IDSA COMMENT

Will Indian Defence Private Sector Deliver with Recent Policy Changes?

November 24, 2009

With the growth of the public sector in Defence Production a large number of industrial units in the Private Sector has also grown with varied scales of operation in areas like outsourcing of raw materials, components, sub-systems, assemblies and sub-assemblies.

With the growth of the public sector in Defence Production a large number of industrial units in the Private Sector have also grown with varied scales of operation in areas like outsourcing of raw materials, components, sub-systems, assemblies and sub-assemblies. While the Defence Public Sector Undertakings outsource to the extent of more than 30 percent, this figure is about 80 per cent in the case of Ordnance factories. Thus the role of the private sector in Indian defence industry should not be underestimated despite several constraints faced by the industry as a whole. Private players have the potential to contribute much more to meet the country’s defence requirements and help achieve the stated goal of self-reliance.

For an abstract analysis of the role it can play, Indian defence industry can be divided into different categories as follows: producers of raw materials to feed existing public sector units and other big private sector manufacturers; providers and manufacturers of IT services and equipments; those with expertise in making different types of automobile equipments; those providing test equipments and maintenance services; and, providers of major subsystems and assemblies for highly complex major defence systems. The potential of the industry will vary vastly depending upon the magnitude and type of constraints for each defence requirement. These broad groupings will be differently affected by the policy pronouncements of the Government from time to time on various issues.

The Government of India has announced a series of policy changes for promoting the growth of the Indian defence private sector. These include: 100 per cent participation of the private sector in defence production with FDI to the extent of 26 per cent subject to licensing from the Department of Industrial Policy and Promotion (DIPP), funding research and developmental (R&D cost to the extent of 80 per cent by the Government, as well as appropriate provisions in the Defence Procurement Procedures of 2005, 2006 and 2008 along with some amendments to DPP-2008 that became effective from November 1, 2009. A significant provision in DPP 2005, 2006 and 2008 is the incorporation of a defence Offset policy. Presently, the requirement is a minimum of 30 per cent of direct offsets for all capital procurements worth Rs. 3,000 million or more. These defence offsets are intended to promote defence industrial capability through transfer of technology, increased investment in R&D, and licensed production.

One of the most significant amendments in DPP 2008 effective from November 1, 2009 is the introduction of a procurement clause ‘Buy and Make (Indian)’.This clause is expected to create a positive impact on the private sector industry but the extent of its impact is not easy to assess at this stage. The earlier provision under ‘Buy & Make’ category had not really encouraged the formation of joint ventures or alliances for co-production with Indian companies. It did not even help in building up higher technical capabilities as no RFP was issued to Indian companies. The new amendment will lead to the issue of RFP to Indian companies and it is expected to provide the Indian private sector a greater say in negotiations, in obtaining technology from foreign Original Equipment Manufacturers (OEM) and in co-production arrangements. However, the products so manufactured and supplied by the Indian company must have 50 per cent indigenous content.

Another amendment to DPP 2008 is with regard to sharing of information by the armed forces with the Indian industry in the form of a public version of a long term perspective plan of 15 years on the Ministry of Defence’s website and the involvement of the domestic industry in acquisition planning. Another amendment enlarges the role of independent monitors for better scrutiny of violation of integrity pact to bring about enhanced probity and public accountability. In addition, the amendment for improvements in formulation of SQRs has also been brought about. The offset provisions have also been liberalized in terms of permission to the vendor to change the offset partner to fulfil the offset obligation though no change is allowed in offset components or their value after signing of offset contract. However, as per amendment-2009, offsets will not be applicable in option clause cases where it was not provided for in the original contract.

The above policy provisions and amendments are likely to have a positive impact on the Indian private sector though it may be quite difficult at this stage to make even a tentative assessment about the increase in domestic production of defence related goods. Gauging the extent of the rise in production of domestic industry in consonance with rising demand from the users is going to be very difficult in the short run. However, such an assessment may be possible over the next four to five years. In addition, the huge time-lag involved between obtaining an order from the user and its actual execution cannot be ignored. The impact of a liberal FDI policy has been so far quite marginal. The impact of DPP provisions about ‘Buy & Make’ category has also been quite marginal. However ‘Buy & Make (Indian)’ category is certainly going to make a positive impact. Here too the impact may be visible in the long run and it will also be determined by the degree of success of the private sector in dealing with foreign vendors on issues like TOT, joint ventures for co-production since the issue of transfer of technology may not be that easy to resolve with the foreign vendors in certain crucial areas as reluctance on their part to part with technology cannot be ruled out. From the requirements of offset policy, it gives a clear indication that extracting offset benefits from foreign vendors is bound to be challenging.

It may also be relevant to briefly indicate the constraints which the Indian defence private sector may inherently face and these can also be company specific like capital, technology, R&D, quantum of demand from the user, dynamic nature of demand patterns, obsolescence in technology etc., though these already stand addressed in various policy announcements of the government. Yet, the private players can be hesitant in investing large chunks of capital in many highly complex defence ventures as they may avoid the high risk involved. In this eventuality, there is a probability that they may continue to play their conventional role on a much larger scale in the defence industry. Despite these constraints, the capabilities and capacities of the Indian private sector in promoting defence production cannot be underestimated in terms of helping India achieve the goal of self reliance in defence production to the extent of 70 per cent by the end of 2010. A periodic assessment of the contribution of the private sector may be necessary for policy review by the government from time to time.