An overview of India's defence economy: Business Standard special gazette

Preparing for a two-front war

An IAF C-130J Super Hercules lands for the first time at the Daulat Beg Oldi forward airstrip on 20th Aug 2013

By Ajai Shukla

Business Standard Defence Gazette

11th Sept 13

For decades, the Indian military and its defence posture were structured to ensure “deterrence” against Pakistani adventurism on the western border, and “dissuasion” against China in the north and east. Put simply, that meant being able to wage, and quickly win, a punitive war against Pakistan; while also being able to hold off a Chinese attack for a short time. With China having rattled sabres on the Sino-Indian border (the Line of Actual Control, or LAC) to distract India during the Indo-Pakistan wars of 1965 and 1971, New Delhi is clear that it must continue to defend the LAC, even through a war with Pakistan.

But what has been a relatively light presence on the China border is now being strengthened dramatically, as India’s military prepares itself for what the Indian Army chief in 2009, General Deepak Kapoor, termed a two-front war. This apprehension was also voiced by his successor, General VK Singh. China’s emergence as a global powerhouse that pursues its national interests and territorial claims unapologetically has forced New Delhi to rethink its basic security calculus. This could have enormous implications on Indian defence spending, procurement and the emerging defence industry in the country.

As the People’s Liberation Army (PLA) of China has modernized; created quality road and rail infrastructure in Tibet that permits rapid build-up and switching of forces between sectors; and conducted annual manoeuvres involving the rapid build-up in Tibet of divisions from other theatres, New Delhi too is shifting gears on the LAC. After years of deliberation and debate, the Indian military has added defensive muscle and is transforming an exclusively defensive strategy into one with a significant offensive element.

“China spends nearly one-fourth of its (estimated $120 billion annual defence budget) in the borders with India and is reflected in over 30 military exercises conducted in and around Tibet in the last two years,” notes Srikanth Kondapalli, Professor in Chinese Studies at Jawaharlal Nehru University.

India’s counter to China’s growing muscle started with the raising of two mountain divisions (some 40,000 troops), during the 11^th Defence Plan (2007-12), which have already beefed up defences on the McMahon Line, the border between Arunachal Pradesh and Tibet.

Today four Indian corps defend the LAC --- 14 Corps holds Ladakh; 33 Corps defends Sikkim; and 4 Corps and 3 Corps safeguard Arunachal Pradesh. The ten divisions under these corps have roughly 220,000 troops. But that may not be enough, says Professor Kondapalli. Across the LAC in the PLA’s Chengdu and Lanzhou military regions, are 400,000 troops of the 13^th, 14^th, 21^st and 47^th Group Armies (the equivalent of corps).

To partially even out this mismatch, India is raising a “mountain strike corps” during the 12^th and 13^th Defence Plans (2012-22). Analysts like Brigadier (Retired) Gurmeet Kanwal estimate that the strike corps will have 90,000 troops and raising it will cost Rs 64,000 crore over the next seven years. But more than the numbers, India’s decision to raise a strike corps is a decision to raise the ante with China. It is a statement from New Delhi that any war that China initiates will not be fought just on Indian soil. The strike corps is tasked to launch attacks across the LAC, taking the war to China.

Along with this unprecedented army build up, the Indian Air Force (IAF) too is turning its attention to the LAC. Sukhoi-30MKI squadrons have been located in Tezpur and Chhabua, in Assam. Jorhat, Guwahati, Mohanbari, Bagdogra and Hashimara air bases are being strengthened too. Eight old ALGs (Advanced Landing Grounds) have been refurbished so that they can support light aircraft and helicopters. The multi-billion dollar acquisitions of ten C-17 Globemaster III heavy lift aircraft, six C-130J Super Hercules transport aircraft and the impending procurement of the CH-47 Chinook heavy lift helicopter will further strengthen capabilities on the LAC.

This remarkable force accretion, India’s largest since the 1962 war with China, could have a potentially galvanising effect on the country’s defence industrial base. The growth of local industry could be catalysed not just through direct procurement of arms and equipment, but also through industrial partnerships with global Original Equipment Manufacturers (OEMs), who would be discharging offset liabilities arising from billions of dollars of procurement. Furthermore, there would be opportunities for Indian companies to participate in the maintenance, repair and overhaul of the equipment being procuring for India’s on-going force expansion and modernisation.

Besides equipping tens of thousands of soldiers, the major new acquisitions that could arise include 400-450 ultra light howitzers (ULH) for seven new artillery brigades --- one each for the four new mountain divisions, and three directly under the strike corps. Negotiations are already under way for 145 pieces of BAE Systems’ M-777 155 millimetres, 39 calibre howitzers for up to $885 million. If the army is satisfied with this weapon, it could purchase as many as 900-950 more for the artillery regiments of 15 more mountain divisions. In that case, the MoD would press BAE Systems hard to shift production of the M-777 to India.

There is also a growing requirement for helicopters to airlift troops on “vertical envelopment” missions to capture heights in the enemy’s rear and flanks. India is negotiating to buy 15 CH-47 Chinook heavy lift helicopters, an order that could well be expanded. The tried and tested Russian Mi-17 V5 helicopter that the IAF has already ordered in large numbers could potentially see additional demand.

India’s expanded security perspective is also catalysing a major expansion of the Indian Navy. This is aimed at tightening Indian control over the Indian Ocean Region (IOR), particularly the shipping lanes between the geo-strategically vital choke points at the Straits of Hormuz and Malacca. A powerful navy would allow New Delhi to react to any PLA attack on the Himalayan border with a blockade on Chinese shipping, particularly its hydrocarbon supplies and manufacturing exports that transit through the IOR.

Unlike the IAF and the army, the navy has chosen to pursue the path of building capability rather than buying it. The success of its warship-building programme was evident in the successful start-up of the nuclear reactor of INS Arihant, the first indigenously built nuclear ballistic missile submarine (SSBN). On Aug 12, the indigenous aircraft carrier INS Vikrant was launched in Kochi. Of 47 navy vessels currently being constructed, 46 are being built in Indian shipyards.

This has created work not just for the four MoD-owned shipyards, but also for a crop of private shipyards. Also thriving are sub-contractors and ancillary suppliers that provide a host of systems and sub-systems for Indian warships.

But how green are these shoots for India’s defence industry? Traditionally, the military’s vast requirements have been met through import, not by supporting the development of Indian R&D facilities, vendors, sub-vendors and component manufacturers. Regrettably, the MoD has financed foreign manufacturers, especially Russian and Israeli, paying them to develop systems that even their own militaries did not want.

After the Soviet Union collapsed, three-quarters of the vaunted Soviet-era design bureaus folded up when 1,149 individual R&D projects were cancelled by the bankrupted state. In the early 1990s, Russia’s military spending plummeted to one-thirtieth of the 1989 figure. Over a million Russian scientists were on the streets, and China was hiring them in large numbers to assist in developing its own defence industry. India, however, chose to put its money into resurrecting Russian capability. For over a decade, until rising oil prices in 2005 put money into Moscow’s pockets again, India bankrolled Russia’s military industry by buying T-90 tanks, Sukhoi-30MKI fighters, and Talwar-class frigates from Russian shipyards. India paid Russia to modernize MiG-21 fighters, and develop the Uran-E and Klub naval missiles.

Then Israel’s defence industry was allowed to penetrate the Indian market, riding piggyback on the Russian military systems --- tanks, fighters, air defence systems and earlier warships --- that form the bulk of India’s arsenal. Since the Israeli defence industry does not build major weapons platforms, it has penetrated the Indian market by improving the performance and extending the life of outdated Russian systems. Retrofitting and providing mid-life upgrades to old platforms is as lucrative, or more, than selling new ones. A MiG-21 fighter, bought for a few crore rupees, costs multiples of that to upgrade. French vendors are charging the IAF about Rs 220 crore to upgrade each Mirage-2000 fighter, significantly more than the purchase price. Israeli companies excel in developing upgrades and force multipliers; and New Delhi pays them to do that. Having developed that capability at India’s cost, Israeli companies market it to other militaries that use similar platforms.

“There is no reason why Indian private companies cannot develop the systems and upgrades that the Israelis do. We are skilled software engineers. The MoD has a “Make” category in its procurement procedure that allows it to pay Indian industry to develop and deliver those capabilities. But while MoD is willing to take risks in foreign design and development, it is not willing to support and finance its own industry in developing those capabilities,” says the CEO of a prominent private sector defence company.

Tai Ming Cheung, expert on the Chinese military and author of the acclaimed book, “Fortifying China: The Struggle to Build a Modern Defense Economy”, says, “The ability to take risks in R&D projects is critical. If you are a catch-up country like China and India, you need to perform technological leapfrogs. If you don’t have a high-risk tolerance culture, you are not going to achieve some of the breakthroughs that you desire.”

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Procurement policy sees change of focus

A Pinaka multi-barrel rocket launcher is test-fired

By Ajai Shukla

Business Standard Defence Gazette

11th Sept 13

The Defence Procurement Policy of 2013 (DPP-2013), released on Jun 01, 2013, aims at providing “a boost to the Indian Defence Industry, both in the Public and the Private sector,” according to Defence Minister AK Antony in his Foreword to the document. This is sought to be achieved by according priority to acquisitions from Indian companies; simplifying the “Buy & Make (Indian)” procurement category; and revising the procedure for shipbuilding, amongst other measures.

DPP-2013 is the latest ministry of defence (MoD) procurement policy, which has evolved steadily, if slowly, since the turn of the millennium. Current procurement structures trace their roots to the Group of Ministers (GoM) report on “Reforming the National Security System,” formulated after the Kargil Review Committee submitted its report in 1999. The GoM comprehensively reviewed the procurement structures that had been in vogue since 1992, and recommended the framing of new procurement structures.

In a watershed change in April 2001, private companies were permitted to engage in defence production, subject to licensing and to an FDI cap of 26 per cent. In Oct 2001, the Defence Acquisition Council (DAC) and the Defence Procurement Board (DPB) were put in place to “bring in better synergy between the MoD and the Service Headquarters (HQ) in planning, defence acquisition and operations so that all stakeholders may function in a coordinated manner,” according to former MoD additional secretary, SN Misra, in his authoritative book, “Impact of defence offsets on military industry capability and self-reliance.”

The following year, the MoD promulgated DPP-2002, specifying a procedure for “Buy” cases that involved importing defence equipment. This was fleshed out in DPP-2003, which laid out a procedure for the “Buy & Make” category, in which the purchase of foreign equipment was followed by licensed production within defence public sector undertakings or ordnance factories (DPSUs/OFs).

While these initial DPPs did not trigger any major rise in military procurements, the MoD actively sought and obtained feedback from a range of stakeholders, including foreign Original Equipment Manufacturers (OEMs), foreign and Indian industry bodies, private and public sector Indian companies and the military. Two years later, DPP-2005 was promulgated, incorporating several major changes.

DPP-2005 mandated that qualitative requirements (QRs) should be broad-based in order to avoid single-vendor situations; that there should be joint services QRs for equipment common to all three services; and it incorporated the ministry of finance (MoF) suggestion that there should be more objective techniques for comparing bids, catering for Discounted Cash Flow (DCF) and Exchange Rate Variation (ERV).

In what has evolved into a major policy pillar of Indian defence procurement, the DPP-2005 accepted the recommendations of the Kelkar Committee --- which submitted its report that year --- and mandated that offsets of at least 30 per cent would be imposed on all foreign procurements worth more than Rs 300 crore. Vendors could discharge offset liabilities by purchasing or exporting goods and services produced by the Indian defence industry, or by investing in India’s defence industrial infrastructure.

The following year, DPP-2006 fleshed out that preliminary offset policy. Vendors were permitted to discharge offset liabilities by investing in Indian defence R&D, and were allowed to choose an Indian Offset Partner (IOP), who was required to have a defence production licence. A MoD agency was established to facilitate offset tie-ups between IOPs and vendors, but this agency, called Defence Offset Facilitation Agency (DOFA) would never be empowered, or provided with the infrastructure, to discharge this role effectively.

DPP-2006 also introduced the “Make” category of procurement, which provided a framework for the Indian private and public sectors to lead the development of defence products. DPP-2006 also reviewed and revised the Fast Track Procedure for procuring urgently needed defence items; and the Procedure for Indigenous Warship Building. An “Integrity Pact” was made compulsory for all contracts above Rs 100 crore.

By 2008, increased public and institutional scrutiny of defence procurement, and the internationally-watched procurement process for 126 medium multi-role combat aircraft (MMRCA), had created a momentum for fairer procurement. DPP-2008 introduced greater transparency in the trial evaluation of equipment, mandating the Request for Proposals (RfP, or tender) would describe what trials would be conducted so that vendors would be aware of the modalities and evaluation criteria. Vendors would receive directions during the course of trials as well as the result of the evaluation. If any vendor’s product were disqualified, the MoD would communicate the reasons in writing and place that on record.

DPP-2008 also liberalised the offset policy, acceding to a chorus of demands from foreign OEMs and prospective IOPs. Offset credit banking was introduced, permitting vendors to bank offset credits for up to two years in anticipation of offset liabilities that arose in the future. And IOPs no longer needed a defence production licence; they only needed to meet guidelines set by the Department of Industrial Policy & Promotion (DIPP).

More changes to the offset policy were made in DPP-2011, which came into effect on Jan 01, 2011.  Vendors were permitted to discharge offset obligations through partial indirect offsets, i.e. in the related spheres of civil aerospace, internal security and training. Two further amendments, notified later that year, permitted offsets to be discharged through a “grant” to government entities; and permitted Tier-1 sub-vendors to discharge offset obligations in proportion to their work share in the system that had incurred the offset liability.

DPP-2013, the current procurement procedure that was promulgated on Jun 01, for the first time explicitly backs indigenous procurement over foreign purchases. It stipulates that Indian defence companies will get access to the military’s long-term equipment roadmap, providing them with the time needed for developing the military’s future equipment requirements; levels the playing field between the defence public sector undertakings (DPSUs) and private defence companies; simplifies the “Buy & Make (Indian) procedure to benefit Indian industry; and defines ambiguous terms in the DPP like “indigenous content.”

The new policy, which only applies to tenders initiated after Jun 01, is structured to ensure that each piece of equipment that the military requires should be bought abroad only if developing and building it in India proves impossible. This is done by mandating priorities in the “categorisation” process. “Categorisation” is a key decision point in each acquisition project, in which the MoD decides whether the equipment should be developed and built in India (“Buy Indian” and “Make” categories); or built in India by an indigenous consortium (“Buy & Make Indian”); or built in India with transfer of technology (“Buy & Make with ToT”); or bought over-the-counter from a foreign vendor (“Buy Global”).

DPP-2013 lays down an order of preference for categories, in which building and buying in India is at the top, and buying over-the-counter abroad is the last priority. The order of preference is: (1) “Buy (Indian)”; (2) “Buy & Make (Indian)”; (3) “Make”; (4) “Buy & Make with ToT”; and (5) “Buy (Global)”. Any proposal to select a particular category must now state reasons for excluding the higher preferred category/ categories.”

The new policy also entitles private companies to access to important details from the military’s 15-year Long Term Integrated Perspective Plan (LTIPP). This will allow industry the lead-time needed to meet future equipment needs.

But DPP-2013’s most far-reaching change lies in its stringent definition of “indigenous equipment”. The successive DPPs of 2002, 2005, 2006, 2008, 2009 and 2011 have regarded all equipment purchased from Indian suppliers as “indigenous”, even when it contains 80-90 per cent foreign-sourced items, with just 10-20 per cent Indian components, that too in secondary fields like assembly and delivery. Now DPP-2013 rules that, “Import content in the products supplied by the sub-vendors will not qualify towards indigenous content.”

The new definition of “indigenous content” requires the following to be deducted from the cost of indigenous equipment: the direct costs of all materials, components, sub-assemblies, assemblies and products imported into India; the costs of all services obtained from non-Indian entities; all royalties, license fees, technical fees etc. that are paid abroad.

While vendors are allowed to self-certify the true value of indigenisation, certain safeguards have been put in place, such as the banning or suspending of a vendor for up to 5 years if any false certification is detected.

In addition to the steady evolution of the DPP over the years, there is recognition that the “Make” procedure needs to be simplified to attract more Indian private players into defence production. In addition to simplifying procedures in successive DPPs, a full-fledged exercise is underway to rewrite the ‘Make’ and the ‘Fast Track’ Procedure. This, MoD insiders hope, might be completed by the end of this year.

A key drawback remains the continuing applicability of the various editions of the DPP to procurements initiated during their validity. For example, the MMRCA contract continues to be governed by the provisions of DPP-2006, even if it has been concluded after DPP-2013 became valid. An RfP issued today will be governed by DPP-2013, even if a far more enlightened policy comes into force two years hence.

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Private sector seeks reform of tax and duties structure

 A self-propelled howitzer undergoes test-firing in the desert

By Ajai Shukla

Business Standard Defence Gazette

11th Sept 13

Notwithstanding the private sector’s half-cheer to the new DPP-2013, there is unanimity that policy reform alone will not level the playing field, vis-à-vis global vendors and the public sector. Writing to Mr Antony just days after DPP-2013 was promulgated, Ficci complained that the new policy ignored “critical survival issues” for the private sector, such as anomalies in taxes and duties; and protection against exchange rate variation (ERV). Soon thereafter, in a seminar in Delhi, Assocham urged the ministry of defence (MoD) to move beyond mere “emotional support” and to address “practical business realities” that were blocking the private sector from playing a larger role in defence manufacture.

These industry bodies were referring to a taxes and duties regime that --- in contradiction to the MoD’s oft-proclaimed intention to promote defence indigenization --- rewards the import of fully built defence equipment through tax and duty exemptions, while levying charges on equipment built in India.

Assocham has drawn the MoD’s attention to an “inverted structure” in which private industry is taxed by both the centre and the states when it engages in defence manufacture. Importing ready-built defence equipment into the country attracts zero customs duty, since it is exempt. But value addition in India attracts excise duty, service tax, central sales tax (CST), and value added tax (VAT). Paradoxically, the more value one adds in the country, the higher the tax rate.

According to Assocham’s calculations, which it has presented to the MoD, equipment that costs Rs 100 when procured ready-built from a foreign OEM and imported into the country, would cost Rs 116.31 if a private Indian company chooses to buy only 70 per cent ready-built, and adds 30 per cent value in India.

Incredibly, the greater the component of work transferred to India, the more the cost. If 70 per cent value-addition is done in India, the cost would rise to Rs 120.51. This makes a mockery of the MoD slogan that India must rapidly enhance indigenization in defence from 30 per cent to 70 per cent.

This tax and duty structure burdens Indian private companies with a serious competitive disadvantage. DPP-2006 granted the private sector a level playing field with respect to foreign vendors and DPSUs on taxes and duties, but only for “Buy (Global)” acquisitions, i.e. in open international tenders. Inexplicably, none of the subsequent DPPs, including DPP-2013, have extended this equity to the other procurement categories --- Buy (Indian), Buy & Make (Global), Buy & Make (Indian), Make and to procurements carried out under the Defence Procurement Manual (from the revenue, not the capital head) and to DRDO procurements. These taxes and duties, which are included in L-1 computations, add about 20 per cent to the supply cost of private companies. Industry bodies have given the MoD detailed calculations while making their case for tax and duty exemptions.

Foreign exchange rate variation (ERV) risk is another major bugbear for the private sector in defence. Even “Made in India” defence systems contain many “commercially available off-the-shelf” (COTS) sub-systems and components that are purchased from abroad. Therefore, Indian private companies bidding for defence contracts invariably incur substantial foreign exchange expenditure.

The need for them to hedge against ERV has been hammered home over the last three years, as the rupee slid from Rs 44 to a dollar in October 2010 to below Rs 60 today. Given the rupee’s continuing weakness, and the fact that most defence contracts run 5-10 years from signing to conclusion, an ERV hedge is essential.

But the MoD does nothing to mitigate that burden. DPP-2006 and subsequent revisions provide DPSUs with ERV protection on the forex component of their bids. That is extended to private Indian companies from DPP-2011 onwards, but only for global tenders, i.e. procurements categorised as “Buy (Global)”. Industry bodies had expected DPP-2013 to extend that protection to every category of procurement, but that hope has been belied. In every category other than “Buy (Global)”, private Indian companies compete at a disadvantage against foreign vendors (that are not affected by ERV), and against DPSUs that enjoy ERV protection in “nominated” manufacturing, which constitutes the bulk of their portfolio. That gives DPSUs a buffer that mitigates their ERV risk on other contracts where they do not enjoy protection.

While hedging rates vary, Ficci says that most banks charge an average of 20 per cent as the cost of a three-year forex hedge. If 70 per cent of this year’s capital budget of Rs 86,740 crore were spent in foreign exchange, that would amount to Rs 60,718 crore. The cost of a three-year hedge on that would be approximately Rs 12,000 crore.

Pointing out that banks invariably make a profit on hedging, CII has suggested that the MoD do “self-hedging”, bearing the ERV risk in the interests of building indigenous defence industry. It has also been pointed out that Ministry of Finance rules explicitly permit the MoD to include ERV protection in a tender. The Manual of Policy and Procedures for Purchases of Goods, issued by the Department of Expenditure, specifically “In case of a contract involving substantial import content(s) and having a long delivery period (exceeding one year from the date of the contract) an appropriate Foreign Exchange Variation clause may be formulated by the Purchase Organisation in consultation with its Finance Wing, as needed, and incorporated in the Tender Enquiry Document.”

The MoD says it is now responding to these concerns. Defence Minister A K Antony told Business Standard, “We have taken up a case with the finance ministry for private-sector defence companies to be protected from ERV. Now the ball is in the finance ministry’s court.”

Indian industry has also drawn the MoD’s attention to another structural disadvantage that they face vis-à-vis foreign OEMs while competing for multi-year defence contracts --- the significantly higher rate of inflation in this country. Contending that inflation increases the effective cost of a contract by about 50 per cent over a decade, industry bodies have petitioned the MoD to adjust payments for inflation, linking the indigenous component of every bid to the Wholesale Price Index (WPI).  

Assocham has also highlighted the discrimination against domestic private vendors caused by a more rigorous payment schedule than the one that the MoD offers foreign and public sector vendors. The latter are paid in tranches that are linked to a series of production milestones, such as placement of orders for materials, receipt of goods, and other production stages. But in contracts with private sector suppliers, the bulk of the payment is made only when the product is delivered, leaving the vendor with the job of arranging his own cash flow right through the production process. Assocham has suggested that private vendors be given letters of credit for progressive milestone payments.

Additionally, industry has asked the MoD to impose a 10-15 per cent import duty on all imported systems, in order to offset the advantages that overseas OEMs enjoy through the availability of finance at low rates of interest, low inflation regimes, and exchange rate stability.

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"Building strong global competitive advantage in defence manufacture is an achievable goal"

Interview with Baba Kalyani, Chairman, CII National Committee on Defence & Aerospace

Ajai Shukla: Do you believe that Indian industry is currently ready to take on the challenge of high-tech defense manufacture?

Baba Kalyani: In today’s globalized world, the strength of a country’s economy reflects its military power and preparedness. The intrinsic capabilities in Indian manufacturing industry now need to be sufficiently reflected in our defense manufacturing base. Clearly the emphasis has to be on indigenization to make the country largely self-reliant in critical items of defense equipment. The  large expenditures that we presently incur on imports need to be instead channeled to expand our domestic manufacturing capabilities. I strongly believe that Indian industry has the necessary capabilities and capacities to manufacture high-tech equipment and components. We have demonstrated this in various other sectors in which Indian companies have achieved global leadership. I see no reason why we cannot emulate our successes in the defense manufacturing sector and thus contribute towards large scale indigenization in this critical sector of the national economy.

What do you think about the recently released DPP 2013?

It is a forward looking policy document and there are many positives like preferred procurement through indigenous sources, maintenance Transfer of Technology to private industry, properly defined Indigenous content for various categories of procurements and much more. There is however a feeling that the issue of taxes and duties has not been addressed. This will need to be taken up at the earliest to encourage participation by Indian industry. The policy document is a reflection of government's intent however this needs to be followed  by  implementation of the various measures that have been announced in letter and spirit. Industry is optimistic that this would happen. 

What do you think is the biggest impediment in the implementation of this policy?

Notwithstanding our genuine readiness to work with the MOD, a veil of secrecy still appears to cloud various defense  programs. This has resulted in a certain amount of trust deficit between  government and industry which needs to be removed. The key lies in optimal utilization of resources available in the country notwithstanding whether these are available in the public or private sectors. We need to talk to each other transparently, frequently and continuously and in the process build mutual trust, confidence and respect for our respective capabilities. The dividing lines between DPSUs, OFs and domestic manufacturing industry need to be systematically dismantled. This is how most leading defence industries have been built up in other nations. This is a process that takes time but, must begin with industry and the defence establishment working together towards a common goal through well-defined and structured programs.

Is the private sector geared for Innovation and Design & Development that will be required?

The key to bring progress in defence & aerospace sector is innovation and development of new technologies. Technology denial will always remain an instrument of foreign policy. India has been and will continue to remain on the receiving end of technology denials. It is therefore important that capabilities are developed within the country to develop technologies. Emphasis must therefore be placed on research and development and their applications. De-bottlenecking innovation and R&D would need government institutions and the private sector to work together in national interest. It is therefore necessary to evolve a system through which research and development is incentivized, equal opportunities are provided for its commercial exploitation and costs are amortized over long term supply contracts. Indian industry is highly entrepreneurial and has demonstrated it's capability in a variety of sectors. With many leading Indian companies now being globally present, they have the means to create or acquire the required technology.

What do you think about defense exports and capability of Indian industry in this regard?

In the past 10 years the traditional stereotype of Indian manufacturing companies as ‘unreliable’ and ‘poor quality’ has changed and given way to recognition of our global vision, quality and ability. Many of our companies led by visionary entrepreneurs and driven by a passion to be truly world class have emerged as globally significant players in their respective fields. Indian industry is now widely recognized as a potential leader in the global manufacturing industry and a key player in the new knowledge age. I believe that the opportunity is ripe for government and industry to leverage the inherent strengths within Indian manufacturing, including in the Public and Private sectors, to build strong global competitive advantage in the area of defense manufacture. I strongly believe this is an achievable goal provided we pool our resources and work together to achieve a common objective. 

Since you head the Kalyani Group, Let me ask: Is your group prepared to put in the resources required to take on this challenge?

As a company which is engaged in the automotive, and key high tech engineering industries, one of our key strategies has been to create capabilities and capacities ahead of demand. Such a proactive approach has worked in our favor and we have created global leadership in our business. We are committed to following the same strategy in our other businesses, including defense and have already taken effective steps in this direction. We have requested the government to take note of the large front end investments that we have made and to give us equal opportunities to compete in its various procurement programs. We can start production of various key components very quickly and support the indigenisation efforts that are planned. Our vision is to contribute in building various "Made in India" defense systems, equipment, components and products. We are confident that our government will provide us opportunities to do so and through these we will be able to contribute significantly in reducing country's dependence on imports and in building a strong domestic defense manufacturing base.

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Indigenisation: a false debate

L&T's Strategic Systems Complex, at Talegaon, near Pune

By Ajai Shukla

Business Standard Defence Gazette

11th Sept 13

In 2001, a growing MoD realisation that the public sector could not meet India’s defence needs triggered the entry of private companies into this sector. But that laudable policy change was not accompanied by a clear, holistic plan for indigenising defence production. A dozen years later, there is no clarity about what indigenization means. Instead, indigenisation has been reduced to a slogan --- India’s current equipment ratio of 30 per cent indigenous and 70 per cent foreign equipment must be reversed to 70 indigenous and 30 foreign.

Nowhere in this oversimplification is the crucial question of what must urgently be indigenised and what can be imported without jeopardising military readiness. With the MoD unwilling or unable to identify critical technologies --- the withholding of which would bring the production or operation of a particular system to a halt --- foreign OEMs pay lip service to indigenisation through low-tech products like packaging and casings.

This indecision permeates policymaking circles, even though the Kelkar Committee --- enlightened and experienced experts, all --- defined indigenisation in a manner that remains valid today. The Kelkar Report states: “There is an urgent need to review the whole concept of indigenisation and self-reliance and it is time to go beyond the idea of looking at indigenisation purely as import substitution of components, sub-assemblies, etc within the country from raw materials. Today indigenisation as a concept will need to involve capability enhancement and development, increasing know-why, design and system integration, rather than having numerical targets.”

A prominent private sector CEO points out, “We could indigenise 70 per cent and still have no real control over a product that we build a large part of. That is because we continue focusing on components and numbers rather than design expertise and on integrating sub-systems and systems into a weapons system. If we build most of a system in India, but cannot tweak, modify or export it; how can we say we have indigenised it?”

Within the MoD there is still no grand strategy for meaningful indigenisation. Until the 1990s, obtaining high-end technologies for defence systems required money, strategic clout, skulduggery or espionage, since military technologies were ahead of civil knowhow and were carefully guarded. Since the digital era began, however, that trend has reversed: most cutting-edge digital technology is first developed for civil applications and later “trickles up” to military use.

Today this is also true for aircraft design, materials for aero and automotive engines, personal armour and surveillance equipment. Only in a handful of areas like night vision and stealth design does military equipment have a technological lead over civil applications. This trend is set to continue. As defence budgets decline in advanced western countries, the money available for military R&D is reducing disproportionately. Consequently, advanced weaponry being developed today contains a great deal of “commercial off-the-shelf” (COTS) equipment, and its ruggedized, but freely available, version, “military off-the-shelf” (MOTS) equipment.

Intelligent conceptualisation and sophisticated design capabilities can integrate COTS and MOTS technologies into highly effective weapons systems and platforms. Apple, it would be recalled, created the iPad almost entirely from technologies that had been freely available for some time. Its success lay in conceptualising a device that consumers would consider useful, and then carrying out the architectural innovations needed to build it. In similar fashion, China has rearranged existing technologies to build the Dong Feng-21B anti-ship ballistic missile, which US strategists have dubbed the “aircraft carrier killer.”

This logic works for operational doctrines too. In the 1930s, Germany created the Blitzkrieg from tactical concepts that had been debated since armoured vehicles first appeared on the battlefield in 1916. But German generals employed tanks in a new conceptual framework, in which fast-moving, massed armour, supported by air and artillery firepower, raced on multiple thrust lines into the heart of the enemy, dislocating his battle plan and mentally paralysing the enemy commanders. No revolutionary new weapons were deployed; but existing systems were innovatively combined into a revolutionary battle-plan.

Over the last three decades, India has evolved significant design capabilities, as evident from its missile programme, its nuclear propulsion programme, a series of light helicopters, the Tejas light combat aircraft (LCA), the Arjun tank, and an array of naval technologies that drive warship building. Safeguarded technologies in electronic warfare, combat management systems and secure communications have also been developed. These skills have been combined with COTS and MOTS systems into viable platforms that are less than cutting edge, but highly capable in the South Asian defence environment.

However analysts and government watchdogs like the Comptroller and Auditor General (CAG) are critical. In Aug 2010, the CAG criticised the Dhruv helicopter, pointing out that 90 per cent of its systems and sub-systems are sourced from abroad. The Tejas LCA and the Arjun tank also have a high percentage of foreign components. While the warship building programme has made indigenisation a priority, some 60 per cent of the weapons and sensors in most Indian-built warships continue to be sourced from abroad, including in the recently launched aircraft carrier, INS Vikrant.

In fact, the success of design and development has not been followed by the logical next step, which is to indigenise systems, sub-systems and components. For integrators like Hindustan Aeronautics Ltd (HAL), which builds the Dhruv, it is cheaper and less risky to buy COTS and MOTS equipment abroad cheaply, rather than indigenising. And with New Delhi discouraging defence exports, MoD orders alone do not commercially justify the indigenisation of systems and sub-systems.

Interestingly, indigenisation has achieved its greatest success in platforms where India faced the tightest technology denial regimes after the 1998 nuclear tests, such as the integrated guided missile development programme (IGMDP). Dr Avinash Chander, Director General, DRDO, says that the denial of even COTS and MOTS sub-systems left the DRDO with no choice but to indigenise every major system and sub-system in its missiles.

Today, India enjoys far easier access to COTS and MOTS systems, but dependency on foreign suppliers has created vulnerabilities like the high cost of maintenance and inventories, and the danger of shortfall of spares later in the life cycle due to the closure of overseas production lines. Also, it is difficult to optimise a platform’s design with a high percentage of COTS and MOTS sub-systems and systems; because “systems engineering” demands that sub-systems and systems be specifically engineered and optimised for the platform. Only then can the effectiveness of the platform be more than the sum of its parts.

The MoD could catalyse the building of COTS and MOTS products in India with a policy decision, financial commitment, and by permitting exports by Indian defence manufacturers. But obtaining guarded technologies to build critical components requires more --- a centralised, inter-ministerial strategy. China has shown the way, squeezing vendors in major foreign buys for technologies and processes. Airbus, for example, was induced to set up an A-320 production line in Tianjin, providing China’s aerospace industries with the technologies, and an understanding of production line processes in manufacturing aircraft.

India too could do the same with its large purchase volumes, such as the combined aircraft procurement of India’s many commercial airlines and the IAF’s multi-billion dollar aircraft purchases. But the narrow and uncoordinated offset policies (which are separate for defence and for civil buys) have not been managed strategically, allowing foreign OEMs to get away with supplying baggage handling systems and ground administrative services.

Over the years, New Delhi has squandered many opportunities, such as during the setting up of nation-wide cellular networks. The sheer size of those contracts could have brought in the technology and manufacturing expertise needed to create an Indian Huawei and establishing research establishments for sector-specific projects like developing metals for high-tech applications.

A key reason for the neglect of indigenisation is that, every Defence Procurement Policy (DPP) till 2006 was geared exclusively towards importing defence equipment. Subsequent DPPs addressed domestic manufacture but failed to change the basic nature of the document. For example, OEMs must still provide basic spares for two years (Maintenance Repair List of Spares, or MRLS), with subsequent maintenance the responsibility of military repair organisations like the Corps of Electrical and Mechanical Engineers (EME).

This system is wasteful on several counts. It has adversely skewed the military’s tooth-to-tail ratio, with the EME --- a logistical service --- now constituting between 15-20 per cent of the army. The EME confines itself mainly to repairs, without any mandate or incentive to improve, upgrade or build products afresh. Several studies, including an authoritative report by the Vice Chief of Army Staff (VCOAS), Lt Gen Chandra Shekhar, in the aftermath of the Kargil Conflict, have suggested downsizing the EME, and outsourcing maintenance, repair and overhaul (MRO) to the private sector.

For private industry --- which is rich in managerial expertise and technological skills but short of experience in defence manufacture --- Maintenance Transfer of Technology (MToT) provides an ideal entry point. DPP-2013 permits private companies to compete for annual maintenance contracts (AMC) for equipment being procured, with life-cycle support amounting roughly to 4-5 times the cost of the initial sale. Indian defence vendors argue that it should be mandatory for Indian vendors to execute the annual maintenance contract (AMC) in every defence contract. Life-cycle costs would dramatically reduce; industry would work with the military in the front lines, developing an understanding of defence; and the more dynamic companies would quickly absorb technology, moving up the value chain from maintenance to upgrading to designing next generation products.

Says Rajinder Bhatia, CEO Defence & Aerospace, Kalyani Group: “Maintenance ToT to private industry is an important first step towards utilization of all national resources both in public and private sectors.”

While MRO would facilitate the creation of Tier-3 and Tier-4 contractors that are essential to any defence production eco-system, Tier-1 integrators and Tier-2 systems builders would emerge from the careful implementation of the “Make” category of procurement.

Vivek Rae, the MoD’s former Director General (Acquisitions), believed that the market dynamism of the “Make” procedure --- in which private vendors compete to develop major platforms with the MoD contributing 80 per cent of the cost of development --- would galvanise the creation of a large, competitive defence industrial base. Speaking at Defexpo 2012 in New Delhi, Rae said, “I think we could energise the defence industrial base of this country by encouraging industry to participate in design and development, sharing risks and costs… it will be a significant step forward. We will make out a list of 150-180 “Make” projects that we will put on the web soon.”

In fact, the “Make” category has not got off the ground so far. Only two “Make” projects were tendered, and one of them has been cancelled. Now the MoD has undertaken an extensive rewrite of the “Make” procedure, which could be promulgated later this year as an amendment to DPP-2013.

Another central pillar of the indigenisation process was to be a public version of the military’s 15-year Long Term Integrated Perspective Plan (LTIPP), which would inform industry about the military’s equipment needs 15 years into the future. Called the Technology Perspective and Capability Roadmap (TPCR), the MoD says it would “provide useful guidance to the Indian Defence Industry for boosting its infrastructural capabilities and directing its R&D and technology investments.”

The TPCR that has been put out has failed to enthuse industry. Says Colonel (Retired) HS Shankar, who heads Alpha Design Technologies, “The TPCR lists every possible technology, some of which may never see the light of day. For industry to start R&D activity towards a particular product, the document must give out a detailed description of each product that the military needs, its specifications, the quantities needed and the time frame for its induction.

Another more blunt CEO, speaking anonymously, said, “I don’t know why the MoD took five years to put out this document that has so few actionable items. The first somewhat actionable item that I found (Long Endurance UAVs) was on Page 16 of a 43-page document.”

Says the CEO of a private defence company, “ Industry was eagerly awaiting the release of Public version of LTIPP, which has been promised for the last five years. The TPCR that has been put out is a disappointment, particularly the MoD disclaimer on the released document that says industry that participates does so ‘solely at its own risk.’ This does not argue well for the trust needed to build a robust defence industrial base in India.“

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"We should work towards a defence industry that exports"

Interview with Dr Avinash Chander, DRDO chief

Ajai Shukla:    Is defence R&D in the country at a crossroads?

Chander:   Indian defence industry is in transition. It has tremendous potential to move ahead but must also be ready to absorb some level of risk; to upgrade its competitiveness. There are many new opportunities, since the acquisition process has become more proactive. DRDO is working with industry and will provide support wherever required as a technology partner.

Is industry being too cautious in wanting more guarantees?

We should not get into a Catch 22 situation, which would happen if the MoD demands industrial capability before placing an order, while industry demands orders before putting money into developing capabilities. Secondly, if the “Make (Indian)” category of procurement is to survive, we should work towards global competitiveness and a defence industry that exports. Otherwise, domestic industry will never be competitive in cost.

Would that mean loosening export control regulations?

Exports would be fine, provided we first meet our own military’s requirements. But a large, assured market is essential for economically viable development programmes. Take the Tejas fighter --- the Indian market may be for just 100-200 aircraft but the global market could buy another 500 aircraft. There is demand for this class of aircraft and not many competitors. If we build the Tejas in large numbers it can be globally competitive.

A competitive defence industry must export for volumes. This will require policies, a well-crafted methodology, and MoD support.

Should there be greater funding for the DRDO?

Chander:        China spends 15 per cent of its officially declared defence budget on R&D, as do other countries. We spend just 5.5 per cent, including on salaries, capital expenditure, and on strategic systems. We don’t have any hidden budgets. It is imperative we spend more on defence R&D if we want to become self-reliant. Not just DRDO; a larger R&D budget can be shared with industry too.

But we are yet to develop an expenditure model where the government is ready to fund a private industry project, regardless of success or failure. For that the system needs to mature. Also, we need to identify 4-5 key thrust areas for R&D. One such area is the Advanced Medium Combat Aircraft, with unmanned systems developed in parallel. Another is artillery, where we need to develop our own gun design. We are developing that with a new partnership model: an Ordnance Factory-industry-DRDO partnership.

Tell us more about this.

Industry is developing the capability to manufacture a barrel. The DRDO’s Armament R&D Establishment (ARDE) is designing electromechanical systems, better recoil capabilities, and a totally automated gun with higher rates of fire. We have set a timeline --- the prototypes will be ready within 3 years.

Bharat Forge is developing its own gun too, alongside with partnering the DRDO project.

The DRDO has no problem with that; if industry does anything on its own, or even with foreign technology input, we are happy. 7000 DRDO scientists cannot handle defence R&D for the entire country. But we do not want industry initiatives to get into indirect import, with only minor assembly done in India. In so-called Transfer of Technology (ToT) manufacture earlier, 80 per cent of the inputs were coming from abroad. Manufacturing must enhance indigenous capability; industry must be able to upgrade products that it builds. Only then can one call it an Indian product.

Tejas, guns, missiles. What else is DRDO working on?

The future of DRDO will be defined by 3-4 R&D areas: Firstly, unmanned warfare, on ground and in air. Robotic soldiers and unmanned aircraft will require us to develop a host of technologies. Secondly we need to end ammunition import by creating indigenous manufacturing processes and upgrades. Thirdly, we need state of art missiles with far greater ranges than at present, which we can launch from multiple platforms. 100 km was considered a good standoff range, but now we need to hit aircrafts and ships at longer distance. We need dynamic design processes to keep pace.

What developments can we expect in the DPP?

The DPP will constantly evolve. There will be more emphasis and clarity on indigenisation. The “Make” category has some parameters, but we need to work out processes for selecting a development partner for a system where the end product is not fully defined. We buy on a lowest cost (L-1) basis but how do you cost if the product has not been defined?

There is an unresolved debate on increasing FDI in defence…

FDI is not really relevant to DRDO. But, as an engineer, I feel FDI brings in skills that are essential for growth. In the automobile industry, it brought quality processes in manufacturing, automation, cost consciousness. Once foreign partners invest, their teams get integrated into management and that can transform the industrial pace and capability.

The counter argument is that defence is a sensitive matter, and so how much FDI is acceptable? That debate has to be resolved in appropriate forums. Also, if I transfer a proprietary technology to a firm, which is then acquired by a foreign company and it stops production then it compromises our total program.

Will the DRDO not be evaluating technology where companies apply for 100% FDI on the grounds that high end technology is being brought in?

We will be the arbiters who evaluate the technology. But we will not decide whether a particular technology is needed or not. That is a different role.

What are the difficulties in making your evaluation?

Evaluating technology is a tricky problem, even in offsets. We will need to identify and define critical technology. We will need to evaluate its cost. We will need to see how it fits in with our acquisition plans? These are the three keys issues that we are resolving. We hope mature methodologies will evolve on the costing of technology, its necessity, its impact factor, its long-term benefits and its ability to produce spin offs.

What is happening on the Defence Technology Commission (DTC)?

The DTC will have all stakeholders -- the armed forces, MoD, PMO, scientific community, production community, industry bodies --- together taking integrated, holistic decisions in the national interest, rather than in individual or group interests. I’m confident that it will come through by the end of the year. It has to go to cabinet for clearance. In principle there is no hurdle.

Will the DTC only set a broad agenda for indigenisation?

It will fix the parameters related to developing indigenous products --- how to promote science and R&D, how to smoothen production interfaces, what kind of products and what numbers should be made..

Is the DRDO stepping up cooperation with overseas partners?

As India’s capability and visibility grows, there will be more partnerships. Increasingly, a major part of the development would be from the Indian side with a small part coming from abroad.

But this is getting bogged down in procedure?

If we have to attract overseas partners we must simplify processes so that interfacing becomes faster. The world will not wait. If we delay, they will look for other partners.