Searching for the ideal FDI in defence production

Published: July 24, 2014

Surya Gangadharan

NAUTICAL MILES BEHIND: India is a world leader in ship design and building but is poor in electronics, sensors and naval weapons. Picture shows the indigenously developed warship INS Chennai in 2010. Photo: Vivek Bendre

Foreign vendors are more than willing to sell or collaborate but this does not necessarily bring state-of the-art technology to India’s military hardware

When Finance Minister Arun Jaitley kept the FDI cap in defence at 49 per cent, he said: “Our assessment of the market is that the 49 per cent FDI limit in the sector would be a significant step in establishing domestic defence market. The public opinion and Parliament’s opinion in India is ready to accept the proposal that I have made.”

Mr. Jaitley was also in consonance with the policy sentiment that has evolved within the government over many years. As far back as in 2004, key economists argued before the Planning Commission that 100 per cent FDI in high technology would enable India to reduce or limit its technology imports; in 2008, the National Manufacturing Competitiveness Council constituted by former Prime Minister Manmohan Singh had recommended FDI to facilitate technology transfer and enhance manufacturing in strategic sectors like aerospace; four years back, the Commerce Ministry had recommended 74 per cent FDI (a recommendation that remains despite the exit of the United Progressive Alliance government). But former Defence Minister A.K. Antony had vetoed this, deeming it “politically unwise.”

Opposition from industry

With elections in key States set to take place later this year, it would appear that Mr. Jaitley also preferred to play cautious. The chorus of opposition from key industry bodies like Confederation of Indian Industry (which supported a liberal FDI cap only to back down later), and Federation of Indian Chambers of Commerce and Industry would have helped Mr. Jaitley in his decision. FICCI, seen as the “embodiment of the 1960s era state protection”, warned that Indian industry would lose out, foreign companies would dominate the sensitive and highly strategic defence market, and no significant technology transfer would take place. It even brought out a laundry list detailing its views on defence FDI. It said a higher FDI should lead to full platforms being produced with minimum capitalisation of $100 million; the proprietary technology can be indigenised and further developed; the foreign partner will undertake to source 50 per cent to 70 per cent of components/subsystems by value from Indian vendors; the technology received should come without restrictions on its global exploitation and; no retrospective law should be applicable to restrict technology exploitation.

The list underscored the sad fact that when it comes to defence, India’s private and public sector industries lack technology, expertise and skills. India lags far behind the West, Japan, South Korea and Taiwan in the Technology Standing Index. A 2011 global study by the Martin Prosperity Institute of the University of Toronto measured 82 nations on technology, innovation, human capital and other measures of economic competitiveness, with the focus on Research and Development, scientific and research talent and innovation. Israel topped the list followed by Sweden, Finland, Japan and Switzerland. The U.S. figured sixth; India was 38. India placed 36 in terms of scientific and engineering researchers per capita and 26 in terms of patents per capita.

But the report card is not all that poor. Technologies such as composites or fly by wire have been painfully built up (owing to U.S. sanctions) over many years, entirely through indigenous effort in places like the Defence Research and Development Organisation.

Some technologies flowing from the Kaveri engine programme have been transferred to the private sector and these are being exported in the form of aerospace components. But the Kaveri engine itself failed to deliver the required thrust for the LCA Tejas fighter and had to be dropped, its place taken by the General Electric engine.

India is a world leader in ship design and building but is poor in electronics, sensors and naval weapons. To date, the Army lacks a carbine considered essential for close quarter battle. Trials are on to select, from among five foreign vendors, a suitable assault rifle. The Ordnance Factory Board is working on a “improved variant” of the three-decade-old Bofors howitzer. The list goes on.

Foreign vendors are more than willing to sell or collaborate. But a straight sale means India resorts to another import 20 years down the line when the equipment in question has become obsolete. Collaboration does not necessarily result in state-of-the-art technology coming to India. Foreign MNCs that have joint ventures in India are clear that the 49 per cent cap on FDI is “not unattractive.” Helicopter maker Sikorsky’s India head Air Vice Marshal (retd.) Arvind Walia said: “Forty nine per cent FDI is a welcome step but if it goes to 51 per cent and beyond, it will help build technologies here, train local talent and skills. Foreign vendors will bring in new business practices. Higher FDI limits will give us the flexibility to take a call and provide the best solution.”

Others admit it could bring in foreign firms that wish to take advantage of India’s lower cost labour base and of course, 49 per cent equity translates into a larger share of profits. Small and medium enterprises could benefit here as they are all looking to get into the global supply chain but lack capital and technology. The only point is this technology may not be of the high-end variety.

As a senior executive in a multinational defence major in India described it: “Foreign firms need to be in control since it is their technology, developed often at considerable cost, and therefore the need to protect their intellectual property. This is non-negotiable.”

The result is that the movement toward FDI has been slow and halting, with the Defence Ministry blamed for being reluctant to shake off old mindsets and attitudes. Security considerations also seemed to have weighed heavily on the government. Domestic private industry was allowed into defence only in 2001 when the realisation (finally) dawned on the government that the public sector, with its low levels of productivity and virtually no Research and Development vision, would not be able to deliver a self-sustaining military industrial base. There followed a slew of other measures.

In 2003, the Defence Procurement Procedure was amended to include the ‘Buy and Make’ category to allow Indian industry to build equipment through technology transfer; in 2006, an offsets policy was introduced in projects of Rs. 300 crore and above; in 2008, Indian industry was given first preference in licensed production contracts; in 2011, private shipyards were allowed to enter naval shipbuilding; in 2012, foreign vendors were encouraged to tie up with Indian small and medium enterprises.

Other steps followed. In 2013, Indian companies were given first preference in various categories of defence production. A Technology Perspective and Capability Road map was also unveiled to give Indian industry advance intimation of the military’s future requirements. Small and Medium Enterprises were targeted for financial help. Indigenisation directorates were set up by each of the three services to indigenise spare parts and small equipment.

Short of expectations

But results fell far short of expectations. Amit Cowshish, former Financial Adviser (Acquisitions) in the Defence Ministry, wrote recently: “The policy for providing assistance to the small and medium enterprises was drafted by the Department of Defence Production sometime in 2006 or 2007, but it was never promulgated. Consequently, no allocation was ever made under the aforesaid budget head since it was created. The Directorates of Indigenisation continue to function independent of each other and without linkage with the overall indigenisation effort. Suggestions to introduce outcome budgeting for these directorates were treated within the MoD with total indifference.”

The end result was confusion, and, of course, no progress in procurement. It has led some industry insiders to suggest that India scrap the DPP and return to the “good old days” when all deals were government-to-government. At least it ensured the services got the equipment they wanted in the desired time frame. That would be wishful thinking but the last word on FDI in defence is still awaited. Mr. Jaitley said “If I can get technology, capital and manufacturing at 51 per cent Indian ownership.” That’s the challenge.

(Surya Gangadharan is chief editor, Defence and Technology Magazine and a strategic affairs commentator.)

Printable version | Jul 24, 2014 6:52:17 AM | http://www.thehindu.com/opinion/op-ed/searching-for-the-ideal-fdi-in-defence-production/article6242496.ece