IDSA COMMENT

Mahindra’s Giant Leap into Defence Production: The Need for Further Policy Initiatives to Promote Private Sector

December 22, 2009

On December 15, India’s Mahindra Group, a US $6.6 billion dollar industrial conglomerate, simultaneously acquired majority stakes in two Australian defence companies, Aerostaff Australia and Gippsland Aeronautics, signalling its entry into the defence and aerospace business. The acquisition, valued at nearly Rs. 1.75 billion, follows Mahindra Defence Systems’ (a Speciality Business entity of the Group), November 2009 announcement about setting up a joint venture (JV) in India with the UK’s largest defence company, BAE Systems. The intention of the JV, in which Mahindra holds a 74 per cent equity stake, is to produce a range of high-mobility, armoured and bullet-proof vehicles as well as artillery items. This commentary assesses the importance of Mahindra’s forays into the defence business and suggests further policy measures to promote the Indian private sector at large.

The acquisition of the Australian companies is no doubt a major step for the Mahindra group. This is the first time an Indian private sector company has successfully acquired majority equity share of not one but two foreign defence companies at the same time. However, unlike its previous interests shown mostly in land-based systems, the recent acquisition is directed towards aerospace components and the aviation market in general and India’s defence offsets market in particular. Aerostaff Australia is a certified company with expertise in manufacturing “close tolerance high precision sheetmetal components and assemblies.” Gippsland Aeronautics on the other hand is a designer and manufacturer of a range of 20-seater turboprop aircraft. Acquiring a majority stake in these companies will provide Mahindra a direct yet controlling access to their services, products and technologies. Besides, their customer base will also be of great utility for Mahindra. Aerostaff’s customer base, for instance, includes global majors such as Boeing, Lockheed Martin, BAE Systems, General Dynamics, and Thales, among others. These customers will be valuable for Mahindra when they win orders from India’s Ministry of Defence (MoD) and discharge their offset obligations. Under the MoD’s offset policy provisions, foreign vendors are free to choose their Indian offset partner. Mahindra will be a natural partner for them because of the working relationship they have established. To gain benefits from the offset business, estimated to be at least $10 billion by the end of 10th Plan period, Mahindra plans to set up a plant in Bangalore.

Mahindra’s venture into defence production and acquisition of foreign companies in particular is a clear indication of how much the Indian private sector is interested in participating in the defence industry. It also shows that given the right impetus from the MoD, the private sector can venture into hitherto unassailable areas.

There is no doubt that the MoD of late has taken a keen interest in promoting the private sector to increase self-reliance in defence production. The intent - which started in 2001 in the form of opening up of defence industry to private sector, with an added stimulant by way of foreign direct investment (FDI) up to 26 per cent (both of course subject to licensing) - has taken the shape of many other reform measures in recent years. The ‘Make’ procedure and offset policy of 2006 and the recent ‘Buy and Make (Indian)’ provision along with the provision of sharing a public version of the long-term plan of the Armed forces with the industry - are the indications of such measures. These efforts notwithstanding, the MoD needs to examine how to further promote the private sector in defence industry.

As of now, the private sector is still at a disadvantage vis-à-vis the established defence public sector enterprises comprising eight Defence Public Sector Undertakings (DPSUs) and 40-odd Ordnance Factories (OFs). Unlike the government-owned enterprises for which dedicated high-level MoD officials are appointed and hold responsibility for their growth, the private sector is struggling to push its interests through non-governmental channels such as the Confederation of Indian Industry (CII), Federation of the Indian Chambers of Commerce and Industry (FICCI) and Assocham. Given the fact that many a time public sector enterprises get a non-competitive advantage because of their close proximity with the MoD, the government needs to ensure that the private sector is not discouraged. In this regard, the MoD needs to redefine the role of its Department of Defence Production (DDP), so as to enable it to play a larger role beyond its current confinement to the public sector. Among others, it needs dedicated officials appointed and made responsible for the growth of the industry in the private sector.

The private sector is also at a disadvantage vis-à-vis state-owned enterprises in terms of technical limitations, even though the former does not suffer from financial and managerial shortcomings. This is primarily because of their late entry into the industry and the government’s years of investment in its own companies. To raise its technical capability in the shortest possible time, the private sector needs to form a partnership with domestic as well as established foreign companies. As far as forging partnership with foreign companies is concerned, the existing FDI cap of 26 per cent seems to be the biggest hurdle. It is noteworthy that prior to Mahindra’s November announcement of a JV, it was denied permission to bring in 49 per cent FDI into it. Although BAE Systems finally accepted 26 per cent equity share in the JV, not many foreign companies have the same inclination. Big international companies are not interested to part with technology to an Indian JV in which they have so little control. That is why despite eight years after the opening up of the industry, the FDI in defence industry is at an abysmal level. The latest data published by the government puts the figure at a mere $0.15 million - a fraction of inflows compared with even a sector like Timber Products.

The private sector’s role in the Indian defence industry is still at a nascent stage, though it is growing. What India needs to do is nurture at least a part of the industry that has the potential to assume the role of a system integrator for platform producers. Keeping this in view, the Kelkar Committee in its Report-I has suggested that government designate a select number of private companies as Raksha Udyog Ratnas (RURs), whose prime responsibility would be system integration and the manufacture of big-ticket items for the armed forces. Even though an Expert Committee was appointed to go into the identification process and submitted its report, the implementation of its recommendations has been somewhat delayed for unknown reasons. It is high time the MoD re-examines the concept of RUR and makes an immediate announcement.

Mahindra’s foray into defence production and the recent acquisition of foreign companies is demonstrative of Indian corporate initiative in the private sector. The government needs to seize the opportunity and introduce further reforms to promote private companies. It needs to enhance the role of its DDP in taking direct responsibility for promoting the private sector, increase the FDI cap to at least 49 per cent, and make an immediate announcement with regard to RURs.