Time to call out defence PSUs

In recent weeks there have been two significant announcements on disinvestment of two faltering public sector units — the government’s decision against disinvesting Air India for want of takers, and LIC’s acquisition of IDBI Bank. The debate around using LIC as a bail-out investor is often discussed, as is the poor state of India’s public sector enterprises. However, the gaping hole in the public discourse has been around defence PSUs (DPSUs). 

DPSUs have long been treated as a breed that is superior to other PSUs by virtue of the sector they serve in. They have been the most protected of all PSUs, with practically no competition, and with all the advantages of a monopoly (without calling it as much). They manufacture for one buyer who is obligated to buy from them. Yet, their profitability (for the handful that is in fact profitable) does not come from any manufacturing prowess but from their huge cash assets that earn interest. It is time to call them out. 

The balance sheets of DPSUs point to dismal productivity and profitability. Take their profit before tax (PBT) and profit after tax (PAT) figures. There are nine DPSUs, and their PAT ranges between Rs 1,22.3 million and Rs 26.15 billion. Now, if we were to deduct the value of their “other income” from their total revenue, then the PAT is either miniscule or mostly negative. Mazagon Dock Shipbuilders Limited (MDSL) and Garden Reach Shipbuilders and Engineers Limited (GRSE) will show losses as high as Rs 2.31 billion and Rs 2.15 billion respectively. This leads us to the second tell-tale sign.

IIndia’s second Scorpene-class submarine INS Khanderi, launched at Mazagon Dock Shipbuilders Limited, Mumbai, in January 2017 | Photo: PTI

The difference between revenue from operations and other income is important to examine. The “other income” under revenue in the balance sheet is largely made up of interest income on financial assets, sale of scrap, and adjustment of trade receivables or trade payables. Interest income is anywhere between five per cent and 20 per cent of total revenue across all DPSUs. (MDSL and GRSE lead with 18 per cent and 20 per cent.) In other words, between five and 20 per cent of total revenue is generated outside of main business revenue, a clear indication of poor productivity. 

The ratio of inventory to total revenue is another measure of productivity. DPSUs’ average inventory as a percentage of revenue is around 59 per cent. Hindustan Aeronautics Limited (HAL) and MDSL hold inventories of 115 per cent and 114 per cent of revenue from operations respectively. A high figure means that what is being produced is not sold. This is a strange place for DPSUs to be in, especially HAL, which is for all practical purposes the only aircraft manufacturer in the country.

Even for other PSUs such as Bharat Heavy Electricals Limited (BHEL) and GAIL (India) Limited, this figure is 24 per cent and three per cent respectively. For private sector companies such as L&T and Mahindra, the figure is three per cent and six per cent. What is therefore baffling is that the figures for purchases of new inventory for HAL and MDSL as a percentage of total revenue are 36 per cent and 45 per cent respectively. This begs the question: Why do these DPSUs spend as much as one-third their earnings on new inventory when, clearly, the old is unused? 

The DPSUs’ productivity is not flattering, but let us set that aside for a second. Any PSU is believed to be tasked with welfare for the sector rather than accruing profits. In the recent context, it is believed that DPSUs are primary business providers for MSMEs through their back-end supply chains. This argument is easily debunked by a quick look at the trade payables.

Of the seven out of nine DPSUs that provide a break-down of total trade payables, those to MSMEs across the board are as low as one to two per cent of total trade payables. The only exception to this is Bharat Earth Movers Limited (BEML), where it is four per cent. Clearly, DPSUs are nowhere close to being major business providers for MSMEs. In fact, even their annual reports mention MSMEs sparingly. While DPSUs may have empanelled thousands of MSMEs, and the intent is true, the amount of business that is actually being generated from MSMEs is negligible. 

If rumours are to be believed, the ministry of defence is believed to have decided not to pump in any more money into DPSUs in order to ensure more private sector participation. However, this is not the solution to improving DPSU productivity. According to Arun Jaitley, gradual disinvestment of the DPSUs is one way to increase operational efficiency (Business Standard, August 4, 2017). In fact, a PIB press release dated March 1, 2016 documents the government’s approval for divesting 10 per cent of HAL through an IPO. So far, nothing seems to have moved on this front. This is not surprising. Why should the success of DPSU disinvestment be any different from the disinvestment of other PSUs?

In the meantime, other solutions should be considered. First, the government must muster the political will to close down ailing units and sell their fixed assets. Existing employees may either choose voluntary retirement or a mandatory period of upskilling, so that they may be absorbed by the remaining players in the industry. Second, existing behemoths could be broken up and restructured to bring them down to manageable sizes and assigned one platform for them to specialise in. Third, any order given to DPSUs must necessarily contain the caveat that they must mandatorily collaborate with the private sector, at least until such time as the DPSUs’ operational efficiencies increase.

The competitive edge that DPSUs have over private sector players is their infrastructure. In the interest of building self-reliance in defence, this infrastructure must be shared with the private sector. India has options for procurement — DPSUs, the private sector, or import. With the delays in DPSU production and no long-term covenant for the private sector, is it surprising that we turn to imports? The only other option is to leave our armed forces ill-equipped. 

 Nirupama Soundararajan is Senior Fellow, and Dnyanada Palkar is Senior Research Associate, at Pahle India Foundation. These views are personal