Hundred Days of Governance: Drift in Defence Matters Continues

Hundred Days of Governance: Drift in Defence Matters Continues

(FORCE Oct 14)

Major General Mrinal Suman

A span of 100 days is too short a period for an objective appraisal of the performance of a government. However, initial indicators do reveal the direction in which the new dispensation plans to move and inter-se importance being assigned to various challenges facing the nation. Unfortunately, there is little to cheer the hearts of those who are concerned about the security of the nation. Worse, the new government has not been able to appoint a full time Defence Minister. The drift continues unabated.

The country was expecting Prime Minister Modi to initiate dynamic changes in the defence regime to make it more responsive to the emerging geo-strategic milieu, both in our immediate neighborhood and in the global arena. All hopes have been belied. Not a single measure has been initiated so far to rid India’s higher defence management of the incapacitating stranglehold of the bureaucracy – no Chief of Defence Staff, no integration of servicemen in the ministry, no institutionalised arrangement for the evolution of strategic policies, no joint commands and no reforms of public sector undertakings. It is business as usual.

Most observers attribute Modi’s neglect of defence matters to his past inexperience. He is more comfortable with the issues in which he excelled as a Chief Minister, and defence was not one of them. He is yet to demonstrate his ability to grasp the minutiae and intricacies of security imperatives. Leaving aside a few decisions to promote indigenous defence production, he has shown no concern for the issues that impact national security. As the subsequent discussion will show, the report card of the Modi government falls much short of promises and expectations. Some of the major issues have been discussed here.

Revisiting the Policy on Foreign Direct Investment

On 26 August 2014, the government raised the Foreign Direct Investment (FDI) limit in the defence sector from 26 per cent to 49 per cent through approval route, subsuming the 24 per cent cap for portfolio investment. Whereas the 49 per cent cap is a composite limit for all kinds of foreign investments, portfolio investment cannot exceed 24 per cent of the total equity of the investee or the joint venture company.

It was also declared that the Cabinet Committee on Security could allow FDI beyond 49 percent in proposals that entail infusion of ‘modern and state-of-the-art technology’. However, this provision appears to be a stratagem to silence critics who wanted higher FDI cap as no guidelines have been issued and no rules have been framed.

Although the policy initiative fell short of the expectations, it did show government’s intent to open the defence sector to foreign investments. It was also a tacit admission of the utter failure of the decade old policy of 26 percent cap. India received paltry USD 5 million of FDI inflow in defence manufacturing during the last decade.

FDI limit determines the degree of control a foreign partner can exercise over the joint venture.  It also indicates right to pass resolutions; both ordinary (passing of accounts, approving dividend levels and appointing directors) and special (buy back of shares, diversification and merger/amalgamation). Leaving aside a proportionate increase in the repatriable profits, there is little difference between FDI limits of 26 percent and 49 percent. A partner with 26 or 49 percent holding can stall passage of special resolutions but cannot block ordinary resolutions. In both the cases, effective control remains with the indigenous company and the foreign partner has no say in the day-to-day functioning.

Foreign vendors want FDI cap to be raised to 51 percent or more to enable them to exercise control over the joint venture.  In other words, raising of FDI limit from 26 to 49 percent is a half-baked measure whose effectiveness remains suspect as foreign manufacturers may be reluctant to share their technological expertise unless given effective control. Apparently, the government succumbed to the pressure of selfish entities and missed a rare opportunity to open the defence sector to foreign investment.

Promotion of Indigenous Production and Integration of the Private Sector

The Ministry of Defence (MoD) issued a global Request for Proposal (RFP) on 08 May 2013 to the manufacturers of transport aircraft for the procurement of transport aircraft to replace the ageing fleet of AVRO 748 aircraft. The proposal entailed procurement of 16 aircraft off-the-shelf from a foreign vendor and manufacture of 40 aircraft in India with complete transfer of technology to an Indian private sector entity (Indian Production Partner). Exclusion of Hindustan Aeronautics Ltd (HAL) from RFP was a deliberate decision as it is already overloaded with orders and is not in a position to accept additional work.

The programme was considered to be an ideal platform for the integration of the private sector and the development of alternate facilities for aerospace manufacture. Credit goes to Antony for such a dynamic decision and providing an opportunity to the private sector to prove its manufacturing prowess.

Threatened by the entry of the private sector into its monopolistic domain, HAL cleverly converted the above proposal into a private sector versus private sector duel. A sustained media campaign was undertaken to play up imaginary security concerns. The subterfuge proved effective and Antony failed to muster adequate courage to counter opposition. Submission dates were extended and the proposal was consigned to the cold storage.  

It goes to the credit of the Modi government that it has decided to revive the proposal, thereby demonstrating its resolve to co-opt the private sector in its quest to achieve self-reliance in defence production. It is a praiseworthy decision.  

Similarly, the government has refused to give in to the pressure exerted by the Cochin Shipyard Limited for permission to participate in the Rs 25,000 crore contract to construct four landing platform docks for the Navy. Sticking to the earlier decision, only private sector shipyards are being allowed to submit bids.

As per the reports appearing in the press, India is likely to change the mode of acquiring Naval Multi-Role Helicopters. Instead of buying fully built-up machines from abroad as planned earlier, tenders may be issued to Indian vendors for manufacture in India with foreign collaboration and technology transfer. It will be another major step to promote indigenous defence industry. In another landmark decision, import of artillery guns has been deferred. Instead, both the public and the private sectors have been invited to demonstrate performance of their locally-manufactured artillery guns.

The above initiatives are bold and path-breaking for the country. In case the indigenous companies, especially in the private sector, make a success of the opportunities, sky will be the limit for their participation in defence production.

Rationalisation of Policy on Blacklisting of Vendors

India’s defence procurement regime is known for its strange contradictions. On one hand, every major procurement contract gets mired in the allegations of wrongdoings, euphemistically known by the interesting taxonomy of ‘speed money’. On the other hand, the government tries to demonstrate ‘zero tolerance’ for corruption by blacklisting the involved vendors.

Interestingly, every act of blacklisting does more harm to the Indian security interests rather than the erring company’s commercial interests. As most major defence companies produce a large array of equipment, blacklisting in one contract has a cascading effect on all other purchases as well. Floating of tenders afresh entails major delays and cost overruns.

Under the contractual provisions of the procurement procedure, MoD can take a number of actions in case any vendor is proved to be guilty of violation of probity norms. However, jurisprudence demands that punishment be commensurate with the degree of misdemeanor. Therefore, it is a prerequisite to determine the seriousness of the alleged transgression and award punishment accordingly. In addition, before deciding on the quantum and nature of punitive action, likely fallout on India’s own interest must always be taken into account.

When the current government took over, three major foreign manufacturers were under close scrutiny for alleged transgressions – Finmeccanica, Israel Aircraft Industries and Rolls-Royce. Having suffered the adverse effects of banning Bofors, HDW and Denel, it was feared that their blacklisting would stall all the programmes in which the said companies were involved.

The new government seems to have realised the futility of acting in haste. On 26 Aug 2014, a well thought through order was issued in the case of Finmeccanica. The government decided not to impose a blanket ban on Finmeccanica and its subsidiaries but opted for a graduated-cum-selective approach, thereby safeguarding India’s interests.

All on-going contracts with Finmeccanica will be allowed to continue. Contracts in which the Finmeccanica companies are sub-contractors will also remain unaffected. Cases in which Finmeccanica has emerged as the lowest bidder (but contract not signed) will be put on hold till further orders. However, all Finmeccanica firms stand debarred from participating in any new defence tender where more than one vendor exists outside the group.

The new government deserves credit for realising that blacklisting is a serious matter and should always be the last option. The objective of the punitive action should be to send a strong message that imposes caution on the environment and acts as a deterrent to the delinquent elements.

Continuance of Bureaucratic Stranglehold

It was hoped that Modi would be able to initiate wide ranging changes to improve India’s combat and strategic prowess. Much to the disenchantment of the security experts, the government has singularly failed to initiate any reforms in the functioning of MoD. Not a single step has been taken in that direction. The new political leadership appears to have no control whatsoever. The bureaucracy continues to rule supreme through its vice-like grip to ensure status-quo.

Modi has failed to tame the obdurate bureaucracy. In early June, well after the swearing-in of the Modi government, bureaucrats filed an affidavit in the Supreme Court castigating a member of the cabinet for his allegedly ‘illegal and extraneous decision’. It was the first ever occasion in the Indian history that the government indicted its own minister in a court of law with obnoxious expletives. It is apparent that the bureaucrats did not consider it necessary to consult the Defence Minister.

Despite loud declarations by the ruling party of its empathy for the soldiers, MoD continues to file cases against all judicial verdicts that go in favour of soldiers, ex-soldiers, war-widows, soldiers’ families and even war casualties. India must be the only country in the world where the government fights legal battles against the soldiers whose welfare is its prime responsibility. What a dubious distinction! The political leadership remains a powerless spectator as bureaucracy rules the roost.

Soldiers Feel Letdown

Over the last two decades, the growing adversarial relationship between the government and the soldiers (including ex-servicemen) has been a matter of grave concern for all those who are concerned about the morale of the Indian military. Of late, an impression has been gaining ground that the government has become apathetic towards the soldiers. As military is an instrument of the government, it defies logic that a government lets itself be seen as an adversary of its own constituent, thereby denting the morale of the services.

Modi came as a ray of hope for the soldiers. En-block support extended by 50 lakh strong military community and their family members was a major factor in the unprecedented victory of his party. Soldiers expected Modi to deliver on his promises. Unfortunately, he has frittered away all the goodwill and support that he had garnered by assiduously cultivating the soldiers and ex-soldiers. Even the die-hard opponents of BJP had never expected such a short honeymoon.

The way a government cares for its ex-servicemen has a profound effect on the morale of the serving soldiers. Shabby and apathetic treatment meted out to ex-servicemen by an ungrateful government can never motivate a soldier as he sees himself as an ex-serviceman of the future. He starts entertaining doubts about government’s sincerity in fulfilling its commitments to him after superannuation.

Grant of OROP was considered to be the litmus test of Modi’s sincerity in fulfilling pre-election promises. Modi promised OROP and not sham-OROP, whose definition is being reinvented by the bureaucrats. To almost all soldiers, both serving and retired, it is a breach of faith – a promise broken and a ‘great betrayal’. They feel let down. Modi will do well to remember that credibility once lost is difficult to redeem. BJP will rue its ill-advised act of neglecting soldiers and reneging on its promises.

Finally

Modi surprised all by giving the additional charge of the defence ministry to Finance Minister Jetley. His decision can be faulted on three grounds. One, Jetley has little time to spare for the defence ministry. As he cannot study matters in depth, he has to give decisions on the basis of the notes put up by the bureaucrats. Resultantly, bureaucrats are running the show. Two, Jetley is not known for any special knowledge of the security matters. As the leader of opposition in the upper house, he rarely participated in serious debates on security matters.

Finally, Jetley has been a part of the ‘Delhi Durbar’ for far too long. He is comfortable with the status quo.  It is unfair to expect him to take bold decisions and risk his own comfort level. According to a member of a veterans’ organisation who was present at a meeting called by Jetley, “It was sad to see the Defence Minister letting the bureaucrats run the show. He showed no courage or interest to oppose their negative tactics.” Jetley did irreparable damage to the credibility of the Modi government by asking the veterans to lower their expectations. He would not have dared to say so while seeking votes.

To sum up, achievements of the Modi government in the field of security matters have been highly mediocre. Antony-era was often ridiculed for drift, non-performance and policy-paralysis. Well, the current dispensation is no better. Not a single measure of consequence has been initiated so far. Inertia, lethargy, lassitude and complacency continue to dog MoD, as before. It is time Modi steps in to arrest the rot, lest the history remembers him as a leader who promised a lot but achieved little to enhance India’s defence potential. That shall be unfortunate for India as he is considered to be the last hope.*****  

Dismal State of the Indian Defence Industry: Challenges for the New Government

Dismal State of the Indian Defence Industry: Challenges for the New Government

 (FORCE May 2014)

                                                                                                             Major General Mrinal Suman

Indisputably, India’s defence industry is in a pitiable state. India is the largest buyer of conventional weapons in the world. Even after 67 years of Independence, India continues to remain wholly dependent on the imported defence systems. Despite repeated assertions in quest of self-reliance, India’s dependence on imported defence equipment has increased from the earlier 70 percent to close to 75 percent now. Worse, the indigenous production of the balance 25 percent is limited to the assembly of imported sub-assemblies and manufacture of low-tech components. While the indigenous defence production is languishing, the armed forces continue to suffer shortage of critical defence systems.

Since the inception of the Defence Procurement Procedure (DPP) in 2002, India has been revising it biennially, but the much touted reforms have been limited to the rationalisation of some clauses. Similarly, all expert committees constituted to suggest reforms have also limited themselves to minor procedural changes. No serious thought has been given to providing an impetus to the indigenous production.

The current dispensation has been an unqualified failure. The new government will have to initiate bold, drastic and innovative measures to kick-start the indigenous defence industry. Six key areas that need urgent attention have been highlighted in this article. 

1. Need for Structural Revamp  

As regards provision of the required defence equipment to the armed forces, two basic imperatives cannot be ignored. One, acquisition of defence systems is intrinsically interlinked with the development of the indigenous defence industry. Therefore, there has to be a single agency to oversee the complete gamut of related activities. The present system of the Acquisition Wing and the Department of Defence Production (DDP) handling acquisition and production functions respectively can never deliver.

Two, planning and implementation functions are distinctly different. They demand dissimilar but highly focused treatment. Therefore, they must be segregated. Planning functions should primarily be performed by officials and military leaders who possess necessary understanding of the national security issues. On the other hand, implementation functions must be entrusted to professionals who are fully conversant with modern technologies and are aware of the latest management tools and techniques to administer multi-faceted and multi-agency programmes. 

A multi-disciplinary and broad-based Defence Perspective Planning Council (DPPC) should be constituted as the highest policy making body to handle all planning functions. Its role should include identification of the capability gaps, approval of 15-years Long Term Integrated Perspective Plan and 5-years Services Capital Acquisition Plan. It should be empowered to approve changes in the acquisition procedures, grant deviations from the laid down policies and accord approval to invoke the Fast Track Procedure.

For executive functions, a Defence and Aerospace Commission should be established to implement perspective plans approved by DPPC. It should be the nodal agency to oversee the complete defence acquisition process and the development of the indigenous defence industry. Highly successful models of the Atomic Energy Commission and the Space Commission can be replicated, albeit with due changes.  

Chairman of the Commission should be a distinguished person who is known to possess competence to synergise, harmonise and administer complex programmes involving multiple agencies. He should be given the rank of Minister of State to authenticate his status.

The Defence and Aerospace Commission should be tasked to handle all activities pertaining to the production, acquisition and export of all defence systems/equipment. While promoting the development of the indigenous defence industry, the Commission will have to ensure that all approved procurement proposals are implemented within the specified timelines, satisfying all performance parameters and obtaining best value-for-money for the country.

For each procurement proposal, the Commission should debate, analyse and determine the route that should be adopted – outright import or indigenous development or a combination of the two. Factors like quantity, economic viability, urgency, criticality, indigenous capability and acceptable timelines would be the key deciding factors. However, technical evaluation and field trials should continue to be held under the aegis of the respective Service Headquarters as hitherto fore.

2. Modernisation of the Public Sector and Integration of the Private Sector

DDP was set up in 1962 in the Ministry of Defence (MoD), in the aftermath of the Chinese aggression to create a self-reliant and self-sufficient indigenous defence production base. Unfortunately, it has turned out to be the biggest impediment and is mainly responsible for the current deplorable state of the indigenous defence industry.

DDP failed to appreciate the fact that both the public and the private sectors constitute a nation’s defence industry. It assumed the mantle of being the god-father of the defence public sector units and concentrated on perpetuating their monopoly. Consequently, DDP faced internal contradictions in its role; leading to acute conflict of interest with ensuing subjectivity and impropriety.

DDP is guilty of shielding an inefficient public sector whose proverbial complacence is solely due to their conviction that DDP would force the services to buy whatever they produce. All ploys are tried to ensure regular flow of orders to the public sector units. The private sector is kept at bay through cleverly introduced provisions of nominating public sector units for major contracts. Thus, the nation remains deprived of the technological prowess acquired by the private sector and its enormous potential remains untapped.

MoD has to realise the fact that both the public and the private sectors are national assets and harnessing of their potential is essential if India wants to build globally competitive defence industrial base with necessary economies of scale. While the public sector possesses huge infrastructure, trained manpower and considerable experience in systems integration with imported technology, the private sector excels in innovative management, marketing and financial skills.

Four measures need to be taken on priority. One, DDP should be abolished and a Department of Defence Industry be created in its place. It should look after the interests of the defence industry as a whole and not be biased in favour of the public sector units. A level playing field should be provided to all companies. Two, MoD should shed control of all public sector units to other ministries. Three, all ordnance factories should be corporatised, as recommended by the Kelkar Committee. Four, working with an open mind, MoD should explore all viable avenues such as formation of consortia, joint ventures and public-private partnership for optimum results.

3. Supporting Innovations and SMEs

It is a well-established fact that any country that neglects innovations is doomed to become a technology-laggard. Innovation is considered to be a dynamic catalyst to growth. It implies an active and exploratory drive that seeks to better existing products, processes (including services) and procedures for more effective results. Neglect of innovations means stagnation, languishment and decay.

In the case of defence systems, innovations acquire added criticality. As continuous upgradation of defence equipment through the application of innovative solutions is of vital importance, an open architecture which allows ‘plug and play’ is considered essential to ensure seamless incorporation of evolving technologies for defence systems.

Unfortunately, India has failed to assign due importance to the promotion and development of a culture of innovations. Despite having a plethora of defence laboratories and public sector entities, not a single innovative idea or technology solution has been generated through indigenous efforts during the last six decades. The Global Innovation Index 2013, issued by the reputed business school INSEAD, places India at 66^th rank in the world. Most distressingly, instead of improving, India’s position has been sliding – 41^st in 2009, 56^th in 2010 and 62^nd in 2011.

Whereas most defence contractors are simply systems integrators; small and medium enterprises (SMEs) drive innovations and are rightly called ‘the engines that spearhead technological advancement’. Although Indian SMEs have been supplying sub-assemblies and components to the public sector entities for decades, they produce low-tech items and continue to be peripheral players. Their technological competence has not kept pace as they have never been encouraged to invest in developing newer products or carrying out pioneering innovations. Resultantly, very few SMEs have acquired competence to develop, manufacture and upgrade defence systems.

Being small players with limited resources, SMEs cannot thrive on their own. They lack adequate financial endurance for long term sustainment and find investment risks to be dissuasive due to the uncertainties of the defence business. As they operate in niche segments, economies-of-scale is also a matter of serious concern for SMEs. Therefore, they need governmental support and hand-holding. It is for MoD to create a favourable ecosystem that is conducive to the promotion of new initiatives in defence systems to keep pace with cutting-edge technologies.

4. Flexible FDI Policy

No issue concerning self-reliance in defence production and modernisation of the armed forces has been subjected to as intense a debate as the question of Foreign Direct Investment (FDI) in defence. The current FDI policy was promulgated in 2001 with an upper limit of 26 percent. However, foreign investors have given it a cold shoulder. There has been negligible inflow of funds during the last 12 years.

FDI is a need based concept. The host nation needs funds and technology for its accelerated growth while a foreign investor is guided purely by economic considerations. Therefore, most consider the policy with 26 percent FDI limit and associated restrictions to be highly dissuasive. For, no foreign investor is going to part with his closely guarded technology unless he has adequate control over the enterprise. The host nation’s policy must provide sufficient autonomy. Excessive bureaucratic control is resented by foreign investors as they feel stifled.

FDI is not just a question of getting funds, but access the latest technologies as well. FDI pre-supposes a long term commitment and lasting relationship between the foreign and the local entity. FDI sets in motion a chain reaction wherein FDI upgrades local technology which, in turn, attracts more FDI with higher technology and the cycle goes on. This is of vital importance to the defence sector which is highly capital intensive and undergoes rapid obsolescence of technology.

MoD has opposed all proposals to increase the FDI cap on the ground that the ownership of core strategic industries like defence must always remain under Indian control. Apprehensions are being expressed that foreign investors may close production and deny supplies to the armed forces during warlike emergencies.

There cannot be a more specious argument. No foreign vendor will ever risk his total investment by such a hostile move. In any case, factories cannot be shut and shifted at a short notice. As a matter of abundant caution, the Government can reserve the right to take over critical industries under certain extraordinary circumstances of national emergencies. An enabling provision can be incorporated in the licence.  Most nations that allow 100 percent FDI follow the same route.

Most importantly, a vast range of items (from mundane low-tech articles to high-tech systems) fall under the taxonomy of defence industry. It is patently incorrect to apply a single FDI cap to all of them. Therefore, India should adopt a flexible and technology-specific FDI policy. Upper cap should be determined on the basis of nature, level, depth and exclusivity of the technology involved.

Proposals that entail infusion of frontier and cutting edge technologies should be allowed FDI up to 100 percent. An upper limit of 74 percent should be accepted for joint venture proposals that promise transfer of technologies that are not available commonly. Similarly, FDI caps should be fixed at 51 and 49 percent in cases that bring in high technology. The current cap of 26 percent should be retained for proposals with commonplace low technologies. 

As prospective investors are guided purely by economic considerations, they carry out a comparative appraisal of all likely destinations to identify the best option available to them to earn optimum returns. Therefore, if India is serious about attracting FDI in defence, it has to position itself as the most lucrative FDI destination.

5. Simplification of the Offset Policy

India announced its intent to demand offsets against defence procurements in early 2005. Products and services eligible for discharge of offsets relate to defence, internal security and civil aerospace. Services mean maintenance, overhaul, upgradation, life extension, engineering, design, testing of eligible products and related software or quality assurance services with reference to the indicated eligible products and training. The first offset contract was signed in 2007. The policy has undergone a number of revisions. The latest policy, called the Defence Offset Guidelines (DOG), came into effect from 01 August 2012.

Offsets worth 21 billion dollars are expected to flow into India during the next 10 years. However, offsets do not come for free as foreign vendors have to incur additional expenditure to fulfill their obligations. It is seen that offsets generally result in cost escalation by 10 to 20 percent. It is a huge cost penalty. Hence, offsets make sound business sense only if the trade-off results in extraordinary economic or technological gains.

To upgrade indigenous technological base, the powerful leverage of offsets can be used to obtain technologies that industrially-advanced countries are unwilling to sell. However, India’s experience of the past few years has been highly disappointing. No benefits have been drawn from the offsets received to develop a vibrant defence industrial base.

All nations seek offsets that are in consonance with their national needs – either to meet an urgent economic need or to fill a critical technology void. It is not the type of offset but its relevance that matters. Therefore, offsets must be need-based and not availability-based. Shockingly, India has abrogated the right to select methodology, fields and offset programmes in favour of the vendors, thereby rendering India’s needs inconsequential. As is expected, foreign vendors opt for programmes that cost the least and are easy to fulfill – India’s needs do not matter to them at all.

Penchant for preferential treatment of the public sector has made MoD promulgate a highly complex and convoluted offset policy. Instead of having a single policy for the transfer of technology (ToT) to all Indian entities, MoD has created exclusive provisions for the public sector and the Defence Research and Development Organisation (DRDO).

For example, government institutions/establishments and DRDO are allowed to receive equipment and/or ToT from foreign vendors for augmenting capacity for research, design and development; training; and education. This facility has not been extended to the private sector. Similarly, DOG stipulates that ToT to Indian enterprises must be provided without licence fee and there can be no restriction on domestic production, sale or export. However, there are no such stipulations in the case of receipt of technology by the government entities.

It is rightly said that ‘unmonitored offsets are unimplemented offsets’. As India lacks a credible verification mechanism, it is an open invitation to unscrupulous foreign vendors and their dishonest Indian partners to collude and cheat the country by presenting exaggerated claims. MoD has no option but to accept their claims at their face value. 

It will not be incorrect to state that India’s defence offset regime is in a total mess. DOG suffers from major infirmities and can neither contribute to the growth of indigenous industry nor provide long term economic benefits. There is an urgent need to take a fresh look at all facets of the policy. 

6. Training and Accountability of the Workforce

No reforms can yield results unless the concerned functionaries are trained and equipped to translate progressive policies into tangible actions on ground. Sadly, the thrust so far has been on policy revisions and procedural reforms only, whereas mediocrity of the workforce has been one of the primary reasons for the non-delivery.

Promotion of indigenous defence industrial capability and management of defence acquisitions are multifaceted processes and are highly specialised activities needing extraordinary professional skills and unique attributes. Unfortunately, officers on routine postings are being asked to handle these functions. They are not selected on the basis of any demonstrated flair or talent or expertise.

Worse, all civil servants and service officers feel that they can carry out any job assigned to them. They believe that their initial training and subsequent exposure equip them to shoulder any responsibility. Resultantly, they do not strive to educate themselves. Equally worrisome is the fact that there is a complete absence of the concept of accountability in the current dispensation. With assured career progression, it is always considered safer not to take a decision rather than take one and risk being held accountable for the same. Inaction never gets punished.

It is time that India pays attention to the quality of the workforce and takes concrete steps to improve it. Delays due to deliberate dithering should never be condoned. Additionally, any functionary who vacillates in taking decisions as per the powers delegated to him should be considered unworthy of that appointment.

Finally

Continuance of the current status quo is in the interest of all the beneficiaries, and most unfortunately, they are the ultimate decision-makers. As supremacy of personal interests over national interests is the hallmark of the Indian governance, MoD refuses to acknowledge the fact that the current regime is an utter failure. Regrettably, MoD is living in a denial mode with ostrich-like mindset. Unless existence of severe infirmities is accepted, reforms cannot be initiated. Therefore, despite incontrovertible effectiveness and practicality of the recommended six measures, the next government would need to muster great courage to counter bureaucratic inertia to change and break free of deep-seated prejudices to implement them.

In the past, all review panels and expert committees have dealt with reforms in a piecemeal manner, concentrating mainly on irksome policy provisions and streamlining procedures. No holistic, comprehensive, dispassionate and objective exercise has ever been undertaken to identify intricate interplay of dynamics of domain interests and conflicting attitudes that defeat all attempts at improving the system. Lack of courage to undertake radical overhaul of the regime have been making the government officials flounder in the labyrinths of bureaucratic indecision while the armed forces and the country continue to suffer. *****

Proposal to Raise FDI Cap in Defence Faces Selfish Opposition

Proposal to Raise FDI Cap in Defence Faces Selfish Opposition

(FORCE Jul 14)

Major General Mrinal Suman

The Indian policy regime is infamous for subordinating national concerns to the interests of some self-seeking pressure groups. Worse, a number of self-proclaimed experts readily join hands with egocentric lobbies to spread disinformation. Invariably, truth becomes the first casualty. False examples, taken out of context, are cited in support of their flawed contentions. The case of Foreign Direct Investment (FDI) in defence is symptomatic of the detrimental malaise that afflicts the Indian polity and the intelligentsia.

Every time a proposal is mooted to raise FDI limit in defence sector, a highly motivated and vicious media campaign is unleashed by the selfish entities who feel threatened. Most unfortunately, efforts are made to frighten the policy makers through well-planned subterfuge of spreading falsehood. FDI is portrayed as an evil that threatens national security and has the potential to cripple the indigenous industry to make India captive to foreign companies. Attempts are made to make their opposition appear credible by quoting select examples, albeit in a highly inventive manner. Full facts are never revealed.

In a recent article, it was claimed that Germany had lately reduced FDI cap in defence from 26 percent to 25 percent; thereby suggesting that India should draw lesson from Germany and not consider enhancement of FDI limit. Oddly, India (with its abysmal defence industry) was ingeniously compared with the world leader Germany and the underlying reason for the German step was intentionally passed over.

The fact is that Germany wanted to prevent leakage of its exclusive defence technologies by reducing the clout of the foreign investors. Thus, the example of Germany was just a red herring to mislead people and has no relevance to the ongoing Indian debate. It needs to be highlighted here that as per a report released by the UN Conference on Trade and Development, Germany is one of the three most attractive and investor friendly countries. It received Euro 23.4 billion in FDI in 2013.

Most shockingly, whereas the whole world strives to attract maximum FDI, our bought-out experts trash the very validity of the concept of FDI. They go to the ridiculous extent of claiming that no country has ever benefited from FDI. They forget that the entry of Suzuki ushered in a revolution in the India automotive industry.    

Unraveling the FDI Conundrum

The World Bank defines FDI as ‘net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor’. FDI comprises of funds provided by the foreign direct investor to the FDI enterprise as equity capital, reinvested earnings and intra-company loans.

FDI is a need based concept. The host nation needs funds and technology for its accelerated growth while a foreign investor is guided purely by economic considerations. Any country that covets FDI has to convince the prospective investors of the advantages accruing to them as compared to competing suitors.

FDI pre-supposes a long term commitment and lasting relationship between the foreign and the local enterprise. FDI sets in motion a chain reaction wherein FDI upgrades local technology which, in turn, attracts more FDI with higher technology and the cycle goes on. This is of vital importance to the defence sector which is highly capital intensive and undergoes rapid obsolescence of technology.

FDI limits are generally discussed in terms of three primary considerations – one, quantum of profit that a foreign investor can repatriate; two, degree of control that he can exercise over the joint venture; and three, liberty to pass resolutions, both ordinary (passing of accounts, approving dividend levels and appointing directors) and special (buy back of shares, diversification and merger/amalgamation).  

100 percent ownership gives total and unhindered control to the holder. He can take any decision that he considers prudent for the venture. In other words, he can pass both special and ordinary resolutions, provided they are in consonance with the host country’s policies and laws. On the other hand, 51 percent holding implies working control and day-to-day functional oversight of the joint venture. 26 percent holding empowers the holder to stall passage of special resolutions.

From the above, it is apparent that leaving aside a proportionate increase in the repatriable profits, there is very little difference between FDI limit of 26 percent and 49 percent. The control remains with the indigenous company while the foreign participant can prevent passage of special resolutions. Similarly, there is little to choose between 51 percent and 74 percent FDI caps.

The Current Policy – a Flop Show 

To achieve the often stated objective of procuring 70 percent of defence requirements from indigenous sources by 2010, the Government allowed 26 percent FDI in the defence sector in May 2001. Detailed guidelines for the production of arms and ammunition were issued by the Department of Industrial Policy and Promotion (DIPP) of the Ministry of Commerce and Industry, after consultations with the Ministry of Defence (MoD), in January 2002.

As per the current policy, the applicant company has to be either an Indian company or a partnership firm with management control in Indian hands. The Chief Executive has to be a resident Indian. A licensee can produce only the licensed products and in the sanctioned quantity – he can neither diversify nor enhance production. The policy directive further stipulates that arms and ammunition will be primarily sold to MoD and their sale to other security organisations in the country will be with the prior approval of the Government. Similarly, their export will also need prior sanction. Non-lethal items may be sold to non-Government agencies but with the concurrence of MoD.

The current policy has been an utter failure as India has received paltry USD 5 million of FDI inflow in defence manufacturing during the last decade. Analysing reasons for the same, the Department of Industrial Promotion and Policy (DIPP) opined, “FDI cap of 26 percent discourages original equipment manufacturers from bringing in proprietary technology, as they may be reluctant to license their proprietary technology to a company in which their equity is restricted to a minority of 26 percent. This has resulted in India not being able to access the latest high-end technologies available.”

Interestingly, as per an official declaration of 2006, even 100 per cent FDI in defence is allowed on a ‘case-by-case’ basis. However, it is purely a theoretical proposition and means little – no guidelines have been issued and no rules have been framed. Despite repeated requests, Mahindra’s proposal for a joint venture with BAE Systems holding 49 percent equity was rejected without assigning any reasons, making it obvious to all that the government is dead set against granting permission to proposals entailing more than 26 percent FDI. Therefore, to say that no foreign investor has come forward with a proposal of 100 percent holding is simple baloney.

A discussion paper was initiated by DIPP in May 2010 advocating raising of the FDI limit in the defence sector to 74 percent. The policy makers were reminded that it was unrealistic to expect domestic manufacturing to make state-of-the-art equipment without sourcing high-end technologies from abroad by encouraging foreign defence manufacturers to establish manufacturing bases in India to help catalyse the growth of the indigenous industry. 

DIPP sought views of all involved parties. Whereas the services backed the proposal, both MoD and the industry could not rise above petty selfish considerations. To protect the grossly inefficient public sector, MoD wanted status quo to continue wherein defence public sector undertakings import sub-assemblies under the garb of transfer of technology through  ‘Buy and Make’ route, put their own label on the assembled products and sell them to the services at a huge profit.

The response of the Indian industry was equally self-seeking. Major players did not want FDI above 49 percent as entry of powerful foreign manufactures was viewed as a threat to their business interests. They wanted joint ventures but with controlling stake. Accordingly, all the three major industry associations/chambers opposed raising the limit beyond 49 percent.

In May 2013, the Commerce Minister initiated a fresh proposal. In order to mollify MoD, he advocated that the limit be raised to 49 percent initially, instead of 74 percent recommended by him earlier. It was a conciliatory move as he felt strongly that the cap of 26 percent was too low to attract foreign investments.

Once again, terming the proposal to be a ‘retrograde step’, MoD decided to stick to its earlier stand of keeping the limit at 26 percent. Defence Minister Antony felt that allowing foreign companies to set up manufacturing/assembly facilities in India would stymie the growth of indigenous design and development.

After the recent change of guard at Delhi, the Commerce Ministry has once again raised the issue of increasing FDI cap. The cabinet note spells out three options – raising caps to 49 percent, 74 percent and 100 percent. True to the past precedence, an aggressive media campaign has been initiated by the interested parties to oppose the move.

FDI versus Indigenous Industry

Defence Minister Antony’s statement that ‘building up India’s own indigenous capabilities for designing and developing weapon systems is vital’ cannot be disputed at all. However, his assertion that allowing foreign companies to set up manufacturing/assembly facilities in India would be a retrograde step and stymie the growth of the indigenous capability is totally erroneous.

Statements like ‘every weapon system that is imported leaves one less for indigenous industry to develop’ are hollow and misleading. What has the indigenous industry achieved during the last six decades to demand protection? Has it been able to develop a single major system so far? Assembly of imported sub-assemblies and components is not development of defence systems.

The confidence expressed by MoD in India’s capability to build-up defence industry through indigenous efforts is a case of self-delusion. One has been hearing such confident predictions since the early 1990s that defence imports would be reduced from 70 percent to 30 percent within a period of ten years. Despite repeated protestations, imports have climbed to close to 75 percent now.   

 

Leaving aside the limited progress made in the field of missiles, the Defence Research and Development Organisation (DRDO) has not been able to develop a single system in the promised time-frame and conforming to the accepted parameters. The only success it has to its credit relates to replication of some imported products (fancifully called ‘reverse engineering’ and ‘indigenisation’). It will be unrealistic to expect DRDO to change overnight and make India self-reliant.   

 

The defence public sector consists of defence public sector undertakings and the Ordnance Factories Board. Most unfortunately, the Indian military is a captive customer of the Indian public sector and is forced to buy what it produces. With assured orders in hand, the public sector carries on inefficiently, without bothering about the quality parameters or the time frame.

It is also suggested by some observers that need for technology can be met by indigenous development under the ‘Make’ procedure, even with imported sub-assemblies and components. It is conveniently forgotten that the ‘Make’ procedure was introduced in 2006 and has failed to deliver so far. Currently, two projects are being progressed under the ‘Make’ procedure – Futuristic Infantry Combat Vehicle and Tactical Communication System. Both have failed to take off and stay mired in bureaucratic muddle. Interestingly, even the much touted ‘Buy and Make (India)’ has not made a start as yet.

Security Threat Posed by FDI

When every other argument fails, specter of security concerns is raised by the self-seeking entities to stymie any proposal to raise FDI limit. Apprehensions are expressed that foreign investors may close production and deny supplies to the armed forces during warlike emergencies. It is one of the most ridiculous excuses.

The fact that it is infinitely more reassuring to indigenously produce (through joint ventures) those systems which are otherwise being imported in fully built up form is conveniently overlooked. Whereas supplies can be easily cut-off unilaterally by foreign suppliers, factories in India cannot be shut and shifted. Additionally, indigenous manufacturing facilities also ensure better life-time support including supply of spares.

Equally importantly, all major defence equipment producers follow ‘Global Factory’ concept, wherein various manufacturing functions are spread over a number of locations in different countries. When a major defence company invests in any country, it makes it an integral part of its overall production chain. For example, European Aeronautic Defence and Space Company has more than 70 production sites and Safran carries out industrial, design and commercial operations in more than 30 countries. In such a scenario, it is not easy for a company to shut down any facility and risk disruption of its worldwide production network.

As pointed out by Commerce Minister Anand Sharma, most nations in the world (including the United States and the European Union) allow 100 per cent FDI in defence with security issues being addressed through verification/clearance procedures’. India should also incorporate adequate safeguards while issuing licence. It can reserve the right to take over the licenced facility under certain extraordinary circumstances of national emergencies. Most nations include such an enabling provision.

Surprisingly, in some of the recent writings in the media, it has been claimed that no country in the world allows majority stake with the foreigners. It is expediently forgotten that our own Mahindra Group has acquired majority stake in two Australian defence companies, Aerostaff Australia and Gippsland Aeronautics. Both the companies are niche players with well-developed technologies and products. 

Infusion of Technology and FDI Cap

Advocates of higher FDI cap argue that an increase in stake will provide incentive to foreign manufacturers to share their technological expertise, thereby promoting self-reliance in defence production. However, the opponents have conjured up a novel hypothesis. According to them, exporting country would not allow sharing of its proprietary technologies with India, even if the FDI cap is raised to irresistible levels. It is a hollow argument.

In the present day geo-political environment, economic considerations rule supreme. For attractive economic benefits, all countries grant waivers. There may be an odd exception. It is a well known fact that major defence contractors enjoy immense clout to pressurise their governments. Irresistible financial gains will make countries allow export of technologies which they may not be ready to share in normal business deals. Thus, higher FDI cap will act as a forceful magnet to attract FDI.

As stated earlier, the current revolution in the Indian automotive industry started with the arrival Suzuki. As it possibly could not bring all components from Japan, it urged its Tier-II and Tier-III sub-contractors to have collaborations with Indian companies to manufacture components in India. Resultantly, development of a vast network of ancillary industry got a big boost.  

Recommendations

Defence industry covers too vast a range to be branded as a single entity as regards infusion of technology for the formulation of FDI policy. The range varies from cryogenic engines, aero engines, gun-stabilisation system of tanks and terminal guidance system for missiles to small arms for the infantry. Therefore, it is patently incorrect to apply a single yard-stick to the complete defence industry. A more prudent option would be to categorise defence industry on the basis of technology being infused and the FDI upper-cap fixed accordingly.

In other words, India should adopt a flexible and technology-specific policy. See Illustration. 

Illustration: Technology-Centric FDI Policy

All joint venture proposals should be assessed on the basis of nature, level and depth of technology involved and categorised accordingly for the fixation of FDI cap, as follows:-

·         Tier  1: Proposals that entail infusion of frontier and cutting edge technologies – up to 100 percent.

·     Tier 2: Proposals that promise transfer of exclusive technologies not commonly available – up to 74 percent.

·         Tier  3: Proposals involving latest high technologies – up to 51 percent.

·    Tier 4: Proposals with stabilised technologies that are available from multiple sources.

·         Tier 5: Proposals with commonplace low technologies – up to 26 percent.

To start with, approval for Tier 5 proposals should be through the automatic route. In areas where adequate indigenous capability exists, FDI cap can be retained at the current dissuasive level of 26 percent. Similarly, to encourage indigenous R&D, it should be ensured that only those proposals are sanctioned that entail import of technologies which India is struggling to master.

FDI is an effective mechanism for persuading foreign companies to manufacture within India those systems which are otherwise imported in fully built up form. Degree of assurance and resulting comfort accruing from indigenous facilities will always be more than the imports. However, necessary safeguards should be included in the licence to address security concerns.

FDI could either be in a Greenfield project or through merger/acquisition. Normally, developing countries attract Greenfield projects, whereas acquisitions/mergers are more prevalent in the developed nations. India today stands at a threshold where both the options can be exercised.

As economies of scale are essential to ensure commercial viability of a project, capacity constraints and restrictions on exports should be relaxed, albeit keeping national interests in mind. Import of dual use technology should also be encouraged as it benefits other segments of the economy as well.

As more companies establish defence industries in India, significant reduction would accrue in the outflow of foreign exchange. Ancillary industry will grow and local employment opportunities will increase multifold. India’s export potential would get a boost. More importantly, a raise in FDI is essential to facilitate fulfillment of offset obligations which are expected to be over USD 12 billion in the next ten years. 

Finally

Opponents of the proposed hike in FDI cap have adopted contradictory stands. On one hand, they cite the example of telecommunication sector to question the very purpose of seeking FDI.  On the other hand, they are ready to welcome FDI in defence as long as the control stays with the Indian partners. It is a strange logic that FDI is beneficial to India only if does not exceed 49 percent. It reveals the true intent of the opponents – they dread competition from foreign manufacturers and seek protection by portraying FDI as an evil.

If India feels that FDI is not required in defence, it can continue to stick to the current failed policy. In any case, self-serving stake holders have already joined hands to oppose any change. However, if the government wants foreign companies to invest in India, it has to change its approach and revisit the policy. The much-hyped provision of sanctioning higher FDI caps for cases involving state-of-the-art technologies is a sham.

What is really surprising is the fact that the opponents of FDI express confidence in the capability of DRDO to usher in technological advancement. It is a preposterous proposition. Optimism is justified only when based on the past track record.

Given its favourable geo-political position and technical man-power, India must strive to be a hub for global outsourcing and partner co-production of defence products as a part of multi-nation consortiums. For that, India has to put its act together by evolving an investor-friendly policy, streamlining procedures and projecting India as an ideal FDI destination for the defence industry. 

In defence technology, India is lagging behind by up to twenty years and the gap has been increasing every year. In addition to the indigenous efforts, imported technologies should be used to close the technology gap. Thereafter, they should be used as a spring board for developing newer technologies indigenously. To achieve that, India has to make its FDI policy highly attractive and investor-friendly.*****