Defence Reforms – Foreign Industry Observations and Suggestions
Sub Title : Foreign Industry suggestions to iron out the creases
Issues Details : Vol 17 Issue 1 Mar – Apr 2023
Author : Defstrat Editorial Team
Page No. : 47
Category : Military Affairs
: March 25, 2023
India’s quest for Atmanirbharta or Self Reliance is being given the right push by the government by ushering in enabling reforms. However, as things are still in a nascent stage, some creases have been noticed in the reforms by the Foreign Industry. The article enunciates observations/ recommendations being suggested by the Foreign Industry with regard to ironing out the same
Foreign OEMs and Industry have lauded the reforms undertaken by the Government of India since 2014 both in EODB and in the defence sector. Foreign OEMs are keen to be a part of the Atmanirbhar initiative of the Indian government by co-creating, co-developing and manufacturing defence equipment in India for the Indian armed forces as well as for export. Though progress has been made in this regard there are some areas wherein the defence industry still lags behind other sectors of the manufacturing economy. These are in terms of foreign investment, job creation and export success. The present reforms have certain grey areas, which need to be removed. Essentially the way the Indian MoD procures equipment and the way the Ministry of Commerce & Industry and Ministry of Finance permit foreign investment need to be revisited and further streamlined to help the initiative fructify faster. This paper makes a series of recommendations that would support and speed up India’s attainment of its defence manufacturing goals.
Indian Government: Goals
The Government’s goal is to make its armed forces self-reliant insofar as equipment is concerned. To this end effort is being made to create a resilient supply chain and ensure local supply of critical equipment, increase investments in the defence sector and obtain latest technologies by partnering with foreign technology providers. To achieve this goal a number of reforms have been introduced and in consequence there have been some notable successes like the Dassault Aviation JV worth $110m with Reliance Aerospace Ltd for the Rafael and the Boeing partnership with HAL and Mahindra Defence Systems for F/A-18 amongst others. In spite of this there are some provisions which need to be tweaked to make the reforms more effective. These are covered in the box.
In light of the above, the Industry has made certain recommendations to effect improvements, which are enumerated below.
Challenges: High levels of Indigenous Content. The higher the indigenous content level the less likely is a foreign provider to bid for a contract, because as indigenous content levels rise, margins decrease. In addition, India does not yet have systems / sub-systems / niche high-tech providers who can provide indigenous alternatives to previously imported equipment. Another point that must be paid heed to is that conceptually, the notion of attempting to indigenise a high proportion of all required equipment runs counter to ‘globalisation’, which helps optimise a product or service.
Suggested Solutions. In DAP2020 categories such as Buy (Indian-IDDM) should adopt a graduated pathway towards 50/60% content. For example, for a first order or item (depending on the programme / value etc) start with XX% IC, building up gradually in stages as more units / orders are placed, or over the lifetime of a project. We should have lower IC requirements for high-tech, low-volume orders in recognition of India’s (at present) limited internal market for these items, and the fact that there is no guarantee of future orders. There are some items like computer chips etc which cannot be sourced in India, hence there is a need to give relaxation for the same.
Make Categories of DAP 2020
Make-I (Government Funded). These are projects involving design and development of equipment, systems, major platforms or upgrades thereof by the industry. For Projects under Make I sub-category, MoD provides financial support upto 70% of prototype development cost or maximum of INR 250 crores per Development Agency (DA).Presently there are no takers for credible projects due to the fact that these being very large projects, govt funding of INR 250 crores is too small. GOI is allocating only 250 crores (30M USD) to develop locally designed platforms under Make I, which cost foreign firms hundreds of millions if not billions to develop. For projects being developed under the Indigenously Designed Developed & Manufactured (IDDM) category, there is the requirement of 50% Indigenous Content (IC), which is currently unrealistic in India and also that the rules for IP are too stringent. To make the category work Government Funding for a prototype should be provided on a case-to-case basis ( upto a minimum of at least 30-40% of the project cost, a graduated approach should be followed for Indigenous Content percentage and the cost of IP should be factored in separately into the cost of the prototype.
Projects Under Make II. There are fundamental issues with the Make II business model, which is an industry-funded prototype with no government funding. Companies are required to manufacture an indigenous prototype, after which they will have to follow the competitive bidding process. Few Indian companies would invest in getting foreign tech to build a prototype in India, with little or no guarantee of winning the contract. The fundamental flaw needs to be looked at.
FDI rules in the Defence Sector
As a part of 2020 policy reforms, the prevailing limit of 49% FDI through the automatic route in the defence manufacturing sector was raised to 74%. However, this increase in FDI limit came with a stringent stipulation that all new investments will be subject to scrutiny on grounds of ‘national security’. A 74% automatic FDI will not significantly influence decision-making by foreign firms. They will still have concerns about the transfer of IPR to a JV in India.
Boost FDI. A bold solution would be to allow 100% FDI in defence through the automatic route in India (with national security clearance if required). This would be a game changer as it would help technology infusion and address issues like IPR. The Indian government also needs to simplify procurement categories. Removing of the different FDI qualifying levels in various programmes (e.g. SP & IDDM -49%) and making contract specific IC provisions will also help boost FDI.
It is a challenge for the foreign firm to make a business case for their product when 50-60% of the product must be sourced locally. Duties on imported (non-indigenous) components further reduce the margin, making the decision to bid for or invest even more difficult. A reduction in duties would encourage foreign firms to provide high-value technology as part of their share of a programme.
The Offset provisions have been a matter of concern for foreign OEMs as they put considerable constraints and thus even the most well intentioned player tends to move with caution. The foreign industry has some recommendations and observations with regard to the updated Offset policy. Firstly, they suggest that the updated Offset policy should be applied retrospectively to previous contracts. Secondly, as establishing valuable long-term supply chain partnership takes time, effort and financial resources to be implemented, especially in the defence domain a Cap at 50% for avenue 3.1 (a) on the direct purchase avenue would de-incentivise investments.Thirdly, to forbid the clubbing of multipliers would go counter to doing ease of business for , if offset multiplier clubbing is not permitted the process to work with MSMEs will be very complicated. Some miscellaneous points suggested are:-
- Investment in DIF/ SEBI regulated Funds. Considering the conditions inherent to the proposed funds (no control over the investment, uncertainty on the financial return on investment (RoI)), a more appropriate multiplier (8 to 10) will be necessary to ensure a fast investment flow. Furthermore, exit clause from this investment should be clarified.
- Permitting Companies for offset discharge. Offset rules should also allow uncapped participation of OEMs’ Tier-1 suppliers as well as Tiers 2 or 3 to enable India to become a global centre of excellence in various areas.
- Increasing Offset Contract discharging period. Extending the period of offset discharge would allow smooth implementation of high technology projects that require significantly longer time to achieve.
- Additional avenues for claiming offset credits should be considered in particular regarding “Educational programs” including collaboration with Indian public / private engineering and technology university and funding of scholarships for Indian students to attend high level post- graduate engineering courses in first class universities worldwide.
The recent amendments in the GeM portal do not allow MNCs to participate unless they have local manufacturing. This is barring the customers from access to knowledge about market availability of cutting-edge technologies. The fact that internal components and assemblies continue to have large imported content therefore remains hidden and local assembly (with poor product support) wins. This eventually leads to enhanced lifecycle costs as also weak equipment performance. GoI should consider that its customers should be able to view the other technologies on offer in the market when procuring through GeM.
With inputs from UKIBC