PREVIEW DEFEXPO 2008: Private sector eyes the defence pie - Broadsword by Ajai Shukla - Strategy. Economics. Defence.

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Friday 15 February 2008

PREVIEW DEFEXPO 2008: Private sector eyes the defence pie

Business Standard
16th February 08

Defexpo India 2008 --- the fifth exhibition in a series that began in 1999 --- may be the first one where India’s private sector makes a serious splash with the delegates. For six decades, private companies have played a subordinate role in defence production, functioning mainly as ancillary suppliers to India’s 39 Ordnance Factories (OFs) and eight Defence Public Sector Undertakings (DPSUs). Defence production was opened up to the private sector as far back as 2001, but the enabling regulations and policy changes have evolved slowly, in fits and starts. But a critical mass may have been reached, and private companies now sense the opportunity to seize a larger share of the pie from the slower-moving public sector behemoths. 

This jump-off point has been slow in coming; the watershed notification of 2001, allowing the private sector (subject to a cap of 26% on foreign holding) to apply for licences for defence production, did not exactly set off a riot. While the government has issued 73 Letters of Intent to private players since then, only a handful have actually manufactured anything. Private companies complain that liberalisation has been largely cosmetic; the public sector, with its institutional and financial linkages with the Ministry of Defence (MoD), continues to enjoy significant advantages in defence production. Their manufacturing facilities have been set up at government expense, MoD-controlled pricing assures them profits in a protected market, and they enjoy a 10% advantage when tenders are evaluated. With senior MoD officials sitting on their boards, the playing field is, indeed, tilted in favour of the public sector.

Industry bodies, like the CII, FICCI and Assocham, have lobbied strenuously to remove, or at least reduce, this bias. The stakes are enormous for the private sector, especially in domestic defence procurement: away from the media limelight on “foreign arms deals”, indigenous defence manufacture accounts for 77% of India’s defence procurement (Rs 25,647 crores in 2006-07, out of the total procurement budget of Rs 33,356 crores). The Kelkar Committee, set up in 2004 to recommend ways of strengthening self-reliance in defence preparedness, submitted a path breaking report in 2005, which focused on bringing reliable private sector companies into defence production, and synergising their skills with the existing public sector establishment.

The most important of Kelkar’s reforms were promulgated in September 2006, in the Defence Procurement Procedure of 2006 (DPP-2006), the current bible of defence production. The new manual explicitly answers the key commercial question that holds back the private sector from costly defence R&D and production: “Who will bankroll the development of high-tech products when there is no guarantee that the defence services will even accept them into service?” 

DPP-2006 specifically mandates that the government will share R&D costs; senior MoD officials have clarified to this newspaper that the MoD would pay as much as 80% of R&D costs for projects that it identifies. DPP-2006 also undertakes that the MoD will place a minimum order on private manufacturers to amortise the cost of R&D and production. The Kelkar Committee suggested that a set of technologically and financially excellent private companies be identified (he termed them Raksha Utpadan Ratnas, or RuRs), which would be eligible for R&D partnerships, and for manufacturing the equipment that they develop. DPP-2006 would be an extraordinarily progressive document if the government were to follow it in letter and in spirit.

But the government does not. Instead, the process has been stalled by trade union pressure. The Probir Sengupta Committee, set up in May 2006 to evaluate which private companies should be nominated as RuRs, recommended some 15-20 companies in June 2007. But the MoD was blocked from promulgating the RuRs by public sector trade unions, which apprehend that the entry of the private sector would close down public sector plants. The Defence Minister has publicly assuaged trade union fears, pointing out that defence production offers enough space for both the public and private sectors. But trade union pressure continues, reinforced by the Left Front political parties; eight months after receiving the Probir Sengupta report, the MoD remains silent on RuRs.

In this policy paralysis, aspiring RuRs like L&T, Tata Power, and the Mahindra Group remain in limbo, ineligible for R&D funding and customs exemptions, and unable to compete with the public sector units on equal terms. Unwilling to commit major funds into developing major weapon systems, private companies have strengthened their role as ancillary suppliers to the DPSUs and OFs. If there is a trend today in defence production, it is for the government-funded public sector to function as R&D centres and “platform integrators”, which design and assemble the final product from sub-assemblies that are increasingly manufactured by the private sector. DPSUs and OFs located around Bangalore, Hyderabad, Pune and Chennai, have spawned hundreds of small, medium and large private companies, which are manufacturing increasingly complex components and assemblies, and looking for opportunities to expand their roles.

Some 250 such private companies will constitute the bulk of the Indian exhibitors in Defexpo India 2008. They will be looking for additional manufacturing orders from the DPSUs and OFs, as well as for tie-ups with foreign defence majors, some 200 of which will be exploring opportunities for local tie-ups as a foot in the door of the Indian defence market. With some Rs 300,000 crores (US $75 billion) worth of defence purchases likely to be made by India’s MoD over the next five years, Pragati Maidan will witness brisk business between 16th-19th February.

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