Up to $30 billion in defence deals could be unlocked with the new policy. But the fine print will decide whether it will give a leg up to Indian firms and reduce the country’s dependence on costly imports.
It has been well over a decade since India’s private sector was directly involved in defence manufacturing. Citing security concerns, India’s defence procurement has largely been driven by the various defence public sector undertakings (DPSUs) and the Ordnance Factory Board (OFB). While defence manufacturing was ‘liberalised’ in 2001 and opened up participation to not just private players but also to foreign entities (26% foreign direct investment (FDI) in defence). Yet, we do not have a defence production base outside of the DPSUs and the OFB. Private sector companies have been hesitant to dive into defence manufacturing due to restrictions on products and lack of orders. Their vendor base (in this case, largely MSMEs) is limited and one that has not been given its due. Despite FDI limits having being increased to 49% on automatic route and 100% on a case-to-case basis, FDI has only dribbled into the country. And when it comes to technology transfer or knowledge sharing, the situation is far more dismal.
The result is, the defence production sector as it is today, driven by behemoths of DPSUs, are not all efficient. The lack of private sector participation and competition in indigenous defence production has resulted in an ill-equipped armed force that has been driven to rely more on imports rather than look inward. Defence public sector enterprises, therefore, function as a monopoly in India.
History of the ‘strategic partnership model’
When the Modi government came to power in 2014, the prime minister’s ‘Make-in-India’ project was a natural fit for defence manufacturing: In public rallies, Modi spoke of having 70% indigenous weapons procurement (an ambitious target considering it’s currently around 35-40%) with a good chunk of that procurement hopefully coming from India’s private sector.
The roots of the strategic partnership policy, a potential solution to India’s defence manufacturing problems, goes back to the Dhirendra Singh committee in 2013. Based on one if its recommendations, a taskforce was to be set up to lay out the criteria for selection of ‘strategic partners’ for weapon platforms of critical importance. The V. K. Aatre task force was convened in September 2015 and was directed to submit its report in three weeks’ time. However, this was revised to November 2015 and subsequently to January 15, 2016, when the taskforce intimated the ministry of defence (MoD) of regarding the need for more time to put down specific financial and technical criteria in consultation with experts. The report has finally been made public and the broad contours of a strategic partnership policy has now even been cleared by the cabinet.
The taskforce report on strategic partners (taskforce/report) is therefore both a brilliant and timely document mainly because it has taken honest stock of Indian defence procurement and has consequently re-examined and reoriented the entire process. Not only does the report suggest an alternative model to defence procurement, it also suggests a framework, which if successful, will be a major driving force for the growth of defence MSMEs in India. The report has recognised the importance of defence MSMEs not only as possible strategic partners but also the crucial role that they play in the defence manufacturing value chain.
In the last five years, India has executed a handful of few major defence acquisitions: the Rafale jets, the Scropene subs and the T-90 tanks. The major deal that fell through was the acquisition of carbines. The combined value of these is approximately $18 billion. Based on the Long Term Integrated Perspective Plan and the Technology Perspective and Capability Roadmap, the guiding documents to defence acquisitions in India, the strategic partnership model could potentially unlock deals worth $30 billion over the next five years. This would not only include the acquisition of new weapon systems but also take care of the armed forces’ priority of modernising their existing capabilities.
The report also takes cognisance of the current limited capabilities of the Indian private sector and therefore rightly suggests a model where, atleast for the initial years, the private sector is to act as the lynchpin that brings together all stakeholders, including foreign original equipment manufacturers (OEMs) for developing indigenous defence manufacturing. It is hoped that over the years, through the strategic partnership model, there will be a marked increase in the transfer of technology, a definite requirement for stepping up Indian indigenous defence manufacturing.
Rationale behind “strategic partners”
The strategic partnership model was envisioned in order to bring private industry into the fold of defence manufacturing, but under the auspices of well-defined terms of agreement. Given that development and production of weapons platform is a time-intensive process, the idea was to ensure that long-term, regulated partnership for product development and production could be put in place.
After comparing best practices in the global defence industry, the Dhirendra Singh committee noted that private industry can be involved in defence procurement only through “well-defined models depending upon … strategic needs, quality criticality and cost competitiveness.” It has been emphasised that the ‘strategic partner model’ is to be established in addition to the existing infrastructure and capacity of public sector units (DPSUs). In other words, it was time for India to move away from our existing dependence on DPSUs alone for indigenous production and allow competition to bring in efficiencies.
Given that weapons platforms have specific uses and involve precision and field expertise in both production and use, the terms of reference for the task force was straightforward. The task force was to recommend detailed criteria, both generic and specific, and prescribe the methodology and parameters for the selection of strategic partners. It also had to draft a long-term covenant that the government and selected strategic partners would enter into and cover any other aspects relating to strategic partners and their selection that required mention.
Weapons platforms and groupings
The platforms identified as important for strategic partnership by the Dhirendra Singh committee were aircraft, missile systems, armoured vehicles, warships and submarines, command and control systems and critical materials. The Dhirendra Singh committee had also provided the broad parameters for selection criteria, which the Aatre task force then detailed in their own report. The task force highlights in its report that the main difference between the commercial bidding process under the ‘buy and make’ category of Defence Procurement Policy 2013 and 2016 and the strategic partnership model is that the selection criteria are based on “inherent capacity and ability of the entity rather and not on the lowest bidder principle.”
This is a momentous change because it paves the way for private sector participation on the merits of capability rather than cost, but more importantly, it signals a change in the entire philosophy of defence procurement.
The report states that India needs strategic partners that are ‘system of systems’ integrators, citing that this is a best practice followed in defence manufacturing internationally. In the chapter on methodology the weapons platforms identified by the Dhirendra Singh committee report have been differentiated into two groups. This puts aircraft and submarines under Group I as ‘system of systems’ projects, and it puts critical materials under Group II as ‘other projects’.
The task force suggests that under Group I, the focus should be on selecting strategic partners for aircraft, helicopters, submarines and armoured vehicles and puts ammunition under Group II. The current strategic partnership model ratified by the MoD has focused only on the Group I products and does not include ammunition (which is a Group II product). This implies that no strategic partners will be considered for ammunition, at least in the short to medium term.
The drawback of this is that the strategic partnerships will fail to deal with one of India’s more pressing defence shortfalls in ammunition. On the other hand, this could well be interpreted as a strong warning signal to the OFB (whose main focus has been on producing artillery and ammunition) to pull up their socks up and increase their production capacity or fade away sooner rather than later when competition is introduced.
Methodology and criteria
The task force has recommended setting up of an ‘evaluation committee’ and a ‘verification sub-committee’ for reviewing the applications made by companies for becoming strategic partners. The former will have the responsibility of evaluating the applications of companies vying to be strategic partners. The latter will be responsible for conducting on-site inspection and verification of all technical capabilities that companies have mentioned in their applications. Together, these will form the first two steps of the methodology for evaluation and selection of strategic partners or the ‘composite gate’ and ‘verification’ of applicant companies. The final step involves marking each company’s application based on technical, financial and segment specific criteria (detailed in chapter four, five and six of the task force’s report) and ranking them. Ranking will be based on the company’s own preference for each segment and the marks they receive for each set of criteria.
Among the composite gate criteria, companies applying to Group I are required to have a turnover of Rs 4,000 crores and those applying to Group II a turnover of Rs 500 crores. This immediately puts most MSMEs out of reckoning for selection as a strategic partner most definitely for Group I but more importantly for Group II.
India has only a handful of private sector companies that manufacture defence products in Group I. Since only a limited number of Group I segments have been approved under this model, the question that needs to be asked is whether there will be an adequate number of applicants (private sector companies) to competitively choose from?
Another point to consider is if under this model a greater than or equal to Rs 4,000 crores turnover company fails to qualify for Group I, will it now be forced to produce or develop products under Group II segments, because clearly, the non-qualifying companies can no longer manufacture the same systems as the strategic partners, because they cannot and because they will literally have no buyer.
Another point that merits some discussion is on foreign market access for the strategic partners. While the new proposed model for strategic partners has provided for limited competition in private sector defence manufacturing and has also provided a certain degree of purchase security to the manufacturing company, we must remember that the MoD is under no obligation to purchase systems from the strategic partners. MoD may choose to continue to buy from DPSUs, who are after all competitors to the strategic partners, or worse, continue to import. If the latter two were to happen, then the strategic partner has no other revenue stream available. Exports will be the only option available. Unless a new export policy is created that will work in tandem with the new strategic partnership policy, unless the strategic partners are allowed to export some or all their production (subject to domestic procurement and security concerns) private sector participation will continue to remain muted.
The inclusion of the research and development (R&D) culture as an evaluation parameter is a double edged sword. The lack of focus on R&D in India is as much the fault of the private sector as it is of the government’s and public sector undertakings. The ingrained indifference to R&D is alarming and to this extent, the inclusion of R&D culture into the evaluation parameter is a masterstroke that will force the private sector to concentrate more on this ignored segment. On the other hand, the evaluation committee must also be prepared to face a situation where many of the private sector companies may fail to meet the prerequisites for applying to be a strategic partner merely because they have not fulfilled the basic requirement for R&D culture.
The permissible FDI limit for strategic partners is 49%, not very different from the existing FDI limits. That the strategic partner must be Indian owned and Indian controlled has been given paramount importance. The rationale behind the 49% permissible FDI is to allow for foreign OEM participation. Despite the increasing of FDI limits in defence, actual capital inflows into the sector has been less. One is hopeful that this might change if the recommendations of the task force are implemented in a timely manner and procurement processes are changed. What may however not change is the lack of technology transfers. This is not surprising. First, at 49%, FDI technology transfers are not likely to take place. Second, defence manufacturing in India in the private sector rarely incorporates cutting edge technology. Our manufacturing ecosystem has not developed enough to facilitate and incorporate cutting edge technology. The entire model of strategic partnerships rests on technology transfer and/or technology innovation through R&D. If somehow, through the strategic partnership model, India is able to harness and use technology, defence production and indigenisation will leapfrog.
A good start?
There is a long way to go before the strategic partnership policy comes into fruition. As a few experts have pointed out, it could take up to two years before a contract is issued or a deal is inked under this policy. However, the model does address several problem areas in the procurement process. Most importantly it gives the private sector a chance to truly compete. Capabilities rather than just cost will be taken into consideration. MSMEs have been given a chance to prosper.
Positive spillovers from the strategic partnerships will help MSMEs to develop capacity and many will hopefully move into the above Rs 500 crore bracket, making them eligible for Group II partnerships. For it to come to fruition however, many of the supplementary aspects discussed must also be addressed. Most importantly, the strategic partnership model must be viewed as an arrangement that will provide the private sector the fillip for development.
Ideally, once private sector manufacturing has taken off and the MSME vendor base has developed, all private sector must be given an equal chance to partner with MoD for development, not just strategic partners, but that is a bridge that is far away. For now, timely implementation of the recommendations of the report, including the setting up an independent defence acquisitions regulator, will ensure that the purpose of this entire painstaking exercise is served. After all, if India is to develop a robust indigenous defence manufacturing base outside of the public sector, the private sector needs this opportunity to do so.
Nirupama Soundararajan is Senior Fellow, Pahle India Foundation and Dnyanada Palkar is Senior Research Associate at the Pahle India Foundation.