Prime Minister Narendra Modi launched his government’s flagship Make in India programme last year, with defence manufacturing identified as a priority sector. This is not the first conversation about Make in India in defence. It took place in colonial India as well, just before the outbreak of the Second World War. The Commander-in-Chief in India appointed a committee under Major General Claude Auchinleck to consider the modernization, composition and redistribution of the Indian Army in light of the emerging international situation. This modernization committee, which submitted its report on 10 November 1938, recommended that India should be as self-supporting as possible in the matter of armaments. It also laid down plans for the reorganization and expansion of ordnance factories and ammunition depots to ensure proper supply of military equipment.

This plan for modernization was given a concrete shape by the Expert Committee on the Defence of India, 1939-1941, which was headed by Lord Chatfield, Admiral of the Fleet. Noting the complete absence of an armaments industry in India, the committee observed that there was a good potential for it. It also considered enlisting private enterprises for production and short-listed Tata Steel, but came to the conclusion that it would not be economical for Tata Steel to set up special plants for the manufacture of steel for military requirements. After detailed deliberations, it arrived at the same conclusion about other private industries – that the scheme was not practical for existing Indian industry and would be an uneconomical proposition for them.

Notwithstanding the final outcome, it is significant that the Chatfield Committee considered this approach. It established the principle that if the private industry is to be involved in defence production, it must be a profitable venture for them. Thus, the scales of production, continuity of supply, and a reasonable pricing policy for defence products would need to be facilitated by the government.

Another fact established by the Chatfield Committee was the close linkage of India’s defence modernization to self-sufficiency in defence production within India. This linkage was eventually lost sight of in independent India, as defence modernization became a euphemism for imports from foreign suppliers.

 

At the peak of the Second World War, Chatfield and post-Chatfield plans were found to be inadequate for producing armaments and in 1939, the British government sent a new mission under Sir Alexander Roger to India. The recommendations of the Roger Mission, also called the Eastern Group Plans, were accepted for implementation in April 1941. Unlike the Chatfield programme which focused on armament production in government ordnance factories, the Roger Mission recommended pooling and harnessing the total production capacity of the country, including railway workshops and leading civil engineering firms and plants.

But those lessons were forgotten in the post-independence industrial policy, which kept the production of defence items in the Reserve List, which could only be manufactured by the public sector. What emerged was a defence-industrial base in the public sector, which today has nine Defence Public Sector Undertakings (DPSUs) and 39 Ordnance Factories (OFs).

The monopoly of DPSUs and OFs over defence manufacturing was broken in 2001, with 100% private sector participation and 26% Foreign Direct Investment (FDI) being permitted by the government. The FDI limit has since been increased to 49%, with greater FDI permissible on a case to case basis. Thereafter, the Defence Procurement Procedure (DPP) was formulated – and has been revised regularly – for higher self-reliance in critical technology. It included an offsets policy, which seeks to leverage big arms’ acquisition to bring in state of the art technology, and long-term partnership with Original Equipment Manufacturers (OEMs).

Various expert committee reports – Kelkar Committee and Ravindra Gupta Committee, among others – have recommended a level playing field for the private sector, but to little avail. These reports have also emphasized self-reliance in defence supplies. In 1995, a committee under A.P.J. Abdul Kalam, then Scientific Advisor to the Defence Minister, had recommended that India should increase its indigenization content from 30% to 70% by 2005. Despite many well intentioned plans, the self-reliance index of defence acquisition is still at around 35 per cent. Even when defence products are manufactured domestically, there is a large import component at both system and sub-system levels.

 

Among the top 10 countries in the world in terms of military expenditure, India allocates 1.73% of its Gross Domestic Product towards defence spending. Approximately 40 per cent of the defence budget is allocated for capital acquisitions, half of which goes towards imports from foreign suppliers. The defence budget has itself grown from $11.8 billion in 2001 to $38.3 billion last year. In 2014, $9.2 billion from capital acquisitions went for capital liabilities, while $814 million was used for signing new contracts. The same figures this year are $10.75 billion and $914 million respectively.

Despite this sustained expenditure over the last decade, the equipment profile of the armed forces has reached an alarming stage. While the desirable equipment profile, as per the defence secretary’s testimony to the parliamentary standing committee this year, is 30:40:30 (30% state of the art, 40% current and 30% nearing obsolescence), experts estimate the current state of defence equipment to be 15:45:40.

 

Meanwhile, the Defence Acquisition Council (DAC), chaired by the defence minister, has approved procurement of defence equipment for more than $26 billion. A simple modelling of 35 major projects cleared by DAC, along with their likely dates of induction, from 2012 to 2023 shows that India will need $40 billion dollars for these purchases. This translates into a 7% increase in capital budget in real terms. When adjusted for an inflation rate of 6%, it comes to an annual increase of 13% in absolute terms. It should be noted that while the capital acquisition budget has increased in absolute terms in the last few years, it has hardly seen any increase in real terms.

The current resource allocation is not sufficient to modernize the equipment profile of the armed forces. As established by the Chatfield Committee, self-sufficiency in defence production is directly linked to defence modernization. Unless the government can find additional resources for capital acquisition, indigenization in defence – and consequently, Make in India in defence – cannot be kick-started in the immediate future.

Defence production needs heavy investment over a long period so as to bring in modern technologies with low economies of scale. Unlike other sectors, defence industry is a monopsony in which the single buyer, the government, is also the authority laying down procurement policies. This makes active government support essential for private defence manufacturers, a fact borne out by the experience of countries – United States, Israel, Brazil and France – where private defence industry has flourished.

The Indian government will thus have to actively support the creation of a private defence industrial base to Make in India. It will require a change in mindset from the government in terms of partnering with these companies for long-term programmes required by our defence forces. The government will have to fund research and development (R&D), provide a low interest regime to reduce capital costs, provision specific tax benefits, assure consistent sectoral policies, place firm orders and encourage exports to achieve economies of scale.

Most of these suggestions form part of the deliberations of an expert committee chaired by Dhirendra Singh, which submitted its report on amendments to DPP-2013 to the defence minister in August. Of the 43 recommendations made by the committee, 15 directly pertain to ‘Make in India’ while the balance concern the DPP. Many of the DPP recommendations also have a direct impact on indigenous defence production. Thus the action taken by the government on the Dhirendra Singh Committee report will, to a great extent, determine the future trajectory of Make in India in defence.

 

In the last 15 years, the defence sector has often been identified as one with immense possibilities: for attracting investment, setting up manufacturing, obtaining high-end technologies, and for generating employment. Coupled with India’s requirement of military platforms, it has had a very high potential to attract investors. But the level of domestic and foreign investment has never matched the potential. While the broad policies enabling private investment have been put in place, a large number of specific policies – and their interpretation and implementation – have acted as deterrent to investment.

 

The first project awarded for development to the private sector under the Make scheme in 2011-12 was the Tactical Communication System for the army. A consortium of L&T, HCL and Tata Power System had to bear 20% of development costs while government was to pitch in with the rest. As per industry sources, this was supposed to be the first Make in India project in defence scheduled to be announced last year, but has not progressed due to a deadlock over interpretation of the DPP. The consortium wants the cost of capital to be included in reimbursement while the government is still considering the issue.

Similar is the case of implementation of offsets. A request was made last November to the prime minister by Boeing’s global CEO for certain changes in the defence offset policy. Despite being monitored at the highest levels, it took nearly nine months before the defence ministry notified two of the seven suggested changes. The problems faced by foreign defence manufacturers are being replicated with Indian companies too. The lack of urgency in taking decisions, and the confusion in interpretation and implementation, tends to negate the benefits of an offset policy and India’s advantage in low cost manufacturing and skilled manpower.

For government policies to create synergies, it is essential that the government creates capacity for defence acquisition and manufacturing. While the Pentagon has 12,000 cost engineers on its rolls, India’s defence ministry has none. The structure and the organization of the defence ministry, particularly the department of defence production, which is responsible for DPSUs and OFs, puts private sector at a disadvantage. If form has to follow function, the defence ministry will have to be restructured to promote private players, and promote Make in India in defence.

The Dhirendra Singh Committee has also noted that the ‘time is ripe for a second set of reforms’ in defence procurement. The existing structure has neither the mandate nor the expertise to further the interest of the local industry, which will play a major role in Make in India. The committee has proposed a specialized organization, physically separate from the defence ministry, and manned by trained people with longer tenures, to undertake this activity. Good intent and the proposed changes in policy and DPP will lead to nought unless the government changes the system, the processes and approach of the defence ministry.

 

The private defence manufacturers in India are not without blame either. Instead of working on the delivery process, they have been focused on levelling the bidding process with DPSUs. Furthermore, despite the implementation of offsets policy, their capability in terms of value addition and creating self-reliance in critical technology has been limited. The transfer of technology route via offsets or otherwise has provided the private industry with the ‘know-how’ without providing the ‘know why’. The situation in defence PSUs is no better. They are equally dependent on the original licensors for any upgradation or system integration, Su-30 aircraft being an example of dependency on the Russians. In contrast, when Japan started its journey on the path of phenomenal growth in the 1950s, it had a highly skilled workforce which absorbed and adopted technology from the US. Japan’s success in electronics and automobiles is a testimony to its ability to harness commercial success through dual-use technology.

With the role of information technology (IT) gaining more importance in defence, the proportion of value in modern military platforms is increasingly skewed towards embedded software and IT systems. The private Indian defence industry has an opportunity to leverage India’s globally acknowledged IT expertise to occupy a high value niche. While the Indian defence industry takes time to catch up with the international industry in producing military hardware, it could start on a better platform by focusing on software and related IT technologies.

 

Since the announcement of Make in India, a number of leading industrial houses have started or enhanced the defence manufacturing divisions in their companies. It will require long-term commitment from these groups to sustain investments in their defence arms. Without these investments, the private producers will fail to create capabilities that stretch their technical, operational and research capabilities. Once such capabilities have been acquired by these firms, global OEMs will also start finding them an attractive partner.

The success of Make in India in defence will depend on how these large private companies build their capabilities, whether through global partnerships, technology transfers or even fundamental R&D programmes. For this to happen, these private firms will have to focus on their ability to work with global OEMs and government. This will require a capable leadership and a radically new approach from private defence manufacturers, which has hitherto been missing.

 

A significant objective of Make in India is to develop export capabilities in the defence sector. This is necessary to build economies of scale and to become globally competitive. India currently exports $80 million worth of defence products annually, which if increased five times would equal 10% of India’s annual defence budget. In comparison, Israel exports defence items worth nearly 45% of its annual defence budget; similar figures for major European countries are 25-30%. The US, which has the highest defence budget in the world, also exports defence products worth nearly 8% of its budget.

In order to meet this modest objective of exports, India needs an ecosystem that facilitates building a domestic defence industrial base. For that, besides providing incentives for exports, government will also have to simplify policy and make synergistic, constructive and proactive interpretations in policy implementation.

India can emulate the Chinese example in this case. When the Chinese economic reform started in the late 1970s, Deng Xiaoping realized that the Chinese defence industry was a ‘golden rice bowl’ – rich, yet asking for more resources. The Chinese undertook radical reforms, which followed the strategy of ‘import, innovate and export’. It was realistic in its ambitions to use imported engines for its fighter jets, while working on developing its own. JF-17 fighter jets are now in service with Pakistan Air Force while the Indian Tejas has yet to become operational.

India can also learn from the Chinese how to consolidate its future requirements and demand that global OEMs set up complete assembly lines for those critical platforms. China consolidated its future demand for commercial aircraft – as a quid pro quo – and convinced Airbus to establish an A320 assembly plant in Tianjin. A facility for components of the A350 aircraft at Harbin and an A330 completion centre is now planned in Tianjin.

To emulate China, India’s armed forces will have to identify a dozen technologies critical to their future plans for modernization. In suggesting the strategic partnership model, the Dhirendra Singh Committee has identified six sectors in which strategic partners from the private sector can be identified. Aircraft: fighter, transport and helicopter and their major systems; Warships of stated displacements, and submarines and their major systems; Armoured fighting vehicles and their major systems; Complex weapons which rely on guidance systems to achieve precision hits, which may include anti-ship, air defence, air-to-air, air-to-surface, anti-submarine, land attack; Command, control, communication and computers, intelligence, surveillance, target acquisition and reconnaissance; Critical materials (tita-nium alloys, aluminium alloys, carbon composites, nickel/cobalt alloys etc.).

While India acquires these technologies as part of Make in India, the rest of the defence requirements can be procured from global OEMs. The proof of Chinese success lies in the fact that it was the fifth-largest arms exporter by 1987, but in 2014 it had become the third-largest defence exporter globally.

 

Emulating the Chinese model will necessitate creation of half a dozen defence and aerospace manufacturing hubs across India, where government can attract top players by providing adequate tax holidays. Simultaneously, the government can establish a Defence Industry Promotion Fund for seed-funding of MSMEs, which will be plugged into these prime suppliers and Tier-1 manufacturers. In these hubs, the defence sector can then interface with other civilian sectors in areas such as aerospace and shipbuilding, where there is considerable civilian and military convergence, and a growing market. This civilian interface will nullify the problem of a long gestation period before results of indigenization start showing in the defence sector.

India accounted for 7% of Israeli defence firm Rafael’s global orders in 2014. Speaking at an international seminar recently, Uzi Melamed, Corporate Offset and Industrial Cooperation Director, Rafael said that, ‘How to "Make in India" remains a big challenge.’ The Israeli official also added that ‘India is the most difficult to do business, which is not in favour of India or Indian industry.’

This encapsulates the biggest challenge facing India. Make in India in defence cannot be a policy but an outcome of creating a multidimensional ecosystem. In a nutshell, India thus needs a bold three-pronged approach: abolish monopolies of DPSUs and OFs, promote Indian private sector, and ease the entry of global OEMs. This is an opportunity to lay the foundation of a strong defence industry. If the challenge is accepted by all stakeholders – private sector, investors, public sector, international companies, armed forces and the government – then only will Make in India in defence become a reality.

 

References:

Amiya Kumar Ghosh, India’s Defence Budget and Expenditure Management in a Wider Context. Lancer Publishers, Delhi, 1996.

Dhirendra Singh et al., Report of the Committee of Experts for Amendment to DPP-2013, including formulation of policy framework. Ministry of Defence, GoI, Delhi, July 2015.

ASSOCHAM and PwC India, Self-reliance in Defence Production: The Unfinished Agenda, 2014.

S.N. Mishra, ‘Make in India: Challenges Before Defence Manufacturing’, Indian Defence Review 30(1), January-March 2015.