Impact of Demonetisation(De-Mon) in the Defence Sector
If there was one event that attracted attention it was the big announcement of November 8th 2016, viz, Demonetisation. It assumed centre-stage as year 2016 came to close after the announcement of phasing out of existing denominations of INR 500 and 1000. This was a rude shock to many delivered in a gentle manner through an announcement that was to bring about a revolutionary change in terms of curbing black money and regaining a control over the economy in a very subtle manner.
India as a nation was forced to reconcile to the hardship that was to follow with the changed scenario, the country was expected to see a major leap in digital payments and financial transactions over the Internet. Be prepared for the inevitable and adapt to changes. Those that were quick in adapting to changes with change in technology were less affected and the ones that kept the traditional methods of cash flows were more affected. It seems that many were quick to find interim solutions to avoid major losses in trade and cash flows and may be few of them laughed away to the banks. The year saw a few major global events which would such as Brexit and the election of Donald Trump as the President elect to assume office on January the 20th even when this article goes to print, which are likely to shape economic and financial trends across the world in coming months. Indian financial markets did not react sharply to these massive events to the extent that they were expected to. So, another lesson learnt would be not to plan your finances on short-term events. Instead, one should have long term financial goals and work towards them through market cycles. The Defence Ministry was busy handling the OROP scheme for the Defence Forces; the dynamic political leadership saw to it that this long-standing promise made to the Forces, was taken to fructification in a relatively short period. Then there was the implementation of the 7th Pay Commission that had its own problems. The nation also witnessed Pathankot and Uri, besides many other bad skirmishes both in the North and the NE. There was a huge financial drain in an effort to deal with these situations. Amidst all of this, was the whole concept of DE-MONETISATION and its consequent impact on the economy. It is widely reported in the media that more than 97% of the cash has come back into the system. Now, is this a good news or not so good? Let us analyse the impact it could have in the Defence Sector. Defence procurements are not done in cash, fortunately. Is there a cash component somewhere? Even the MSMEs operating in the Defence Sector, do not operate in a cash component as their raw materials and other tools and jigs are obtained through established banking channels. The big boys in any case operate only through the banking channels and the government procurement policies have a well laid out and defined process of payments. What about the dirty money that has plagued many a defence deal? May be this money has been curtailed and stopped albeit temporarily. In the ensuing two years we can hope to see a great deal of transparency and accountability in each of the deals that are signed and executed. While the government is clamping down on the un-accounted for money, that is still at large and is also targeting the hoarders of cash, in many cases with the new currency denominations, there is yet hope that the defence deals will become free of this menace of money laundering. Defence sector reforms have had a positive impact on the growth of the sector with a great deal of energy that is flowing in. De-licencing of the sector with more than 60% of the products and all of the components and accessories removed from compulsory licencing, has indeed opened up the industry gates for a larger segment of the industry to become partners with the Ministry of Defence in research, development and production. Defence Procurement Procedures have been revised to an extent of providing a greater impetus for indigenous manufacturing while encouraging the small and medium industries for direct partnership with the government. The MAKE procedure, providing intense indigenous impact has been rewritten providing the intended impact by encouraging industry to take up challenges and become partners with the government. This is the platform that the indigenous industry may like to exploit to derive the greatest benefit to the Armed Forces for inducting indigenous technologies and for the industry to move the business into India. The revision of the FDI policy to be in harmony with the changes in the sector has added to its potential. If there is one sector that can pursue the “Make in India” policy, it is the Defence Sector and the work has begun in right earnest. Easing of norms of executing Offsets, has encouraged the foreign OEMs to look at the indigenous industry with a greater interest, more Indian companies are getting hooked up to the Offsets wagon. One of the major concerns of the Defence Sector in so far as the MSMEs are concerned was the cash flow to enable them to be in business. This has also been addressed in the procurement policies for timely payments. Delays in payments by the payment authority to the industry is worrisome. While the foreign companies are paid through an LC, the same does not apply to the domestic companies. The domestic companies have to deal with different authorities for each part of the procurement/supplies. Initially with the planning process for making an entry to be considered good enough for receiving an enquiry for tender(the Defence procurement process by and large believes in limited tendering, save some revenue procurements that are tendered openly), thereafter, with the execution process for response to RFP and trials with the trial teams of the Armed Forces and thereafter with the bureaucracy for finalising the contract. The story does not end here, the execution/deliveries are interspersed with interaction with the end user, the Armed Forces, often seeking small increments in performance (not always in the book/RFP document/contract, but the supplier is obliged to support the end user both from a customer point of view as also due a patriotic fervour). Once the deliveries are done, the agony begins, as was highlighted by a number of suppliers in many forums, in following up with the payment authority (PCDA concerned); many times it could be a for ever exercise, unless of course the supplier understands the dynamics of cash flow. The payment authority is not a stake holder and is generally not answerable to anyone, this can be fixed if the domestic vendors can also have their payments through a system of LC. De-monetisation may have a favourable effect in this case, since there is limited liquid cash available, with the industry, to fix and fill in the time-gaps in payments. Before full restoration of money circulation takes place, the government may like to plug these gaps through an effective mechanism as also create accountability. The De-Mon story is not so rosy elsewhere. In the informal sector, experts have commented that, while this critical sector that contributes over half of India’s economic output, and employs about 90% of India’s 470 million workforce; they have been badly hit. According to the Secretary General of FISME, Anil Bharadwaj ( as reported in the ET of Jan 15), “Demonetisation has given us the biggest Jatka, for example in Yamunanagar(UP), the hub of India’s plywood industry, factories are shut. Now they have only two options: shut down or shift to the formal economy. This is however unaffordable, since thin margins and higher compliance costs render it unaffordable”. De-Mon has virtually stalled the economy with a sharp dip in consumer demand and job cuts, auto sales have dipped 18% in December, fuel demand is expected to slow by upto 40% in 2017, a recent survey by SBI among SMEs reveals a 66% dip in business; a study by SME outfit AIMO reveals 35% layoffs and a 50% revenue dip, investment proposals dropped to 1.25 lac crore in third quarter of 2016 as against an average of 2.36 lac crores. Defence sector being a strategic sector, with well defined rules of business is generally ever-green and has been made greener by the effective reforms undertaken by the Parrikar led ministry. Leading from the front the minister has made an effort to revive an indigenous approach to all requirements of the Armed Forces. The announcement of Strategic Partnerships for Defence Production and the much awaited Innovative Funding Mechanism in Offsets, will be the game changers. This is expected soon, may be before the grand Aero India show in Bangalore beginning valentine’s day for four days, this year. What then would be the effect of De-mon on say, the budget. Media reports suggest that the GDP would grow at a maximum of 6% for a few years due to De-Mon, while the world bank has down revised the GDP growth to 7%; effects will be seen in the near future. When GDP reduces, gross income reduces and there will be less money for the government to spend, so the government is faced with the following options : either reduce the spending on non-priority sectors or increase deficit financing. Will the Defence Budget take a hit? While it is expected that the earnings for the government would be low(even the sale of stake in PSUs is not expected to yield desire results, with an estimated shortfall of more that 565 billion rupees($ 8.4 bn), the Minister of State for Defence, while delivering a lecture on “leveraging Defence Expenditure as a tool for Nation Building”, in the first week of Jan, stated that the Minister is eying for an enhanced budget allocation for the ministry, while the Finance Minister presents his budget on Feb 1 this year. The Shekatkar committee was also appointed in mid 2016, by the Defence Minister to suggest recommendations on rebalancing the Defence Expenditure besides those for enhancing combat capability. “Produce locally, sell globally”, the eye that the government has on exports is interesting. The Raksha Mantri has been drilling down all those who can hear and those who cannot too; that enhancing exports is key to military advocacy and military economics. De-limiting the geographical boundaries for business is always not a great idea. The prevalent philosophy of first supply to our Armed Forces and then only can you export is fast changing, if not already changed. This strategy will usher in the much needed FE, that otherwise has been frittered away in big time purchases for the Forces. The reduced cash flow for middlemen to meddle with the procurement process, concept of G2G deals to eliminate money power from any interference have all added to strengthen the economic fundamentals of procurement. Mr Parrikar, had in May 2016, announced his ambitious plan of hiking the defence exports by USD 2 bn by 2018. This could be termed as ambitious by those that are not able to visualise the 360 degree coverage policy revamp. Besides other initiatives as elucidated earlier, the government has also simplified the process of obtaining a “No-Objection” certificate that was an effort lasting an indefinite time period in the yester years. Increased participation of private industry, encouragement to DPSUs to earmark at least 10% of their produce for exports, increased tenders under the “Buy Indian” category of procurement, all add up to increased cash flow and boost in exports. Talks of a possible sale of the indigenous Surface to Air missiles, AKASH, to Vietnam has already forced China to raise their tentacles, a worried China, has taken suo-moto cognisance as reported in their media. This is just the beginning of military diplomacy. The LCA, Dhruv helicopters, other missiles and systems, radar systems, NPOVs, Brahmos cruise missiles, anti-submarine torpedoes are all there in the horizon besides the traditional bullet proof jackets, OPVs, spares, components and few syb systems, in electronics, radars and aerospace components. Will De-Mon then have any effect on the Defence Sector? Well yes, a positive effect. The increased budget allocation for the Defence Ministry with an earmarked allocation for defence modernisation and MAKE programs, the Innovative funding mechanism in offsets, reduced cash availability for laundering to sustain a cleaner procurement process, increased exports, increased order flow into domestic companies under the “Make in India” categories of procurement, will all actually boost defence cash flows. Well, De-Mon may actually have a positive effect on the Defence Sector, gearing up the sector to meet the challenges of increased indigenous production, investment in research and design, increased number of partnerships in the sector, increased FDI flows are all positives.