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FDI in defence: Raising cap may help reduce dependence on imports
Several weeks after the government was buffeted by the Finmeccanica scandal early this year, defence minister AK Antony promised a CEO of a local defence firm "winds of change".
This chief executive, who requested anonymity, was "gladly surprised" when the 73-year-old politician â known to be more sympathetic towards public sector undertakings than even champions of the Swadeshi movement â vowed to boost the domestic private sector's role in defence production. "He kept saying, 'winds of change are coming'," recounts this top executive who is part of a trade body.
While ET Magazine couldn't independently verify this story, reducing huge dependence on defence imports has been on the defence ministry's agenda for a while. The talk of indigenisation, too, is nothing new. Besides, Antony has made it clear that he is not averse to enlisting more local private sector support in defence production. He expects the move to bring down graft.
Antony is known to follow zero-tolerance towards corruption; he has blacklisted six companies since he took over in 2006: Singapore Technologies, Israeli Military Industries, Germany's Rheinmetall Air Defence, Corporation Defence of Russia, Delhi-based T S Kisan and R K Machine Tools of Ludhiana. However, he hasn't yet blacklisted Italian conglomerate Finmeccanica whose chief is in jail over charges of hiring middlemen to get Indian officials to swing a multi-crore chopper deal in India.
The latest amendments to the defence procurement policy (DPP), recently cleared by the defence advisory council (DAC), is another step in the direction of weeding out corruption. The changes are "quite different", claims a defence ministry official, adding that "they will give a lot of opportunities to Indian private players".
The official was initially sceptical of the move. He had his reasons, he concedes. After all, India is the world's largest arms importer thanks to high demand from its armed forces to replace obsolete equipment and poor manufacturing capabilities of its state-owned and private defence firms.
"But I think this is a beginning. This is a long-haul game. The current defence minister may go down in history as the one who took that big step in helping India's defence go global. But in the short term he is going to draw criticism," vouches another official known to be close to Antony. He also didn't wish to be named. Good for India?
Vivek Lall, CEO of Reliance's homeland security and aerospace divisions, is a NASA veteran who was formerly president of Boeing India. In a recent speech he said that getting rid of "the process of nomination" in DPP for choosing companies that maintain, repair and overhaul (MRO) aircraft opens up a lot of opportunities for private players.
Thanks to outdated technologies, ordinance factories and defence PSUs had to do work frequently on aircraft and other defence vehicles, incurring high costs. "This measure [doing away with nomination of defence PSUs alone] is expected to have a positive impact on private-public sector cooperation in MRO work," hopes Lall.
Of course, better technology can slash the frequency of such work and help cut costs. Defence strategist and author Brahma Chellaney is in full agreement with the latest DPP amendments, at least in theory. "These are important technical and legal steps to spur indigenisation," he declares, emphasising the need to arrest the "heavy dependence on imports for meeting even basic defence needs". India's defence imports rose from $1.26 billion in 2007 to $3.4 billion in 2011.
Who Should be Happy?
According to the amended policy, "buy Indian" comes on top in the hierarchy of preferences for purchases. The next is "buy and make Indian" (through joint ventures with foreign vendors); then comes "make Indian" (where local firms design, develop and build systems). "Buy and make" (with transfer of technology) comes next. The last on the list is "buy global" (getting overseas equipment).
Rahul Gangal, defence analyst and principal at Roland Berger Strategy Consultants, a Munich-based consultant with operations in India, says local firms in certain sectors will gain from this policy (which does not apply to ongoing procurement projects). The sectors, according to him, include strategic electronics; radar and radar sub systems; C4I networks; air defence launchers; and small umanned aerial vehicles, among others.
Some Indian companies that fall in those sectors include Tata Power SED, Bharat Electronics Ltd (BEL), Electronic Corporation of India Ltd (ECIL), Spectrum InfoTech (owned by Larsen & Toubro), Astra Microwave, Wipro, Rolta, TCS, L&T, Ashok Leyland, Hindustan Aeronautics Ltd (HAL), Aurora Integrated Systems, and Bharat Forge.
Gangal, however, is unsure whether the amendments are a good thing. "One perspective is that this [policy] opens procurement to Indian industry, thereby improving its business potential. The other perspective is that it may lead to further and unrealistic congregation of order-books with Indian companies, something which can impact the delivery-to-user services." He adds that the second point needs merit of attention as even today most defence PSUs are operating with order-books that are "many multiple years of their turnover."
Anxiety Rises
There are rays of hope: the Pinaka multibarrel rocket launchers are manufactured by Tata Power and L&T. The latter was also involved in a project to develop a hull for a nuclear submarine for the India Navy. Still, "Indian Indian" defence capabilities are "fragmented", notes Neelu Khatri, head, defence and security advisory services, KPMG India.
Khatri is worried that the local industry clearly does not possess the required domestic supply chain, infrastructure, or the technology to support the spirit of the DPP amendments. "Till these capabilities are developed domestically, we will continue to be dependent on the global integrators for their technology and close assistance while working towards on-ground implementation," she adds.
To be sure, the new policy cuts both ways. Unless India hikes the cap on foreign direct investment (FDI) in defence from 26% to 49%, foreign players may shy away from aligning with Indian partners and transferring technology. Besides, thanks to uncertainty over when they would secure orders, Indian firms, including the private ones, will hesitate to buy technology from overseas companies.
Theory vs Practice
Robert Metzger, a lawyer with Washingtonbased Rogers Joseph O' Donnell and an expert on India-US defence ties, says the current FDI limit of 26% is hardly any lure for foreign firms to join hands with local firms and transfer technology. "They [overseas firms] worry about protection of their IP and exposure to their business reputation. An increase in FDI, at least to 49%, will encourage technology transfer and give more confidence to foreign partners that they can manage business risks and implement successful compliance measures," says Metzger.
He feels that even if India is determined to buy from its public and private sector domestic suppliers, access to foreign technology and assistance is necessary if the objective is timely supply of equipment. "An increase in the FDI cap actually will help India achieve its 'buy Indian' goals."
Over recent years, India has relied largely upon the 'buy global' or 'buy & make with ToT (transfer of technology)' modalities, explains Metzger. The former answers the needs of the armed forces but "does little to advance India's goals of an indigenous defence manufacturing and sustainment base," he adds. Meanwhile, a Union minister ET Magazine spoke to didn't deny efforts to push for a hike in FDI in defence. "It is likely that the government may agree to 49% FDI," said a person close to the matter who didn't wish to be identified.
The FDI Question
Khatri, too, states that the amendments to DPP don't work without an increase in FDI in defence. She scoffs at any idea of putting all eggs in the 'buy Indian' basket: "There has been little or no movement till now for the private industry to witness any major gain from this opportunity. However, the private sector will also need to upgrade competencies â which are currently limited due to inexperience as system integrators and manufacturers of complex systems â as this has primarily been the domain of the defence PSUs," she argues.
The DAC note has mentioned the total value of the existing 'make' programmes to be about $25 billion (Rs 1,32,500 crore). These include future infantry combat vehicle programme at an estimated cost of $10 billion; the tactical communication systems at an estimated project cost of over $1 billion; and the battlefield management system at an estimated cost of $2 billion.
Gangal and a few other experts say sectors that will see delays over the new policy include aircraft procurement, transport aircraft procurement, naval procurements, helicopters, artillery systems, hand-held weapons etc. The new rules won't hurt medium multirole combat aircraft (MMRCA) programme, a deal secured by France's Dassault Aviation for its Rafale fighter.
Knee-jerk Reaction?
While some analysts and company chiefs blame the government for its "decision in a hurry" to "cover up" the recent defence-related scandals, others say foreign firms â faced with defence budget cuts in the West â may look at "repainting" their products and selling in India by tying up with local firms. One justification for the latest decision is that India will follow the China model of reducing its dependence on imports.
American defence strategist Edward Luttwak can't suppress his laughter at this comparison: "The Chinese import all kinds of weapons they can but are severely limited by embargoes. Given the sad obsolescence of Indian weapons the only priority should be a procurement process instead of a nonprocurement non-process."
Privatisation of HAL should be a top priority too, reckons Luttwak. "Only an ISI subsidiary would peddle Jaguars to the IAF in this century. Given that the ineffective BRO [Border Roads Organisation] provides infrastructure for the Indian forces on the Chinese border, the pursuit of all possible priorities but for effectiveness will one day earn the [BM] Kaul/ [VK Krishna] Menon prize for utter incompetence," thunders Luttwak.
Menon and [Lt General] Kaul had drawn flak over huge "military follies" that led to India's defeat at the hands of the Chinese in 1962. He adds that China is also hobbled due to "strict embargo from the US and Europe". Besides, he says, "Israel is forbidden to sell to Beijing". About China "attempting" to cut imports, he jokes: "Yes, it is true that the Chinese are refusing to import cardboard aircraft from Iran, etc. But they would go to any extent to import the aircraft being offered to India." Currently, nearly half of India's defence equipment is obsolete and even replacement of the fleet of Cheetah/Chetak choppers bought in the 1970s is stalled by scandals, putting in constant danger the lives of soldiers in high-altitude, hyper-sensitive locations.
The India Fatigue
A senior official of a European defence company told ET Magazine that the slow implementation of orders and procedural bottlenecks mean several companies have developed what he calls "India fatigue".
Khatri understands why. "The threshold of foreign companies is being tested by issues such as Indian MoD's delayed procurement timelines, tax and licensing issues, the various costs attached to field trials and teething and implementation issues with their designated production agencies," says she. For his part, Metzger is of the view that such fatigue is a short-term phenomenon. Nobody can afford to ignore a defence market as big as India's, he contends.
Between 2012 and 2020, India is expected to spend $150 billion to replace its outdated equipment and expand its military. "Some firms have developed such fatigue. But there are many others who appreciate both the size and importance of the market that India represents, for aerospace and defence, and the many talents and skills of the Indian workforce that, if properly harnessed, can be mobilised to great achievements in these sectors," he says.
Chinese Incursion as Ruse
Overzealous patriots have chosen the "opportunity" â Chinese incursions in Ladakh â to attack Antony for adding to India's military modernisation woes, says another defence ministry official. "Pending orders with defence PSUs is not his doing. He has inherited a legacy and is looking to change it," he claims, asking not to be named because he is not authorised to speak to the media.
Seminar-room comparisons of China's military might versus India's may just do the trick, says a military intelligence official. "In the wake of the Chinese threat, India has an opportunity in hand and I hope they make the most of it: hike FDI." While top spenders on defence are scaling back their expenditure, India, on the other hand, is looking to raise its spend. "The time is ripe to hike FDI," he adds. Well, this is the argument that the commerce ministry is expected to raise. But without doubt, the ball is in Antony's court. Indications are that he may agree to such a plan â on what a person close to the matter calls â "a case to case basis".
Defence Procurement: An Evolution
2003 - A new set-up was introduced after the Kargil conflict of 1999 and 4 years later rules were revised to include procurement under "buy & make" category.
2006 - Procedures for indigenous warship building announced, concept of offsets introduced; envisaged $10 billion to flow back between 2007 and 2012.
2008 - Concept of offset banking introduced, allowing vendors to discharge offset credits against request for proposals issued within two financial years of the date of approval of banked credits; offset penalty introduced for 'buy (global)' tenders.
2009 - A new category of procurement introduced - "buy and make (Indian)" â to issue initial bids to only Indian vendors with requisite capabilities.
The Latest Initiative
Defence ministry has given high priority to 'Indian-made' products, lowest for foreign vendors & offers incentives for local-overseas JVs.
Expectations are that defence PSUs will see competition from local private players & JVs.
Ministry vows to increase the pace of projects under the "make" and "buy & make (Indian)" categories.
Rs 1.2 lakh crore - Estimated value of defence projects considered for speedier conclusion.
The Concerns
With FDI cap at 26%, overseas defence players will be hesitant to share technologies with local partners.
Defence PSUs will continue to have an advantage over private players, say analysts.
The Indigenisation Imperative
India's defence establishment is keen to reduce dependence on foreign players to bring down widespread corruption.
China has over the past decade embarked on a massive defence indigenisation drive.
India is now the world's biggest importer of defence equipment. Imports went up from $1.26 billion in 2007 to $3.34 billion in 2011.
FDI in defence: Raising cap may help reduce dependence on imports - Page 3 - Economic Times
Several weeks after the government was buffeted by the Finmeccanica scandal early this year, defence minister AK Antony promised a CEO of a local defence firm "winds of change".
This chief executive, who requested anonymity, was "gladly surprised" when the 73-year-old politician â known to be more sympathetic towards public sector undertakings than even champions of the Swadeshi movement â vowed to boost the domestic private sector's role in defence production. "He kept saying, 'winds of change are coming'," recounts this top executive who is part of a trade body.
While ET Magazine couldn't independently verify this story, reducing huge dependence on defence imports has been on the defence ministry's agenda for a while. The talk of indigenisation, too, is nothing new. Besides, Antony has made it clear that he is not averse to enlisting more local private sector support in defence production. He expects the move to bring down graft.
Antony is known to follow zero-tolerance towards corruption; he has blacklisted six companies since he took over in 2006: Singapore Technologies, Israeli Military Industries, Germany's Rheinmetall Air Defence, Corporation Defence of Russia, Delhi-based T S Kisan and R K Machine Tools of Ludhiana. However, he hasn't yet blacklisted Italian conglomerate Finmeccanica whose chief is in jail over charges of hiring middlemen to get Indian officials to swing a multi-crore chopper deal in India.
The latest amendments to the defence procurement policy (DPP), recently cleared by the defence advisory council (DAC), is another step in the direction of weeding out corruption. The changes are "quite different", claims a defence ministry official, adding that "they will give a lot of opportunities to Indian private players".
The official was initially sceptical of the move. He had his reasons, he concedes. After all, India is the world's largest arms importer thanks to high demand from its armed forces to replace obsolete equipment and poor manufacturing capabilities of its state-owned and private defence firms.
"But I think this is a beginning. This is a long-haul game. The current defence minister may go down in history as the one who took that big step in helping India's defence go global. But in the short term he is going to draw criticism," vouches another official known to be close to Antony. He also didn't wish to be named. Good for India?
Vivek Lall, CEO of Reliance's homeland security and aerospace divisions, is a NASA veteran who was formerly president of Boeing India. In a recent speech he said that getting rid of "the process of nomination" in DPP for choosing companies that maintain, repair and overhaul (MRO) aircraft opens up a lot of opportunities for private players.
Thanks to outdated technologies, ordinance factories and defence PSUs had to do work frequently on aircraft and other defence vehicles, incurring high costs. "This measure [doing away with nomination of defence PSUs alone] is expected to have a positive impact on private-public sector cooperation in MRO work," hopes Lall.
Of course, better technology can slash the frequency of such work and help cut costs. Defence strategist and author Brahma Chellaney is in full agreement with the latest DPP amendments, at least in theory. "These are important technical and legal steps to spur indigenisation," he declares, emphasising the need to arrest the "heavy dependence on imports for meeting even basic defence needs". India's defence imports rose from $1.26 billion in 2007 to $3.4 billion in 2011.
Who Should be Happy?
According to the amended policy, "buy Indian" comes on top in the hierarchy of preferences for purchases. The next is "buy and make Indian" (through joint ventures with foreign vendors); then comes "make Indian" (where local firms design, develop and build systems). "Buy and make" (with transfer of technology) comes next. The last on the list is "buy global" (getting overseas equipment).
Rahul Gangal, defence analyst and principal at Roland Berger Strategy Consultants, a Munich-based consultant with operations in India, says local firms in certain sectors will gain from this policy (which does not apply to ongoing procurement projects). The sectors, according to him, include strategic electronics; radar and radar sub systems; C4I networks; air defence launchers; and small umanned aerial vehicles, among others.
Some Indian companies that fall in those sectors include Tata Power SED, Bharat Electronics Ltd (BEL), Electronic Corporation of India Ltd (ECIL), Spectrum InfoTech (owned by Larsen & Toubro), Astra Microwave, Wipro, Rolta, TCS, L&T, Ashok Leyland, Hindustan Aeronautics Ltd (HAL), Aurora Integrated Systems, and Bharat Forge.
Gangal, however, is unsure whether the amendments are a good thing. "One perspective is that this [policy] opens procurement to Indian industry, thereby improving its business potential. The other perspective is that it may lead to further and unrealistic congregation of order-books with Indian companies, something which can impact the delivery-to-user services." He adds that the second point needs merit of attention as even today most defence PSUs are operating with order-books that are "many multiple years of their turnover."
Anxiety Rises
There are rays of hope: the Pinaka multibarrel rocket launchers are manufactured by Tata Power and L&T. The latter was also involved in a project to develop a hull for a nuclear submarine for the India Navy. Still, "Indian Indian" defence capabilities are "fragmented", notes Neelu Khatri, head, defence and security advisory services, KPMG India.
Khatri is worried that the local industry clearly does not possess the required domestic supply chain, infrastructure, or the technology to support the spirit of the DPP amendments. "Till these capabilities are developed domestically, we will continue to be dependent on the global integrators for their technology and close assistance while working towards on-ground implementation," she adds.
To be sure, the new policy cuts both ways. Unless India hikes the cap on foreign direct investment (FDI) in defence from 26% to 49%, foreign players may shy away from aligning with Indian partners and transferring technology. Besides, thanks to uncertainty over when they would secure orders, Indian firms, including the private ones, will hesitate to buy technology from overseas companies.
Theory vs Practice
Robert Metzger, a lawyer with Washingtonbased Rogers Joseph O' Donnell and an expert on India-US defence ties, says the current FDI limit of 26% is hardly any lure for foreign firms to join hands with local firms and transfer technology. "They [overseas firms] worry about protection of their IP and exposure to their business reputation. An increase in FDI, at least to 49%, will encourage technology transfer and give more confidence to foreign partners that they can manage business risks and implement successful compliance measures," says Metzger.
He feels that even if India is determined to buy from its public and private sector domestic suppliers, access to foreign technology and assistance is necessary if the objective is timely supply of equipment. "An increase in the FDI cap actually will help India achieve its 'buy Indian' goals."
Over recent years, India has relied largely upon the 'buy global' or 'buy & make with ToT (transfer of technology)' modalities, explains Metzger. The former answers the needs of the armed forces but "does little to advance India's goals of an indigenous defence manufacturing and sustainment base," he adds. Meanwhile, a Union minister ET Magazine spoke to didn't deny efforts to push for a hike in FDI in defence. "It is likely that the government may agree to 49% FDI," said a person close to the matter who didn't wish to be identified.
The FDI Question
Khatri, too, states that the amendments to DPP don't work without an increase in FDI in defence. She scoffs at any idea of putting all eggs in the 'buy Indian' basket: "There has been little or no movement till now for the private industry to witness any major gain from this opportunity. However, the private sector will also need to upgrade competencies â which are currently limited due to inexperience as system integrators and manufacturers of complex systems â as this has primarily been the domain of the defence PSUs," she argues.
The DAC note has mentioned the total value of the existing 'make' programmes to be about $25 billion (Rs 1,32,500 crore). These include future infantry combat vehicle programme at an estimated cost of $10 billion; the tactical communication systems at an estimated project cost of over $1 billion; and the battlefield management system at an estimated cost of $2 billion.
Gangal and a few other experts say sectors that will see delays over the new policy include aircraft procurement, transport aircraft procurement, naval procurements, helicopters, artillery systems, hand-held weapons etc. The new rules won't hurt medium multirole combat aircraft (MMRCA) programme, a deal secured by France's Dassault Aviation for its Rafale fighter.
Knee-jerk Reaction?
While some analysts and company chiefs blame the government for its "decision in a hurry" to "cover up" the recent defence-related scandals, others say foreign firms â faced with defence budget cuts in the West â may look at "repainting" their products and selling in India by tying up with local firms. One justification for the latest decision is that India will follow the China model of reducing its dependence on imports.
American defence strategist Edward Luttwak can't suppress his laughter at this comparison: "The Chinese import all kinds of weapons they can but are severely limited by embargoes. Given the sad obsolescence of Indian weapons the only priority should be a procurement process instead of a nonprocurement non-process."
Privatisation of HAL should be a top priority too, reckons Luttwak. "Only an ISI subsidiary would peddle Jaguars to the IAF in this century. Given that the ineffective BRO [Border Roads Organisation] provides infrastructure for the Indian forces on the Chinese border, the pursuit of all possible priorities but for effectiveness will one day earn the [BM] Kaul/ [VK Krishna] Menon prize for utter incompetence," thunders Luttwak.
Menon and [Lt General] Kaul had drawn flak over huge "military follies" that led to India's defeat at the hands of the Chinese in 1962. He adds that China is also hobbled due to "strict embargo from the US and Europe". Besides, he says, "Israel is forbidden to sell to Beijing". About China "attempting" to cut imports, he jokes: "Yes, it is true that the Chinese are refusing to import cardboard aircraft from Iran, etc. But they would go to any extent to import the aircraft being offered to India." Currently, nearly half of India's defence equipment is obsolete and even replacement of the fleet of Cheetah/Chetak choppers bought in the 1970s is stalled by scandals, putting in constant danger the lives of soldiers in high-altitude, hyper-sensitive locations.
The India Fatigue
A senior official of a European defence company told ET Magazine that the slow implementation of orders and procedural bottlenecks mean several companies have developed what he calls "India fatigue".
Khatri understands why. "The threshold of foreign companies is being tested by issues such as Indian MoD's delayed procurement timelines, tax and licensing issues, the various costs attached to field trials and teething and implementation issues with their designated production agencies," says she. For his part, Metzger is of the view that such fatigue is a short-term phenomenon. Nobody can afford to ignore a defence market as big as India's, he contends.
Between 2012 and 2020, India is expected to spend $150 billion to replace its outdated equipment and expand its military. "Some firms have developed such fatigue. But there are many others who appreciate both the size and importance of the market that India represents, for aerospace and defence, and the many talents and skills of the Indian workforce that, if properly harnessed, can be mobilised to great achievements in these sectors," he says.
Chinese Incursion as Ruse
Overzealous patriots have chosen the "opportunity" â Chinese incursions in Ladakh â to attack Antony for adding to India's military modernisation woes, says another defence ministry official. "Pending orders with defence PSUs is not his doing. He has inherited a legacy and is looking to change it," he claims, asking not to be named because he is not authorised to speak to the media.
Seminar-room comparisons of China's military might versus India's may just do the trick, says a military intelligence official. "In the wake of the Chinese threat, India has an opportunity in hand and I hope they make the most of it: hike FDI." While top spenders on defence are scaling back their expenditure, India, on the other hand, is looking to raise its spend. "The time is ripe to hike FDI," he adds. Well, this is the argument that the commerce ministry is expected to raise. But without doubt, the ball is in Antony's court. Indications are that he may agree to such a plan â on what a person close to the matter calls â "a case to case basis".
Defence Procurement: An Evolution
2003 - A new set-up was introduced after the Kargil conflict of 1999 and 4 years later rules were revised to include procurement under "buy & make" category.
2006 - Procedures for indigenous warship building announced, concept of offsets introduced; envisaged $10 billion to flow back between 2007 and 2012.
2008 - Concept of offset banking introduced, allowing vendors to discharge offset credits against request for proposals issued within two financial years of the date of approval of banked credits; offset penalty introduced for 'buy (global)' tenders.
2009 - A new category of procurement introduced - "buy and make (Indian)" â to issue initial bids to only Indian vendors with requisite capabilities.
The Latest Initiative
Defence ministry has given high priority to 'Indian-made' products, lowest for foreign vendors & offers incentives for local-overseas JVs.
Expectations are that defence PSUs will see competition from local private players & JVs.
Ministry vows to increase the pace of projects under the "make" and "buy & make (Indian)" categories.
Rs 1.2 lakh crore - Estimated value of defence projects considered for speedier conclusion.
The Concerns
With FDI cap at 26%, overseas defence players will be hesitant to share technologies with local partners.
Defence PSUs will continue to have an advantage over private players, say analysts.
The Indigenisation Imperative
India's defence establishment is keen to reduce dependence on foreign players to bring down widespread corruption.
China has over the past decade embarked on a massive defence indigenisation drive.
India is now the world's biggest importer of defence equipment. Imports went up from $1.26 billion in 2007 to $3.34 billion in 2011.
FDI in defence: Raising cap may help reduce dependence on imports - Page 3 - Economic Times
