What it'll take to make weapons in India

The need to boost Indian defence manufacturing is unquestioned. There is broad national consensus in this matter. However, the strategy for achieving this, especially with regard to FDI in defence, has been hotly contested. The UPA Government articulated the way forward in the Defence Production Policy announced in 2010. Unfortunately, the policy did not articulate a credible strategy and has remained a dead letter. The new NDA Government has been vocal and forceful in articulating the need to boost indigenous defence production and has recently announced a more liberal FDI policy for defence manufacturing.

The new FDI policy marks a step forward by increasing the FDI limit from 26% to 49%. FDI beyond 49% is also permissible on a case by case basis, wherever it results in access to modern and state of art technology. The stipulation that management of the applicant company should be in Indian hands has been relaxed for proposals seeking FDI beyond 49%. A new stipulation has been introduced that the company should be structured to be self-sufficient in areas of product design and development.

While these changes are welcome, large gaps still remain in terms of an overall strategy to strengthen the defence manufacturing base. The FDI policy also has two grey areas prone to subjective and arbitrary decisions.

(a) the caveat that FDI beyond 49% will be allowed only for modern and state of art technology will raise issues about what is modern and state of art. This could be problematic.

(b) to expect companies to be self sufficient in product design and development, ab initio, is impractical and is likely to be observed in the breach, thereby creating complications while granting approvals.

These provisions of the FDI policy require review.

In terms of the larger eco-system required to strengthen the defence manufacturing base, there are several key issues that deserve attention at the policy making level.

"Make" in India has been a non-starter under the Defence Procurement Procedure (DPP). With the nation being called upon by the Prime Minister from the ramparts of the Red Fort to "Make in India", it is high time that the "Make" procedure under DPP was re-invigorated. The Make procedure, which borrows from the DARPA model of USA, envisages indigenous design and development efforts to produce new weapons systems and technologies. The cost of prototype design and development is shared 80:20 between Ministry of Defence and the company. Under "Make" in India, the IPR for the weapons systems and technologies will reside in India. As of now, only two significant 'make' projects have been initiated relating to the Future Infantry Combat Vehicle (FICV) and Tactical Communication System (TCS). These proposals have made slow progress due to problems in bid evaluation and project structuring, and several years have been lost in the process. The experience of these two projects points to the lack of capacity within the Ministry of Defence, including the Armed Forces headquarters, to hand hold and progress such projects in a time bound manner. The institutional framework for 'Make' projects needs to be reviewed and strengthened. Among other things, there is need to have strong and stable Integrated Project Management Teams (IPMT), a point recently emphasized by Khutub Hai in a recent article in Business Standard.

There is need to kick start at least 20-25 'Make' in India projects so that the entire eco system for Indian defence manufacturing is energized. For this purpose, feasibility reports need to be commissioned by Integrated Defence Staff (IDS) Headquarters in respect of project concepts already identified under the Long Term Integrated Perspective Planning (LTIPM) for the Armed Forces, 2012-2027. There is no possibility for headway unless this is done.

The planning process in the country has recently come under scrutiny, with a question mark being raised regarding the functions and utility of the Planning Commission. Ironically, the planning process in the Ministry of Defence is relatively weak and needs to be strengthened. LTIPP 2012-27 is essentially a list of project concepts, weapons systems and technologies which are required by the armed forces to meet strategic objectives and threats, without linkage to budgetary allocations for capital expenditure. In order to give teeth to LTIPP 2012-27, there is need to establish a clear linkage between plan targets and resources available over a 15 year time frame, with LTIPP being approved by the Cabinet Committee on Security. Only a resource based plan would impart the degree of seriousness required to enhance the capabilities of the armed forces to face emerging geo-strategic challenges. The Indian defence budget for capital expenditure also needs to be increased to 0.75% of GDP.

While the FDI regime for defence manufacturing has been liberalized, an aspect often overlooked is that global defence OEMs are not in a position to transfer technologies without approval of the parent governments. Enterprise level relationships under the FDI policy therefore need to be backed by Government-to-Government initiatives at the diplomatic level. There is a vast menu of options available across countries and continents, and the collaborative arrangements need to be dictated by strategic objectives in a multi-polar world.

One of the key attributes of defence manufacturing is monopolistic and oligopolistic industrial structures, with procurement often been confined to a small vendor base, sometimes to a single vendor. Besides closely held technologies and high product differentiation, defence manufacturing also entails the need for placing repeat orders on the same vendor to enable amortization of the high cost on research, design and development. India has followed the easy option of placing orders and repeat orders on Indian Defence Public Sector Enterprises (PSEs), where the moral hazard, risk and accountability is low, since these are government companies. The key challenge is to move away from this model and encourage the Indian private sector to get into defence manufacturing. In the absence of price discovery through competitive bids, the only option left is cost plus pricing, which in turn entails deep analysis of the cost structure of both public and private sector companies. USA found a solution to this problem as far back as the 1960s when it set up the Defence Contract Audit Agency (DCAA) through statute. DCAA has about 14000 employees, most located at the factory premises of OEMs! The lesson for India is that it will simply not be possible to build up Indian private sector defence manufacturing capability unless cost audit functions of the Ministry of Defence are upgraded. To illustrate, India has been seeking capability to design and manufacture submarines for over three decades and all the submarines manufactured so far have been in the public sector. There are hardly any companies in the Indian private sector who could undertake such complex projects. If these companies are to be encouraged, an institutional mechanism, other than competitive bidding, needs to be found to award projects to such companies. The Kelkar Committee had recommended as far back as 2005 that certain companies should be designated as national champions on the basis of transparent criteria and defence projects awarded to them. However, Ministry of Defence has not been able to move forward on this proposal. This logjam needs to be broken if the country is to establish a strong defence manufacturing base in the Indian private sector.

While development of an indigenous industrial base is a laudable objective, the question that arises is indigenization at what cost? The country surely cannot embark on the path of high cost indigenization and produce products and systems which are not globally competitive. The indigenous cost of design and development of a Basic Trainer aircraft for IAF is reported to be much higher than the cost of importing the aircraft. The cost of indigenous production of Sukhoi 30 MKI is reported to be higher than the cost of importing fully-fitted aircraft from Russia. The public sector Indian defence companies as well as Ordnance Factories have established high cost structures and are likely to be at the receiving end as and when they are subjected to increasing competition from the Indian private sector. Since exports are the true test of global competitiveness, export orientation of the defence manufacturing base must be an integral part of the overall strategy.

Besides issues relating to FDI and the 'Make' in India procedure, there is a pressing need to shift the flow of technology and orders from the public sector to the private sector under the 'Buy and Make' procedure. The recent decision by the Ministry of Defence to leave the choice of the private Indian partner to the OEM for replacement of the Avro fleet is a welcome development. It is through such decisions that the deep bias in the Indian defence eco system in favour of the Indian public sector can be moderated and the Indian private sector allowed to grow.

Defence Manufacturing was opened up to the Indian private sector in 2001. FDI was also allowed upto 26%. However, experience over the last 13 years has been dismal and defence manufacturing in the Indian private sector remains inconsequential and risky. FDI in flow during this period has been only a few million dollars. Lessons need to be learned from the experience of these 13 years so that the same story does not repeat itself over the next 13 years. Strategic vision and direction is required if the country is to develop a credible military industrial complex, which is an essential attribute of great power status. The country simply cannot chug along at the glacial pace of the last decade.

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