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Private Sector Participation in Indian Defence Industry

Laxman Kumar Behera was Research Fellow at Manohar Parrikar Institute for Defence Studies and Analyses, New Delhi. Click here for detailed profile.
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  • January 08, 2008

    India opened up its defence industry to the private sector in May 2001, in a move to enhance the country’s ‘defence preparedness’. To give further impetus to this policy, the Ministry of Defence (MoD) came out with new policy measure related to the concepts of private Industry Leaders [or Raksha Udyog Ratnas (RURs)] “Make” procedure, and defence offsets, in its 2006 Defence Procurement Procedure (DPP). With these policy initiatives, the government’s focus seems to have shifted towards the private sector as far as achieving its long-cherished goal of ‘self-reliance’ is concerned.

    Before the liberalisation in 2001, the history of Indian defence industry was characterised by what can be called State-led industrialisation. State intervention, though, succeeded only in creating a vast defence industrial base consisting of 39 Ordnance Factories, eight Defence Public Sector Units (DPSUs) and 50 Research and Development laboratories, but failed to achieve the desired objective of ‘self-sufficiency’ in defence production. With a ‘self-reliance’ index of 30 to 35 per cent, the country has been forced to pay a heavy price for its excess dependence on external sources for critical products and technologies. As any layman would affirm, excessive dependence not only weakens bargaining power but also deprives one of the knowledge and other benefits associated with it. This is exactly what has happened to India. During times of crises, some external sources have not only charged exorbitant prices for much needed products but in some cases have also denied the same because of political and strategic considerations.

    The failure of State-led industries to meet the country’s military needs stemmed from the State monopolising military production and preventing the private sector from playing a meaningful role in defence production. Under a monopoly situation, public sector enterprises were deliberatively made immune to competition and allowed to draw their sustenance from huge government subsidies and secure supply orders from the Armed Forces. The absence of competition and the presence of a secure market led to complacency, which left little room for product innovation, technology upgradation, quality control, export promotion, finance and human resource management. At the same time, the prime customers (Armed Forces) saw their needs becoming more and more sophisticated and technology intensive over time. With no other domestic alternative in sight, the government had to either fall back on unreliable and costly external sources or pump more money into the existing inefficient system.

    Fortunately, the wider liberal economic policy pursued since the early nineties demonstrated to the defence establishment what the private sector can do with its pool of management, scientific and technological skills and the ability to raise resources in the market. Since liberalisation, the Indian private sector has made a significant impact on various fields, leading to a higher degree of economic development. The success of private industry has not been limited to the national borders but has extended to foreign shores, as seen from an increasing number of merger and acquisitions activities it has been undertaking in recent years. Economic opportunities unleashed by liberalisation and the competitiveness of its industries have made India an attractive place for global capital and finance and an engine of the global economy.

    In a logical sense, liberalisation in defence production is an extension of wider economic reforms undertaken at the national level. The growing influence of private industry has compelled policy makers to open up the defence arena to the private sector in order to gain from its strengths. But can the private sector replicate its success story in the defence sector as well? The answer lies in a set of policy issues.

    The policy decision of May 2001 allowed 100 per cent private participation in defence production, subject to licensing. It also allowed Foreign Direct Investment (FDI) up to 26 per cent of the host company’s equity value. With this, any private firm can produce any defence item after obtaining a license for the same. So far, 73 letters of intent/industrial licenses have been issued to more than 20 Indian private companies, and a number of joint ventures have been formed in collaboration with foreign partners from Australia, Singapore, Israel and Russia.

    While the recent policy decision has attracted private firms into the defence sector, the policy statement has been silent on the functioning of the public sector enterprises, which still continue to get a considerable amount of State support. State support has the tendency to distort the market mechanism and make it difficult for the private sector to compete against State industries. It is therefore the responsibility of the State to ensure fair-play in the system and make state industries compete against their private counterparts on the basis of ability, competence and results.

    Unlike other industries, defence industry is characterised by a high degree of secrecy, limited market access, heavy dose of R&D investment, and closely linked with the country’s foreign policy. To ensure viability against all these odds requires some sort of initial handholding, which the State can provide in terms of R&D support, allowing access to the international market, and encouraging international collaboration. In this regard, the Raksha Udyog Ratna (RUR) policy is an encouraging step in the right direction. Once the government identifies those Indian companies to be treated as RURs, the private sector would get a further push towards establishing itself as a viable alternative to defence units in the public sphere. RURs will not only bring parity with State industries in terms of treatment, getting R&D support, forging partnership with others, but with their proven expertise and resources they can take India towards ‘self-reliance’.

    Another related area with respect to private sector participation in defence is offsets. Presently, the MoD demands a minimum 30 per cent of direct offsets for all capital procurements with an indicative value of Rs. 3,000 million or more. The offset amount is used to enhance Indian defence industrial capability through technology transfer, greater investment in R&D, and licensed production. But given the tricky business of defence offsets and the unwillingness of foreign vendors to part with core technology, there is a greater need to closely monitor all offset transactions. Besides, the Defence Offset Facilitation Agency (DOFA) – a single window agency under the Department of Defence Production (DDP) for all offset related transactions – needs to engage all stakeholders, including private industry to iron out the complexities involved. As the private sector is more proactive in assimilating and making use of any investment, it should be given a greater say when it comes to offsets.

    Despite having a vast defence industrial establishment in the public sphere, and nearly 60 years after independence, India is still dependent on foreign countries for critical military products and technologies. Import dependency has not only denied the private sector a meaningful role in defence production but has also made the country dependent (with all its attendant constraints) on foreign powers during times of crises. This does not augur well for a country which boasts of a booming private sector that has been driving much of its economic growth over the last decade and more. The policy decision of May 2001, which for the first time opened up defence production to the private sector, holds tremendous potential to enable the country achieve its long-elusive goal of self-reliance. The objective would only be met if the private sector is allowed to operate in a business-like environment, and all the hurdles are removed to ensure fair-play in the defence production sector