Increasing Foreign Direct Investment limit in defence manufacturing from 49 per cent to 74 per cent under the automatic route, creating a negative list for imported weapons, a separate budget for Indian-made defence equipment and the corporatisation of the Ordnance Factory Board have been announced by the Narendra Modi government as part of the stimulus package to counter the Covid-19-affected economy. The amended rules are aimed to boost the ‘Make in India’ programme, attract private sector in defence production and reduce the import bill on weapons purchase.
But apart from the increase in Foreign Direct Investment (FDI) limit, the other measures are not going to help boost Make in India or increase private sector investments in defence manufacturing. Corporatisation of the Ordnance Factory Board (OFB) may help bring in some efficiency, but privatising it would have been the major reform. One of the reasons that the private sector is struggling in defence is because the OFB and other Defence Public Sector Undertakings (DPSU) always get government preference.
Failing to attract FDI in defence
The increase in FDI limit to 74 per cent is good, because without having the control of the company, being liable for the quality and performance of the product was an issue for foreign original equipment manufacturers (OEM). It is not clear if the change in FDI norms will apply to big-ticket projects under the Strategic Partnership model like the Navy’s P-75i submarine project. Swedish company SAAB quit the submarine project last year citing the lack of control, with the ownership being capped at 49 per cent.
The raise in the FDI limit will only help if it is backed by good procurement policy. The Modi government had revised the FDI limit to 49 per cent in July 2016 via the automatic route and also allowed 100 per cent on a case to case basis. But it did not result in increased FDI. In 2016-17, India failed to attract any FDI in defence. In 2017-18, it received $0.01 million, and in 2018-19 that stood at $2.18 million.
Not only has India failed to attract FDI in defence, but it has also failed to attract any substantial private sector investments. India is notorious for delays in taking decisions, placing piecemeal orders, cancelling tenders and unreasonable qualitative requirements by the armed forces. Private companies that have invested in defence production hoping for government support have been left disappointed. From warship building to Howitzers, they have suffered due to the lack of orders or small orders. An example of this is the K-9 Vajra self-propelled Howitzer being manufactured by Larsen and Toubro, whose factory in Gujarat was inaugurated by PM Modi. In the absence of new orders, the production line will go idle after the last of the 100 guns on order is delivered later this year. The total requirement was projected to be at 250 guns. Recently, a private company, Tonbo Imaging, wrote an open letter to PM Modi lamenting cancellation of orders and delays in making payments. Such policies even hurt the DPSUs.
The private sector will thrive only if the government places firm orders and in quantities that make it viable to invest. Thanks to the lobbying by DPSUs, the government nominates them to manufacture big-ticket projects. Private firms also cannot compete with DPSUs whose infrastructure has been created by public funds and are not considered while preparing a quote. Private firms have to consider the investment, the cost of money and making a profit. Lack of level-playing field will continue to hinder private investments in the defence sector.
The creation of a negative list for import of weapons is not going to make a difference. The current defence procurement procedure has the provision under ‘Buy Indian-IDDM (Indian Designed, Developed and Manufactured)’ category. There is also ‘Buy Indian’, and ‘Buy and Make Indian’ categories. As the government is the only buyer of weapons, procurement of certain types of weapons can be put under any of the existing categories. Perhaps this can be simplified to ‘Made in India’ and ‘Make in India’ with the former being Indian design and manufactured and the latter being a foreign design manufactured in India under joint venture or fully OEM owned.
Over the years, the armed forces have returned unspent money due to delays in procurement. Instead of creating a separate budget for buying Indian-made weapons, the government should approve the long-standing demand for non-lapsing funds. It should consider project-wise allocation of funds that don’t lapse and put the money in a special account. Not only will this provide ready access to funds when a deal is to be signed, but any cost escalation due to delays will also be partly offset by the interest accrued. Such a system will not be affected by a sudden financial crunch like the one the Modi government is now facing due to the pandemic leading to postponement of weapons purchase.
Opening space and making way for private sector
Opening up the space sector for private enterprises and the use of ISRO facilities by them is a good move that will help the private sector fulfil rising domestic and global demands for satellites and space launchers. The armed forces will also benefit from private innovations in technology as the space war heats up.
India imports 70 per cent of its weapons and has consistently been in the top two weapons importers in the world. It’s unsustainable for any major power. Simplification of defence procurement procedures, timely decisions and placing sizeable orders are required. Certain weapons categories or projects should be procured only from the private sector even if there is a competing DPSU.
Export of weapons has to be pursued aggressively too, so that spare capacities can be utilised, especially in the private sector. This will help drive down India’s own acquisition cost and also fund research and development to make the next generation of weapons for the Indian armed forces.
The author is editor of Defence Forum India. He is a commentator on defence and strategic affairs. He tweets @YusufDFI. Views are personal.
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