Bringing the private sector into defence - Broadsword by Ajai Shukla - Strategy. Economics. Defence.

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Monday 29 January 2007

Bringing the private sector into defence

by Ajai Shukla
Business Standard: 11th Apr 2006

The allocation of Rs. 89,000 crores to defence in this year's budget -- almost 9 per cent more than last year's revised estimates -- was passed without question in parliament. At first glance, it seems the fiscal equivalent of "Jai Jawan". But some 37,500 crores are for capital expenditure, or purchasing arms and equipment for the military's long-term modernization. Since over half of our defence purchases are still sourced from the international market, foreign arms companies will pocket close to 20,000 crores this year -- not exactly a victory for the Jawan. The trend continues, of paying lip service to the principle of indigenisation and hard cash to foreign manufacturers.

Until the 1990s, there was little choice but the international arms bazaar. India's Defence R&D Organisation (DRDO) performed dismally, and the private sector didn't have the expertise, capital, or will to enter the field of defence production. Buying foreign made sense through the 1970s and 1980s, when New Delhi's special relationship with the Soviet Union provided ready-built systems on favourable financial terms. As long as India bought Soviet tanks for peanuts and paid for them with bananas, there was little space for domestic manufacturers in the upper regions of the value chain. Meanwhile, India's vast network of 39 Ordnance Factories and 9 defence PSUs wandered in the low-tech wilderness of spares and components, small arms and ammunition, and the assembly of relatively simple weapons platforms. 

With the demise of the USSR and the dawn of economic liberalization, private companies started looking to the defence market. But it took a full decade for the defence ministry to open the defence sector to private Indian companies (with up to 26% foreign equity) in May 2001. Five years later, the private sector has only 10% of that market. Their annual business amounts to just 3100 crores, the bulk of it in low-tech materials, sub-assemblies and components, purchased by the ordnance factories and defence PSUs.

But even though successful participation by an indigenous private sector will strategically deepen India’s defence capabilities, the MoD has done little to build relations with a private sector that is as Indian as the defence PSUs. The Confederation of Indian Industry (CII) does have a National Committee on Defence that interacts regularly with the Defence Ministry, lobbying for a greater role in defence industry. But the partnership has grown slowly. Last April, the Kelkar Committee submitted a report to the MoD on enabling private sector participation in defence production. A year later, there's yet to be a comprehensive announcement on the Kelkar Report. And the MoD’s instinct remains to protect its PSUs; after all senior MoD officials sit on those PSUs’ boards.

In developed defence economies like the US and the UK, private sector companies are involved through the entire cycle of production. This includes formulating long-term defence requirements, translating these into specific platforms and systems, developing such systems through R&D, holding trials and evaluations, and competitive tendering for the final order. Through all this, private and public companies compete on exactly the same terms, so that the best possible defence comes for the cheapest price.

In India, the dice are thoroughly loaded against the private sector. When the MoD discusses its requirements, the DRDO, the ordnance factories and the defence PSUs actively participate. The private sector is excluded from this process. After influencing decisions on what products are needed, the PSUs benefit further from another huge anomaly: the process of “nomination”. Having tied up a transfer of technology (TOT) alliance with a foreign vendor, this readymade PSU-vendor combine claims the deal without any tenders. The government signs a TOT arrangement with the foreign vendor and “nominates” the PSU partner to receive the technology and manufacture the equipment. Atul Kirloskar, Chairman of CII's Defence Committee, explains, "While the policy has been announced that the private sector can participate, the reality is that it cannot because it doesn't even know that there is a requirement." Kirloskar wants a CII or FICCI representative to be invited to all meetings where the defence PSUs are called. 

Private sector companies bitterly complain that defence PSUs openly “front” for foreign companies in bypassing the tendering process. In a proposed 700 crore rupee contract for T-72 tank radio equipment earlier this year, a Polish company, WB Electronics, tied up a transfer of technology arrangement with Bharat Electronics Limited (BEL) to manufacture the harnesses in BEL. To the surprise of a number of Indian private companies that were putting together their own bids for tendering, the WBE-BEL combine suddenly emerged as a readymade awardee for the contract. The CII defence committee had to approach the defence minister directly to demand competitive bidding instead of this “back-door entry” by the WBE-BEL combine.

The reluctance of MoD to let its PSUs and ordnance factories compete freely with the private sector is not unlike the private sector's fears when the economy started opening up in 1991. Fifteen years down the road, India's private companies have survived, indeed flourished. Allowing the private sector a larger role in defence production is an essential step towards a real defence capability.

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