Policy delay thwarts private firms’ defence ambitions

The government is struggling to force a consensus on the policy for selecting strategic partners

By Ajai Shukla

Business Standard, 26th Jan 17

Defence Minister Manohar Parrikar, even after repeated unfulfilled promises, has been unable to formulate a policy for nominating “strategic partners” (SPs) for defence production --- private companies, pre-selected as the defence ministry’s production agency in ten different technology areas, such as warships, submarines, aircraft, armoured vehicles and others.

While the new Defence Procurement Procedure of 2016 (DPP-2016) was promulgated on March 28, it has a gaping hole where Chapter VI should be. This is the chapter on SPs, the policy for which has still not been finalised.

The idea of strategic partners was mooted by the Dhirendra Singh Committee, which, in July 2015, recommended amendments to the Defence Procurement Procedure of 2013 (DPP-2013) to smoothen the path to producing more defence equipment in India, thus lowering import dependence.

Defence production through strategic partners relates to the “Buy & Make” procurement category, which, in essence, amounts to building foreign defence equipment in India with technology provided by a foreign vendor. An Indian company nominated as the strategic partner would be the automatic production partner in India. If the Indian Air Force contracted to buy Gripen E fighters, then its manufacturer, Saab of Sweden, would go straight to the designated strategic partner and jointly establish manufacture in India.

In the joint venture the foreign company is allowed a stake up to 49 per cent. This could be problematic, like during negotiations with French vendor, Dassault, for building 108 Rafale fighters in Hindustan Aeronautics Ltd (HAL). Dassault declined to take responsibility for the fighters HAL built, since it did not control the company.

The nomination of strategic partners was meant to bring clarity, assurance and predictability to defence contracting. Overseas vendors would know which Indian firm to negotiate with, and build long-term capability that might come in use during production. Contracting would be simplified, since the Indian partner would have been nominated in advance. Most importantly, private firms nominated as SPs would be able to invest in building capability and infrastructure, having been assured of business over the coming years.

While superficially resembling the Vijay Kelkar Committee’s 2005 proposal to designate “Raksha Udyog Ratnas” (RuRs) from amongst the most capable private sector companies, the notion of strategic partners is different in important ways. First, the RuRs were intended not just to manufacture defence equipment based on technology transferred from a foreign vendor, but to also design and develop indigenous defence platforms under the “Make” category --- in which they would pay 20 per cent of the cost of developing a platform, with the defence ministry paying 80 per cent. Effectively, being designated an RuR meant that a private firm was on the defence ministry’s “go-to shortlist”, with a status on par with the defence public sector undertakings and the Ordnance Factory Board.

Another vital distinction was that, with a number of RuRs bidding for each tender, there was an inbuilt element of competition. An SP, on the other hand, would enjoy a near-monopoly for a decade or two. Essentially, designated private sector SPs only replaces a public sector monopoly with a private sector one.

In contrast, SPs will merely be a production partner for foreign vendors, enabling the in-country manufacture of a large enough share of the system to meet the modest indigenisation requirements of a “Buy and Make” contract. Nor would this involve building futuristic defence technology, since a “Buy and Make” contract, by definition, is for proven weapons systems that are already in service. Separately, the SP would be expected to absorb maintenance technologies from the foreign vendor, enabling it to provide “life cycle support” to the equipment it had part-manufactured. While the SP would develop a level of maintenance and manufacturing capability, it would have to work on its own to develop the design and development capabilities needed for designing high-tech, futuristic defence products. With the foreign partner holding 49 per cent of the equity, it would be likely to block the development of a rival capability in India.

Unfortunately, the idea of strategic partners has been contentious from the outset. Private defence firms vie bitterly to be nominated as SPs; they see this as a “golden key” to entitlement, with automatic benefits flowing from India’s foreign arms procurements. This has generated cutthroat competition, with private defence vendors lobbying frantically for guidelines that would enhance their own prospects for selection.

Meanwhile, defence ministry bureaucrats have steadfastly undermined the strategic partner policy, for fear that the exercise of discretion in selecting privileged winners might --- as in the spectrum and coal block allocations --- place even honest officials in the cross-hairs of corruption investigations later.

There is equal apprehension, both in the ministries of defence and finance, about any strategic partner-like arrangements that would subsequently involve granting contracts without going through the process of price discovery through competitive bidding.

In order to smoothen the process of selecting strategic partners, Parrikar appointed a body under VK Aatre, a former Defence R&D Organisation (DRDO) chief. The so-called VK Aatre Task Force submitted its findings in January 2016, laying down two sets of eligibility criteria for evaluating private firms. A “financial gate” was specified to ensure a company has deep pockets to support its equipment for the duration of its service life, often decades long. Separately, a “technical gate” required applicants to be capable of building systems with multiple technologies.

While the Dhirendra Singh Committee recommended selecting one SP for each “strategic segment” --- aircraft/helicopters, warships/submarines, armoured vehicles, missiles, command & control systems, and critical materials --- the Aatre Task Force rearranged these into two groups. It recommends selecting one strategic partner for each segment in Group I, which includes aircraft, helicopters, aero engines, submarines, warships, guns and artillery, and armoured vehicles. For another three segments in Group II --- metallic material and alloys; non-metallic materials; and ammunition, including smart munitions --- the Aatre Task Force recommended selecting two strategic partners for each.

Segments for Strategic Partners

Dhirendra Singh Committee	VK Aatre Task Force	Industry Sub-Group 5
Aircraft: fighters, transport aircraft and helicopters	Fighter and transport aircraft	Fighter aircraft
		Transport aircraft
	Helicopters	Helicopters (marine)
		Helicopters (non-marine)
	Aero engines	Aero engines
Warships and submarines	Warships	Warships
	Submarines	Nuclear submarines
		Conventional submarines
Armoured fighting vehicles	Armoured vehicles	Heavy armoured vehicles
		Light armoured vehicles
Complex guided weapons, including missiles	Guns and artillery	Guns and artillery
		Small arms
Command & control systems
Critical materials and alloys	Metallic materials and alloys	Metallic materials and alloys
	Non metallic materials	Non metallic materials
	Ammunition	Ammunition

Controversially, it has been recommended that a single company should be selected as a strategic partner for no more than one segment. For a company like Larsen & Toubro, which has been deeply involved in several areas of defence, such as submarine building, shipbuilding, guns and artillery, command and control systems and armoured vehicles; this amounts to an unacceptable curtailment.

With little agreement between prospective strategic partners, Parrikar last year created five working sub-groups, headed by defence industry leaders, to submit recommendations. Four sub-groups recommended policy for appointing strategic partners for impending contracts relating to armoured fighting vehicles (AFVs); aircraft and helicopters; submarines; and ammunition. A fifth sub-groups deliberated upon the policies and differentiators for selecting SPs.

Business Standard has reviewed the recommendations of the fifth sub-group, which, even while presented as a consensus, also serves to highlight the chasm between prospective strategic partners.

A key recommendation, which is based on a legal opinion affixed to the report, restricts all the companies in a single promoter group to just one segment in Group I. That means that big groups like the Tatas would be restricted to just one of the companies that they control. This is likely to be sharply contested.

As contentious is the recommendation on the minimum annual revenue needed to be a strategic partner. While the Aatre Task Force recommended a minimum turnover of Rs 4,000 crore for each of the last three financial years, there has been argument over whether companies like Tata Motors, which has a major share of its income from an overseas entity --- Jaguar Land Rover --- is entitled to count that consolidated turnover. The sub-group recommends that, if the entity gets more than half its turnover from India, it could add the overseas income to its turnover, but not if more than half comes from abroad.

The report also reflects opinion across all stake holders that many more segments need to be created. For example, the fighter aircraft segment should be separated from transport aircraft; the helicopter segment should be split between marine and land-based helicopters and armoured vehicles segment should be split between light and heavy vehicles.

Although more than six months have elapsed since these recommendations were presented to the defence ministry last June, the strategic partner policy is nowhere in sight. Chapter VI of DPP-2016 remains blank. Meanwhile, uncertainty dogs a host of important overseas acquisitions like that of a single-engine fighter.

 “We want to start cooperating with whoever the defence ministry nominates to build a single-engine fighter; and to start building aerospace components in India. But we can only do so, when a company is nominated as the aerospace strategic partner”, says a senior Saab official, who hopes to build the Gripen E in India.