INDIAN DEFENCE INDUSTRY An Agenda for Making in India INDIAN DEFENCE INDUSTRY An Agenda for Making in India Laxman Kumar Behera INSTITUTE FOR DEFENCE STUDIES & ANALYSES NEW DELHI PENTAGON PRESS Indian Defence Industry: An Agenda for Making in India Laxman Kumar Behera First Published in 2016 Copyright © Institute for Defence Studies and Analyses, New Delhi ISBN 978-81-8274-905-4 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without first obtaining written permission of the copyright owner. Disclaimer: The views expressed in this book are those of the author and do not necessarily reflect those of the Institute for Defence Studies and Analyses, or the Government of India. Published by PENTAGON PRESS 206, Peacock Lane, Shahpur Jat, New Delhi-110049 Phones: 011-64706243, 26491568 Telefax: 011-26490600 email: [email protected] website: www.pentagonpress.in In association with Institute for Defence Studies and Analyses No. 1, Development Enclave, New Delhi-110010 Phone: +91-11-26717983 Website: www.idsa.in Printed at Avantika Printers Private Limited. Contents Preface ix Acknowledgements xiii List of Abbreviations xv List of Tables xvii List of Figures xxi 1. Indian Defence Industry: The Journey to Make in India 1 Defence Industrialisation Phases 3 Can the Indian Defence Industry Make in India? 17 2. Ordnance Factories 20 Origin and Growth 20 Management 21 Employees, Production, Sales and Accounting 22 R&D and Technology Absorption 24 Execution of Orders 27 Pricing of OFB Products 29 Quality of Products 30 Exports 31 Capacity Utilisation and Impact of Modernisation 32 Poor Inventory Management 33 Outsourcing and Vendor Development 34 Corporatisation 34 Challenges from the Private Sector 35 Conclusion 36 3. Defence Public Sector Undertakings 38 An Overview 38 vi Indian Defence Industry: An Agenda for Making in India From Nomination to Competition 43 Defence Procurement: Share of DPSUs 44 Indirect Import 44 Vendor Development and Outsourcing 45 R&D and Technology Assimilation 47 Value Addition 50 Labour Productivity 50 Analysis of Profit Margin 53 Exports 54 Disinvestment and Listing on Stock Exchanges 57 Conclusion 59 4. The Private Sector 63 Why Private Sector in Defence Production 63 Defence Production: The Role and Scope of the Private Sector 64 Private Sector’s Contribution to Capital Acquisition 67 What has Hindered Private Sector’s Participation 68 Can the Make in India Initiative Save the Private Sector? 70 Conclusion 80 5. Defence Research and Development Organisation (DRDO) 83 DRDO: Origin and Growth 83 DRDO’s Performance: An Overview 85 DRDO’s Performance: A Critique 87 Defence R&D: The Problem Areas 90 Conclusion 106 6. Offsets 111 Evolution of Defence Offset Policy 112 Part I 113 Impact Analysis 113 Part II 125 Lessons from International Practices 125 Conclusion 139 7. Review of Policy Recommendations 143 Group of Ministers 143 Kelkar Committee 148 Sisodia Committee 151 Rama Rao Committee 153 Contents vii V.K. Misra Committee 155 Dhirendra Singh Committee 156 8. An Agenda for Make in India 164 Set up a Make in India Council within MoD 164 Articulate an R&D and Manufacturing Plan 165 Appoint an Additional Secretary within the DDP for the Private Sector 166 Reform the OFs and DPSUs 166 Revitalise DRDO 167 Provide Conducive Financial and Procurement Framework to the Private Sector 168 Streamline Defence Offset Policy 169 Curb Indirect Import 169 Involve the Industry in the Formulation of Qualitative Requirements (QRs) 170 ANNEXURES Annexure A DPP-2016: An Overview 173 Annexure B Strategic Partnership: An Overview of the Aatre Task Force Report 183 Annexure C Foreign Investment Proposals Approved in Defence Sector (As on July 2015) 187 Annexure D Details and Status of Major Ongoing Projects (Cost above Rs. 100 crore) of DRDO 191 Index 194 Preface India has one of the largest defence industrial complexes in the developing world. Currently, it consists of 39 ordnance factories, 9 defence public sector undertakings under the administrative control of the Ministry of Defence (MoD); and 150-odd companies in the private sector. In addition, there are 50-odd dedicated research laboratories and establishments under the umbrella of the Defence Research and Development Organisation (DRDO), the premier research and development (R&D) wing of MoD. Together, these entities, which employ over 200,000 people, produced arms and other stuff worth over Rs. 46,428 crore ($7.6 billion) in 2014-15. India is one of the few countries to have designed and produced a fourth-plus generation fighter aircraft, nuclear submarine, main battle tank, and intercontinental ballistic missile with a range of more than 5000 km. Despite these feats, India continues to be overwhelmingly dependent on arms and equipment imports. The target of 70 per cent self-reliance in defence procurement set for 2005 is still to be achieved. Currently, India's self-reliance is hovering at around 35-40 per cent. According to the Stockholm International Peace Research Institute (SIPRI), India with a 15 per cent share in global arms import during 2010-14 was the single-largest arms importer; and China was the world's third-largest arms exporter ahead of countries like France, Germany and the UK. To reverse the country’s huge arms import dependency and put the country on a self-reliance path, the National Democratic Alliance (NDA) government led by Prime Minister Narendra Modi has launched the ambitious Make in India initiative. Although it covers 25 different sectors, defence manufacturing, as stated by the Prime Minister in his Aero India 2015 address, constitutes the ‘heart’ of the initiative. Under Make in India, many reform measures have been taken to revitalise the moribund defence industry, x Indian Defence Industry: An Agenda for Making in India particularly in the private sector, whose contribution to India's defence procurement continues to be abysmal even though nearly 15 years have passed since it was allowed to undertake defence manufacturing. The reform measures taken so far include a hike in foreign direct investment (FDI) cap from the earlier 26 per cent to 49 per cent through the automatic route; simplification and streamlining of defence industrial licensing, permitting the industry to undertake arms manufacturing without getting into bureaucratic entanglement; articulation of a first ever defence exports strategy along with a set of guidelines for grant of defence export licences; rationalisation of taxes; and certain measures to insulate the industry from currency fluctuations. In addition, MoD is working on a host of other reform measures, including the ones suggested by the 10-member Experts Committee set up by the current government with the specific task of suggesting measures to promote Make in India in defence manufacturing. The key question that still remains, however, is whether Make in India will enable India to attain its long cherished goal of 70 per cent self-reliance in defence procurement. This book examines this question. In doing so, it examines not only Make in India as it evolves, but also the key constituents of defence industry and the policies surrounding Indian defence production, relying extensively on hard evidence. Chapter 1 maps the various phases in Indian defence industrialisation. It observes that the latest phase is a continuum of the policy initiatives undertaken in the past several years, although it focuses more on the private sector, thus far the marginal players in India’s defence production sector. Chapters 2 and 3 examine the public sector defence production entities, namely the ordnance factories (OFs) and the defence public sector undertakings (DPSUs), the traditional pillars of India's defence industry. Their gross inefficiency has been the main reason why India has failed to become self-reliant in defence industrialisation. But given their size, experience, vast skilled human resources and huge public investment, much is expected of them in the foreseeable future, provided they manage to transform themselves. Radical steps such as shutting down non-performing factories, corporatisation of the Ordnance Factory Board (OFB) and the process of privatisation of DPSUs are among the steps that the government needs to take. Chapter 4 deals with the private sector. Although the private sector has received a much-needed fresh lease of life under Make in India, many existing hurdles could prevent its performance. Lack of R&D and skilled human Preface xi resources, uncertainty in procurement decision-making and the inherent bias of MoD in favour of the public sector entities are some of the hurdles that the government needs to address. The government should also bring in an enabling fiscal mechanism to make the defence sector attractive for a much larger private investment. Chapter 5 deals with DRDO, the monopolistic defence R&D agency, which is often blamed for India’s poor self-reliance in the defence sector. DRDO would have to perforce play a far more significant role to not only reduce India's arms import dependence but turn back India’s traditional licence-based production approach to one based on own intellectual property, indigenous design and development. Chapter 6 examines India's defence offsets policy, a key feature in India's defence capital procurement manual since 2005. The offsets have so far played a negligible role. Based on the experience of several countries including Canada, Israel, South Korea, UAE, Malaysia and Turkey, the chapter suggests a range of options to make the policy effective. Chapter 7 discusses the policy recommendations made by the various committees set up after the Kargil conflict to look into various aspects of promoting indigenous defence production. Chapter 8 makes certain recommendations in the light of the preceding discussion. Much of the work for this book was done well before the publication of the revised version of MoD’s capital procurement manual, the Defence Procurement Procedure 2016 (DPP-2016) and the report of the Task Force on the Selection of Strategic Partners.