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Updated: February 18, 2010 19:14 IST

India’s growth opportunity in defence

D. Murali
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Neelu Khatri, Manager, Defence Advisory Services, KPMG.
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Neelu Khatri, Manager, Defence Advisory Services, KPMG.

Defence could be the next boom after the IT (information technology) and automotive sectors, hopes Wg Cdr Neelu Khatri (Retd), Manager, Defence Advisory Services, KPMG, New Delhi. “The total defence spending from 2010-2016 would be to the tune of $280 billion. Based on last five years’ average revenue, capital expenditure on major acquisition would translate into about $115 billion,” she mentions, during a recent telephonic interaction with Business Line.

India’s capital acquisition includes aircrafts and aero engines, radars, artillery guns, heavy and medium vehicles, and naval vessels, interceptor boats, among others; this opportunity is to be seen as one that could benefit all stakeholders, Neelu feels.

“A good beginning has been made. The Government of India must be appreciated for formulating the Defence Procurement Procedure, a dynamic document that has shown incredible improvement since inception. With more impetus from the Government, India could well be the next defence and aerospace manufacturing hub.”

Excerpts from the interview, over the phone and email.

How has the defence industry evolved since independence?

India had very little national industry after independence and most military weapons and equipment were of British make. It was after suffering a setback in the Sino-Indian War (1962), that the Government of India took up a resolve to develop an effective production base.

This was done by procuring arms from the Soviet Union on highly subsidised terms and creation of an infrastructure for in-house production and maintenance. The installation of Ordnance Factories, defence public-sector undertakings (PSUs) and over 40 defence research and development (R&D) laboratories bear testimony to this effort. Over the years, these organisations have been aiming to achieve self-sufficiency and indigenisation of defence manufacturing in the country.

The early 90s witnessed the economic reforms in India and rapid decline of support from the erstwhile USSR due to its serious politico-economic crisis. It was after this phase that there was a spurt in defence expenditure from Rs 15,000 crore per annum to a massive Rs 50,000 crore towards the close of the decade.

The Kargil episode in 1999, although a tactical victory for the country, was considered as a strategic failure. The lack of adequate and modern equipment at the battlefront exposed the state of obsolescence in the defence forces. Further investigations, especially sting operations such as Tehelka highlighted various scams in the defence procurement. Various enquiries and reports mercilessly criticised the defence procurement methods as being time consuming, tedious and complicated.

Gory details of deals were brought to the public view illustrating the long, complex and arduous process that took decades before finalisation. The procedures marred the forces’ capabilities to modernise. Deals such as the “Hawk” Advanced Jet Trainer (AJT) from BAE of the UK had taken 22 years to finalise for acquisition. The $1.62 billion Hawk purchase in March 2004 was based on Air Staff Requirements (ASR) in 1987.

The Group of Ministers’ report on National Security post Kargil war faulted the then existing procedure. In 2004, the Kelkar committee was constituted to suggest improvements in defence acquisitions and production. The committee pointed out that India “…should diversify its defence procurements not only to reduce dependence and prevent Russia’s strategic stronghold, but also as a business strategy. This will allow for competitive bidding and better deals.”

What are the initiatives taken by the Government to boost this sector?

To provide an impetus to the indigenisation plan and to introduce transparency to the hitherto secretive domain, the Government launched the official Defence Procurement Procedure in 2002. Introduction of the offset policy in 2005 meant that anticipated cost of requests for proposal (RFPs) exceeding Rs 300 crore must include an offset clause amounting to at least 30 per cent of the indicative cost. These offsets could be in the form of direct purchase of designated defence products, services and FDI (foreign direct investment) in industry and R&D.

What are the key growth drivers of this industry?

Defence will be priority area for spending by the Indian Government given the recent conflicts and continued threats from terror strikes. Keeping with the adage that ‘change brings opportunity,’ the defence industry in India is experiencing significant and progressive change. Opportunities abound both for India Inc. in meeting Government of India’s defence requirements, and for the Government in achieving its aspiration of autonomy in defence supply through the development of a home market defence industry.

Rising annual defence expenditure, big-ticket modernisation programme, simplified, transparent procurement procedures and overall macroeconomic growth are a few “push” factors available in this industry today.

On the status of current equipment profile in the defence forces.

The picture does not appear very encouraging. The current profile of the equipment held by our forces highlights the need for modernisation. ‘Obsolete’ equipment currently accounts for 50 per cent of equipment, whereas the Ministry of Defence required profile would have this at 30 per cent. The proportion of state-of-the-art equipment also needs to grow from its current level of 15 per cent to at least 30 per cent.

The Indian Armed Forces have announced some significant procurement in recent years. The Multi Mission Role Combat Aircraft (MMRCA) deal to procure 126 combat aircraft amounting to $10.5 billion is India’s largest procurement deal. It has already earned the label of being “mother of all deals” amongst global defence and aerospace suppliers. There are several other billion-dollar-plus deals that are making India one of the most attractive markets for defence companies worldwide.

Why should the Indian companies be excited?

They may well be. For, the current developments in the Indian defence sector present the opportunity for India to become a part of the global supply chain.

India is currently the 10th largest defence spender in the world with an estimated 2 per cent share of global defence expenditure; yet, 70 per cent of the equipments are imported and only 30 per cent of equipments being manufactured in India.

The current policies display Government’s keenness to reverse this ratio. Two themes are very evident from the Government’s official statements and policies. First, the realisation that overdependence on foreign suppliers is not conducive to national security in critical times; and secondly that this dependence can only be reduced with a pro-active involvement of both PSUs and the private sector.

Global aerospace and defence companies are currently facing a fall in demand and increasing cost constraints in their domestic market. They are naturally looking at India from a strategic perspective. India also offers trained and skilled workers who could form a large and qualified resource pool for them.

Many leading Indian industrial houses such as the Tata Group, Larsen & Toubro Ltd, the Mahindra Group, and Kirloskar Brothers Ltd are diversifying into this sector, forming joint ventures with foreign companies on both strategic and product-specific bases.

What do you see as the factors providing a sustained push to this industry?

The defence PSUs, DRDOs and Ordnance Factories have great capacity for technology absorption. However it is clear that they will not be able to meet the emerging requirement of offsets without the involvement of private defence industry.

It is to be noted that as on date offset contracts worth Rs 7,500 crore have already been signed. Year 2010 will see a major implementation of these projects on ground. SMEs have a good chance to be tier I/II suppliers for Indian OEMs and may expect to earn significant revenues through defence supply with the right business strategy and investment in Indian defence technology.

The Government, however, needs to provide a realistic “push” with the same vigour as done for PSUs given the fact that this industry is capital-intensive, has a long gestation period and requires meticulous planning.

Some of the key aspects that need to be looked at are:

• Development of a national industrialisation strategy for defence that can go a long way in creating an oriented industry. A key step towards this could be introduction of offset multipliers that would facilitate transfer of core technologies (as against low-end technology) to India. I would like to quote the example of Saudi Arabia’s offset policy that is seen as an extension to the country’s industrial policy. Their policy puts emphasis in not providing work for domestic industry but on encouraging foreign companies to form joint ventures with Saudi partners to reduce economy’s dependence on oil.

• Having a dedicated senior official at the ministry to facilitate entry of private sector would enable creation of true level-playing field.

• Allow an official platform of interaction with the private industry at the policy-making level.

• Increase of FDI limit from the current 26 per cent would allow access to desired niche technology and processes.

• An increase in the periodicity of banked offset by foreign OEMs. Current validity of 2.5 could result into lapsing of offset earned by global players thereby act as a deterrent.

• Withdrawal of protective cover from the Ordnance Factories and defence PSUs.

Your take on what the key stakeholders expect.

The three stakeholders in this scenario i.e. the Indian Government, the Indian industry and the global players have legitimate expectations from one another. Government expects Indian industry to respond to this opportunity in a rapid and well-structured manner, making the best use of the skills, capabilities and resources available to it.

Economic and industrial growth would be the real “win” for the Government. Indian industry expects Government to provide a defence industrialisation strategy and appropriate planning, procurement, legal, regulatory and tax environments. The industry would win with expansion of new technology and their export portfolio.

Global integrators “win” by attaining productivity gains and cost reduction. They expect smoother entry processes, single-window clearances and enhanced FDI limit for obtaining the same. I would like to quote the example of Kongsberg (Norway) and Lockheed Martin that formed a successful joint venture (KLM Space Data Systems) to develop the Svalbard ground station on Spitsbergen Island as an F-16 contract offset project. The enterprise value being $50 million, the enterprise has grown to half a billion dollars that has been a win-win for all stakeholders.

Any lessons from the developed world?

Major countries such as the US, the UK, France and others have evolved with efficient and transparent defence procurement procedures. Issues like integrated project teams, smart acquisition process, top-down approach in acquisitions have to be addressed regularly.

India is a beginner in the field of offset and zealous defence procurement reforms. It is important that each step taken must contribute effectively towards enhancement of the defence procurement machinery.

A few steps such as the following could go a long way in this direction:

• Enhancement of DOFAs (Defence Offset Facilitating Agency) capabilities with expertise in field of accounts, technology and legal affairs of offset contracts to provide a significant window to evaluate proposals and oversee implementations both technically and financially.

• Creation of an aptly trained specialist team with longer posting tenures to undertake the procurement functions. For example, in France acquisition is largely left to special bodies to complete the process within the desired time and the desired technology criteria. The defence forces only need to spell out broad operational requirement.

An organisation such as the DMA (Defence Manufacturers’ Association) of the UK can serve as a platform for voicing concerns of the industry, advising the Government on policy issues, and also provide export opportunities through intensive interaction with global primes and their suppliers.

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