Since early-February, when the Indian defence establishment was shaken by the arrest of Finmeccanica chairman in Italy for graft in selling helicopters to India, defence minister AK Antony has repeatedly said that his ministry will strive for greater indigenisation. At a seminar on February 20, in a statement he has repeated at least thrice since, Antony said the government intends to change two key policies to allow the private sector a greater role.
This line is of some vintage. At least since 2002, it has been the stated policy of the government to encourage private sector participation in defence production. But companies say the ministry's actions run contrary to this claimed ideal. Large engineering companies that invested crores of rupees into what they hoped would be a new stream of business are today staring at an uncertain future for their investment.
Tata Power SED, Larsen & Toubro, Mahindra & Mahindra, Bharat Forge, Ashok Leyland and many others have invested in developing defence capabilities and are prepared to invest much more. But they face an uncertain policy environment, and staunch opposition from a powerful union of defence public sector employees that opposes any move the government makes to allow the private sector a leg in.
The government made its most significant move in 2006, when it added a new category in the Defence Procurement Procedure, a key policy document governing purchases. Under this 'make' category, for the first time, the private sector was allowed to wholly design and develop complex systems, with the government funding 80% of the development cost.
Further, the government announced two projects, with a combined value of Rs 60,000 crore, under the 'make' category: the TCS (Tactical Communication System) and the FICV (Future Infantary Combat Vehicle) projects. "A year and a half ago, it seemed as if at least the announced programmes in the 'make' category were moving forward," says Madhukar Kotwal, president (heavy engineering) at L&T. "Although the pace was slow, the direction gave us some hope." Kotwal says these programmes are showing little progress. "So somehow, the government's oft-stated position of encouraging participation of the private sector and the reality on the ground don't point in the same direction," he adds. "This has created disappointment and uncertainty."
For 2012-13, the union budget allocated Rs 89 crore for the 'make' project. For 2013-14, this amount was slashed to Rs 1 crore, even as India was confirmed as the world's largest importer of defence systems for the third year running and the Italian helicopter deal threw up old questions about the greasy nature of defence imports.
In Rollback Mode
Most advanced nations are neither dependent on defence imports nor do they have their governments doing all the work in the purchase chain, to the exclusion of the private sector. Those governments outline what they want from, say, a fighter jet and provide financial support to private companies to develop prototypes; the winning model (sometimes a combination of multiple prototypes) gets a massive contract.
Take the US, which imported just 10% of its $698 billion military spend, according to a March 2012 BCG report titled 'Creating a Vibrant Domestic Defence Manufacturing Sector'. Its Defense Advanced Research Projects Agency (DARPA), credited with developing some of the most advanced defence technologies, works closely with private companies such as Boeing, Northrop Grumman and Lockheed Martin.
India's 'make' programme was supposed to incentivise the private sector as per the so-called 'DARPA model'. In 2010, the defence ministry invited three private players (Tata Motors, Mahindra Group and L&T) and one public sector entity (Ordnance Factory Board) for the FICV project—potentially a Rs 50,000 crore project to replace some 2,600 units of the army's BMP-2 infantry vehicles. But, in October 2012, the ministry withdrew its letter of intent and the project has gone back to the drawing board. Such about-turns cost companies. According to an industry executive, a detailed project report, typically, costs about 1% of the project size.
Compared to the FICV project, the TCS project made more progress. In June 2012, the government shortlisted two parties for this $2 billion project: a consortium of L&T, Tata Power SED and HCL, and state-owned Bharat Electronics. Almost a year has passed and there has been little progress.
The timeline of this project is illustrative of the pace of the ministry's decision-making in contracts involving potential private participation. The 'make' policy was announced in 2006, the TCS project under it in 2008, and the letters of intent were issued in 2010. Another two years went by in the process known as 'down-selection', in which the ministry narrows down the participants. But, as of today, five years after the government first announced the project, there is little to show for by way of progress.
A defence ministry spokesperson said he was unable to comment for this story. "Intensive consultations are on to revise both the defence procurement procedure and the defence production policy to increase the private industry's role," spokesperson Sitansu Kar said. "It would be inappropriate to comment at this point." Public Sector Monopoly
India's defence production is almost entirely controlled by state-owned entities. R&D is done by DRDO (Defence Research and Development Organisation), while the manufacturing is done by nine defence PSUs (public sector undertakings) and the Ordnance Factory Board, which runs 41 ordnance factories around the country.
According to the BCG report, the DPSUs and ordnance factories employ about 180,000 people; the DRDO another 30,000. Although they manufacture Rs 35,000 crore of defence equipment a year, their productivity is abysmal. The BCG report cited a finance ministry survey to show that productivity in the state-owned defence sector was the lowest among all industries—Rs 15 lakh per employee per year—and half of the national average.
For a country with such a large defencemanufacturing base, India is unique in its dependence on imports. Countries such as UK and France, which employ a comparable number in the defence sector, are large exporters of weapons. India, in stark contrast, is the world's largest importer, sending 70% of its defence acquisition budget overseas.
India uses about 30% of its defence acquisition budget—Rs 86,740 crore this fiscal—to import directly, and sends most of the rest to defence PSUs. They, in turn, spend nearly half of that money overseas as well, through an opaque process that sometimes involves a single vendor selected at the executives' discretion. The New Delhi-based think-tank Institute for Defence Studies and Analyses (IDSA) puts the collective import dependency of defence PSUs at 35-45%.
Politics Of Continuity
The political pressure to perpetuate this system is immense. A statist mindset that glorifies defence PSUs, and the large and unionised workforce that opposes privatisation, both exert pressure on minister Antony, who lends a sympathetic ear to such concerns. "The workforce at defence PSUs are unionised and will not allow any reforms," says Laxman Behera, a research fellow at IDSA. The All-India Defence Employees Federation and other unions oppose any move by the government to allow the industry any space, saying this will compromise national security.
The other problem that structurally poses a hurdle to private sector participation is the office of secretary, defence production. This office, which reports to the defence secretary, is responsible for defence production, and the performance of defence PSUs and the Ordnance Factory Board.
The incentive is to send orders to the companies under this office's watch and keep the private sector out. Consequently, the order books of defence PSUs such as Hindustan Aeronautics and Bharat Dynamics are multiples of their turnover. "This is one of the biggest policy reforms we need to make," says Behera. "How to bring the private sector into the government sector, and how to make the government responsible for the growth of private industry."
But for every step forward, the government also takes a step back. In 2005, the Vijay Kelkar committee on defence acquisition recommended that select private sector firms be given the status of 'Raksha Udyog Ratnas'—and the government treat them on equal footing with defence PSUs when allocating business. In 2007, the ministry examined 40 companies and found 15 eligible for the status. But in the wake of strident opposition from defence PSUs, the proposal was shelved in 2010.
The ministry unveiled a defence production policy in 2011, spelling out a major role for the private industry. It said all long-term needs should be met indigenously and the ministry would "proactively encourage" a larger involvement of the private sector. There has been little action since. "That policy was a path-breaking step," says Rajinder Bhatia, executive vice-president and head of defence at the $2.5 billion Kalyani Group. "The government has shared its intent with us, but not specifics. There has been no action, and that places a question mark on the intent itself."
Private Sector Dilemma
This wavering intent on the government's part is leaving private companies in the awkward situation where their risk and capital is not being duly rewarded. For example, L&T and Tata Power SED have long worked with DRDO on strategic projects. The two companies built the Pinaka multibarrel rocket launcher. They, along with Walchandnagar Industries, played a major role in building INS Arihant, India's first nuclear-powered submarine.
Despite demonstrated success, the establishment has been unwilling to lend a sympathetic ear to their projects. In December 2012, Tata Power SED displayed an artillery gun—52 mm-calibre, top range of 50 km—with 52% indigenous components. For three months now, the company has been requesting the ministry to allow them to test fire from a military firing range. The response hasn't been encouraging, even though India has large artillery gun acquisitions lined up. "They haven't said no, so that is a relief," says Rahul Chaudhry, CEO of Tata Power SED. "For how long will the life of our soldiers and national security be held hostage by the narrow interests of unions?" he adds. L&T and Bharat Forge are also developing howitzers.
The larger problem is that the state-run defence set up has not kept pace with the country's industrial abilities. "Normally the defence industry and defence research helps to expand a country's industrial capability," says Bhatia. "In India, it lags the existing industrial capability in the country." Even India's celebrated success with software is not harnessed for the increasingly automated weapon systems. On the other hand, nearly every major defence and aerospace companies in the world get Indian software firms to code for them.
Bharat Karnad, research professor for security studies at the Centre for Policy Research, says the demonstrated ability of the private sector was being ignored and this could prove costly. He points out how L&T and Tata did most of the "practical work" for INS Arihant. "Yet, we are still looking overseas for the next conventional submarine project," he says. "The government doesn't treat the private sector as a national resource. That is a mistake. This kind of reliance on imports is dangerous because all military suppliers have a history of choking supplies during a crisis."
