Making “Make” happen

By Ajai Shukla

Business Standard, 17th March 15

In the afternoon of November 10, within ten minutes of occupying his new office as defence minister, Manohar Parrikar proclaimed that “transparent and swift decisions” were his speciality. Since then, he has repeated that boast at least thrice, alongside other confident promises of policy reform. Yet, not a single important policy has emerged from Mr Parrikar’s ministry so far, only slipping deadlines that recall the enervating days of his predecessor, AK Antony. If the previous defence minister neither spoke nor acted, the current one is quick to promise transformation. Neither, however, has delivered real change.

At a media conclave in early December, Mr Parrikar promised ex-servicemen their One Rank One Pension demand within four to eight weeks. This deadline has been repeatedly extended, but exasperated ex-servicemen continue to wait. In December Mr Parrikar also promised a new policy by January that would monetarily penalise, rather than ban, corrupt arms vendors. That promise has been renewed repeatedly, including at Aero India 2015 last month. Yet, top helicopter maker, AgustaWestland, remains excluded from a slew of impending helicopter purchases (Mr Parrikar estimates the military will need 800-1000 new helicopters over the next five years), creating single-vendor situations in which India might buy choppers for hundreds of millions of dollars more than in a procurement where competing vendors drive down prices. In October, an Italian court threw out the bribery charges against AgustaWestland. Yet the defence ministry remains frozen, even though the Central Bureau of Investigation has failed to even file a charge sheet against AgustaWestland during the past two years.

Mr Parrikar’s most worrying delay relates to his promise to simplify and rationalise the “Make” category of defence procurement, under which Indian companies design and build major defence systems, with the defence ministry reimbursing 80 per cent of the development cost. Both Mr Antony and Mr Parrikar agree that “Make” category projects would vitalise Indian defence industry.

Like elsewhere, Mr Parrikar has overpromised and under-delivered on the new “Make” procedure. In December, he invited the who’s who of the defence industry to Goa and assured them of a new “Make” procedure by end-January. The next day, he told defence journalists in Delhi that the “Make” procedure would be ready “in the next two-three weeks”. Seven weeks later, Mr Parrikar declared during Aero India 2015, in February, that the “Make” policy would “crystallise” in March and be notified by April/May.

Currently, the government and private defence industry are debating the new “Make” policy, with private firms determined to wrest parity with the eight defence public sector undertakings (DPSUs) and 41 ordnance factories (OFs), in whose favour the deck has traditionally been stacked. To counter the defence ministry’s well-known bias towards its pet mastodons, the Prime Minister’s Office has asked the Department of Industrial Policy and Promotion (DIPP) to arbitrate the framing of the new “Make” policy. Even so, the draft of the new policy, which I have examined, remains contested. The private sector has told Mr Parrikar that the “Make” procedure, in its currently proposed form, is destined to fail.

First, the new policy ignores the private sector’s concern over the debilitating cost of capital. True, the defence ministry eventually reimburses the “development agency” (DA) --- the company, or consortium that leads a “Make” project --- 80 per cent of the development cost. However, until the money is reimbursed at stipulated development milestones, the DA must bear the cost of capital. With interest costs ranging from 14-16 per cent, industry argues that their putative 20 per cent share actually rises to 40-50 per cent. If the defence ministry cannot pay up front, private industry wants it to share the cost of capital in an 80:20 ratio. The government does not dispute the interest cost; but the draft “Make” procedure disallows “interest” from being included as a project cost.

Ludicrously, the defence ministry argues that the US Pentagon’s Defence Advanced Research Projects Agency, famously known as DARPA, which similarly sponsors small research projects, does not reimburse interest costs. The private sector retorts that DARPA reimburses 100 per cent of project cost; and capital costs just about 2 per cent in America anyway.

Second, major private firms have protested the dilution of three key eligibility conditions in the draft policy that could open the doors for foreign defence majors to access Indian funding under the “Make” procedure. So far, a company was eligible for “Make” projects only after operating for 10 years; the draft policy halves that to five years. Earlier, a company required an asset base of Rs 100 crore and turnover of Rs 1,000 crore to participate; the draft policy only requires a “positive net worth” that is 5 per cent of the project size. For micro, small and medium enterprises (MSMEs) the net worth criterion is waived entirely. So far, the policy required a company to have a defence licence; now it need only have applied for one. A foreign defence major can win development contracts with 80 per cent Indian government funding merely by forming a 49:51 joint venture with an unscrupulous Indian MSME that has had a sleeping company for 5 years.

Third, the private sector has strongly protested a draconian provision that renders any company that violates any policy guidelines (and presumably the ministry would be the judge of that) punishable by a five-year ban from doing business with the defence ministry. Industry bodies have requested that a ban be limited to ethical violations, which could be covered under an “Integrity Pact” that already forms a part of all defence procurement contracts.

“My board would never allow the company to participate in a development programme where the company could be excluded from all defence business for a minor procedural violation”, says a defence firm chief executive officer.

From the delays and disputes, it appears as if the defence minister is not entirely clear about what the “Make” procedure intends to achieve --- to create Indian “system integrators” that own the intellectual property that goes into a military platform, allowing not just in-country design and manufacture of that equipment, but also life-cycle support and periodic systems upgrades, all of which add up to 6-10 times the procurement cost. This is qualitatively more strategic than simply boosting manufacture to create jobs. So far Mr Parrikar’s embrace of the “Make” procedure is apparently rooted more in his boss’ enthusiasm for the “Make in India” slogan than from a hard-eyed realisation that Indian defence industry needs to be nurtured, hand-held and protected so that it can develop and supply defence equipment designed and built specifically for India’s military requirements. There has been enough delay and prevarication. The “Make” procedure needs to be finalised and at least 15-20 development projects contracted, for which the Rs 144 crore provided in the defence budget must be increased substantially.