Firing up our defence industry

It is estimated that India’s defence sector — which is one of the world’s largest and lucrative markets — requires $130-150 billion for modernisation and restructuring in order to become self-reliant in the coming decade. The Government has allocated over $40 billion for the development of the sector in this fiscal year, but how long can we keep importing most of our defence equipment and be content with a sub-developed manufacturing base despite having the skill sets and capabilities?

This extremely capital intensive industry stands on thin ice in terms of financial and regulatory policies, with hands tied to the availability of basic resources at competitive prices. On the one hand, despite all the facilities, growth of PSUs is stagnating, while private sectors are not keeping pace with other countries.

Private manufacturers lack the incentive to delve into the sector considering risk on returns due to the rigorous checks in the sector, stringent and ambiguous policy framework, irregular grant of orders, lack of demand and commercial feasibility of small orders, scarcity of resources and skilled manpower to meet the sensitive requirements of the sector, supplemented with a lack of economies of scale in production and long gestation periods.

There is also a feeling in the private sector that they are alienated, thereby resulting in a lack of a level playing field vis-a-vis the public sector on account of various reasons including vast infrastructure, investments, technology collaborations, facilitated by the government for the public sector.

Incidentally, the private sector has not shown any equitable pioneering success from research and development, technological advancements and collaborations in the defence sector.

With the sector at the cusp of an inflexion point, the Government is taking necessary steps to bridge the gap between its intent and strategy. Ninety per cent of Acceptance of Need during the last two years have been given to Indian industries propelled by the ‘buy’ and ‘buy and make’ categories, hitting 94 per cent in 2014-15.

But considering the potential of the sector, the Government should assume more responsibility to boost the efficiency of the sector.

After taking into account the unique nature of defence equipment and the configuration of the global defence industry, the following are some recommendations:

FDI liberalisation: A liberalised FDI regime can promote investment into the country and boost an inflow of technology and subsequent export of defence products manufactured domestically. There is a need to embrace FDI, while simultaneously having the right checks and balances in place to regulate the environment and end use of the outputs.

Also, a mere opening to FDI is insufficient rather the Indian subsidiaries of foreign companies should also be given an equal platform vis-a-vis Indian public and private undertakings.

With the advanced technical know how and manufacturing capabilities of the foreign investor working in sync with top-notch scientific and technical institutes in India with advanced IT skills and sustained availability of quality workforce, India is bound to earn synergy in domestic defence production.

Simplification of policy: Today, the defence sector is governed by varied policies including industrial licensing, import, export, security manuals, tax regulation and procurement policies. Superfluous controls and restrictions imposed on the players operating in an already uncertain and unclear legal framework severely affect their efficiency and productivity.

The multiplicity of approvals and bureaucratic delays in obtaining the requisite approvals act as a deterrent to the inflow of foreign investment and its concomitant advantages. All the policies should be harmonised and synchronised to work towards a single window clearance mechanism with predetermined timelines so that the set up and operational time frame is reduced. This would boost the ease of doing business campaign of the government for the defence sector.

Tax incentives: The Government may consider extending benefits to the defence manufacturers giving the sector an infrastructure status wherein they could enjoy 100 per cent of profits for a stipulated number of years. Further cutting down the duties on import of capital equipment and manufacturing defence products in the country would help in strengthening the base of the manufacturing industry and help them to manufacture better priced and quality products for domestic use and exports.

A focused approach to inclusive development: The MoD with Department of Defence Procurement needs to have advanced infrastructure, technological development and a functional fund in place to finance a prototype level for SMEs, to help them bear the risk on returns, provide regular orders and carry out design and development work efficiently so as to absorb the distinct characteristics of innovative capabilities in niche manufacturing.

Moreover, it will highlight the lucrativeness of the sector making it an opportunity for the angel investors to explore. PSUs should outsource more to SMEs and take the initiative to spearhead investments in the sector to balance out profitability with development considering the challenges faced by foreign companies approaching the government for partnership with the private sector.

Implementation of the strategic partnership model: The Government has recently notified the strategic partnership policy focusing on selecting an Indian strategic partner for all major defence procurements by the Government in key segments like helicopters, submarines, etc.

This policy is an integral step towards indigenisation and capability development. It would not be an exaggeration to say that, if properly implemented, the policy may result in revolutionary changes in domestic defence production and the creation of an ecosystem for defence manufacturing.

The key is to ensure that all necessary steps are taken to capitalise latent resources and technologies, develop the required skills and not shy away from foreign collaboration wherever needed, to strengthen Indian defence players.

In the pursuit of self-reliance in the defence sector, its effectiveness depends on the right model selection based on strategic needs, quality and cost competitiveness which is indispensable to mark the presence of India in global supply chain. These factors have been taken into account while proposing the aforementioned recommendations.

India’s future in defence manufacturing is very promising and in sync with the Make in India initiative. It is just a matter of proactive management of the current and potential resources and a supportive push from financial and regulatory stand point.

Mehndiratta is Partner-Tax and Duggal Associate Director at KPMG in India. The views are personal

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