Defence needs projects, not FDI

An artillery gun barrel, machined in an Indian private company

by Ajai Shukla

Business Standard, 10th Jun 14

There are widespread misconceptions about raising the foreign direct investment (FDI) limit in defence production. This is especially so in the hazy post-Congress euphoria of economic azadi, where any loosening of government controls is reflexively lauded as a progressive step even when it involves issues far beyond economic liberalisation. I observed this while participating in a recent television discussion on the initiative by the Ministry of Commerce and Industry to raise the current 26 per cent cap to 49, 74 or even 100 per cent. My co-panellists --- one from the Bharatiya Janata Party (BJP) and the other from the Congress --- had little interest in debating whether, or how, a higher FDI cap would boost indigenisation. Instead, they squabbled over credit. The BJP member boasted about his party’s purposefulness on defence; the Congressman claimed correctly that the UPA had already permitted 100 per cent FDI for firms that brought in high technology. Ironically, they were both seeking credit for giving foreign arms vendors concessions that are both unprecedented and unnecessary.

FDI in defence is usually considered in a highly simplistic context, summarized in a 2010 proposal by the Department of Industrial Promotion and Policy (DIPP), which has now been dusted out again. The 2010 proposal notes: “Manufacturing within the country… will be a better option than importing the equipment from abroad. The general perception is that the present FDI cap of 26% discourages original equipment manufacturers (OEMs) from bringing in proprietary technology, as OEMs may be reluctant to license their proprietary technology to a company in which their equity is restricted to a minority of 26%. This has resulted in India not being able to access the latest high-end technologies available.”

This argument is plain wrong. Since 2006 the government has permitted 100 per cent FDI in defence on a “case-by-case basis”, i.e. for OEMs who bring in high-end technology to build weaponry in India. Since then, not one OEM has responded with a proposal, nor is anyone likely to. That is because even when a vendor sees a terrific business case in building defence systems in India, it is not her board but her government that will have the final say on technology export. The OEM can release no proprietary technology to an Indian production unit, even fully owned, without the home government’s explicit sanction. This requirement is legislated by every major defence exporter through laws like the US International Traffic in Arms Regulations (ITAR). As the Federation of Indian Chambers of Commerce and Industry wrote to the government in 2010 while contesting the DIPP proposal, “A 100% owned Indian subsidiary (hypothetical case) of an OEM thus has no special status when it comes to obtaining technology from (the) overseas parent company.”

The DIPP is even more mistaken in measuring indigenisation in the framework of percentage of manufacture rather than design capability. There is no truth in the belief that transferring defence manufacture to India, even of low-to-medium-end equipment, would make India more secure or its defence more affordable. Instead, the crucial first step in indigenisation is to nurture the expertise needed for designing major weapons platforms in accordance with our operational requirements, environmental conditions and user capabilities. India must build on its growing ability to design the major weapons platforms it needs ---tanks, artillery, battlefield communications, warships and fighter aircraft. It is acceptable to initially build these platforms with foreign components that are readily available over-the-counter, especially to a high-volume buyer like India. Just as western OEMs see no conflict in designing defence electronics and avionics with computer chips built cheaply in southeast Asia, India should have no problem in initially building its fighters with foreign engines and cockpit avionics; its tanks with bought-out engines and thermal imaging sights; and its warships with imported engines and transmission. Having established design capability, manufacturing indigenisation can proceed based upon an evaluation of what sub-systems can be manufactured cheaply in India, and what would be essential for supporting the basic platform through its service life.

This fundamental truth animates the Kelkar Committee report of 2005, which notes: “There is an urgent need to review the whole concept of indigenization and self-reliance and it is time to go beyond the idea of looking at indigenization purely as import substitution of components, sub-assemblies etc within the country from raw materials. Today indigenization as a concept will need to involve capability enhancement and development, increasing know-why, design and system integration rather than having numerical targets.”

Once the defence ministry prioritises design capability over manufacture, the logical next step would be to prioritise “Make” category acquisitions over other categories like “Buy & Make (Indian)”, which involves the production of foreign weaponry by an Indian manufacturer, based on technology transferred by the OEM. It is often forgotten that the “tried and tested” weapon thus built would be technologically 15-20 years old when it enters service --- at least five years in development, five years in host country operational service and five years in evaluation and production for India’s military. With the hope of exporting such a system bleak, the Indian production line would shut down after fulfilling the domestic order. Furthermore, the OEM does not transfer key technologies for production in India; the DPP allows the retention of “proprietary technologies”.

In contrast, the defence ministry should act purposefully on its oft-expressed intention to promote “Make” category projects, in which Indian consortia develop and manufacture futuristic platforms, co-opting foreign OEMs only for inaccessible technologies. This category galvanises indigenisation across the spectrum, from research, design and development to manufacture, with the IPR resident in India. While the MoD is already committed to funding 80 per cent of development cost, the user service should contribute another 10 per cent. Success would depend heavily upon the full involvement of user services in the integrated project management teams (IPMTs) that oversee each project, rather than outsourcing technology management to the DRDO, which is the current tendency. Currently there are just two “Make” category projects under way. Stepping these up to 100-150 would galvanize India’s defence industry and put an end to the uninformed FDI debate.