Inside the next Defence budget

  “There was no clarity on whether the 25 per cent earmarking would be drawn from the Defence Research and Development Organisation’s (DRDO’s) existing budget or provided as an equivalent amount over and above its allocation. Nor was there any clarity on who would define the scope of research, what would qualify as R&D in the first place, and who would ultimately control the flow of funds,” said an industry insider, who did not wish to be named.

  A private-sector stakeholder noted, “The DRDO can legitimately argue that more than 25 per cent of its R&D spending already flows to the private sector, since a significant portion of projects is executed through industry. However, our expectation was that the earmarked allocation would be routed directly by the Ministry of Defence (MoD) to credible companies—not only for requirements specified by the MoD, but potentially even for projects conceived by firms themselves.”

  Both agreed that, to date, no funding had flowed to the industry under the FY23 announcement—at least not in the manner the private sector had anticipated.

  However, as the lessons of 2025 — self-reliance being key to strategic autonomy and the tactical advantages of 

made-in-India equipment — are absorbed, industry insiders hope that steps will be taken to realise Prime Minister Narendra Modi’s call to break down silos and adopt a “whole-of-nation” approach to defence. This is an objective that Defence Secretary Rajesh Kumar Singh said in November would require “credible” private and public sector firms to work together.

  That said, regardless of how the coming Budget shapes up for the industry, at least one positive development may be on the horizon. 

    Modernisation boost

   When Sitharaman presents a record eighth consecutive Budget next month, the allocation for the MoD is expected to rise by about 10 per cent year-on-year — marginally above the 9.53 per cent increase over the FY25 Budget Estimate (BE) reflected in the ₹6.81 trillion allocation for FY26. This is the level of growth senior executives in the private defence industry broadly anticipate, despite Operation Sindoor in May 2025 marking the most intense India–Pakistan clashes since the 1999 Kargil War. 

“While the defence budget will likely follow the established growth trajectory, the modernisation component that is used for capital acquisition will likely see a substantial jump,” said Rajinder Singh Bhatia, president of the Society of Indian Defence Manufacturers (SIDM) and chairman of Kalyani Strategic Systems, the defence arm of Bharat Forge.

  Echoing that expectation, Arun T Ramchandani, senior vice-president (precision engineering and systems) at Larsen & Toubro (L&T), said: “We anticipate the defence spend to reach two per cent of GDP — around ₹7.5 trillion — assuming GDP growth of 6.5 per cent. Given the thrust on modernisation, the overall capital component could cross ₹2 trillion.”

  This is not to suggest that the defence budget will be insulated from developments in India’s immediate neighbourhood or the broader geopolitical churn, most visible in the rearmament exercise underway across Europe and the Association of Southeast Asian Nations. Citing these factors at an industry event in November last year, Defence Secretary Singh said the country’s outlay for procuring new military equipment was likely to rise, with the MoD expected to seek a 20 per cent increase in the modernisation component of the FY27 defence budget — roughly double the usual 10 per cent increase seen in previous years. Singh added that he did not anticipate difficulties in securing such an allocation.

  A subcomponent of the capital allocation, the modernisation budget finances the capital acquisition requirements of the Army, Navy and Air Force, covering new aircraft, ships, tanks, weapons, missiles, and other modernisation needs.

  Underscoring that defence expenditure has been declining as a share of gross domestic product (GDP) — at 1.91 per cent in FY26 — the secretary said that a year-on-year increase of 20 per cent in the defence budget’s modernisation component over the next few years would be sufficient to meet the armed forces’ capability plans. 

Taking the FY26 BE of ₹1.49 trillion — about 21.9 per cent of the overall defence allocation — as the base, this rate of growth would translate into a modernisation outlay of approximately ₹1.79 trillion in FY27.

  If this materialises, it would favour the domestic defence industry — across both the public and private sectors — precisely because another government promise has been carried through in both letter and spirit. In FY21, the MoD decided that a substantial share of the modernisation budget would be earmarked for capital procurement from domestic sources. It was also decided that a portion of this domestic share would be further earmarked for acquisition from the private Indian industry.

  A record was set in FY24, with 75 per cent of the modernisation budget — approximately ₹1 trillion — earmarked for the domestic industry, up from 68 per cent in FY23. For FY26 as well, more than ₹1.11 trillion — 75 per cent of the modernisation budget — was earmarked for procurement from domestic sources. Of this, around ₹0.28 trillion, accounting for 25 per cent of the domestic share, was specifically allocated for domestic private firms. The 75 per cent share is a normative target, which the defence secretary said in November 2025, would not only be adhered to in the coming years but was already being exceeded.  The secretary underscored that of the ₹2 trillion worth of contracts signed by the MoD in FY25, ₹1.33 trillion — nearly 88 per cent — was placed with domestic suppliers.

  Welcoming the projected 20 per cent increase in the modernisation budget, Bhatia said, “This is well aligned with the government’s goal of doubling domestic defence production to ₹3 trillion by FY29, and substantially increasing the private  sector’s contribution.”   

  Anaemic R&D spending

  However, greater self-reliance — the ultimate objective of expanded domestic production — cannot be secured through higher procurement from Indian firms alone. Industry sources and experts point to a second, indispensable pillar that they expect the upcoming Budget to address: An increase in defence R&D allocations.

  Arguing that comparisons with the United States (US) or China distort the picture by suggesting that India lags only the major powers in defence R&D spending, Laxman Kumar Behera, associate professor at Jawaharlal Nehru University’s Special Centre for National Security Studies, said, “Even countries with smaller defence budgets and GDPs outspend us. South Korea, for instance, allocates between 17 and 18 per cent of its defence budget to R&D, while India spends less than four per cent.”

  The US and China allocate roughly 17 per cent and 15 per cent of their defence budgets, respectively, to R&D. In absolute terms, the difference is equally pronounced: The US spends over $140 billion on defence R&D and China nearly $35 billion, compared with India’s roughly $3 billion, based on the Department of Defence Research and Development’s (DDR&D’s) FY26 allocation of ₹26,816.82 crore.

  “Even a 0.1 per cent increase in the defence budget as a share of GDP would amount to roughly ₹36,000 crore — enough to provide a near-term lift to both capital acquisitions and R&D,” Behera said. He cautioned, however, that without a rise in overall national R&D expenditure as a proportion of GDP, any sustained and substantial increase confined to the defence sector would be difficult to achieve. Government data shows that India’s Gross Expenditure on Research and Development (GERD) stands at just 0.6–0.7 per cent of GDP, well below levels in China (2.4 per cent), the US (3.5 per cent), and Israel (5.4 per cent).  The government has attributed this gap primarily to relatively low private-sector investment in R&D, with public spending accounting for 63.6 per cent of GERD and the private sector 36.4 per cent. 

Though he did not hazard a guess on the likely rate of growth, Ramchandani said, “We expect a thrust on defence R&D in the upcoming budget.” Both he and Bhatia see this as a likely outcome of the lessons drawn from Operation Sindoor, in which indigenous systems proved their worth.

  If it materialises, the enhanced allocation will follow the spirit of Modi’s Independence Day address in August last year, where he said Operation Sindoor demonstrated the centrality of strategic autonomy and indigenous capabilities — including Made-in-India weapons — to decisively address security threats. He also stressed that national security cannot rest on foreign dependence. Notably, the Prime Minister issued a pointed call for Indian innovators and youth to develop jet engines, a long-standing gap that has constrained the country’s indigenous defence programmes. 

The focus on aero-engine development, in particular, most clearly underscores the direction in which the defence R&D component of the Budget must evolve. With a projected investment of ₹40,000–50,000 crore spread over several years, a high-thrust engine programme alone would require more than three times the FY26 allocation available to the DDR&D — under which the DRDO operates — for capital expenditure and R&D projects. In FY26, the DDR&D’s allocation for this purpose stood at ₹14,923.82 crore, which is 55.65 per cent of the ₹26,816.82 crore total allocation. Needless to add, this is only one among several strategically significant programmes India is pursuing. 

In January 2025, while outlining the requirements for building a next-generation aero-engine, DDR&D Secretary and DRDO Chairman Samir V Kamat argued that R&D expenditure would need to rise to between 10 and 15 per cent of the defence budget to meet national ambitions. He expressed confidence that such an increase could be achieved over the next five to ten years. 

While concurring with the lower bound suggested by Kamat, Behera said the share of R&D within the defence budget has, in fact, declined — and that this erosion must first be halted. The DDR&D has seen its share of the defence budget (excluding allocations for MoD – civil and pensions) fall from 5.92 per cent in FY17 to 5.45 per cent in FY26.   

  Robust mechanisms needed 

  Higher allocations for R&D alone, however, will not be sufficient to achieve the final objective articulated by the government – to break down silos in defence. As the industry insider cited before said, “While the budget is ultimately about allocating money, the focus increasingly has to shift to value creation from that spending and to putting in place the mechanisms required to ensure it — particularly when it comes to harnessing the private sector.”

  This argument gains added force given that, once again in November 2025, Defence Secretary Singh highlighted how China has used military–civil fusion (MCF) to develop complex military systems and produce them at scale and speed, while calling for defence public sector undertakings (DPSUs) and private firms in India to be brought together into a unified “dual-production pipeline”.

  More than a decade after China elevated its MCF vision to a national-level strategy — designed to integrate economic and defence development under a single umbrella by systematically linking civilian and military research, industry, and infrastructure so that commercial technologies and production capacity directly feed military modernisation — the dividends of this approach are becoming increasingly visible. These range from the flight testing of aircraft assessed to be sixth-generation prototypes to the commissioning of China’s third aircraft carrier, equipped with an advanced aircraft launch system that, until recently, was available only with the US Navy. 

One of the pillars on which replicating this success will depend is strengthening defence R&D in the private sector. “There must be a mechanism to channel funding allocated in the Union Budget to private-sector R&D in a way that materially lowers the cost of capital for defence manufacturing. Ideally, this should extend even to zero-interest funding, enabling India to be globally competitive in the long run,” said N Raveeswaran, a veteran industry captain and chairman of SIDM’s R&D committee. He argued that this would enable the defence sector to emulate the success Indian industry has achieved in the automotive, banking, and telecom sectors.

  Suggesting that a prospective model could be structured to ensure repayment to the government — potentially through royalties — once firms begin securing orders, Raveeswaran emphasised that India’s private defence industry is still in its sunrise phase. Meaningful production, he noted, only began around 2017, making 2047 a realistic horizon for full self-reliance — by which point companies operating in the sector would be in a position to generate the returns such long-gestation investments are intended to deliver.

  “At the same time, government officials would need to put in place robust mechanisms to disburse R&D funding and ensure appropriate oversight of its intended use and repayment,” Raveeswaran said.

  This brings the focus back to the FY23 Budget announcement. “There was no agreed-upon mechanism in place for disbursing the earmarked 25 per cent of the defence R&D budget,” said Behera, adding that the policy had not been thought through. “Assuming that the earmarked amount was not envisaged as being over and above the allocated R&D budget, it was not a practical approach. Consider that about 35–40 per cent of the allocation is spent on strategic systems, followed by employee costs and running expenditure. In effect, this would have reduced the DRDO’s own R&D budget, even though the organisation already channels funds to industry through schemes such as the Technology Development Fund (TDF) and the DRDO–Industry–Academia Centres of Excellence (DIA-CoE),” he added.

  The previously cited industry sources, however, pointed out that schemes like the TDF only scratched the surface. “TDF is for smaller companies, and while larger players have availed themselves of its benefits, that defeats the purpose in the long run,” one of them said.

  The DRDO operates three grant-in-aid schemes, administered respectively by the Directorate of the Technology Development Fund (DTDF), the Directorate of Extramural and Intellectual Property Rights (DER&IPR), and the Directorate of Futuristic Technology Management (DFTM). 

According to a Parliamentary Standing Committee on Defence report released in December, the DER&IPR has spent ₹1.28 crore and committed approximately ₹20 crore for FY26 on deep-tech and intelligence, surveillance, and reconnaissance (DT&ISR) projects. Similarly, the DFTM has already spent ₹44.23 crore and has committed a further ₹45 crore during FY26 through 15 DIA-CoEs for DT&ISR projects. An additional grant/corpus of ₹500 crore has also been approved to support deep-tech and cutting-edge projects as separate verticals under the TDF scheme. During FY26, the DTDF is committed to spending approximately ₹60 crore on DT&ISR projects.

  According to the report, a provision of ₹1,756.25 crore has also been made for industry, startups and academia from the FY26 defence R&D budget.

  The TDF scheme, established under the MoD in 2016 and executed by the DRDO, aims to bring together public- and private-sector industries, especially micro, small and medium enterprises (MSMEs) and startups, for the development of emerging technologies. The quantum of funding under the scheme has been increased from ₹10 crore to ₹50 crore per project.

As of August 2024, a total of 78 projects, with an approximate cost of ₹333.21 crore, had been sanctioned under the TDF scheme. 

Industry insiders argued that while schemes such as the TDF should continue, treating the private sector as an equal partner — and realising military–civil fusion — cannot be achieved by subsuming large-scale private-sector R&D funding within the DRDO’s budget. Instead, they said, such funding must be provided in parallel. “The idea of earmarking an amount equivalent to 25 per cent of the defence R&D budget can be revived. These funds could be allocated to projects under the ‘Make’ category of the Defence Acquisition Procedure, or disbursed through a new scheme for large companies, modelled on the existing Innovations for Defence Excellence (iDEX) framework,” said one of them. 

Introduced in 2006, the “Make” procedure is now organised into three distinct sub-categories. Make-I (government-funded) pertains to the design and development of equipment, systems, major platforms, or their upgrades by industry, with financial assistance from the government covering up to 70 per cent of prototype development costs. Make-II (industry-funded) relates to projects involving design, development and innovative solutions undertaken by Indian vendors entirely without government funding. Make-III applies to products that are not indigenously designed or developed but can be manufactured in India, either in collaboration with foreign original equipment manufacturers or through transfer of technology arrangements. 

Launched in April 2018, iDEX seeks to foster an innovation and technology development ecosystem in the defence and aerospace sectors by engaging MSMEs, start-ups, individual innovators, R&D institutes, and academia. Under the original iDEX framework, grants of up to ₹1.5 crore are provided to support the development of cutting-edge technologies. As of June 2025, the armed forces had procured 43 items worth over ₹2,400 crore from iDEX-supported startups and MSMEs.  To further strengthen self-reliance, ₹449.62 crore has been allocated to iDEX for FY26, including its sub-scheme, Acing Development of Innovative Technologies with iDEX (ADITI). Building on the original framework, iDEX Prime was introduced to enhance funding support to ₹10 crore, while the newly launched ADITI scheme offers assistance of up to ₹25 crore to help scale breakthrough innovations. In April 2025, Defence Minister Rajnath Singh stated that projects worth over ₹1,500 crore had been approved under iDEX. 

Given that iDEX is funded and managed by the Defence Innovation Organisation, which was set up under the aegis of the MoD’s Department of Defence Production, this template appears to resonate with industry as a potential model for a scheme or framework scaled up to accommodate larger companies.   

Outlining a possible institutional model for administering such a scheme, Behera said, “The office of the scientific adviser to the defence minister could be revitalised with greater manpower and resources, independent of the DRDO. This structure could then be tasked with deciding which projects to fund and which technology areas to prioritise.” He pointed out that Israel found success with its Office of the Chief Scientist in the Ministry of Economy, which was converted into an independent authority — the National Authority for Technological Innovation — in early 2016. 

Irrespective of the framework adopted, Behera argued that, at least initially, ₹1,000 crore should be allocated annually by the MoD directly to industry for R&D. “Industry can perhaps be expected to fund the development of land systems on its own, but aerospace and complex technologies need incentivising,” he said.

  This gains urgency given that, in Budget 2016, the government announced a reduction in the weighted tax deduction on in-house R&D expenditure by industry — from 200 per cent to 150 per cent starting FY18, and to 100 per cent beyond FY20.

New funding avenues could, however, emerge. For instance, the government launched the Research Development and Innovation (RDI) Scheme Fund of ₹1 trillion on November 3, 2025, aimed at building a private sector-driven innovation ecosystem capable of accelerating scientific and technological progress. The scheme provides long-term financing or refinancing support with extended tenors at low or nil interest rates, and also offers growth and risk capital.

  Against the backdrop of the RDI Scheme’s four objectives — encouraging private sector participation, financing transformative projects, supporting the acquisition of critical technologies, and facilitating a deep-tech fund of funds — Ramchandani argued that a dedicated carve-out should be made for the defence sector. Such a provision, he said, would be particularly relevant for funding the transition from prototypes to production-ready systems, a gap that remains acute at present. “RDI is a move in the right direction and could benefit defence projects where adequate technology readiness levels have been achieved,” he explained. 

Whatever the final shape of the architecture and source of funding, the expectation within industry is unambiguous: It seeks recognition as an independent pillar of India’s self-reliance agenda, not merely as an adjunct to DPSUs or the DRDO. The forthcoming budget is therefore being watched closely for indications that policy intent aligns with this view. 

  The stakes are substantial. India’s pipeline of indigenous programmes — from nuclear-powered attack submarines and the stealthy advanced medium combat aircraft (Amca) to a national air and missile defence shield under Mission Sudarshan Chakra — stands to gain materially from a genuinely realised vision of a “dual production pipeline”. Early movement is already visible, with public and private firms partnering to compete for the Amca programme. The question now is whether the budget can carry that momentum further and provide the additional impetus required.