DEFENCE

MODULE 2

GOVERMENTS EFFORTS FOR DEFENCE

DEFENCE PROCUREMENT POLICY (DPP)

Achieving self-reliance and reducing dependence on foreign countries in defence is a necessity today rather than a choice, both for strategic and economic reasons.  The Government in the past has created production capabilities in defence in form of Ordnance Factories and Public Sector Undertakings to cater to the requirements of our Armed Forces. However, there is a need to enlarge the role of Indian private sector as well to develop capabilities and capacities for production of various defence equipments.

Also the demand for equipment modernisation has jumped since the last fiscal across all the services. The Indian Army has already made a strong case for modern artillery, missiles and communication devices. The Navy has made urgent request for hi-tech submarines, frigates and helicopters. The Air Force desperately needs more fighter jets. The multi-billion dollar deal to buy 36 French ‘Rafale’ fighters is in final stages of closure. The shopping list is quite big and investment for upgrades also huge.

The DPP is an official procedural document for capital purchases by Indian armed forces. Defence Procurement Policy (DPP) has been revised for the eighth time since it was first drafted in 1992. Given the complexities associated with almost every aspect of defence procurement in India, successive revised DPPs in past have largely failed to provide an accepted framework for defence business, despite the so-called best efforts from the government.

The DPP, 2016 seeks to fast-track defence purchases even during peace time. It aims at giving a boost to the Make in India initiative, a greater role for the private sector, and a big push to the medium and small scale sector.

  • OFFSET POLICY

Offset provisions were introduced in 2005 into the DPP to develop the defence industrial base in the country. Under this, for deals worth over Rs. 300 crore, the Original Equipment Manufacturer (OEM) has to reinvest 30 per cent of the contract value in Indian industry so as to have indigenous content in the product. This has not yielded great results over the past decade, given that the Indian defence industry is still in a nascent state and has been unable to absorb state-of-the-art technology that defence offsets require. Foreign vendors have been discharging offsets that do not build the capability of Indian industry, thus nullifying their very objective.

Under DPP 2016:

  • OFFSET LEVEL IS RAISED TO 2000 CRORES FROM 300 CRORES

The offset level has been raised to 2,000 crore, from 300 crore currently. This is because the Centre believes that the Indian industry is not in a position to absorb large-scale offsets. Also to give greater room for discharging offsets, a two-pronged approach for mitigating perceived bottlenecks during pre and post-contract stages has been evolved.

  • FLEXIBILITY IS PROVIDED TO VENDOR

At pre-contract stage, option has been given to the vendors to submit detailed offset proposals at a later stage and the vendor can finalise his Indian Offset Partners (IOP) and offset product details one year prior to the intended offset discharge, or can even undertake the offset activity and submit claims thereafter. At the post-contract stage, provisions have been made in the guidelines for changing the IOP and re-phasing of offset schedule giving complete flexibility to the vendor.

  • ‘SERVICES’ IS REINSTATED FOR OFFSET DISCHARGE

Services’ includes maintenance, repair and overhaul, upgrading and life extension, engineering, design and testing, software development, quality assurance, training, and research and development. Services in offsets have a chequered history in the defence procurement procedure. They were introduced in 2012 and were removed in July 2013 following the VVIP helicopter scam in which kickbacks to the tune of Rs. 392 crore were paid through Indian firms in the name of software services.

  • MICRO, SMALL AND MEDIUM ENTERPRISES (MSME)

In a major departure from the previous DPPs, the government sought to give more prominence to Defence firms operating in the MSME segment. Projects that will be government funded and with estimated development cost of less than 10 crore will be reserved for MSMEs.

  • ANALYSIS

The Defence Procurement Policy 2016 is a step forward in increasing the participation of India’s private sector in military manufacturing. It replaces the last DPP unveiled in 2013, and has several recommendations for improving indigenous procurement. The DPP, the governing manual for all defence procurement, was part of a set of military reforms undertaken to address the many deficiencies noticed during the 1999 Kargil war. Since the first one in 2002, the DPP has been revised periodically. The new policy places the highest preference to a newly incorporated procurement class called ‘Buy Indian-IDDM’, with IDDM denoting Indigenous Designed Developed and Manufactured. This category refers to procurement from an Indian vendor, products that are indigenously designed, developed and manufactured with a minimum of 40 per cent local content, or products having 60 per cent indigenous content if not designed and developed within the country. The policy has also liberalised the threshold for offset liabilities for foreign vendors — now the obligation to invest at least 30 per cent of the contract value in India will kick in at Rs.2,000 crore, a significant increase from the previous Rs.300-crore mark. The policy lays stress on micro, small and medium enterprises (MSMEs), and on “Make in India”. A 10 per cent weightage has been introduced for superior technology, instead of selecting the lowest bidder only in financial terms.

DPP 2016, however, falls far short of the expectations raised by Government’s ambitious “Make in India” push that aims to transform the country into a global manufacturing hub. India is the world’s largest importer of defence equipment, and indigenising production is key to such a plan. The DPP is noticeable for the absence of Chapter VII, titled ‘Strategic Partners and Partnerships’, which the Defence Minister said would be notified separately. Under Strategic Partnerships, select Indian private companies were to be given preferential status in major defence projects. The inability of the Centre to finalise a credible policy to radically increase indigenous military manufacturing is a sure sign that India will remain heavily dependent on defence imports. Given the country’s robust financial growth, one of its greatest leveraging points is the annual spend on procurement. India has all the necessary prerequisites for a robust military-industrial complex: a diverse private sector, a large base of engineering institutes, and a growing defence budget. The fact that India faces a combination of security threats from both state and non-state actors is an obvious reason why it needs to be self-reliant in military equipment. There is another important reason why India needs an indigenous military-industrial complex: it will significantly reduce the potential for corruption in military procurement. However, the new procurement policy does not inspire hope that domestic defence production will grow sufficiently. It may not be just an irony that the policy has been released as India hosts yet another Defexpo event, in Goa, where global vendors are hawking their war machines to a technologically famished Indian military.

SUGGESTIONS

  • The defence ministry is struggling to exhaust its modernisation funds with almost 40%capital budget unspent as the financial year draws to an end. Expenditure data shows that as much as Rs 37,355 crore of the defence ministry’s capital modernisation budget of Rs 93,675 crore remained unspent by the end of 2015. Failure to spend the money at a time when India is modernising its defence forces – with several major defence deals like the Rafale fighter, self-propelled howitzers and M777 artillery guns in the last stages of negotiation – shows the capital mess

Defence deals take a long time to negotiate and do not follow the budgeting cycle of the financial year. The consequence, as Parliament’s Standing Committee on Defence rightly noted in April 2015, is that “such under-spending leads to a situation where the preparation of Defence Forces are nowhere near the target”. The committee has therefore called for a “non-lapsable and roll-on allocation” fund for 5-10 years for defence equipment. Such a non-lapsable fund, administered by experts with strict controls on timelines, would reduce bureaucratic hurdles and be more attuned to practical realities. The government must follow through on this suggestion and implement it.

  • The defence industry is like no other. It is evolutionary, highly technology-intensive, and demands continuously high levels of research and development (R&D) investment. Therefore, the focus of any policy should be to draw foreign defence manufacturers to India and, in the process, gain technology transfer. To accomplish this, an enabling architecture that would guarantee the protection of their Intellectual Property Rightscommercial interests is the key. This would require a strategic change that the Defence Procurement Procedure
  • Government should use the mandatory offset (compensations that buyers obtain from sellers) to bolster the ‘Make in India’ programme. When using this strategy, it would be wise to remember that . They are indeed paid for by the buyer. As offsets come at a substantial cost, they would need to be steered. For fulfilling offset obligations, identify equipment from a shelf of projects carefully created to fill identified gaps in Indian defence technology. Make it compulsory for companies to locally produce such equipment with predetermined levels of indigenisation to be achieved over the years.

While on the one hand, Government is making necessary policy changes with regard to procurement, investment including FDI (Foreign Investment in Defence Sector up to 100%), licensing, export etc., the industry also needs to come up and accept the challenge of up-gradation in terms of technology and required investments. Defence is the sector which requires huge investments and technology and is driven by innovation. The industry, therefore, has also to change its mindset and think for long term rather than temporary gains. We need to focus more on Research and Development and state of the art manufacturing capabilities.

DEFENCE PRODUCTION POLICY

The Defence Production Policy, aims at achieving substantive self-reliance in the design, development and production of equipment, weapon systems, platforms required for defence in as early a time frame possible; creating conditions conducive for the private industry to take an active role in this endeavour, enhancing potential of SMEs in indigenisation and broadening the defence R&D base of the country. Indigenous manufacturing of defence equipments is encouraged by the Government through several policy measures, which, inter-alia, include the following:

  • Preference to ‘Buy (Indian)’, ‘Buy and Make (Indian)’ & ‘Make’ categories of capital acquisition over ‘Buy & Make (Global)’ or ‘Buy (Global)’ categories in Defence Procurement
  • Foreign Direct Investment (FDI) Policy under which Foreign Investment Cap upto 49% is allowed through automatic route and above 49% under Government route on case-to-case basis, wherever itis likely to result in access to modern and ‘state-of-art’ technology in the country. The foreign investment in defence sector is further subject to industrial license under the Industries (Development & Regulation) Act, 1951. 
  • Industrial licensing regime for Indian manufacturers has been liberalised and most of the components/ parts/ sub-systems have been takenrequiring Industrial Licence. This has reduced entry barriers for new entrants in this sector, particularly small and medium enterprises. The initial validity of Industrial Licence has been increased from 3 years to 15 years with a provision to further extend it by 3 years on a case to case basis.
  • Issues related to level-playing field between Indian vs. foreign manufacturers and public sector vs. private sector have also been addressed. These include Exchange Rate Variation (ERV) protection for Indian vendors, offset obligations in ‘Buy (Global)’ cases, Excise/ Custom duties on defence equipments, etc.
  • Offset implementation process has been made flexible by allowing change of Indian Offset Partners (IOPs) and offset components, even in signed contracts. Foreign Original Equipment Manufacturers (OEMs) are now not required to indicate the details of IOPs and products at the time of signing of contracts. Services as an avenue of offset have been re-instated with certain conditionalities.

In the current financial year 2015-16, Department of Industrial Policy & Promotion (DIPP) has issued 61 Industrial Licenses (ILs) for manufacture of various defence equipment under IDR Act 1951, till December 2015. 

MAKE IN INDIA INITIATIVE

The Government has taken a very important initiative in form of ‘Make in India’ to promote and encourage domestic manufacturing of various items. The requirement for domestic production of defence equipment is more than for any other sector because it will not only save precious foreign exchange but will also address the national security concerns.

Government being the only consumer, ‘Make in India’ in defence sector will be driven by the procurement policy.  Self-reliance is a major corner-stone on which the military capability of any nation must rest. There is also immense potential to leverage the manpower and engineering capability within the country for attaining self-reliance in design, development, and manufacturing in defence sector. It is therefore of utmost importance that the concept of ‘Make in India’ remains the focal point of the defence acquisition policy/procedure.

Being the multi-billion dollar and most lucrative defence market in the world, India provides several opportunities for Indian and foreign corporate entities for defence manufacturing. Thanks to the Make in India campaign, the defence sector has moved from the periphery to the core of Indian manufacturing. Several CII reports have suggested that the sector not only has the potential to augment manufacturing but also add nearly one million direct and indirect jobs. Some of the top industrial houses have already made some inroads into the sector. Several more are waiting for the right opportunity.

The CII welcomes the much-awaited release of the Defence Procurement Procedure (DPP 2016) on the inaugural day of Defexpo 2016 by the defence minister. The initial feedback from all stakeholders, including industry and end-users, indicates that many issues have been ironed out to enhance the DPP’s efficacy. There has been a clear departure from past practices that often left critical defence procurements in limbo. The revised procedures provide more flexibility to the end-users and the industry to work together, especially on development projects.

A new procurement category — Indigenously Designed, Developed and Manufactured (IDDM) — has been introduced and accorded top priority. It essentially means the government is leaving no stone unturned to give a boost to Make in India. The “Make” procedure has been further classified into three types to address the concerns of MSMEs in particular. The defence ministry would fund up to 90 per cent of the Make project’s prototype development cost. Adding one more safeguard for the industry, the ministry will reimburse the remaining 10 per cent prototype development cost, if the order is not placed within a stipulated timeframe after the successful test of prototypes.

A few issues, including ensuring a level playing field between public and private and the Foreign Exchange Rate Variation (FERV), were addressed before the DPP’s release. For instance, excise and customs duty exemptions available to PSUs/ Ordnance Factory Board (OFB) have been withdrawn. The Union budget also mentions this. FERV is now allowed for the private sector in all contracts, as was available to PSUs/ OFB earlier in nomination cases.

The DPP also addresses issues like incentives to move the Indian defence industry up the value chain. Various provisions remove ambiguities, ensure transparency, offer a level playing field and clearly lay down procedures. It won’t be an exaggeration to say that the defence ministry has taken all the right steps to create a conducive environment for the defence industry’s growth, as envisaged in the Defence Production Policy. Given the opportunity, this industry has the potential to become a huge foreign exchange earner and also lead India to its professed goal of self-reliance.

Nearly $14 billion worth of defence offset obligations will be discharged by the foreign Original Equipment Manufacturers (OEMs) by 2028. It’s heartening to note that the government has taken serious note of the industry’s recommendation for further streamlining the Defence Offset Guidelines. These guidelines are part of the DPP and have been revised to add more flexibility and accountability.

DPP 2016 has also opened up several co-development and co-production avenues for Indian as well as foreign companies. The ministry seems to have successfully bridged the gap between intent and implementation. Earlier policies and procedures were often criticised for lacking in implementation despite the best of intent. For the first time, the defence ministry has accepted the industry’s longstanding request for linking defence procurement with defence production. This inter-linkage would go a long way in realising Make in India in defence.

End-users will literally have to exhaust all possible options of domestic manufacturing before suggesting “Buy Global” procurements. Interestingly, in the past one-year-plus, most of the “Acceptance of Necessity” for forthcoming defence procurements have been granted for “Buy India” and “Buy and Make (Indian)” category. It means the government is walking the talk.

Indian industry is keen to take on complex hi-tech and more challenging projects. It would be desirable to identify and share more Make projects across the three services to enable Indian industry to prepare their business case. Also, prior intimation would also allow Indian industry to look for and tie up with foreign OEMs as a co-developer/ technology partner. The face of the Indian defence sector is changing rapidly with a strong focus on indigenisation.

SKILL INDIA INITIATIVE

The realization of the ‘Make in India’ vision hinges on the availability of a skilled and motivated workforce. Defence R&D activity in India is primarily driven by Government establishments like Defence Research & Development Organization (DRDO) labs, Hindustan Aeronautics Limited (HAL) and Bharat Electronics Limited (BEL). Private domestic investment in defence R&D is very low, primarily for three reasons: the private domestic industry is at a nascent stage; till recently, it was not allowed to participate in defence production and, when it was, the policy and procedure was not supportive. Even though the policies have now been liberalised, it has yet to get any large, long term orders that would justify the huge long term investments and risk.

While domestic private R&D is yet to pick up, India has become an attractive destination for foreign defence companies for R&D due to its inherent advantages of a large number of highly qualified low cost engineers and scientists. Thus, many foreign companies like Airbus, Boeing, Snecma, Textron, Honeywell, Rockwell and GE Aviation have established their global R&D centers in India. Most of these are in Bangalore which is slowly building a reputation as an R&D hub.

India imports almost 70% of its defence equipment. We have a large defence budget to modernise our armed forces. Aerospace and defence are among the most important sectors in the “Make in India” campaign, not just for creating manufacturing jobs but also for enhancing our self-reliance in defence production. But this cannot be achieved without a strong R&D base in the private sector. This will be impossible without a strong and deep R&D eco-system whose key components are equipment and physical infrastructure, skilled technicians, qualified researchers (PhDs, engineers), a robust intellectual property (IP) regime, access to long term, low cost capital and comfort on getting orders.

Given that it is both buyer and regulator in this monopsony industry, the onus of creating the eco-system lies with the Government. It has taken some steps towards this end. The Make in India campaign will result in investments into manufacturing that would support and energise R&D. The new DPP has partially addressed the issue of funding projects under Make-I category in the new DPP. There are a number of industry-academia linkages e.g. IIT Bombay has tie ups with Boeing and Thales, DRDO works with IITs and other universities.

Under the ‘Skill India’ initiative, the National Skill Development Corporation has established two sector councils Strategic Manufacturing Sector Skill Council and Aerospace and Aviation Sector Skill Council for skill development and quality assurance of personnel in Aerospace and Defence sectors. These shall develop necessary frameworks for standards, curriculum and quality assurance at all levels in vocational / technical programs to meet the needs of the industry. The coordinated efforts of councils with various stakeholders viz industry, educational bodies, training institutes and HR function shall narrow the existing Gap between demand and supply of skills.