Narendra Modi’s emphasis on the Indian private sector having to play a much larger role in the transformation of the defence industrial base is laudable and overdue. Though there have been some moves, more needs to be done if domestic production and private sector participation are to approach anything close to the levels envisaged.

The defence Budget for the next fiscal year conforms to the overall pattern of the >Budget presented by the Finance Minister. It is radical in promise but incremental in practice. There was a modest raise in defence allocation of just about 11 per cent. Then again, the proportion of capital expenditure in the defence Budget has shrunk a bit. We may well wonder how the armed forces will shop for their long wishlist that includes howitzers and helicopters, fighter aircraft and attack submarines. Mr. Arun Jaitley’s claim that he has provided “adequately” for the needs of the military surely turns on a generous interpretation of the operative word.

More important, however, was his assurance that the government’s “ >Make in India” policy would help achieve greater self-sufficiency in defence equipment, including aircraft. This was entirely in keeping with the Prime Minister’s remarks at the ‘Aero India’ show in Bengaluru a few days earlier. Speaking on that occasion, Mr. Narendra Modi emphasised that the >defence industry was “at the heart” of the “Make in India” programme. By increasing the share of domestic procurement of military equipment from 40 per cent to 70 per cent in five years, he added, India could double the output of its defence industry. More significantly, he noted that the Indian private sector would have to play a much larger role in this transformation of our defence industrial base.

The case of HAL



The Prime Minister’s call was at once apt and ironic. Bengaluru is, of course, the home of Hindustan Aeronautics Limited (HAL) — the largest defence Public Sector Undertaking (PSU). Few recall, though, that the HAL has its origins in private enterprise. It began during the Second World War as the brainchild of Walchand Hirachand, a leading businessman and nationalist sympathiser. Walchand controlled the Scindia Steam Navigation Company and had long dreamt of reviving shipbuilding in India — an industry that had been monopolised by British firms. His attempt to build a shipyard in Visakhapatnam proved abortive; as did his plan to set up an automobile factory to cater for the war effort. Walchand’s most ambitious undertaking was to manufacture aircraft in India.

Soon after the war began in September 1939, Walchand entered into discussions with an American aircraft conglomerate and offered to build military aircraft for the Indian government according to specifications. New Delhi’s response was shot through with scepticism. Only a year later, when imports were no longer reliable, did the Indian government take up Walchand’s offer. Then too, the government’s unwillingness to support the venture led Walchand to turn to the princely state of Mysore, which agreed to provide land near Bengaluru as well as concessionary loans. On December 23, 1940, the Hindustan Aircraft Company came into existence. The government placed orders for 74 long-range bombers, 48 fighter planes and 30 trainers. By the end of August 1941, the first trainer was handed over to the military. Other aircraft too began to be turned out on schedule. In early 1942, following Japan’s entry into the war, the Indian government decided to take direct control of the company. Much against his wishes, Walchand was arm-twisted into divesting his stake. The plant was handed over to the U.S. Army Air Forces, which used it as a repair and overhaul facility for the remainder of the war. Thereafter, it reverted to the control of the Indian government.

Long road ahead



The HAL has now come to symbolise the stranglehold that the PSUs have on our defence industrial base. The Prime Minister’s decision to give a fillip to the private sector is laudable and overdue. Some initial moves have already been made. The cap on foreign direct investment (FDI) in defence has been raised from 26 per cent to 49 per cent. Investment from foreign institutional investors (FIIs) has been allowed up to 24 per cent. It is no longer mandatory to have a single Indian investor with at least 51 per cent stake. Industrial licences have been dispensed with for some items. Yet, much more needs to be done if our domestic production and private sector participation are to approach anything close to the levels envisaged by the government.

“To create a ‘level playing field’, the government will have to provide other incentives for the private sector to participate in other sectors of the defence industrial base such as assembles, spare parts and components. ”

For a start, the categorisation under the Defence Procurement Procedure needs to be considered afresh. While increasing focus on “Make” and “Buy & Make (Indian)” is important, it will not automatically harness private sector participation. In the latter category, for instance, Requests for Proposal (RFP) have been circulated to foreign manufacturers with the condition that they choose an Indian partner. Yet, Indian companies, including the private sector, that have the requisite capability have not been considered for the RFPs apparently owing to their lack of experience in delivery. This begs the question of how the Indian private sector is expected to acquire experience in the first instance.

A related problem is the use of direct or indirect nomination of defence PSUs or ordnance factories. This too loads the dice against the private sector. The government should do away with this practice: all contracts should be opened up for bidding. The government should also take on board a suggestion made by the Kelkar Committee almost 10 years ago. This is to identify certain firms based on their technical, managerial and financial strength as “champions” (“Raksha Udyog Ratna”) and circulate RFPs for major systems to these firms.

This model has worked well in other countries. In fact, a committee constituted by the government identified 13 Indian firms that could be designated along these lines. But eventually the government baulked at the idea of being seen as favouring some private companies over others. This is a misapprehension, for only a few companies will in fact be capable of producing major systems. To create a “level playing field”, the government will have to provide other incentives for the private sector — especially small and medium enterprises — to participate in other segments of the defence industrial base such as assembles, spare parts and components.

More broadly, the regulatory regime for private sector participation in defence production needs a host of changes: total elimination of licensing; removal of the differential and regressive tax and duties treatment for Indian private industry vis-à-vis the defence PSUs and foreign manufacturers; easing the availability of capital, land and infrastructure; and ensuring better planning and strict implementation of offsets. These measures (and more) have been underscored by the various committees that have gone into these questions. The government is evidently seized of their importance. It should now work systematically to bring about these changes.

For meaningful FDI



The larger challenge is to attract FDI with technology transfer. Increasing the FDI limit to 49 per cent is unlikely to be sufficient to ensure this. For a start, New Delhi may want to consider creative options to circumvent the problem of foreign producers being majority stakeholders. This could be done by ensuring that the control of the entity cannot be transferred without the concurrence of the Indian government. More importantly, the government must recognise that FDI in defence does not work as in most other sectors. The key difference is that most countries have export control laws that regulate the participation of defence manufacturers in ventures abroad. Strategic partnerships are therefore crucial to unlocking the doors for meaningful FDI in defence.

New Delhi will have to take some tough-minded calls on which relationships it wants to emphasise as far as defence production is concerned. For instance, the United States has the most advanced defence technology, yet is cagey about deals that involve substantial transfer of technology. The India-U.S. Defense Trade and Technology Initiative has been talked up quite a bit. But consider the four “pathfinder projects” for joint development and production announced during U.S. President Barack Obama’s recent visit: next generation Raven Unmanned Aerial Vehicles; intelligence and reconnaissance modules for C-130J aircraft; mobile electric hybrid power sources; and chemical-biological warfare kit for soldiers. The Americans evidently feel that Indian companies do not have the capacity to absorb higher levels of technology. In any event, these projects are trivial when compared to the joint development projects undertaken by India with Russia: a supersonic cruise missile and a fifth-generation fighter aircraft.

The management of strategic partnerships abroad is as important as recasting the regulatory framework at home. If defence production is indeed at the heart of “Make in India” — a policy that in turn is central to Mr. Modi’s plans for the economy — then the government has to focus on integrating its efforts at both ends. Facile hopes on either front will be a recipe for frustration.

(Srinath Raghavan is Senior Fellow at Centre for Policy Research, New Delhi.)