Strengthen private sector participation in defence equipment production

Government needs to create few word-class hubs for defence & aerospace on a faster time scale

Centum Electronics acquires French Adetel Group

Last Updated : Jan 25 2017 | 2:47 PM IST

Defence is a strange business. It has been showing a great potential to all the players but the realities are completely different. We don’t witness huge growth of revenues, even in defence public sector unit. Ministry of Defence (MoD) has been surrendering unspent amounts of allocation. Government has been taking lot of efforts in promoting Make in India and FDI in defence but we are yet to see any drastic change in the landscape.

The armed forces are still starving in their needs for modernised weapons & upgrades. Developing the local supply chain is still a long way and we keep importing for defence.

Yet, it needs to be acknowledged that a lot of things have been done in the past two years and there is hope and positivism.

Opportunities unlimited, but challenges persist

The allocation on capital account over the years has been increasing and was Rs 86,340 crores in budget 2016-17. Specific measure to promote Make in India have been taken by setting aside earmarked funds (Rs 324 crores in budget 2016-17) and removing the customs duty exemptions for some military equipment and stores.

Also, the Defence Procurement Policy has been improvised over years to facilitate the Make in India and Ease of Doing Business. All these, provide a great opportunity for the domestic players.

But there are a number of challenges that have to be addressed to see a good growth. Some of them are high bank guarantees affecting vendor’s liquidity, long gestations and process of selection of suppliers. To name a few:

Though the DPP amply provides for clauses to ensure the growth and success of domestic production, the realities are different. For example, the domestic vendors are asked to provide bank guarantees sometimes running up to 30-40 percent of the order value (guarantees for security deposit, integrity pact and performance etc). These Bank guarantees have to be kept active throughout the contract period. Banks, in turn, to provide bank guarantee demand margin money to be deposited for issuing a bank guarantee. Thus the domestic vendor’s funds are locked up for a longer period and affect the liquidity. This results in a wide gap between the policy intention and the practical reality.

For a supplier in defence, the time it takes between sighting an opportunity to the first delivery (assuming that the supplier is able to successfully win the bid) is anywhere between a minimum of 3 to 5 years. Hence, unless the supplier is also addressing markets other than defence markets, it will be extremely difficult even to survive. It is like ‘walking over the rainbow’. After you cross, there may be a pot of gold, by then the journey takes its own toll.

As it is known, the supplier has to be L1 (the least cost) among the bidders to win a defence order, which of course, is the right thing to do. The procedures are comprehensive to ensure the right selection of the vendor but there are instances where the vendor is L1 but not able to deliver the products in time resulting in failure of the project for the defence customer. It is a little tricky. But the challenge is to find a balance between identifying & promoting the right vendor (who will deliver in time & support over longer duration) and working with the supplier who quotes the least cost.

Scope for improvements

Time has probably come to redefine the role of state monopolies such as defence labs (DRDOs), defence PSUs, OFBs, etc. The DRDOs should increase their engagement levels with the private sector. DARPA (the US equivalent of DRDO) is an interesting model. DARPA comprises approximately 220 government employees in six technical offices. It works within an innovation ecosystem that includes academic, corporate and governmental partners, with a constant focus on the nation’s military services. The DPSUs can move to a higher level of being integrators only and nurture more private players to be their reliable partners in the supply chain.

There is a need to strengthen the participation of private sector in defence equipment manufacturing sector. Allocate specific funds for R&D (say 8-10 percent of the budget) and ensure that these are bid out by private players without favouring the state monopolies on a nomination basis. It will also help if the government can create few word class hubs for defence & aerospace on a faster time scale. Government should identify specific and critical technologies for indigenisation and invite private participation. It is important that these indigenisation programs are closely monitored for speedier completion.

It is equally important to focus on technology and FDI. As it is known, most of the OEMs love India for being arms market and not as a strategic partner. They will not part with the technology to create a competition for themselves. At best, they create some ‘build to print’ capabilities in India. Raising the FDI limits from 26 percent to 49 percent to 100 percent (approval route) has not yielded any great results. We need to clearly identify the technologies that we must have immediately and offer specific incentives (both financial and non-financial) to the relevant players and ensure that we have those identified technologies at the earliest.

What to expect in the defence budget this year?

The total budget outlay for defence is slightly less than 2 percent of the GDP while some experts argue it should be 3 percent of GDP, considering the spending our adversaries / super powers. We can perhaps expect a higher allocation - an increase of 15 percent or more in the budget 2017-18 over the revised estimate of 2016-17, hoping that a large chunk of the increase will go to capital account.

Some policy & procedural changes can be expected which should improve the ease and speed of doing business in the defence sector. An increased allocation and specific funding on the R&D would be another welcome move.
____________________________________________________________________________________________

Desikan Srinivasan is the chief financial officer of Centum Electronics