Privatising defence production

Substituting local production for imports can help the economy

Sanjaya Baru

The union budget for 2000-01 had proposed a 47 per cent increase in the capital outlay for defence services, hiking it up from the budget estimate of Rs 12,229.68 crore in 1999-2000 to Rs 17,926.40 crore. While the defence ministry managed to spend only Rs 14,778.70 crore, in 2001-02 a 35 per cent hike was granted, taking the budgeted figure to Rs 19,958.52 crore. A good part of this has been and will continue to be spent abroad on the purchase of armaments and equipment, draining our foreign exchange reserves, adding to our import bill and, in the process, generating jobs and income abroad.

Imagine spending this entire money, or a large part of it, at home. The problem is we do not yet have a sizeable defence production industry capable of handling the orders being placed by the armed forces and adhering to their tight delivery schedules. The public sector defence production industry has its strengths in some areas but in large part it is still an essentially research and development (R&D) establishment incapable of handling commercial production at competitive scales of operation. Given the size of India’s defence procurement budget and the future needs of its armed forces, it is only natural that the domestic defence production industry must graduate from the stage of R&D-based production to commercial production for a world market so that enterprises with scale economies can be set up.

It is to enable Indian industry to move in this direction that the government has opened up the defence production sector to private corporate investment. Make no mistake, the private sector has been in defence production for a long time. There are many private companies, both in the large-scale and small-scale sector, supplying equipment and components to public sector defence production undertakings (defence PSUs).
Indeed, even foreign companies have been operating in defence-related industries supplying equipment to defence PSUs. There are also some instances of defence PSUs entering into joint ventures with foreign companies to manufacture at home equipment that was earlier imported from the parent company of the foreign partner. This is a perfectly natural development when imports constitute such an overwhelming part of defence procurement.

It is an appreciation of such facts that encouraged a team of retired defence officials of high rank and impeccable credentials to recommend to the government two years ago the opening up of defence production to private investment. It is worth quoting at length from a report prepared by this group for the Eleventh Finance Commission:

“The road ahead should be traversed by creating a climate of partnership between the Public and Private sectors in defence production. The Government, of course, will have to lead the way but the Industry will also have to take some risks when venturing into hi-tech areas, which may not show immediate gains. The Government on its part will have to do business in a different way. It will have to share the burden of Research and Development. Quality and timely completion of projects will have to be rewarded. Rules and Procedures would have to be simplified. Cost-cutting exercises should be attempted with the expertise of the industry. Standards would have to be reviewed and re-established. Payment procedures must be quickened. Modernisation of plant and machinery would have to be given priority. More than anything, the mindset of the Government would have to change. From a position of dictating with no accountability, the Government will have to learn to respect the industry. It will have to improve its decision making, process its cases faster and act as a facilitator rather than place obstacles in the path of development. It will have to evolve new methods of functioning. All agencies of the Government, namely the ministry of defence, Armed Forces, the Department of Defence Production, DRDO, DGQA, Defence PSUs and the Private Industry would have to work together in partnership.”

This perspective has informed government policy in the recent past. In fact the Confederation of Indian Industry (CII) has been acting as an important catalyst bringing defence PSUs, the armed forces and the private sector together to facilitate the entry of the private sector into defence production and to help defence PSUs and R&D organisation productionise on a commercial basis.

Several strategic-policy analysts with impeccable nationalist credentials have also been urging the government to open up defence production to private investment and have recommended “generous tax holidays and depreciation schemes to the private sector that enters into defence production.”

Given this background, it is surprising that an organisation like the Bharatiya Mazdoor Sangh (BMS), the trade-union wing of the ruling Bharatiya Janata Party, has opted for such a strident stance against private sector involvement in defence. Clearly, this is a trade-union response, like that of the Left parties, worried about rationalisation of work force in the over-staffed defence PSUs. The union’s view that the entry of the private sector into defence production is a threat to national security is ill-informed hocus-pocus.

From a macroeconomic and developmental perspective, the economy and the people will of course benefit most from a diversion of public money away from defence to investment in productive infrastructure. Public investment in housing, roads, irrigation, power, ports and inland waterways, urban renewal, schools and hospitals is a far better way of spending public money than buying an aircraft carrier from the Russians.

However, to the extent that the armed forces need modern equipment and ammunition, to the extent that our defences have to be modernised and technologically upgraded, a certain share of government finances, perhaps around one and a half per cent of national income (less than half the defence budget), will be devoted to defence procurement. The multiplier effects on national income will undoubtedly be more if the money is spent at home, with a mixed economy in defence production, rather than on imports.

Given the technological imperative and the need to outsource new technologies from global companies, opening up the defence sector to private investment can help access such technologies. Clearly, the government’s new policy on private investment in defence is in the interests of national security, industrial development and economic growth, rather than a threat to any of these.