Changing the "Make" procedure: Foreign arms vendors eye windfall gains

By Ajai Shukla

Business Standard, 29th Sept 14

Indian private companies that aspire to design and develop indigenous defence equipment are worried. The ministry of defence (MoD) is poised to clear a new policy that will let foreign defence companies enjoy Indian subsidies for developing equipment for the military.

The policy in question --- the “Make” category of procurement --- was included in the Defence Procurement Procedure (DPP) of 2006 to foster Indian research & design (R&D) capability; to retain control of technology; and to ensure that defence equipment is supported through its service life. In “Make” category projects, the MoD pays the vendor 80 per cent of the development cost.

This was to enable Indian companies to compete with global defence giants that had established themselves over decades, mostly with enormous subsidies from their respective governments.

Strict conditions exist for a company to be eligible for a “Make” project and, therefore, for MoD funding. The company should have been in operation for at least 10 years; have a minimum annual turnover of Rs 1,000 crore; have been profitable for at least three of the last five years; and have a defence licence.

The new policy that will come up before the MoD’s apex Defence Acquisition Council (DAC) seriously dilutes these conditions, opening the door for foreign vendors to enter as joint venture companies (JVs) and claim “Make” funding.

The new policy reduces the operating period from 10 years to just 5; the asset base is no longer Rs 1,000 crore, but linked with the size of the “Make” project in question; and a defence licence is no longer essential; it is enough to have applied for a licence.

An Indian CEO points out that the proposed changes would permit an Indian business house that has had a non-operating (sleeping) company for 5 years to form a JV with 49 per cent FDI, apply for a defence licence, and be eligible for “Make” category projects.

As worrying, says an MoD official who opposed the new “Make” procedure, is the fact that foreign holding would subject the JV to export control laws and technology restrictions of the country to which the foreign vendor belongs. The US Code of Federal Regulation mandates that a foreign JV, in which an American company owns more than 20 per cent, is subject to US technology control laws.

That would seriously violate the basic aim of the “Make” procedure --- which is to create an Indian product that is not subject to foreign control or licensing. Ensuring that key intellectual property (IP) remains in India would ensure life cycle support and subsequent upgrades of the equipment in question.

In discussions with the MoD from June-Oct 2013, Ficci had strongly opposed diluting the eligibility conditions for “Make” projects. The MoD then engaged private management consultants, PricewaterhouseCoopers, or PwC, to develop the proposed “friendly” policy.

Dhiraj Mathur, Executive Director of PwC, argues that the existing policy does not exclude foreign participation. The truth is, however, that the existing eligibility conditions rule out foreign bidders from “Make” procurements.

This was illustrated in the eventually abortive “Make” project to build a Future Infantry Combat Vehicle. The MoD invited four companies, including Mahindra, to submit proposals. Since Mahindra wanted to partner global major, BAE Systems, they established a JV called Defence Land Systems India (DLSI), in which BAE Systems owned 26 per cent. With DLSI ineligible to bid, it remained a vendor to the principal bidder, Mahindra.

Consequently, Mahindra would have remained in control of the IP, which would not be the case had DLSI been the primary vendor.

The raising of FDI limits in defence, on August 6, from 26 to 49 per cent, allows foreign vendors to have a larger stake in the JV. Anticipating this, Ficci had stated at the time that, “such (JV) companies can be permitted to participate in Buy (Indian) and Buy & Make (Indian) categories of procurement.”

Notably, Ficci did not welcome JV participation in “Make” category procurement. Yet, if the MoD sanctions the proposed new policy this week, the very foundation of the “Make” procedure would have been shifted.

Contacted for comments, the MoD has not replied.