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Defence Security: The Next Sunrise Industry?

The Modi government has opened up the defence sector to 100 per cent FDI. The goal is to make India a defence manufacturing hub and end its dependence on imports. All that spells a huge opportunity for the private sector

With the Modi government having finally cleared the way for up to 100 per cent foreign direct investment (FDI) in India’s defence sector — a longstanding demand of foreign manufacturers — experts are now of the view that defence could be the next sunrise industry in India. What they are yet to agree on is the size of the Indian market, as figures range from $650 billion to $150 billion over the next decade. A more realistic estimate, however, would be $250 billion over the next decade, based on an assessment by SIPRI, the authoritative Stockholm International Peace Research Institute, which says India spends around $24 billion a year, largely on arms imports, making it one of the world’s largest importers of defence systems and equipment. But Prime Minister Narendra Modi’s government wants to shed that dubious distinction and make India a defence manufacturing hub. The question is, how soon can India turn the corner?

Until now, despite the claims of several governments in the past about the need to decrease imports by enhancing indigenous production, the sacred area of defence-related manufacturing had largely been the monopoly of government PSUs (public sector units), which have a cumulative turnover of Rs 50,000 crore. But now, according to A.K. Gupta, secretary, department of defence production, in the ministry of defence (MOD), the government is more than willing to accommodate the private sector in this space, by giving it an opportunity to pick up a 25 per cent share of defence production, as the ministry has already delicensed 60 per cent to 70 per cent of the production.

But even then, perhaps for another decade, India’s armed forces will continue to depend heavily on imported weapon systems, as they continue to lurch from one operational crisis to another, confronting natural disasters, battling insurgencies and cross border attacks, but still alert across India’s vast borders and sufficiently equipped to confront the dual threat posed by China and Pakistan. However, with the sensitivities to scandals high on the minds of those responsible for defence purchases in India’s MoD, almost every single item is purchased only when there is a critical shortage of a weapon system needed to replace the one’s that the armed forces desperately need, having more that exhausted the life span of the equipment they have. There is thus, little or no long-term perspective planning that can be implemented in actuality.

This leaves little room for the armed forces to order and wait for local products, since the design, manufacture, trials and induction of a weapon system often takes 15 years or more. Such long delay in local production of weapon platforms could lead to them being declared either ineffective or outdated. The light combat aircraft has taken more than three decades to ready for induction. Successive governments have said that our public sector undertakings can be allowed to develop almost everything that our forces need. Defence manufacturing being classified as a ‘secret’ domain, however, denies the private sector the opportunity to enter into this domain.

In the last few years, private sector participation in India’s defence sector has increased, however. On the other hand, foreign defence contractors are showing their confidence in India by expanding their tie-ups with Indian companies. This is facilitated by policy support, both specifically for defence and generally, under the Make in India campaign. Thus, large Indian conglomerates have increased their exposure to defence manufacturing.
“Serious players in the space have been investing for the past decade or more (Tata Group, BFL, L&T) and have built a portfolio in electronics, land systems, aerospace products and short-range missiles. Most of these are either in talks or have already concluded framework arrangements with foreign original equipment manufacturers (OEMs), therefore to a large extent, the preparatory work is completed or in progress,” says Kabir Bogra, associate partner at New Delhi-based law firm, Khaitan and Co.

For instance, BFL has tied up with Israel defence tech firm Rafael Advanced Defense Systems and Elbit Systems and UK-based Rolls-Royce. Similarly, the Tata Group has tied up with US-based firms, Sikorsky Aircraft, Lockheed Martin and Boeing. Earlier this year, the Tata Group said it expects the defence and aerospace business to increase its revenue by 7.5 per cent to Rs 2,650 crore in the coming year. Defence and aerospace were identified as important growth drivers by Tata Group chairman Cyrus Mistry and significant investments will be made in these areas, according to Mukund Rajan, member, group executive council and brand custodian of Tata Sons.

“However, for them to deliver on their potential, the government needs to be commercially sensitive and a few large contracts need to be commissioned. Most notably, the naval utility helicopter (NUH) tender needs to be taken on priority, along with artillery products, to send a clear signal to the domestic industry that things are moving. The ministry of defence needs to commit itself to time frames for concluding these,” says Bogra. The success of the Make in India campaign in the defence sector will ultimately depend on the extent to which the government can leverage its massive spending programme to promote domestic manufacturing.

Official statistics show that India’s defence spending has steadily declined in the last decade, with about 1.8 per cent of its GDP being allocated for defence. A parliamentary standing committee report has, however, recommended an allocation of at least three per cent of GDP for defence. Some international observers are of the view, however, that India spends about as much on defence as a proportion of its GDP as the UK or France, with 36 per cent of its spending assigned to capital acquisitions. But, only about 35 per cent of defence equipment is manufactured in India, mainly by the PSUs. The rest is imported. Moreover, even when defence products are manufactured domestically, there is a large import component of raw materials at both the system and sub-system levels. The National Democratic Alliance (NDA) government at the Centre is thus keen to leverage this advantage to promote investments in the defence sector.

To that effect, the NDA government has taken several policy initiatives to lower entry barriers and improve the ease of doing business in defence manufacturing. The regime and procedure for granting industrial licences for manufacturing defence equipment has been significantly liberalised and speeded up, clarifications have been issued to facilitate implementation of offset obligations, an export strategy has been announced and export NOCs are issued online. Furthermore, with the FDI policy liberalised, a new DPP (defence procurement procedure) is being implemented, that should further strengthen the policy regime to promote defence production in India.

The way forward will not be without obstacles, though. For their part, defence firms will have to learn to manage some uniquely Indian requirements. To expand an industry to meet tomorrow’s challenges, India’s MoD and its contractors may have to look towards more mature defence manufacturing markets, such as the United States, France and the UK, as well as developing markets such as South Korea and apply some of the philosophies pioneered by them. One essential move is to decide on core capabilities and focus efforts on building these in India. Other steps include improving the talent market, building skills in both government and private companies and ensuring open and inclusive access to defence markets.

Currently, the reality is that India’s MoD largely controls the business of defence in the country, through its affiliates. “Indian defence industry is dominated by defence public sector undertakings (DPSUs) and ordnance factories (OFs) which contribute about 90 per cent of the total domestic defence manufacturing output. The 41 ordnance factories are spread across 26 different locations and employ close to 1, 25,000 people. The DPSUs and OFs manufacture a wide spectrum of equipment including small arms and field guns, ammunitions, explosives, armoured vehicles, transport vehicles, clothing, parachutes and general stores. The DPSUs account for approximately 65 per cent of the total industrial output of the defence public sector enterprises,” says Ravi Singhania, of Singhania and Partners.

Critics of this centralised approach at indigenisation say that this is precisely where the problem lies, even though the DPSUs and OFs typically outsource 20 per cent to 25 per cent of their production requirements to private companies, resulting in about 6,000 MSMEs that are dependent on the DPSUs for their survival. This has over a period of time created self-complimenting cliques and a culture of nepotism that has eventually led to the Armed Forces rejecting many of their products as outdated or sub-standard. The entry of a growing number of large private companies into this market now, is making the older players nervous. While many private players have in recent years been involved in a minor way with several defence projects like the Integrated Air Defence Command and Control System (IACCS), Tactical Communication System (TCS), Battlefield Management Systems (BMS) and Futuristic Infantry Combat Vehicles (FICV) and some of these are in the early stages of deployment, there is now a new beginning in India’s defence industrialisation with big projects being awarded to private players, according to Singhania.

Over the past year, licences have been issued to the Indian private sector for manufacturing armoured vehicles, electronic warfare systems, military aircraft, unmanned aerial vehicles, radars, ship borne platforms, etc., opening up the doors for Ashok Leyland Defence Systems, Larsen & Toubro, Mahindra and Mahindra, Pipapav Defence and Offshore Engineering, Piramal System and Technologies, Reliance Industries, and the Tata Group, to play a major role in India’s defence industry in the years ahead. But they will need to move quickly to fulfill India’s large military wish list. Much of the Indian military’s arsenal has platforms that are nearing the end of their service lives, resulting in equipment voids in many critical areas.

The longstanding IAF demand for fighters and other aircraft, for instance, needs to be urgently addressed (the new LCA will take some more years to take its place in IAF’s frontline squadrons). The Army’s immediate need for tanks, missiles, artillery systems, and better assault rifles to match the AK-47, a favourite of terrorists worldwide (the demand for rifles to replace the sub-standard INSAS could be in the range of a quarter million rifles) and of course, the need to add some serious blue water punch to the Navy — all offer unprecedented opportunities for those in this business. A more detailed assessment of the big ticket items and their costs follows.

The collective requirement of helicopters for India’s three services and the para-military forces is 800 helicopters of various types, necessitating an immediate investment of $12 billion. The Indian Army’s sorry state of artillery guns, air defence systems and the yet to be fully inducted new-generation personal weapons and battlefield communication systems, shows a projected cost of Rs 1, 81,450 crore ($26.9 billion) for immediate acquisition of ground forces equipment.
Even though the Indian Navy has been way ahead of the other two services in designing and inducting military platforms, the Navy is well short of its stated requirement of 160 warships and vessels, along with their full stock of helicopters, torpedoes, sonar equipment and air defence systems, making its ships vulnerable to enemy submarines, aircraft and anti-ship missiles. All this will cost serious money, even with the urgent procurement of submarines, stealth frigates, logistic support vessels, anti-submarine and counter-mine vessels and crucially, ship-borne helicopters. This adds up to Rs 2,96,800 crore ($44 billion), of which one-tenth must be provisioned for in this budget. After catering for committed liabilities, the Navy’s capital allocation needs to rise to Rs 53,591 crore ($8 billion) this year.

The Indian Air Force, which has now made it known that it cannot handle a two-front conflict should there be a simultaneous push from China and Pakistan, is desperate for fighters to replace its ageing fleet of MiG-21s and MiG-27s. Even though Modi’s visit to France had led to the announcement that India will buy 36 off-the-shelf Rafale fighters, since the joint Indo-Russian venture to co-develop a fifth-generation fighter will still take time, the IAF’s wish list could see contracts worth Rs 1,72,600 crore ($25.5 billion) come into force. This would need an allocation of Rs 17,260 crore in 2016-17, over and above what was committed last year. It takes the IAF’s capital allocation to Rs 48,741 crore ($7.2 billion).

But time is running out. The 2016-17 Budget* wouldn’t immediately precede a national election in which defence is a subject that gets few votes and considering that India’s politicians only pay lip service to doing ‘whatever’ is necessary — Modi’s government could still be bold enough to do the needful. According to official statistics, the share of defence spending in the GDP has declined steadily in the decades after liberalisation, with a particular dip after the United Progressive Alliance government came to power. India now spends less than two per cent of its GDP on defence. In contrast, NATO countries, even though they are safe under the US military umbrella, are required to spend two per cent of their GDP on defence. A Western study suggests that India must spend 4-6 per cent of its GDP, to have a first class military force.

For those in the ‘business of defence’, India will be the market to get into, in the decade ahead. According to consultancy IHS Jane’s report, the combined defence budgets in the Asia-Pacific region will grow from $435 billion last year to $533 billion in 2020, furthering a shift in global military spending away from Western Europe and North America toward the emerging markets, especially in Asia. The figure will put the Asia-Pacific on a par with North America, which is expected to account for a third of global defence spending by then, from almost half now.

Military outlays in Asia and Oceania which includes Australia and New Zealand grew 5.4 per cent in 2015, outpacing a one per cent rise in global spending, according to SIPRI. China had the biggest defence budget in the region last year at $146 billion, according to the government. Jane’s Weekly said it expected China’s budget to rise by about five per cent to $233 billion by 2020. China’s outlays were two per cent of its economy, well below the US expenditure of 4.70 per cent of its economy last year, while Russia’s expenditure of 3.90 per cent of her GDP amounted to $71.90 billion.

If India is to discard its dubious distinction of moving from crisis to crisis — a trend that has led to the acquisition of an ad-hoc arsenal and many top manufacturing firms being black-listed after scandals — it must at the earliest, adopt a national security doctrine, to plan for the purchase or development of weapon systems. Only then can it truly have a long-term integrated perspective plan, as the DPP mandates. At present, each of India’s armed services has its own doctrine, apparently preparing to go to war all by itself! And the armed-police forces are even worse off. They have none at all.

Raza is a commentator on national security issues.

His website is:

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Maroof Raza

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