Defence: New FDI norms will aid indigenisation

In the third week of June 2016, the government tweaked the norms for FDI in the defence sector to encourage multi-national corporations (MNCs) to invest in the production of weapons systems and defence equipment in India through joint ventures (JVs) with Indian companies. 

Earlier, in July 2014, the government had permitted FDI in the defence sector up to 49% without prior approval — known as the automatic route — and beyond 49% after prior approval, provided the MNC brought in or agreed to transfer state-of-the-art defence technology. This requirement has now been relaxed to permit FDI beyond 49% even if modern technology is transferred. The government has also brought the manufacture of small arms and ammunition under the FDI in defence rules. Together, both these moves are expected to encourage the manufacture of weapons systems and defence equipment in India.

No country that is not substantially self-reliant in defence production can aspire to become a dominant military power in its region and, in due course, on the world stage. Make in India is a key feature of the NDA government’s policy for economic development. It was realised by the Modi government that it is necessary to undertake major reform of its defence procurement policies to promote indigenisation. Failing transformational changes, the import content of defence acquisitions will continue to remain between 70 and 80%.

Modernisation and upgradation

Plans for military modernisation must simultaneously lead to a transformative upgradation in the defence technology base and manufacturing prowess, or else, defence procurement will remain mired in disadvantageous buyer-seller, patron-client relationships like that with the erstwhile Soviet Union and now Russia. While India has been manufacturing Russian fighter aircraft, tanks and other equipment under licence for long, the Russians never actually transferred technology to India. New weapons acquisitions must take place with a transfer of technology (ToT) clause being built into the contract, even if it means having to pay a higher price.

The government continues to retain its monopoly on research and development and defence production through the DRDO, the ordnance factories and the defence PSUs (DPSUs). Though the Defence Procurement Procedure (DPP) was amended in March 2016, to reflect the new thinking on making and buying Indian, the changes were not far reaching enough and the process still favours the defence PSUs over the private sector. 

No country will give India strategic technologies, such as nuclear warhead and ballistic missile technologies, know-how on building nuclear-powered submarines and ballistic missile defence (BMD) technology. It will remain the responsibility of the DRDO to conduct original R&D into strategic technologies. For the development of hi-tech weapons platforms like fighter-bomber aircraft and sophisticated defence equipment like over-the-horizon (OTH) radars, there should be no need to reinvent the wheel. These should be developed jointly in conjunction with India’s strategic partners by forming JVs with defence MNCs that are willing to transfer modern technology.

Prioritise privatisation

The privatisation of most of the ordnance factories and some of the defence PSUs should be considered on priority. The private sector has shown its readiness and technological proficiency to take up the production of weapons and equipment designed and developed by the DRDO and must be trusted to deliver.

Though FDI in defence manufacture has been increased from 26 to 49% through the automatic route, this is not considered attractive enough by defence MNCs as it is 74% for many non-defence sectors. Given the time and effort that goes into locating a joint venture partner, the risks involved and the fact that they are expected to bring in proprietary technology, the MNCs prefer to have a controlling stake. In FY 2015-16, FDI in the defence sector was limited to Rs 64 lakh. 

Streamlining the procedures

Just like the government had not defined state-of-the-art technology in specific terms, it has not defined modern technology that would be eligible for FDI beyond 49% with prior approval. Broadly speaking, modern technology would be mature third-generation technology bordering on fourth generation — for example, Hellfire air-to-surface missiles and OTH radars. While exports of defence equipment have been permitted, the procedures for according the approvals that are necessary and the regulatory framework need to be streamlined.

The offsets policy has not worked to India’s advantage. The defence industry’s ability to absorb hi-tech offsets 50 or even 30% is limited at present. It may be more prudent to consider offsets only in cases where the benefits expected to accrue will outweigh the additional costs and Indian JV partners can absorb the technology that is brought in. In November 2015, the government restored ‘services’ as eligible offsets for defence contracts, opening up a business potential of over $3 billion in immediate projects. The government also added the development of software and engineering design to the list of eligible offsets, but limited it to 20% of the project cost. This will bring some relief to the maintenance, repair and overhaul (MRO) and software industries, as also companies involved in the upgradation of military systems and life extension projects of defence equipment. 

Defence Economic Zones

The government should examine the feasibility of establishing Defence Economic Zones (DEZs) to provide incentives for indigenous defence manufacture. There is an inescapable need to establish an Institute of Defence Acquisition under the Chiefs of Staff Committee. The US has a Defence Acquisition University where all officers nominated for posts dealing with defence procurement are trained. The ‘life cycle concept’ of evaluating defence equipment for acquisition was completely alien to the armed forces till very recently. 

Military modernisation has two major facets — the replacement of obsolete and obsolescent weapons and equipment with modern ones, which results in increasing combat effectiveness; and, the qualitative upgradation of combat capabilities through the acquisition and induction of force multipliers. As the defence budget is invariably much smaller than the requirement, military planners face a major dilemma — how to improve operational preparedness while simultaneously making concerted efforts to modernise. Logically, operational preparedness must take precedence over modernisation. The art of leadership lies in finding an optimum balance so that all efforts that are made to enhance operational preparedness also contribute substantively to modernisation.

As the largest importer of arms and equipment in the world, India has the advantage of buyers’ clout. This clout must be exploited fully to further India’s quest for self-sufficiency in the indigenous production of weapons and equipment.  In 10-15 years India must begin to acquire most of its defence equipment needs from Indian companies under the new category Buy (Indian Designed, Developed and Manufactured) introduced in DPP 2016. Only then will the era of self-reliance in defence acquisition truly dawn on the country. It will be a difficult quest, but not one that a great nation cannot realise.

(The writer is Distinguished Fellow, Institute for Defence Studies and Analyses (IDSA) and former Director, Centre for Land Warfare Studies (CLAWS), New Delhi)