Strategic shift: India asks private companies to firm up defence production

With the defence budget stagnating and the public sector lagging in building weaponry, India needs the private sector to galvanize production

By Ajai Shukla

Business Standard, 9th Dec 19

Since his appointment as defence minister in May, Rajnath Singh and his ministry’s officials have held a flurry of meetings with public and private sector defence companies. In these, the Ministry of Defence (MoD) has urged private firms to “Make in India”, so as to meet the indigenous production targets set out in the Defence Production Policy of 2018 (DPrP 2018). This policy explicitly aims to make India one of the world’s top five defence producers, with an annual turnover of US $26 billion (Rs 185,000 crore; Rs 1.85 trillion), by 2025. 

The ambitious targets give India’s aerospace and defence industry just six years to more than double its current annual turnover of Rs 80,000 crore. “For this Indian defence industry needs to grow at the rate of 15 per cent per annum,” Singh told an industry gathering on September 17.

Singh, who expects growth to be driven by the private sector, pointed out that more than half of India’s current annual defence production of Rs 80,000 crore already comes from private manufacturers. Of this, direct orders to private companies account for Rs 16,000 crore. In addition, the public sector outsources about 40 per cent of its production to private firms.

Procurement from Indian vendors

(Rs crore)

	Total Procurement	Procurement from Foreign Vendors	Procurement from Indian Vendors
2016-17	69150	27278	41872
2017-18	72732	29035	43696
2018-19	75920	36957	38963

(Source: Parliamentary answer on July 3, 2019)

Theoretically, it should be possible to raise defence production simply by installing more capacity. As the MoD revealed in Parliament on November 27, the order books of the defence ministry’s nine defence public sector undertakings (DPSUs) currently add up to Rs 231,981 crores (Rs 2.32 trillion). Hindustan Aeronautics Ltd (HAL) has production orders in hand for the next three years. Bharat Electronics Ltd (BEL) has orders for four-and-a-half years of production. And Mazagon Dock Ltd, Mumbai (MDL) has orders that will keep it busy for a full decade. 

Limited defence budget

However, the problem is not just low production. Given the stagnating defence budget, there is also limited capacity to absorb production. Of this year’s defence allocation of Rs 431,011 crore (Rs 4.31 trillion), half will go on salaries and pensions, leaving only about Rs 180,000 crore (Rs 1.8 trillion) for buying defence equipment. This includes the capital allocation of Rs 108,248 crore (Rs 1.08 trillion) and about Rs 70,000 crore from the revenue allocations. And with over half of this going to overseas vendors for imported weaponry, buying more indigenous equipment requires either an increase in defence allocations, or reduced import dependence – or both.

Defence allocations

(Rs crore)

Budget Head	2017-18 (Actual)	2018-19 (RE)	2019-20 (BE)
Revenue allocation	192273	199945	210683
Pension allocation	92000	106775	112080
Capital allocation	95431	98473	108248
Total Defence Budget	379704	405193	431011
Central govt spending	2141973	2457235	2786349
% of govt spending	17.7%	16.5%	15.5%
Total GDP	16784679	18840731	21100607
Percentage of GDP	2.23%	2.15%	2.04%

(Source: Budget documents)

But, given the government’s focus on social sector spending, there is little scope for increasing the defence budget. Inclusive of military pensions, this year’s defence allocations account for 15.5 per cent of the government’s expenditure; or 2.04 per cent of the country’s Gross Domestic Product (GDP). In fact, by these parameters, defence spending has steadily fallen over the last three years.

That leaves the defence industry critically dependent on exports for absorbing any rise in production. Recognising this, DPrP 2018 aims to triple defence exports in the next six years, from the current year’s exports of Rs 10,745 crore to $5 billion (Rs 36,000 crore) by 2025. That would sharply increase Indian industry’s share of global defence and aerospace manufacturing from less than 1 per cent currently.

Furthermore, the MoD appears to have reserved “a major share” of defence production for the DPSUs and Ordnance Factories (OFs), leaving the private sector out in the cold. In June, Sanjay Jaju, the ministry’s interface with industry, bluntly warned private firms that they had to either export, or perish. “The capital budget is currently about rupees one lakh crores (Rs 1 trillion). There are certain committed liabilities. Of what remains, a major share goes to the public sector. A small share of the pie goes to the private sector… Not all of you will get orders. We cannot support so many of you”, he said.

Jaju explained that the government was actively promoting defence exports by obtaining entry into three of the four international export control regimes: the Missile Technology Control Regime, Wassenaar Arrangement and the Australia Group. India was also lobbying actively for entry into the fourth: the Nuclear Suppliers Group. He said this global recognition of India as a responsible arms exporter would reduce barriers into foreign markets. Jaju also pointed out that exports create economy of scale, bringing down prices of defence products and making them competitive in the global market.

Indian weapons for the world?

If Indian weapons platforms have not found global acceptance, at least part of the blame rests on the military’s reluctance to induct indigenous weaponry into its arsenal. The long-delayed induction of the Tejas light fighter into the Indian Air Force (IAF) has triggered international interest in the fighter – Malaysia and at least one other country are evaluating the Tejas. However, the small numbers the IAF has ordered and the piecemeal placement of orders has ensured the Tejas’ price remains high. In contrast, the Pakistan Air Force’s ready acceptance of the Sino-Pakistani JF-17 Thunder fighter and its placement of large production orders have driving down costs, making it attractive to foreign buyers.

Similarly, the Indian military’s delay in ordering the Akash air defence missile and the small numbers ordered, limit its chances in the export market. 

The same is true for helicopters, the HTT-40 trainer aircraft and the Pinaka rocket launcher. The navy has failed to order even a single warship from L&T’s state-of-the-art Katupalli Shipyard, into which the company has sunk over Rs 5,000 crore. There are proposals for the foreign ministry to provide lines of credit for buying Indian warships to smaller maritime neighbours, such as Maldives, Seychelles, Mauritius, Myanmar and Sri Lanka. But slow decision-making and slothful execution make India’s defence industry unattractive.

Private sector trajectory

India’s private sector was formally allowed into defence production only in 2001, subject to licensing and a foreign direct investment (FDI) cap of 26 per cent. Over the years, the MoD has eased the process of granting licences and also pared and rationalised the list of products that require defence licences. Yet, defence firms continue to navigate a complex industrial licensing regime, governed by the Industries (Development & Regulation) Act, 1951, the Arms Act, 1959 and Arms Rules, 2016. Licensing applications undergo security vetting by the defence and home ministries before the Department for Promotion of Industry and Internal Trade (DPIIT) clears them.

Given the private sector’s recent entry, DRDO has been practically alone in developing full-fledged weapons platforms – that is multi-system, multi-technology systems such as aircraft, helicopters submarines, tanks, etc. DRDO systems worth, Rs 275,000 crore (Rs 2.75 trillion)have been inducted into service, or are on order. This expertise has taken decades to accumulate, at significant government expense. Figures tabled in Parliament on November 27 indicate the DRDO was allocated Rs 13,501 crore in 2016-17, Rs 15,399 crore in 2017-18, Rs 17,122 crore in 2018-19 and Rs 19,021 crore in the current year. The private sector must develop its capabilities on its own dime.

With the DRDO developing weapons platforms, the private sector has been confined to an ancillary role, supplying systems, sub-systems and components. The DPSU and OF vendor bases count more than 8,000 Micro, Small and Medium Enterprises (MSMEs). 

Only now are big private sector firms entering the fray in developing complex weapons platforms. The successful development of the Pinaka multi-barrelled rocket launcher, in which the private sector played the leading role, even if under the DRDO umbrella, is being followed by the development of the Advanced Towed Artillery Gun System (ATAGS), led by the Kalyani and Tata groups. In manufacture, L&T is partnering a Korean group to manufacture the K-9 Vajra self-propelled howitzer in India. 

 For years, private sector entry into defence production was regulated by “Industrial Licensing” norms. After 2001, numerous private firms, naively anticipating lucrative opportunities in defence production, applied for multiple licenses, even in technology domains where they had no expertise. Anil Ambani’s Reliance Defence Ltd claims to have 35 defence licences “for manufacture of various platforms and products, highest for any Indian company.”

By March this year, the government issued 439 defence licences, covering 264 companies, the MoD told Parliament. But those initial licences have resulted in little production. On February 5, 2018, the MoD told Parliament that only 69 licensed companies had reported commencement of production.

Now, however, licensing norms have been eased. “The Defence Products List… has been revised and most of the components, parts, sub-systems, testing equipment and production equipment have been removed from the list, so as to reduce the entry barriers for the [private] industry, particularly small and medium segment. The initial validity of the industrial licence granted under the IDR Act has been increased from three years to 15 years with a provision to further extend it by three years on a case-to-case basis,” the MoD told Parliament on July 3.

Policy incentives

The MoD faces numerous Parliamentary questions about encouraging indigenous defence manufacture and it has a boilerplate answer. It lists out policy initiatives that include: Giving top-priority in procurement to equipment categorised as “Indigenously Designed, Developed and Manufactured”; increasing to 49 per cent the foreign direct investment (FDI) cap in defence; simplifying the “Make” procedure, which lets industry propose and develop products for the military; launch of a “Technology Development Fund”, and an innovation ecosystem titled Innovations for Defence Excellence (iDEX) that was launched in April 2018. 

iDEX aims to engage MSMEs, start-ups, individuals and academia and provide R&D funding for futuristic technologies that could serve Indian defence needs. “Under iDEX, innovative solutions have been successfully identified for 14 problem areas pertaining to national defence requirements. More than 600 start-ups have been engaged in the process and 44 different solutions have been identified,” the MoD told Parliament on July 3, 2019.

The MoD has recognised the need to synergise this plethora of initiatives. On September 5, defence procurement chief Apurva Chandra informed an industry gathering in Delhi that anempowered committee was integrating into a unified, common procedure the disparate acquisition processes such as Make-1, Make-2, iDEX and procurements from the Technology Development Fund.

Private industry also hopes to benefit from simplification of the current Defence Procurement Procedure (DPP 2016), which governs capital procurement; and the current Defence Procurement Manual (DPM 2009), which governs revenue procurement. Chandra revealed that revised versions of both documents would be released by March 2020.

The MoD has also pushed the establishment of two defence industrial corridors, where it will set up defence manufacturing and testing infrastructure and provide incentives to defence industry that sets up production there. One corridor in Tamil Nadu covers the “nodes” of Chennai, Hosur, Coimbatore, Salem and Tiruchirappalli. Another spans Aligarh, Agra, Jhansi, Kanpur, Chitrakoot and Lucknow in Uttar Pradesh.

Finally, there are expectations from the long-delayed Strategic Partner (SP) procurement model that is intended to build manufacturing capabilities in the private sector. In this model, SP companies enter into technology partnerships with overseas vendors to build complex weapons platforms in India. Two SP model procurements – to build naval helicopters and submarines – are making progress. The private sector is watching to see how these play out.