Insights into Editorial: Road map for a robust defence industry

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Insights into Editorial: Road map for a robust defence industry

31 March 2016

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India is probably the only large country in the world which is overwhelmingly dependent on external sources for its defence requirements. India remains the world’s largest weapons importer over a five-year period according to latest report of the Stockholm International Peace Research Institute (SIPRI) on global arms purchases released recently. The report also says that China sold most of its weapons to India’s neighbours. India accounted for 14% of total imports between 2011 and 2015. This dependency on arms import is a stark reminder of how far India is from the objective of substantive self-reliance in defence production that it has aspired to since the early days of independence.

  • However, after the new government came to power certain initiatives helped India improve its position in this sector.

Reforms undertaken:

  • One of the early reforms ushered in was the raising of the Foreign Direct Investment limit in defence from 26% to 49% under the automatic route. This move encouraged the entry of both the domestic industry and foreign companies into the defence sector.
  • The ‘Make in India’ (MII) drive also offers a way of improving the country’s self-reliance in defence production.
  • Government’s recent initiatives have also encouraged major corporate houses to forge tie-ups with foreign defence companies.

What else needs to be done?

The focus of any policy should be to draw foreign defence manufacturers to India and, in the process, gain technology transfer. To accomplish this, an enabling architecture that would guarantee the protection of their Intellectual Property Rights (IPR) and commercial interests is key.

This would require two strategic changes:

  1. The FDI ceiling in defence should be revised upwards.
  2. The Defence Procurement Procedure (DPP) has to be fine-tuned to integrate its various components with the liberalised investment regime.

The following strategies related to the above mentioned aspects could be implemented to yield rich dividends-

  1. Given the peculiarities of the sector, the government should consider permitting 100% under the automatic route, subject to certain conditions. This is necessary because even after raising the ceiling to 49%, the inflow in 2015 under the head “defence industries” was only $0.08 million. Profit is not the main issue here; it is the absence of the desired level of control that investing entities will have over their technologies with 49% ownership that acts as the dampener.
  2. Use the mandatory offset (compensations that buyers obtain from sellers) to bolster the ‘Make in India’ programme. When using this strategy, it would be wise to remember that offsets do not come free. They are indeed paid for by the buyer. It should also be noted that offsets are trade distorting. As offsets come at a substantial cost, they would need to be steered. For fulfilling offset obligations, identify equipment from a shelf of projects carefully created to fill identified gaps in Indian defence technology. Make it compulsory for companies to locally produce such equipment with predetermined levels of indigenisation to be achieved over the years. For such projects, permit up to 76% FDI under the automatic route, thereby giving foreign investors sufficient control over the established entity.
  3. Complement the above strategy by employing multipliers (assigning higher value) where foreign companies manufacture defence wares identified to be of critical need for the services. In such cases, allow 100% FDI, mandating only a reporting requirement to the Ministry of Defence.
  4. Establish a separate Department of Overseas Acquisitions in the Ministry of Defence for establishing Special Purpose Vehicles with identified private sector entities to take over foreign companies. The department should in effect function as a Defence Sovereign Wealth Fund.
  5. Finance and support R&D/production in the private sector as the U.S. does (the development and production of U-2, the highly successful reconnaissance aircraft, in the 1950s is a good model).
  6. Create a body in the Ministry of Deference consisting of civilian officers, defence personnel and industry leaders to evaluate FDI flows, steer these flows and offsets, identify foreign companies for acquisition, etc. The mandate of this body should be to achieve convergence of various strategies being implemented by multiple bodies. 

Conclusion:

The defence industry is like no other. It is evolutionary, highly technology-intensive, and demands continuously high levels of research and development (R&D) investment. Hence, development of this industry in the country would require multiple strategies, a synergic approach and unconventional thinking, taking some lessons from China which has successfully adopted many of them.