertakes production based on design and production drawings from the licensor. The value addition is generally minimal. Most DPSUs cannot even make an upgrade, as is the case with SU 30, an aircraft where HAL has enormous production experience. HAL’s design capability remains wobbly, particularly in state of art electronics and propulsion sub systems. The critical factor therefore is how to improve our design capacity in niche subsystems.

The private sector players are also at a serious disadvantage in designing such state of art of defence systems and have to earmark significant amount of their budget to R& D, collaborate with well-known design houses globally to absorb credible design capability. One also notes with concern   a tendency on the part of the government to ask private players to handover their prototypes and design documents to DPSUs for further development and production. This is clearly a retrograde move, as the private sector designer and prototype developer would like to have its choice of the Production Agency. This is tantamount to stopping the momentum of private sector players like the Tatas, L&T and M&M who established good rapport with OEMs in the field of Aeronautics, Naval Systems and Armoured Vehicles and Artillery systems.

The government of the day must take the country out of its asphyxiating bureaucratization that seriously afflicts its defence production segment. UK did it in the 1980s by privatizing the Royal ordnance factories. It has really turned around their performance in terms of cost, quality, timeliness and global competitiveness. Make in India in defence manufacturing, to be truly vibrant, has to consider privatization in its production set up in a significant way. A beginning has been made in surveillance vessels. Time for big bang reform, a change in mind set is long overdue. The great economist Keynes had aptly observed “The difficulty does not lie in introducing new ideas but in replacing old ones”. The present government must clear the cobwebs of palpable inefficiency and lack of accountability that dogs the DPSUs & OFs and inculcate private sector dynamism in to it’s Make in India momentum.

Self-Reliance Index

The (Buy) option viz. importing weapons platforms and systems from OEMs, has been the first priority of the services, as they dread the interminable delay and capability of indigenous initiatives. The technology transfer route, (Buy & Make) is the second option, where the imported parts are assembled and integrated with a fair degree of dexterity by the DPSUs. However, value addition is serious concern in this route, as major platforms like Su-30 aircraft have clearly demonstrated. In the “Know how” route, building design capability is huge casualty. It is because of our lack of depth and commitment in indigenous (R&D), the Make-in-India initiative has taken a serious beating, with our Self Reliance Index as low as 30%. This is particularly poor in subsystems like propulsion, weapons and sensors where our import dependency is abnormally high.

A committee under Dr. APJ Abdul Kalam (1993) had identified the following critical technology gaps.

The above technology gaps still linger in India, without any perceptible improvement.

The Committee had recommended to improve our Self Reliance level to 70% by 2005 by developing work centres at national level and bring together PSUs, DRDO, ISRO, CSIR, DAE, private sector and academia on one platform. The Committee had recommended that instead of setting up separate test facility by each research organization, National Centres should be created for building infrastructure for design and development for the nation as a whole.

 

New Committee to review DPM and DPP

The new defence minister has appointed a committee under the DG (Acquisition) to strengthen the Make in India initiative. The panel is expected to suggest measures how to ensure seamless flow from asset acquisition to life cycle costing. It aims at facilitating greater participation of indigenous industries and develop a robust defence industrial base in the country. It also looks at promoting Indian start-ups and boosting R&D footprint of Indian industry.

 

Life Cycle Costing

Life cycle costing is a globally recognized practice where a country makes an assessment of the total cost of the weapon systems and platform over its lifecycle. Instead of evaluating the lowest bidder on the basis of upfront cost and minimum spares, LCC takes into account the total operating cost over the life time, including cost of spares. It’s also takes into account the down time required for repair and maintenance. India attempted such a system of costing for the MMRCA project where two firms were evaluated for arriving at the minimum cost after extensive trial. However, this contract was cancelled in favour of a direct buy option from M/s. Rafale. Many critics believe that such a policy summer sault has been responsible for putting the clock back on Make in India initiative. Countries like USA and Australia regularly practice LCC. The MoD officials are advised to get themselves trained in the Defence Acquisition University, Washington, to have a practical exposure on how to evaluate LCC.

 

The Way Forward

The defence sector all over the world is unique in their character as they have to contend with adversaries and protect the sovereignty of the country. Organically they have to be guided by strategies, which can’t be shared with the public at large. However, the production segment of the defence ministry has witnessed significant privatization over the years in several countries. In the USA, the private sector is the predominant supplier of weapon systems, UK also chose to privatize the Royal Ordnance Factories in the 1980s to unleash a process of cost and efficiency optimization. The R&D activities of the developed countries also has significant private sector participation. India, in contrast, is still saddled with a huge defence public sector and ordnance factories, which do not function optimally. The private sector was allowed into the shipbuilding sector during 2008-09 for producing surveillance vessels. This has been a very promising development in terms of economy and timely delivery. This will need to tried out in the aerospace sector for building Advanced Light Helicopters, trainers and transport aircrafts. Both shipbuilding and aerospace have considerable potential for dual use. Further the research and development activities must go beyond government funding in S&T departments (DRDO, BARC, Space and DST). The private sector players must earmark funds for improving their design capability. A market economy is essentially an enabler to unleash ‘animal spirits’ of the private sector. India’s defence sector must be part of this economic resurgence. A revamped organizational structure, with liberal FDI policy (>50%) and offset policy can make India a global defence manufacturing hub and be part of the mainstream to promote “Make in India”. One hopes that the new committee appointed to review DPM and DPP, to adapt LCC and bolster military industry capability of India will be a major departure from earlier committees and give a turnaround to ‘make-in-India’ in defence manufacturing.

 

By Prof. (Dr.) S.N. Misra

(The author is Joint Secretary (Aerospace) (Retd.), Ministry of Defence, Government of India)

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