Self-reliance In Defence Production The Unfinished Agenda

Regulatory regimeA domestic or foreign company wishing todo business in the Indian aerospace anddefence industry has to comply with thefollowing, often conflicting, policies: Defence Procurement Procedure(including the Offset Policy) Foreign Direct Investment Policy Industrial Licensing Policy Foreign Trade (Export/ Import)Policy Tax regimeDefence Procurement Procedure(DPP)Defence procurement is governed bythe DPP. First enumerated in 2002, ithas undergone several iterations andthe latest policy, released in June 2013(DPP 2013), made significant changes inthe acquisition procedures as well as theoffset policy. The most important changein DPP 2013 has been the stipulation ofa hierarchy of categorisation of any newdefence procurement with ‘buy (Indian)’and ‘buy and make (Indian)’ being thefirst and second priorities. DPP 2013 alsolays down the method for computingindigenous content: the cost of theequipment to be reduced by the cost ofimported materials and cost of servicesreceived from non-Indian entities at alltiers.Highlights of the revised DPP are asfollows: Prioritisation of ‘buy (Indian)’ and‘buy and make (Indian)’ for capitalacquisitions under the DPP Maintenance ToT (MToT) will nolonger be through nomination butthrough bidding Advance consultations for ‘make’procedure Simplification of ‘buy and make(Indian)’ procedure Clear definition of indigenous content Ensuring faster progress in ‘make’ and‘buy and make (Indian) cases Enhanced delegation of financial12 PwCpowers for capital acquisitions Powers to Defence AcquisitionCouncil (DAC) to approve alldeviations from DPPOffset PolicyThe Defence Offset Policy was last revisedin 2012. This was a major overhaulthat provided for first-time multipliersto supply technology and work withMSMEs. It also restructured the offsetmanagement apparatus and replaced theearlier DOFA with a new Defence OffsetManagement Wing. While on paper, thepolicy is quite liberal, its implementationhas been a cause for concern equally forthe government and OEMs. There is oftena gap between the written policy andits interpretation by different technicaloffset evaluation committees. Offsets arean opportunity for developing capabilityin Indian industry. Proposals need to beevaluated holistically and consistentlykeeping in mind commercial realities. Anoffset contract is for a fixed time periodand inevitably co-terminus with themain programme. Delays and unrealisticconstraints don’t just prevent capturingthe full potential of the offset opportunitybut can even delay the main programme.Foreign Direct Investment (FDI)PolicyIndia’s defence sector, which wasreserved for the public sector, was openedup in 2001 for Indian private sectorparticipation with FDI permissible up to26%, both subject to licensing in order toenable the private sector to participate indefence production within the country.However, the cap of 26% has completelyfailed to attract foreign investment intothe country.Keeping this in mind and with the intentto invite investment and technology anddevelop nascent defence manufacturingto make India self-reliant, the UnionCabinet recently raised the FDI cap indefence production up to 49% under thegovernment approval route. FDI beyond49% will be allowed on a case-to-casebasis where there is access to modernstate-of-the-art technology and will besubject to approval from the CabinetCommittee on Security (CCS), subject tocertain conditions.Industrial Licensing PolicyUnder the Industries (Developmentand Regulation) Act 1951, an industriallicence is required for manufacturingdefence equipment. In order to streamlinethe licensing regime, the Departmentof Industrial Policy and Promotion(DIPP) has recently released a list ofdefence products which will require anindustrial licence vide issue of Press Note3 of 2014. This has greatly enhancedtransparency and should facilitate greaterinvestments–both domestic and foreign.The application is considered by an interministerial committee and the processtakes almost a year.Foreign Trade (Export/Import)PolicyExport of goods and services in India isgoverned by Foreign Trade Policy 200914 (FTP). The Indian Trade Classificationbased on Harmonised System of Coding[ITC (HS)] is adopted in India forregulating import-export transactions.ITC (HS) contains lists of items eitherprohibited, or restricted (i.e. subjectto export or import licence) or freelyexportable and importable (subjectto conditions laid down against therespective entry (items) in the schedules).Items not listed in ITC (HS) are alsodeemed to be freely exportable orimportable without any conditions underthe Foreign Trade (Development andRegulation) Act, 1992 and the rules,notifications, etc. issued thereunder fromtime to time.

The exporter requires to obtain an exportlicence from the Directorate General ofForeign Trade (DGFT) for exporting dualuse items given in the Special Chemicals,Organisms, Materials, Equipment andTechnologies (SCOMET) list. Alternately,the exporter is required to obtain ano-objection certificate (NOC) from theMinistry of Defence (MoD) for exportingmilitary stores.One of the important objectives of theMake in India campaign is to developexport capabilities in the defence sector.This is important not only to buildeconomies of scale but also to becomeglobally competitive. In order to meetthis objective, it is imperative to not onlyprovide incentives for exports but alsosimplify policy and make synergistic,constructive and proactive interpretationsin implementation. Towards this end, thenew government has taken a number ofimportant decisions:Formulation of an export strategyThe government is in the process offormulating a strategy for encouragingthe export of defence products and hasnotified the following strategy: Setting up an export promotionbody with industry representativesin order to render advice to thegovernment on various exportrelated issues, coordinate allexport facilitation schemes of thegovernment and increase awarenessand undertake promotion of exportsthrough specific marketing efforts intargetted countriesConstituting a defence exportsteering committee under thechairmanship of the Secretary,Department of Defence Production,in order to consider and takedecisions on cases of exportpermissions outside the purviewof subordinate authorities andcommittees particularly the exportof indigenously developed sensitivedefence equipment, monitor theprogress in defence exports andsuggest specific steps and strategy toboost exports Providing government support todefence exports by including industrydelegations from the public andprivate sectors as well as the jointventures (JVs) of private and publicsectors in bilateral meetings anddiscussions with various countries sothat the importing country gets duecomfort while importing from India Export financing and otherincentives as the government plansto extend incentives and promotionschemes for defence exports inconsultation with the Departmentof Commerce, industry associationsand the Ministry of External Affairswithin the purview of the ForeignTrade Policy. Line of credit facilityand buyer’s credit facility will also beleveraged suitably to promote defenceexports from India. Possibilities willbe explored for financing defenceexports through EXIM Bank.Similarly, the government intendsto work out a separate strategy tofinance exports to weaker countriesin consultation with the Ministry ofExternal Affairs, EXIM Bank, DPSUs,the private sector and other financialinstitutions.It remains to be seen how soon thisstrategy is translated into policy and howeffectively it will be implemented. For acompany to grow in the Indian defencesector, it is important to be part of a globalsupply chain or build an export market.Tax regime: Impediments inproviding a level playing field tothe private sectorThe government’s initiative forindigenisation in the A&D industry inIndia, through the DPP 2013 requirescomplementary initiatives under theindirect tax regime. Under the customslaws, exemption from customs duty isavailable if the defence equipment isimported by the government of India,the contractors of the government ofIndia, state governments, public sectorundertakings of the central governmentor the state governments and thesubcontractors of such PSUs but not forthe subcontractors of private companies.By virtue of this exemption, in case of‘buy’ global contracts, foreign originalequipment manufacturers (OEMs) andDPSUs may still be on a level playing fieldowing to DPSUs and their sub-contractorsenjoying exemption from customs dutyon the import of goods. However, privatesector Indian enterprises are left at adisadvantage as the latter will have tosuffer higher costs due to the levy ofcustoms duty, particularly on inputs.A similar situation exists in the case of‘buy Indian’ and ‘buy and make Indian’categories when private enterprises arecompeting vis-a-vis DPSUs. The directfall-out of such non-exemption of customsduty on inputs in the case of private sectorenterprises is that they have to absorbthe customs duty paid on imports, thusbecoming non-competitive.Also, no specific exemptions are providedfrom the levy of excise duty on inputs andcapital goods procured for use in defencemanufacturing.Consequently, the private sector has aninherent cost disadvantage that makes itnon-competitive to foreign OEMs, DPSUsand sub-contractors of DPSUs.Self-reliance in defence production: The unfinished agenda13

Creating an eco-system for the aerospaceand defence industry in IndiaMicro, small and medium enterprises formthe backbone of any industry and needspecial support.Education, skill development,training and accreditationWe firmly believe that building a defenceindustrial base in India will require proactive government support to facilitateand encourage the private sector to investin this capital- and technology-intensivehigh-risk industry. The support will needto include funding R&D, creating a lowinterest regime to bring down capitalcosts, addressing the disadvantages ofexchange rate fluctuations, providingstability and assurance in policy andorders and encouraging exports to achieveeconomies of scale and become globallycompetitive.Shortage of a skilled workforce is aserious challenge to the growth of theIndian aerospace industry. There is theneed for better training and educationinfrastructure with a pragmatic policy tobuild an industry-academia ecosystemto tap the huge employment potential inthe industry. To realise this potential, thegovernment needs to facilitate establishingformal education infrastructure. Thisincludes adding aerospace discipline inexisting institutions such as the IITs aswell as setting up an aerospace universitywith the aim of improving the quality ofdesired talent in the country.Defence clusters and consortiaSkill development is critical for achievingself-reliance in defence production.For long, industry has struggled to hire‘industry-ready’ personnel who can hitthe shop floor running. With an urgentrequirement to upgrade existing facilitiesat training and diploma centres so as toproduce technically sound and skilledpersonnel, it is necessary to strengthenthe industry-institute partnershipframework for the A&D sector throughPPPs. This is being done by the NationalSkill Development Corporation but muchmore needs to be done.About 6000 MSMEs operate across thecountry supplying components andsub-assemblies to the DPSUs, ordnancefactories, DRDO and private players.The government of India needs toencourage developing clusters–both bydemarcating brownfield clusters (on thelines of the M-SIPS policy) as well as plangreenfield clusters for long-term productdevelopment with a view to integratedispersed MSMEs into the supply chainsof major programmes right from the wordgo.Foreign and Indian OEMs need to beencouraged to bid in consortia whereinrisks are shared proportionately. Clusterframeworks and consortia biddings canresolve key issues faced by MSMEs. Theseinclude risks of operating in a monopsonywith long gestational periods and theabsence of repeat orders. MSMEs willalso be willing to take on more risk,which hitherto has been negligible andhas consequently adversely impactedcapability-building through R&D andinnovation. State governments havean important role to play in clusterdevelopment by providing basic butquality infrastructure. Several stateshave actively promoted investments inthis sector through building clusters, e.g.Karnataka, Andhra Pradesh, Gujarat and,most recently, Madhya Pradesh.14 PwCDefence production, especially aerospace,involves high precision manufacturingthat requires specialised training andcertification by international accreditationagencies. These accreditations aretime-consuming, expensive and haveto be renewed often. The governmentcould consider subsidising importantinternational accreditations for the SMEsector. In the long-term, once exportsfrom aerospace improve and a criticalmass is achieved, the government needs toimpress upon international accreditationagencies to set up offices in India in orderto bring down overheads involved in theprocess.Addressing issue of high costof capital and exchange ratevariationsA critical issue impacting investment inIndia is the high cost of capital. Whilethis impacts all Indian companies acrosssectors, it severely impacts MSMEswho face an even higher interest rateregime. While various schemes have beenlaunched to provide interest rate subsidyto MSMEs, these have largely remainedon paper. The first Budget of the newgovernment has provided for creating a100-crore-INR technology developmentfund to provide resources to public andprivate sector companies to supportresearch and development (R&D) ofdefence systems. It remains to be seen howthis is operationalised.Another key variable that makes Indianindustry uncompetitive is exchange ratevariation. It is well known that muchof the raw material in the aerospaceindustry is not produced in India andhas to be imported. Besides, a number ofcomponents and sub-systems also haveto be imported. The government used toallow exchange rate variation to DPSUsbut not to private Indian companies. Ithas withdrawn this facility for DPSUs thusdisadvantaging both against foreign OEMswho are paid in foreign currency.Increasing foreign investmentin aerospace and defencemanufacturing to 74%The defence sector was opened upto 100% for Indian private sectorparticipation, with FDI permissible upto 26%, both subject to licensing andgovernment approval. However, this capand the accompanying conditions failedto attract FDI with a mere 5 million USDhaving come in since 2001. Recognisingthis, the new government decided toraise the cap to 49% through the FIPBapproval route and has further decidedthat FDI beyond this will be allowed bythe Cabinet Committee on Security onlywhere cutting-edge technology is beingtransferred.

The DIPP had circulated a discussionpaper proposing to increase the level ofFDI to 74% to boost the domestic defenceequipment manufacturing industry.The paper stated out that “by merelyincreasing the limit from 26 to 49%, wemay be accused by posterity of doingtoo little and too late. Therefore, in casewe really want to have state-of-the-arttechnology, we have to permit anythingabove 50%, if not 100%. It may be,therefore, desirable to allow either 100or 74%, as in the telecom sector.” It wasexpected that the new government wouldfinally bite the bullet and take this longoverdue decision. However, it stopped at49% and the moot point now is whetherthis will make any difference.Many arguments are given againstincreasing the cap. It is useful to list theseand address the underlying concerns. Animportant and sensitive reason cited issecurity and dependability. It is feared thatforeign companies manufacturing in Indiacould stop supplying to us on instructionsfrom their parent governments, or, thatthe technology and products can be soldto unfriendly countries. This may not bean issue at all, as one, the governmenthas far greater control over a companymanufacturing in India. Second, exportcontrols with end-user requirements canbe applied over those critical technologiesand equipment the Indian governmentis concerned may fall into ‘wrong hands’or handed over to countries unalignedto Indian interests. These issues havenot deterred the US and the EuropeanUnion which permit 100% FDI in defenceand address the security issues throughverification and clearance proceduresas well as export controls. It needs to berealised that the production of defenceplatforms is now far more dispersed thanit was a decade ago with the trend movingtowards international participation as inbuilding platforms such as the US JointStrike Fighter programme.Another issue raised is the infant industryargument that says raising the FDI cap willmarginalise DPSUs, ordnance factoriesand the private sector and potentiallycrowd out India’s domestic industry. Thisapprehension, while appearing somewhatjustified, needs to be put in the rightperspective.Change in acquisition procedures with ahierarchy of procurement processes thatplaces the ‘make’ category at the highestlevel will provide ample opportunity forlarger Indian companies to transformthemselves into OEMs. India’s defenceexpenditure has been rising due to bigticket deals and the roll out of massivemodernisation programmes for theforces. The new government has recentlyapproved various programmes worth over1 lakh crore INR. This huge expenditureprovides an attractive opportunity fordomestic enterprises. Second, the newacquisition procedure will compel OEMsto establish partnerships with privateIndian industry. Thus, if governmentpolicies encourage a high degree ofcollaboration between foreign enterprisesinvesting in India with the domesticindustry, then the crowding effects of FDIwill be neutralised.The Indian aerospace industry is movinginto an era of multinational cooperation,or ‘horizontal specialisation’, whereoriginal equipment manufacturers aswell as service suppliers seamlesslyintegrate functions such as engineering,manufacturing, and customer supportacross multiple global locations. Mexico,which did not feature among the topinvestment destinations for the aerospaceindustry a decade earlier, has been ableto attract significant manufacturinginvestments. This can be attributed toits policies: elimination of duties foraeronautic components, allowing 100%FDI, providing various fiscal incentivesfor investments, a location advantageand low-cost manufacturing. As a result,the number of companies within theaerospace sector in Mexico has presentlyreached a total of 290. This includesmanufacturing (79%), maintenance,repair and overhaul operations (MRO)(11%) and design and engineeringservices (10%). There are nine OEMswith aerosp

Self-reliance in defence production: The unfinished agenda 11 The industry is dominated by defence public sector undertakings (DPSUs) and ordnance factories which contribute about 90% of the total domestic manufacturing output. The 41 ordnance factories are spread across 26 different locations and employ close to 1,25,000 people. These