You are here

Economic Downturn: Options for MoD

Laxman Kumar Behera was Research Fellow at Manohar Parrikar Institute for Defence Studies and Analyses, New Delhi. Click here for detailed profile.
  • Share
  • Tweet
  • Email
  • Whatsapp
  • Linkedin
  • Print
  • May 26, 2009

    The present global economic crisis has slowed down the growth of the Indian economy, affecting among others, the fiscal situation and the revenue mobilisation potential of the central government. Defence being one of the largest recipients of central government expenditure, the present crisis casts a doubt on the adequacy of future resources. This commentary discusses some major options that India’s Ministry of Defence needs to consider in order to withstand the likely resource constraints in the coming years.

    The global economic crisis has hit hard the Indian economy. From an annual average of 8.6 per cent growth registered during the past five years (2004-05 to 2008-09), the Indian economy is projected to grow, according to the latest assessment by the International Monetary Fund (IMF), by merely 4.5 per cent in 2009. The future growth prospect is also not so encouraging (although not so depressing vis-à-vis the present year’s projection). The IMF projects that India’s real gross domestic product (GDP) will grow marginally higher at 5.6 per cent in 2010. Beyond that the economic growth will pick up momentum, reaching a peak of 8.1 per cent in 2012, and thereafter sliding marginally to 8.0 per cent in 2013, says Economist Intelligence Unit. However, the highest growth rate in the next four years is expected to remain well below the average growth registered in the past five years.

    To combat the gloomy economic environment, the central government has increased public spending, in a move to revive the economy. The increased public spending has however not accompanied proportionate increase in the government’s revenue earnings, due largely to a fall in overall economic activities. As a result the fiscal deficit – difference between the government’s revenues and expenditures – as a proportion of GDP has widened significantly. From 2.7 per cent in 2007-08, the deficit has so far increased to an estimated 6.5 per cent in the present fiscal year. Moreover, the deficit is most likely to increase as the government intends more stimulus packages to propel the economy.

    The widening gulf between the government’s revenue and expenditure is however not expected to continue forever. The central government is bound by the FRBM (Fiscal Responsibility and Budget Management) Act that requires the elimination of the revenue deficit and limits fiscal deficit to 3.0 per cent of GDP. The present crisis has nonetheless forced the government to deviate from the Act, but it is committed to come back to the targets as soon as possible. In other words, the government would consolidate its revenue/fiscal position, once the economy gains strength. However, the consolidation process would be slow, as the economy will take some time before it reaches the momentum seen in the past 4-5 years. The slow consolidation process would mean limited manoeuvrability of the central government to pursue an expansionary fiscal policy. This will affect many, including the Ministry of Defence, which has complete dependence on central government funding.

    During the current economic downturn, the MoD’s 2009-10 budget, which has registered a growth of nearly 34 per cent over the previous year’s allocations of Rs. 1,41,703 crores is impressive, with no sign of fiscal stress. It is noteworthy that much of the growth of the current year’s allocation is accounted for by the surge in revenue expenditure (which caters to the running or operating expenditure of the defence services), necessitated by the hefty increase in pay and allowances flowing from the recent revision of pay scales of the central government employees. The real fiscal stress is evident on the side of capital expenditure which largely caters to the modernisation needs of the armed forces. In the 2009-10 Budget the capital expenditure has decreased to 14.20 per cent, compared to last year’ growth of 14.5 per cent. Considering that the Armed Forces are on a major modernisation drive, even a marginal slowdown in capital expenditure speaks of the scarcity of resources at a time of economic stress.

    Given that the economic environment will likely remain less than benign in coming years, the MoD would find it difficult to sustain high growth of its resource base, which is already high after the current year’s pay revisions. Further, the fiscal consolidation that will go along with economic recovery will limit total spending capacity of the central government, adding further pressure on the defence budget. In this scenario, an annual increase of 10 per cent each year for the next 4-5 years will be optimistic (this is not to argue that the government will not allocate higher resources if the security situation so demands). Any growth below this optimistic level however painful may not be surprising given the present situation.

    The modernisation of the Armed Forces depends on a higher level of resource allocation; any potential short supply of resources will certainly affect the services, and their modernisation efforts. Unfortunately, there is no acceptable short-term solution to counter the decreased supply of resources, unless the MoD as a part of immediate measures, cuts down some of the planned procurement programmes or adopts other measures that affect current or future operational readiness. Given that these short-terms measures would be vehemently opposed, the solution has to be viewed from a medium- to long-term perspective.

    As a medium-term measure, the MoD needs to curb wasteful expenditure in defence, which primarily occurs due to duplication efforts by the services, and inefficiencies in some organisations. Duplication of efforts could be curbed through sharing of assets of common use, merging training infrastructure, and formulating an integrated procurement plan of the three services. At the same time a great deal of savings could be effected through application of information and communication technology (ICT) in all spheres of defence management and by adopting better inventory management methods and outsourcing of non-core activities to the private sector. Savings could also be made by eliminating inefficiencies that have crept into existing defence support service providers like Military Farms (MFs).

    Presently, the manpower cost (excluding defence pension, which is not part of the defence budget) exerts a heavy yet rising pressure on the overall defence budget. From nearly a quarter of the budget in the previous year, it has increased to about a third in 2009-10, thereby reducing the share of the modernisation budget of the armed forces. Besides, an annual increase of five per cent in pay and allowance will automatically increase the budget by over Rs. 2,225 crores. As modern warfare becomes increasingly technology-centric, the rising manpower cost need to be controlled in order to free more resources for technology upgradation. This however requires a comprehensive review of the current manpower policy. The MoD and the Armed Forces need to act on recommendations of various Committees, which have reported that a combination of measures such as Voluntary National Service, reduced terms of engagement and lateral transfers, among others, could have profound impact on reducing manpower costs.

    Due to variety of reasons, a huge sum of resources under capital expenditure remains unspent. In the last eight years (2000-01 to 2007-08), the underutilisation of capital budget ranges from Rs. 1,490 crores to Rs. 6,500 crores, amounting to four to 31 per cent of total budgeted capital expenditure. At a time of fiscal stress, this is the least desirable. The unspent funds in reality mean forfeiting and delaying modernisation. Though the MoD has undertaken several reviews of the Defence Procurement Procedure (Capital), the inadequacies still persist. The biggest inadequacy of the present system is the lack of an integrated approach for acquisition. In the absence of that various functional elements such as QR (qualitative requirements) formulation, trial and technical evaluation among others are undertaken by different bodies, without a single point of accountability. The Kelkar Committee Report (Part-I) of 2005 had recommended examining the feasibility of an integrated defence acquisition body, which would encompass all the functional elements of acquisition, under one head. Considering that acquisition within a stipulated time saves money in the long-run, it is time that the MoD takes a pragmatic view of creating an intergraded defence acquisition structure.

    In India the capabilities of the private sector, in terms of financial, technological and managerial efficiency, has so far not been fully exploited for country’s defence. Until recently it was debarred from direct production of defence items. Though the MoD since 2001, has allowed private companies to participate in defence production, a significant barrier still persists. The private sector has no formal clue about the materiel needs of the armed forces, is discriminated against the established public sector production enterprises, and not trusted for undertaking any major developmental/production assignments. Consequently, no private company as of now has come up with any major breakthrough in complete systems integration. Considering that the private sector has the potential of accruing savings through faster innovation, better project management, and competition, the government needs to facilitate sector in a more proactive way for long-term benefits.

    The present global economic crisis has affected major advanced countries, such as the US, the UK, and France among others, with substantial defence industrial capability. The defence companies in these counties are expected to face a decrease in their government’s military spending and a fall in domestic procurement budget, adding more pressure on their balance sheets. Exports will be a major option to compensate the fall in domestic demand. Offsets and other arrangements will be aggressively resorted to win potential customers in the arms market which in the post-Cold War period is increasingly favourable to the buying countries. India, which has an offsets policy since 2005, needs to leverage its huge buying power in this environment. However, the present policy needs a bit of revision. The present offset threshold limit of 30 per cent needs to be scaled upward to 50 percent or more and, at the same time, applied across the board on contracts worth Rs. 100 crores or less (presently, offsets are applied on contracts worth Rs. 300 crores or more). The increased inflow of investments/work to be generated through revised offset conditions can then be suitably directed to pre-identified areas for strengthening India’s domestic industrial capabilities, which would go a long way in reducing the import cost of defence items in the long run.

    The present economic crisis, which has affected the Indian economy, is likely to persist for some time in the coming years, though its intensity may reduce subsequently. The impact of the crisis is likely to be felt on defence spending in two ways: slow economic growth will reduce availability of resources for defence in a period of crisis; and, once the economy bounces back to its earlier growth trajectory, the fiscal consolidation process will put pressure on defence spending, in the post-crisis period. In the absence of any acceptable immediate measures, the MoD needs to take some medium- to long-term measures to weather below-expected supply of resources. Among others, the MoD needs to curb wasteful expenditure, control rising manpower cost, reform its acquisition structure, proactively engage the private sector in defence production and pursue an aggressive offset policy.