The Indian defence sector at crossroads: Will the Budget 2015-16 take notice and act?

Inaugurating the 10th edition of the Aero India show on February 18, 2015, Prime Minister Narendra Modi said that India would emerge as a major global center for the defence industry. The occasion and the looming budget for the next fiscal year provides us with an opportunity to reflect on the current status and priorities in the Indian defence sector.

When one considers any defence industrial complex, there are a few major features that we would need to identify as salient. The goals of a typical defence industrial complex would include the following:

(a) The manufacture, procurement and induction of high quality weapons systems commensurate with the degree of risk that exists locally, regionally and globally;
(b) Ensuring the highest degree of self reliance so that national security is never compromised by having to rely on external forces;
(c) Ensuring that we are able to procure all our weapons that are needed at a relatively low cost so that a country at the level of development as India is able to satisfactorily carry out its self-defense duties; and
(d) Once domestic needs are met – to expand globally and look for markets for Indian weapons elsewhere.

While these are in general the goals of any national defence sector policy – in reality we have not been able to satisfactorily achieve and manage even a few of these goals. Indeed, even the government website marketing the “Make In India” campaign (http://makeinindia.gov.in/sector/defence-manufacturing/) itself acknowledges this reality. On its website – it acknowledges this reality and lists the opportunities that the Indian defence sector currently provides:

• India’s current requirements on defence are catered to largely by imports (nearly 60%). The opening of the strategic defence sector for private sector participation will help foreign original equipment manufacturers to enter into strategic partnerships with Indian companies and leverage the domestic markets and also aim at global business. Besides helping build domestic capabilities, this will bolster exports in the long term.
• Opportunities to avail defence offset obligations to the tune of approximately Rs 250 Billion during the next 7-8 years.
• The offset policy (which stipulates the mandatory offset requirement of a minimum 30% for procurement of defence equipment in excess of Rs 3 Billion) introduced in the capital purchase agreements with foreign defence players would ensure that an eco-system of suppliers is built domestically.

It is certainly worthwhile (and instructive) to consider the fate of the one of the most promising policies undertaken by the Indian state (and defence ministry) to achieve some of these important objectives in previous years. A policy related to offsets was first articulated in explicit terms in 2005. A 2013 official document provides us with a good understanding of this concept: “The key objective of the Defence Offset Policy is to leverage capital acquisitions to develop Indian defence industry by (i) fostering development of internationally competitive enterprises, (ii) augmenting capacity for Research, Design and Development related to defence products and services and (iii) encouraging development of synergistic sectors like civil aerospace and internal security.”

The way that the policy worked was this: It dealt with acquisition contracts as two types:

(a) ‘Buy (Global)’ - which meant that the total purchase was from foreign or / and Indian seller; and
(b) ‘Buy and Make with Transfer of Technology’- which meant that the acquisition was from a foreign seller and was to followed by Licensed Production.

The ‘compensation’ or offset had to be 30% of the estimated cost of the acquisition under the ’Buy (Global)’ type of acquisition and 30% of the foreign exchange component under the ‘Buy and Make with Transfer of Technology’.

Even though the policy itself was envisioned with noble aims it was never fully realised. One of the reasons for its failure was also because the Indian private defence industrial sector is very weak a largely not capable of implementing sophisticated technologies. Of course, it is difficult to expect otherwise from a private sector that has largely never supplied anything to the Indian defence sector in the past.

PM Modi mentioned a number of measures during his Bangalore speech on Febrary 18, 2015 that seek to address several of these concerns. In particular, these include:

• Aim to reduce India’s defence imports by at least 20%-25% by using domestic production instead (so that 1,00,000 jobs can generated in India);
• Significant reforms to the offsets policy so that the policy can focus not on low-end products but state-of-the-art core and priority technologies;
• Up to 80% of state-funding for defence prototype design and development;
• Launch of a Technology Development Fund

Modi may well have said in his speech today that India would be a global centre of the defence industry. But surely, as we have now come to appreciate - it must not be as merely a consuming, importing nation, but also as one that has a robust domestic defence industrial sector(fulfilling domestic defence needs) and becomes a significant exporter of defence equipment. We will need to wait to see how many of these specific objectives are taken forward in the upcoming Budget for the next fiscal year.