Column: An ideal hunting ground

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Updated: November 21, 2014 8:47 AM

Global defence majors can rake in a lot of moolah without really investing in India

Global defence OEMs look at India with glee. While their own economies are stagnating and defence orders are being cut, India, with its superpower ambitions, growing economy and belligerent nuclear-armed neighbours, provides a perpetual market.

Lack of a strong indigenous defence industry, resistance from the Defence Research & Development Organisation (DRDO) and defence PSUs (DPSUs), and the disproportionate influence of the ‘Bombay Club’ make India an ideal playground. It saves global players the pain of setting up factories in India at the cost of local jobs and political backlash in their own countries. For urgent requirements, the Indian government would anyway import defence equipment from them through the government-to-government route.

Under the defence offset rules, global OEMs are mandated to outsource a certain percentage of their contract value to Indian industry. Most of the components sourced from the Indian offset partners are what they are anyway good at, so there is no transfer of sensitive technologies. Indian partners simply ‘build as per design’ than ‘design and build as per user requirements’. Since civil aerospace also qualifies for defence offsets, some global players meet their offset obligations by sourcing aircraft doors and floor beams from India. Life is good!

Bold reforms needed

The ‘Make in India’ program in defence will have to be facilitated by the way of bold reforms in policy, procedures and our approach towards global investors. The misplaced bravado of ‘where else will they go’ has to go. India dropping by two ranks, to 142 out of 189 countries, in the World Bank’s latest Ease of Doing Business index doesn’t echo very well in global boardrooms.

The NDA government proposed 49%, 74% and 100% FDI slabs within days of assuming office. The Bombay Club, ably supported by leading industry bodies managed to pressurise it into limiting it to 49%. However, a 49% cap is no different from a 26% one, technically; hence, the opening up of FDI remains a non-starter.

In the case of state of the art technologies (SOAT), 100% FDI has been allowed. But there are no norms laid down on what qualifies as ‘state of the art’. Most OEMs that we spoke to feel that this ‘case-by-case’ approach may create interpretation issues, delays, misuse and legal disputes. No one wants to be the first one in and face undue attacks from competitors, cynics and the media. Therefore, SOAT will not float.

The Indian Air Force’s much-awaited $3 billion Avro replacement programme elicited only a single bid. It was believed that global players may be comfortable with 49% stake in a non-sensitive transport aircraft and may allocate higher work-share to their Indian partner. Not so, apparently.

Five months after the government increased the FDI limit, not a penny has been actually invested in India’s defence industry, while imports worth billions of dollars continue unabated. The situation may be worse with procurement programmes involving sensitive technologies like missiles, drones, stealth and non-conventional warfare. These have been developed by global OEMs over several decades, after investing billions of dollars. It is a fallacy to think that these can be handed over to India without majority control.
Demolish the iron curtain

A key reason behind India’s dubious distinction as the world’s largest importer of defence equipment is the near sidelining of India’s private sector. The DRDO needs to learn from its US counterpart, the Defense Advanced Research Projects Agency (DARPA) which is led by Delhi-born US scientist Dr Arati Prabhakar. The DARPA employs just 140 technical professionals and has no labs. Its entire research and development is handled by the US defence industry, universities, government laboratories and individuals. In stark contrast, the DRDO has 52 laboratories, over 30,000 technical staff and not much to show in return.

The armed forces in the US and the EU almost entirely depend on the private sector for their equipment. We need to jettison the old Indian fallacy that only government-owned entities in India are trustworthy.

Top decision-makers in India’s ministry of defence (MoD) may have administrative experience and high integrity, but their knowledge of defence matters is limited and is developed on-the-job. Their approach towards industry and academia is dismissive. This needs to change.

Ownership and control

The term ‘ownership and control’ gets disproportionate importance in India. We have zero ownership and control over the global OEMs from whom we import fully-built aircraft, guns and missiles. But if the same OEM wishes to assemble the equipment on Indian territory, albeit through a subsidiary it controls, we get fidgety. Real control comes not from Indian ownership, but from time-tested conditions like mandatory local-staffing (say, about 90-100%), local value addition (say, at least 20%), export controls, walk-in rights, exit restrictions, etc.

Ten years from now, some Indians working in such companies may move out to other Indian companies or become entrepreneurs widening our defence industrial base. We have seen that in sectors like auto, telecom, IT and pharma. Defence is no different.

We are proud of our armed forces. It is unfair to dump second-rate domestic equipment on them to support a distorted version of ‘self-reliance’. The range of emerging technologies is so complex that even the US has 100% subsidiaries of foreign defence OEMs like Airbus, BAE, Saab, Rolls Royce, etc. Competing with them improves the standard of the US defence companies and prevents complacency.

What India needs is a single FDI slab of 74% in defence with clear norms and a level-playing field. The 49% cap is of no use and 100% may be too one-sided. Higher FDI limit will also expose certain global OEMs that are not keen to invest in India, and are using 49% FDI as a convenient excuse to stay out. We also need to focus on key areas like land availability, uninterrupted power, logistics infrastructure, tax-relief and faster government clearances.

The NDA government today has the political mandate to bring in bold reforms. Making India an attractive destination for global OEMs is key to India’s long term self-reliance. The DRDO and DPSUs need a rude shake-up. The entry of Indian OEMs into the defence sector should be facilitated through fiscal and monetary incentives. The defence ministry needs to interact more with industry and academia, and heed contrarian opinions.

Twenty years from now, when we develop the capability to design and manufacture best-in-class fighter jets, submarines, missiles and UAVs, we can act all high and mighty. Now is not the time.

Assisted by S R Janakiraman, senior consultant, Aerospace and Defence, KPMG in India

The author is Partner and India Head of Aerospace and Defence, KPMG. Views are personal

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