A blueprint for the defence industry

The Narendra Modi government needs to set up a national committee to resolve turf battles between various government agencies and reconcile competing interests of small and medium enterprises and industry majors

July 10, 2014 12:49 am | Updated May 24, 2016 02:37 pm IST

As the new government prepares to present its first general budget, there is expectation that foreign direct investment (FDI) in the defence sector will be liberalised, but by itself, this is unlikely to contribute much towards the goals of self-sufficiency and self-reliance.

There are reports that the Department of Industrial Policy and Promotion (DIPP) is pushing to allow 49 per cent FDI without transfer of technology, 74 per cent with transfer of technology, and even 100 per cent in cases involving the transfer of state-of-the-art technology and equipment, while the Defence Ministry would like it to be restricted to 49 per cent. This debate is sterile because merely liberalising FDI will not help. What is needed is an appreciation of the characteristics of the defence industry and coordination among the multiple stakeholders who drive, and have often distorted the decision-making process.

Distant goals, continuing imports The twin objectives of self-sufficiency and self-reliance have been articulated, sometimes interchangeably and at times separately, since the early 1950s. In 1947, India inherited the Ordnance Factories (OF) Organisation, which today consists of 41 OFs, nine Defence Public Sector Undertakings (DPSU) and 50 or so defence R&D laboratories under the Defence Research and Development Organisation (DRDO). The model followed was “production of technologies conceptualised by the DRDO; projects nominated by MoD [Ministry of Defence] after consulting the Services; and assembly and production of platforms under licence from foreign OEMs (Original Equipment Manufacturers).” Currently, with about two lakh employees, the OFs and DPSUs have a modest turnover of $7.6 billion. The goals of self-reliance and self-sufficiency remain distant, with almost 70 per cent of defence equipment still being imported.

A task force set up in 1998 concluded that the public sector alone could not deliver; licensed production had fostered neither indigenisation nor innovation; and frequent blame games between the Services, the DRDO and the DPSUs were leading to delays in acquisition. A self-reliance review committee set up in 1992, under Dr. Abdul Kalam’s chairmanship developed a self-reliance index (SRI), defined as the percentage share of indigenous content in total procurement expenditure, and set a target of 70 per cent self-reliance by 2005, now pushed to 2020.

Merely liberalising FDI will not help. What is needed is an appreciation of the characteristics of the defence industry and coordination among the multiple stakeholders who drive, and have often distorted the decision-making process

The first instance of opening up of the defence sector came in 2001, with the domestic private sector being allowed to produce defence items with FDI up to 26 per cent, subject to industrial licensing and security clearances. This was followed by the announcement of a Defence Procurement Procedure in 2002, a Defence Offsets Policy in 2006, a Long Term Integrated Perspective Plan (LTIPP) in 2009, a Defence Production Policy in 2011, and eight committees/task forces set up to look into various aspects of national defence, including defence production and self-reliance, since 2000. Clearly, the issue remained a priority for various governments, but the outcome has been meagre. Certainly, some responsibility rests with former Defence Minister A.K. Antony’s tendency to avoid decision-making if it could be postponed, but there are underlying structural reasons too. Consequently, forward movement during the last decade has lacked purpose.

Growing defence expenditure Since 2001, the total FDI received in the defence sector is below $5 million. Meanwhile, India’s defence expenditure has been growing every year; today, India has the eighth largest defence budget in the world, accounting for 3 per cent of global defence expenditures and, in recent years, has also emerged as the largest defence importer, with nearly 10 per cent of global defence imports. With growing obsolescence and a 10 per cent annual rise in the capital budget for equipment procurement, a conservative estimate indicates that India will spend nearly $100 billion over the next eight years to modernise and equip its armed forces. During the 12th Five Year Plan, the defence capital account budget is expected to go up from $15.9 billion to $25.6 billion. By the end of the 14th Five Year Plan, the cumulative capital expenditures over 2012–27 are projected to exceed $235 billion. Assuming that 80 per cent is meant for platform acquisitions, of which 60-70 per cent is earmarked for committed liabilities, this still leaves 30-40 per cent for new schemes. To meet the target of 70 per cent self-reliance by 2020 requires an indigenous defence industry worth $80-$100 billion, with a direct employment potential of 1.25 lakh skilled workers and indirect support to a workforce of another five lakh.

In addition are investments via the Defence Offsets Policy. This policy, announced in 2005, requires the foreign company to invest 30 per cent of the indicative cost in the request for proposals when the indicative cost is Rs.300 crore or more. Initially, the offsets were for the defence sector, but in 2009, the policy was diluted to permit offsets to civil aviation and internal and coastal security sectors too. Its objectives are to improve the domestic defence R&D base; develop an internationally competitive defence industry, and an industrial base covering dual use technologies (i.e. having both civilian and defence applications). Offsets are implemented by raising domestic procurement, generating exports, bringing FDI into related services and building local supply chains, transferring technology/equipment to Indian entities, etc. The DRDO has identified a list of 15 critical technologies that it seeks to acquire through offsets; incidentally, exports of most of these technologies are controlled and require special approvals by the foreign vendor’s government. Till 2012, 16 offset contracts, worth $4.3 billion, were signed and this is expected to cross $25 billion by 2020.

Manipulation In the Defence Procurement Policy, special incentives to encourage the domestic private sector, including government R&D funding for product development, were announced. Some of the larger enterprises (including TCS, Tata Power, Godrej, HCL, L&T, Mahindra, Kirloskar) are to be classified as Raksha Udyog Ratnas to enable them to be treated on a par with DPSUs. In addition there are about 6,000 Small and Medium Enterprises (SME), many of whom feel that they are nimbler and better suited to innovate in niche areas. In fact, they oppose limiting FDI to 49 per cent, the position supported by domestic majors and the MoD.

By themselves, many of these measures are unexceptionable, but together, these have failed to create a military-capable, dual-use manufacturing technology base. Different lists of defence products in the MoD, the DIPP and the Directorate General of Foreign Trade (DGFT) add to the confusion. Further, most of these technologies are controlled under the Wassenaar Arrangement (a grouping of major arms and dual-use technology exporting countries); India is not a member of this group, which makes it more difficult to acquire such technologies. (China and Israel are also not members, but they have aligned their export controls with Wassenaar lists, and are significant arms exporters.) With multiple players pulling in different directions, it is easy for vested interests to tweak specifications of items to be procured to favour a certain vendor and derail debates to the limits of FDI in defence.

Way forward To make a new beginning, the Modi government needs to take charge by setting up a national defence industry committee which should resolve turf battles between various government agencies, reconcile competing interests of SMEs and industry majors, set targets (including for SRI, intellectual property rights (IPR) generation, integration of SMEs, technology acquisition through offsets), monitor implementation, and coordinate policy approaches by: a) creating uniform lists of defence products and related technologies; b) enabling the harmonisation of Indian lists with the Munitions List and Dual Use Technology List of the Wassenaar Arrangement, with the eventual aim of securing India’s membership. An enabling framework already exists with India’s Special Chemicals, Organisms, Materials, Equipment and Technologies (SCOMET) export control lists; c) amending the Industries (Development and Regulation) Act to bring defence and dual-use technology-related Industrial Licensing into sync with the above; d) amending the terms of the production licence for defence items to ensure that control of the entity cannot be transferred without Government of India (GoI) approval, that all exportable items and services will be available domestically, and that exploitation of IP generated will not be denied in India. These conditions would render the debate of FDI levels irrelevant; e) promoting the clustering of SMEs with industry majors through targeted policies; f) changing the role of the Department of Defence Production, whose structure limits it to a mere administrative unit for OFs and DPSUs; g) integrating the working of the LTIPP with defence R&D, production, procurement and offsets policies; h) providing a degree of continuity and predictability in the policy framework for the next 10 years instead of the annual revisions that have afflicted the sector in recent years.

(Rakesh Sood, a former Ambassador, was the Prime Minister’s Special Envoy for Disarmament and Non-Proliferation till May 2014. E-mail:>rakeshsood2001@yahoo.com)

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