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FDI UPDATE : DEFENCE SECTOR

FDI In Defence : Boon or Bane | Status Paper

Jul’16

On the 20th of June 2016, the Government of India announced a series of FDI measures, all of them relaxations with a view to attract FDI into the country. Before we discuss this important aspect of national policy, it is pertinent to see how this government has taken a wide angle 360o view on the defence sector.

Holistic view

Government of India has taken a holistic view of the Defence Sector and approached reforms in a methodical and integrated manner. While on the one hand the GoI has addressed regulatory aspects from the DIPP side, on the other the MoD has taken concrete steps to enhance ease of doing Business in Defence Sector.

Some of the major reforms affected in the Defence Sector are summarised below :- Industrial Licencing. In one go, the GoI has eased out the requirement of licencing by removing more than 60% of the products/sub-systems/components and accessories from the compulsory list of licencing. Presently, in the context of Defence Sector, only following items under the ITC HS classification are under compulsory licencing. Items not included in the list would not require IL for defence purposes. It has also been clarified by the MoD that Dual Use Items, having military as well as civilian applications, other than specifically mentioned in the list, would not require IL. This is a great boon for the domestic industry that has been hither-to-fore has been harassed for obtaining IL in the sector. The specific list requiring IL are as under (these are various sections under the ITC HS Code):- ITC HS 87.10 :: Tanks and other AFV ITC HS 88 : Defence Aircrafts, space craft and parts thereof :: from 8801 to 8805 : the complete chapter ITC HS 8906.10 : Warships all kinds ITC HS 93 : Arms and Ammunition and allied items of defence equipment; parts and accessories thereof :: 93.01 to 93.07 Reference : Press Note 3(2104 Series) Military products.
The above also provides a general clarity for a product to be classified as a Defence Product. A multitude of radical changes have been made to enable exports of defence products from the country. Following are the major policy initiatives in the regards (these are also elucidated in the update, separately):- Exports Strategy. Also called as Strategy for Defence Exports SOP for Exports Notification No 115(RE-2013)/2009-2014 dated 13 march 2015. This is regarding export of Military stores and the restrictions associated with each of these. Thus the list of military stores that require NOC from DDP have been notified. Obtaining NOC online Reduction of Imports. The GoI, has taken a giant initiative in mandating the OFB and DPSUs to increase their outsourcing from domestic industry, the meagre 2 to 3% outsourcing has been flagged with concern. In this regards the web sites of OFB and DPSUs have included list of items for indigenisation, which by itself is a massive list. This provides an immense opportunity for the Indian industry for participation in defence contracts, especially the smaller industries. A sample list is also produced in tis report and for a detailed list it is advised to visit the website of each of the DPSUs/OFB. Registration by DGQA. MoD has come out with regulations and procedure for registration by DGA, which was suspended a decade ago. This allows for a single point registration and enables expeditious procurement. Revised DPP 2016. The DPP 2013 has been revised in a pragmatic manner with enabling provisions for domestic industry and the small and medium enterprises. This is a landmark DPP with many innovative and industry friendly provisions to align the defence procurement with the Make in India initiative. This is being analysed threadbare for its major provisions. Exercise to revise DPM. This is work in progress and is in advanced stage of completion. Strategic Partnership. Work in progress after intensive consultations with stake holders. FDI in Defence In sync with the above reforms to take the defence sector into productivity from purchase, the government has taken a major reform in the Defence Sector. Ets see what exactly has happened. Review of FDI In Defence : Vide PN 7(2014 Series) the GoI has undertaken a complete review of the FDI policy in 2014, thus easing out the decades old restrictive FDI policy in the sector. The Defence Industry was till then subjected to a IL under the IDR Act 1951 and subjected to a 26% FDI cap under the government route and above 26% on a case to case basis the CCS was to be approached wherever it was likely to result in access to Modern and State of Art technology in the country, besides other conditions. Vide the above PN, in 2014, the GoI enhanced the FDI limit to 49% under the government route and beyond that ipso facto under the CCS. Reference FDI circular 2015.
Radical Changes in the FDI Policy regime. The Union Government has radically liberalised the FDI regime on 20 June 2016 with the objective of providing major impetus to employment and job creation in India. This is the second major reform after the previous one in Nov 2015. The GoI has opened up the Defence Sector under the Automatic route upto an investment of 49% and beyond 49% under the government approval route. While the consolidated FDI circular was effective from June 07th 2016, on the 20th of June the FDI policy was further liberalised by dropping the need of “State-of-the-art technology” for FDI above 49% under the government approval route. Under the present policy there is no necessity for approaching the CCS, since the government approval route by itself can approve FDI proposals upto 100%. In addition the GoI has also made applicable the instant FDI limit to manufacturing of Small Arms and Ammunitions under the Arms Act 1959. This indeed is a significant step. How does this Sync Well, while the government has opened up FDI investments in many sectors, GoI may draw adverse comments from some quarters who have conveniently ignored the other initiatives taken by the government that need amplification. The entire procurement procedure has been reformed to redraw the boundary conditions for procurement. Concept of IDDM(Indigenously Designed, Developed and Manufactured), Industry enabled MAKE procedure with enhanced funding and revolutionary commitment to placement of orders, drifting away from the beaten track of NCNC(No cost no commitment) to NCFC(No cost Firm commitment) is a landmark achievement. This is why this article begins with a holistic view to better appreciate effect of FDI. While the government has opened up the limits of FDI, they have taken care to restrict the limits to the established norms prevalent. What is the Change? Allowing FDI under the automatic route for all investments upto 49% is the first major change. Doing away with the requirement of going to the CCS for approval and simply allowing the investments beyond 49% through government route is the second major change. The third major change is to remove the mandated “State of the art” technology and retaining the “modern” technology for considering cases beyond 49% is the third major change.
Reminder of the policy is consistent with the legacy. Why such a change?  No country can grow on its own steam, peer support is as much a requirement as is for individual growth. Concept of a global village and integration of efforts, such as sharing of knowledge and growth for mutual benefit are the fundamentals for growth. Recognising the requirement of enhancing the growth in the manufacturing sector with a view to create jobs for the ever growing youngest populous country in the world, has propelled the government to take some bold and radical steps, albeit with caution. Even as late as July 2013, and a year preceding that, enhancement of FDI in Defence sector amongst others was engaging the attention of the government of that time. A[1] committee headed by the Economic Affairs Secretary, Arvind Mayaram, had recommended that FDI limit be raised in almost all sectors upto 49% through automatic route. This was also preceded by a commerce ministry note of 2010, which recommended 74% FDI cap in the defence sector. The Home Ministry at that time said that FDI beyond certain limit from countries like China, Pakistan, Bangladesh, Saudi Arabia and Indonesia in defence, space, telecom, information and broadcasting, civil aviation may allow people from these countries to dictate terms which could be contrary to India’s interests. Domestic capital by itself is grossly inadequate for the growth of the defence sector. We have also witnessed a declining trend of provisioning for the defence budget, the shrinking budget leaves little room for modernisation. Foreign capital is usually essential even as a temporary measure during such a dynamic period of development the sector has taken up with a progressive agenda. Foreign capital usually brings with it scare commodities such as technology infusion, business expertise and knowledge, besides providing a fillip to the skill development in the sector. India has been importing to cater for its military needs to be infamously known as the single largest importer of defence equipment and systems, as reported by SIPRI consistently. A decade ago, Indian MoD instituted an Offsets policy to repatriate a uniform 30% of the FE spend in a structured manner into the defence sector. This was a great initiative, but fell short of expectations in performance due to the restrictions imposed on the FDI investment by foreign OEMs. Even if they intended well, they were bound by home constraints in transfer of technology with a minority stake holding. They also feared IPR infringements. What has happened in the Past? The reserved nature of defence sector dissuaded any prospective investment and even after opening up with the Press Note 2 of 2002, allowing 100% private participation with a 26% FDI cap through the government route, did not yield any results, although this was pretty transformational at that time. It is observed with concern by many experts that the meagre USD 5 million that has come as FDI inflow was shameful for a country that aspired to be in the global arena.
Even when this investment was increased to 49% in 2014, scepticism reigned high amongst investor companies. So, a similar apathy to investment into the defence sector in India continued. History is testimony to the fact that our policies were flawed and needed fresh lease of life. “If you always do what you’ve always done, you’ll always get what you’ve always got.” Insanity: doing the same thing over and over again and expecting different results. Albert Einstein. If the results have been disappointing then there was definitely something wrong in the policy that we were hammering to the world. This is where the government stepped in and called for radical changes. What other countries do?  In 2013, Home ministry was quick to observe that many countries like China, Pakistan, Bangladesh and others did not allow more than a certain cap in the FDI in the defence sector and therefore we may also exercise caution. We need to compare apples to apples. So, if we look at say Australia, which allows 100% FDI and companies like Boeing, Lockheed Martin, GE and many others have 100% subsidiaries in there, then are we to believe that this policy has not worked well for them. I have visited some of these companies and felt the pride in the Oz people when they made reference to these companies. So, many countries adopt different strategies to cater for their progress. Certain Myths in FDI norms There have been concerns raised on allowing FDI in defence and some of them are listed herein : This is a sell out, technology transfer may not take place. Indian private sector has got the raw end of the deal, they may not be able to compete with the global companies that would set up shop here. Relaxed FDI norms would have an adverse effect on DRDO Relaxed FDI norms is a sell out to western countries. In a strategic sector like defence, relaxation could compromise national security Analysis FDI beyond 49% is still under the government route, which means that the applicant company will still need approval of the GoI, meaning thereby that the government has retained control where necessary. Requirement of “Modern Technology” as a pre-requisite has been retained by the government, which will mandate the applicant company to come up with technology as proposed/agreed. Also, in a situation of trust and ease of doing business, there is no reason for the applicant company to make huge FDI investments and not transfer technology, as none else will be the loser. Indian private sector has really emerged to its present shape thanks to the reforms attempted in 2002, although much is left to be desired. There is an aspiration in the domestic industry, with more than 1 lac crores worth of business placed under the Make in India categories by the present government. There is energy in the small industry, which has benefitted from offsets besides participating as tier 2/3 vendors. The present government has also made enabling provisions for MSMEs to actively participate in defence contracts under the MAKE category. However, one single gap is in the form of technology.
DRDO developed technologies were made available to the Public sector alone, this has been corrected only recently in 2015, with active interference from the political leadership, to now allow a level playing field. This crucial gap can be filled by foreign companies willing to collaborate. Relaxed FDI norms would be helpful to DRDO to form collaborative arrangements for co-development and also in collaborative research. Taboo gone, their doors are now open and DRDO could do well to exploit this opportunity provided by the government to explore collaboration in niche fields and fill up the identified gaps in technology. Top ten defence exporters are all from the US and EU(assuming UK has not yet formally split), BaE systems is the only company outside of USA in the top five arms exporters of the world. There could be an element of truth in the concern that this could be a sell out to west, but then, statistics are louder than words of accusation, after all the top ten selling countries are from the west. We need them, to propel growth. If we continue to depend on organic growth alone, we could take decades to reach where the west has and by then they would have propel faster to even widen the gaps that were existing. Therefore, an attempt at inorganic growth, as now done, is a good method. The present strategy of the MoD to adopt both the organic as well as the inorganic method of growth has a promise like never before. National security is not so fragile that it can be compromised by a clearly defined set of procurements made from Indian companies from within the geography of our country, even though these are owned by foreign companies, either as wholly owned subsidiaries(WOS) or with a majority share in them. It has been argued even by the commerce ministry papers as early as 2010 and thereabouts that it is better to procure from within the country than from sources abroad. An effective regulatory system will be able to take care of security scenario. In any case, WOS puts plenty of work in the system, energises the supply chain, indigenises the production lines, improves manufacturing technology, increases manufacturing content, enhances requirement of skilled force, creates and sustains job opportunities, all of which are working towards, “Advantage India”. The pressure that develops on the supply chain will propel growth in focus areas of MSMEs, thus diversifying manufacturing expertise. This will kill any monopolies and stimulate competition and with this will accrue quality. Inefficiencies in the DRDO and Public sector have crippled the weaponry in the Armed Forces limiting our Forces to lowest end of technology. The DRDO and OFB have held our Armed forces hostage to accepting the sub-standard equipment they produce, conniving with the department of Defence Production(DDP) and friendly help in the civil set up in the MoD(which in any case is staffed by officers from the OFB in good numbers besides few from other DPSUs as well). All of this happens under the umbrella of Indigenous Production, under the preferred Buy Indian categories. An examination of the foreign content in some of these systems would reveal alarming statistics, thus becoming conduits to certain foreign companies, who have found the back-door entry and are making merry. Why should the nation resort to imports after more than six decades of procurement with a number of technologies already transferred? Inability of the public sector to first understand and then absorb technology and further use it intelligently to the benefit of our Armed Forces has been the primary cause for this failure. Often times, the OFB and DPSUs resort to taking the high moral ground of complete and total adherence to the dictate of foreign companies’ by citing the transfer of technology agreement, to actually hide their incapability and lack of knowledge.
They have got away because the government staffed by the civilian bureaucrats who have multiple exposures to ministries like Animal Husbandry find themselves suddenly in the MoD, so are equally clueless of the stringent requirements of the Armed Forces, hence they have no abilities to question the government owned production units, often succumb to systemic lethargy and a “Chaltha Hai”, attitude. Why should Foreign companies come to India with FDI Is there a more promising destination in the world than India for defence manufacturing? Has the government done enough to improve ease of doing business in India? With the slew of reforms undertaken by the government, it is natural for the global defence majors to view India as the most attractive destination for their future expansion and endeavours. Often, it may be difficult to find a market from a given geography, India helps to ease this problem in more ways than one. The same product produced from India could be cost effective besides providing the abstract boost in terms of acceptability. Labour arbitrage is just one of the small economic benefits that can be drawn in the entire gamut of production advantages in India. Private sector, in the recent past, has exhibited immense energy with demonstrated capability in many areas including niche ones. Small companies and start ups of the 2005/6 era, have grown to mid sized companies, having had first hand experience as Indian offsets partners to foreign OEMS and having participated in some programs in the MoD in the Buy Indian category. In all cases they have won contracts in an open competition and in some DPSUs also have participated. This has opened up yet another challenge to the domination of the OFB and DPSUs to be gifted contracts on nomination basis. While some DPSUs have learnt to compete, the OFB and others have sulked. OEMs may like to view this as an opportunity to make right type of investments in terms of technologies and production enhancements. This would provide the Armed Forces with options to source their systems at cost effective prices and higher global quality standards. Collaboration with DRDO in co-development of critical technologies, addressing gaps in technologies through technology transfer, addressing fundamental research and development of pure sciences is an area the OEs may like to explore. The pool of talent, abject understanding of engineering technologies, immense knowledge base and a young talented population are major attractions. Indian companies will be preferred partners in defence procurements, OEMs have the technology and expertise specially at higher ends of the spectrum, Indian companies have the essential knowledge and skill set, all of this adds up for an intelligent collaboration. OFB being inside the government besides being a vendor and DPSUs scouting the corridors of power are armed with information on the procurement plans and enjoy a first mover advantage. They sometimes forge partnerships ahead of time to be future ready to address a procurement. While the private industry may not have this advantage, they are characterised by higher levels of efficiency, quick decision making, modern machinery and global best practices, may hence become preferred partners for OEMs. MAKE in India has at least twin connotations, one focussed on domestic demand and the other to service global demand. In many cases, both may co-exist, it is all about a business plan. The Indian ocean region in the foreseeable future will witness a proliferation of Indian made weapon systems, as India is best placed to understand regional aspirations and service them efficiently. May be we will have the fortune to witness the type of dominance Chola dynasty had in the region. With the government’s initiatives, this is close to becoming a reality. FDI could come through Tier 2 and Tier 3 cooperation from both sides. These are the ones who hold technology and will make a difference through horizontal integration. We have already witnessed some flavour of Vertical FDI with upstream and own stream investments in the value chain. What we are likely to now experience is the Horizontal FDI and Platform FDI. This will be the game changer. Conclusion The reforms attempted by the government are path breaking and well thought through. It is time our industry takes advantage of these reforms to the benefit of our Armed Forces. Synchronising the Offsets policy with FDI, enabling Innovative funding mechanisms(as suggested by the Experts Committee), prioritise privatisation of inefficient Ordnance factories, corporatize the OFB, encourage OFB to compete for opportunities, creation of a real level playing field, effective implementation of MAKE programs, encouraging tie-ups and JVs, collaborative R&D, risk-sharing design and development in an atmosphere of encouragement and trust, will be the key to growth. Our Prime Minister’s vsion will be fulfilled when every citizen feels the positivity around.

DPP 2016 : Make in India Paradigm :

A New era Dawns MoD, in absolute harmony with the Inaugural ceremony of the DEFEXPO 2016, released the DPP, has created enough hype to justify its formulation or so we would like to believe. For the first time, since it evolved, the DPP was preceded by an Experts committee and then a task force that took a deep dive into the aspect of Strategic Partners. The minister, has been leading from the front, providing the much needed leadership to the bureaucracy. For the first time the MoD got a first hand account of an entrepreneur, voice of a small enterprise, all of this and more, finding its way into the defence quagmire. The minister has provided a voice to the small enterprises, the entrepreneurs, start ups and many others who never had one, despite the numerous associations that exist.  In many a first, some of these concerns have been addressed. Lets begin our analysis with the “Preamble”. This DPP incorporates a Preamble, just like the one enshrined in the Constitution. The idea is noble, it is expected to provide the acquisition executive with the wisdom to choose the “spirit” from the “letter”. The acquisition executive is many a time, “Prisoner to Procedure”; since they are most rigid when it comes to the DPP, for fear of enquiries and an unknown, that may haunt them, down the line. The preamble is expected to open the acquisition executive’s mind to a more rational application of the procedures in the interest of the acquisition at hand. Should there be a doubt in application of any of the procedural paragraphs, the acquisition executive is expected to refer to the “Preamble”, just as how the judiciary would. The question is, does the said preamble indeed incorporate a chosen text, with the ability to provide overarching clarity to the procedures enshrined therein? The fine print somehow falls short of expectations. The Preamble sets the stage for a focussed approach for Defence Acquisitions, “Defence acquisition is not a standard open market commercial form of procurement, and has certain unique features such as supplier constraints,…..”, and so on. The Preamble definitely lacks the ability to stand out as a Preamble, with an ability to provide overarching support to the execution executive. While the political leadership is supreme, the balance of advantage could have been given to the Armed Forces for their procurements.

A path changing inclusion in the DPP is the introduction of a new category called, “Buy IDDM”. DPP places importance on “Indigenous Design”, Development and Manufacture. Although these attributes, were present in a subtle manner, inherent in the “Buy Indian” category, they have now got their pride of place. This is actually the essential ingredient to “Make in India”, philosophy and will receive more AON awards, as the year begins from April the 01st 2016. This is thanks to the minister’s personal intervention. The categorisation demands that if the design is indigenous then a manufacturing indigenous content(IC) of 40% would suffice to pass muster and  else a 60% IC. Does this not beat fundamental logic? A home-grown design would most probably rely on indigenous supply chain resulting in high IC, whereas, a foreign design would have low IC, after all, conform to a foreign supply chain attitude. However, paradoxically, the IDDM category demands just the reverse. Is this demand based on realistic assessment of the domestic industry or was it a fancy tool to impress upon a theory devoid of logic? It would be a challenge for the industry to reconcile to the situation. There is a challenge here, ie, there is no difference between IDDM with indigenous design and the next higher category, viz, “Buy Indian”. Both of them demand a 40% indigenous content, never mind the lack of design or incorporation of it. How will the MoD, ascertain that the design is indigenous, well we would be entering into a new variety of quick sand. MoD is aware of the implications and will address this aspect through suitable guidelines.

While recognising the importance of indigenous design and according it the pride of place right on top of the categorisation priorities, MoD has shied away from a complete and total lifting of the abeyance order placed on design services amongst others, in offsets. Despite many representations, this ban, was lifted only partially, by the present government. If the government truly believes in promoting indigenous design, then a case exists for a total lifting of the Abeyance order. All upgrades could have been covered under either Buy Indian or at best Buy and Make Indian categories(para 15 needs a suitable amendment). That could encourage domestic industry to make investments ahead of time. Everyone in the system need not do everything, it should rather be teamwork, like a relay race, the baton must pass from one stage to another. There is a tendency in the MoD for each successive stage to re-invent the wheel, this tendency must be curbed, this DPP has not brought in this clarity. The RFI process must essentially be a commitment for purchase. Many times the industry is encouraged to make investment basis the RFI and hence the MoD must draw up the RFI for a reason and the reason is procurement by the Forces. Sadly, the formulation is otherwise, reads as follows, “The RFI would be published on MoD and SHQ websites for seeking relevant information, on specific procurement schemes. The issue of RFI is not a commitment for procurement”. How do we expect the industry to have a show of hands when the RFI is not serious enough to lead to a commitment of procurement? In so far as SQRs are concerned, the balance of decision making must shift to the Armed Forces. Let not the necessity, to make generic SQRs, not deprive the Armed Forces of a system they require. A notable achievement is the concept of “Essential Parameters A”, “Essential Parameters B”, and “Enhanced Parameters”. While the concept of broad based QRs seems to apply only to the “Essential Parameters A”, the Forces can use the enhanced parameters to get more out of a system, since no system is designed for exclusive use of the Indian Armed Forces. Also by an intelligent use of “Essential Parameters B”, the Forces can get more even as the production begins. This concept is an intelligent insertion by the MoD, based on the leadership provided by the Minister himself. MoD has expressed a willingness to incorporate technical experts at this stage of the planning process, a very welcome move, indeed. Somewhere the concept of providing a weightage for technical excellence has been inserted. There is an effort to cut down the time in the planning process, by reducing the AON to RFP time to 6 months/1 year for either a Buy Indian/Buy and Make Indian programme. This may be cosmetic, since I believe that the planning process may as well take a little longer, cutting down of time is more necessary in the execution process. Offsets have been pegged at a threshold value of INR 2000 Crores, which comes with a mixed feeling. While the industry would have liked to have the offsets continued at the present threshold of INR 300 crores or even lesser, to enable more offsets business; it appears the MoD is probably not able to effectively manage the offsets, given the other stakeholders/players introduced in the system, such as the CGDA for an audit. A new insertion in this DPP is the design and development by DRDO/DPSUs at para 71 of Chapter-I. It would have been a great idea to also include private industry at this stage. The confidence reposed in the private industry by the MoD would have been reflective by such an insertion. This therefore leads to a conflict at para 101, that reads, “ … Cases which are being undertaken by DRDO/DPSUs/OFB/Indian private industry as design and development projects, would not fall in the category of Single Vendor cases…”. Therefore the MoD does visualise cases that are undertaken by private industry also, besides the Make I and Make II category of cases.

A great deal of credit is to be given to the MoD for the far sighted “MAKE” procedure, with incorporation of MAKE category 1 and Make 2. Forward looking, industry friendly, ability to give large advances to the domestic industry for undertaking “Make” programs, will provide an unprecedented boost to the indigenous industry. A definite boost for MSMEs is clearly visible in this category, once again a pioneering move by the Defence Minister to encourage the small industry sector. The minister has addressed the “Defence Industrial Base”, and some of the concerns of the small scale units that are pegged at the base of the development pyramid. If India lives in villages, the Industry lives in MSMEs. 90% funding in Make 1 category by the government and a 20% advance are key highlights. The fine print is out. The Angel is in the details.   MAKE IN INDIA A focus on IDDM INDIGENOUS DESIGN DEVELOPMENT AND PRODUCTION Background.  Defence Procurement Procedures since inception have been incorporating different categories of procurement to enhance indigenous production. From its just two categories in DPP 2002 to the present six categories, the march has been significant, in the decade and a half. Concept of providing priority to categories in acquisition in Defence procurement was first introduced in the DPP 2013. Never before in the history,  a priority been assigned for indigenous design and development. Having recognized the importance of indigenous design and development, the Manohar Parrikar led ministry has for the first time provided both importance to indigenous design and development as well as granted the pride of place for design and development as a part of the procurement process. What does this mean and what are the implications for the indigenous industry, let us see.

Was there a requirement at all to provide for such a category with overriding priority in the procurement process? Or has this requirement of recognizing the importance of Indigenous Design and Development, come about a bit late into the procedures? DRDO is the nodal agency for design and development of military platforms, systems, subsystems and in many cases components too, for the Armed Forces. It was designed to be so. It came about into being for this very reason to meet the requirements of our Armed Forces. In its more than six decades of existence, has DRDO even remotely met the expectations set out for? Why is it that our Armed Forces have to remain dependent on foreign sources for more than 70% of their needs even after seven decades of independence? What was lacking, (i) was it indigenous design and development (ii) was it indigenous manufacturing or (iii) was it both? What is more important for our Armed forces to be sustained from within the country for all their needs, is it (i) Design and Development or (ii) Manufacturing or both? How did this all begin? DPP 2013 already had flavour so of “Make in India”, by according to priority in categorization of procurements, such as, “Buy Indian”, had the greatest preference over all the others such as (ii) Buy and Make Indian followed by (iii) Make and then (iv) Buy and Make, with Transfer of technology, basically for the foreign OEMs and lastly the Buy Global.  Introduction of Buy IDDM to override and sit above all of this in the order of priority of ‘Make in India’ initiative by Government of India in Defence sector is indeed transformational. An indigenous emphasis has increased the business of Indian Defence Vendors and also strengthened the economy by Rs 1,152.48 crore this year as compared to 2015 as reported by the government. According to a written reply by Minister of State for Defence(RRM) Rao Inderjit Singh to K Parasuraman in Lok Sabha on Friday the Sixth of May 2016, The Defence Procurement Procedure (DPP) 2016 provided strong support to ‘Make in India’ by according highest priority to Buy (Indian-IDDM) that is Indigenous Designed, Developed and Manufactured category. It also focused on enhancement and rationalisation of indigenous content and has provisions for involving private industry as production agencies and technology transfer partners. The ‘Make’ procedure has also been simplified with provisions for earmarking projects not exceeding development cost of Rs 10 crore (Government funded) and Rs 3 crore (industry funded) for MSMEs, Singh added. With this bold initiative, the total expenditure on purchase of Defence equipment for the three services in 2015-16 is Rs 76,169.57 crore in which the procurement from Indian vendors is Rs 49,979.11 crore and from foreign vendors it is Rs 26,190.46. In 2014-15, the total expenditure was Rs 77,986.32 crore in which Rs 48,826.63 crore was from local vendors and Rs 29,159.69 crore from foreign companies.

The numbers prove that Indian companies got more business than their foreign counterparts in 2015-16. Importance of ‘Make in India’ in DPP-16 also reduced the foreign profit by Rs 2,969.23 crores than last year. A number of measures have already been taken to achieve self-reliance in defence production by harnessing the capabilities of the public and private sector industry. The DPP-16, aims at achieving substantive self-reliance in the design, development and production of equipment, weapon systems, platforms required for Defence in as early a time frame possible; creating conditions conducive for the private industry to take an active role in this endeavour, enhancing potential of SMEs in indigenisation and broadening the defence Research and Development (R&D) base of the country. Indigenous manufacturing of Defence equipments is encouraged by the Government through several policy measures like; Preference to ‘Buy (Indian-IDDM)’, ‘Buy (Indian)’, ‘Buy and Make (Indian)’, categories of capital acquisition over ‘Buy (Global)’ category in Defence Procurement Procedure. Foreign Direct Investment (FDI) policy has been reviewed and as per revised policy noticed in November 2015, Foreign Investment Cap upto 49% is allowed under automatic route and above 49% under Government route on case-to-case basis, wherever it is likely to result in access to modern and ‘state-of-art’ technology in the country. Minister of State for Defence Rao Inderjit Singh also informed that Hindustan Aeronautical Limited (HAL) has handed over 156 Dhruv Choppers to armed forces in which 66 choppers are already delivered to Indian Air Force, 78 to Indian Army, 8 to Indian Navy and 4 helicopters to Coast Guards. Defence Research Development Organisation (DRDO) is also working on different indigenous research with the help of Indian vendors which will give a boost to defence procurement and defence preparedness in future. In addition to all of this the government has also taken efforts to de-regulate the requirements for licensing by removing more than 60% of the products form requirement of compulsory licensing, thus providing relief to the domestic industry. So, there has been a holistic approach to the entire defence sector, and IDDM category was the icing on the cake.  So, what are the categories of procurement in DPP 2016? Categories of Procurement in DPP 2016.

Presently the following categories are incorporated  in the DPP 2016, in their order of priority in procurement :-

(a) Buy IDDM

(b) Buy Indian

(c) Buy and Make Indian

(d) Buy and Make (Global)

(e) Buy Global

In addition to the above there is also the “Make” category of procurement, which is now formulated in a more practical and industry friendly manner.

The government has pre-positioned the “Make” category to basically enable the Forces to select programs for consideration under the Make category. Within a month of promulgating the truncated DPP 2016, the MoD has also placed on its website 23 projects for the industry under the Make category. That’s commitment to Make in India. Buy IDDM We shall now analyse the Buy IDDM category. Buy IDDM means Buy from those Indian sources that incorporate Indigenous design, development and Production. This essentially means the following :- (a) Design has to be Indigenous (b) Development has to be indigenous (c) Production  or manufacture has to be indigenous However the government feels that there could be occasions when such conditions cannot be met by domestic industry, due to its evolving nature.

Therefore, the MoD has considered a non-indigenous design and development proposal also as part of this category. This means, a non-indigenous solution by the industry that incorporates a non-indigenous design and development could also be categorised under this priority-1 category of procurement. What then is the difference? Government is aware of the infant nature of defence industry especially in the private sector and to help evolve it to the next levels, has therefore allowed even a non-indigenous design, but has made the difference in the manufacturing indigenous content. If the design and development is indigenous, then a indigenous manufacturing content of 40% could suffice, whereas, if the design and development is non-indigenous then a 60% indigenous content is mandated. Thus the MoD has taken care of both the requirements, viz, design/development as well as manufacturing in the same category. For a given procurement proposal, If the above conditions are met, the planning process would accord highest priority to categorise this accordingly. This actually means:- (a) Encouragement to Indigenous design and development (b) Encouragement to indigenous manufacturing content (c) Manufacturing invariably has to be done indigenously. The content of indigenous manufacturing is called as Indigenous content(IC). To depict the same:- Manufacturing content required is 40% if the design is indigenous, else it is 60%. Apart from overall IC as detailed above, the same percentage of IC will also be required in (a) Basic Cost of Equipment; (b) Cost of Manufacturers’ Recommended List of Spares (MRLS); and (c) Cost of Special Maintenance Tools (SMT) and Special Test Equipment (STE), taken together at all stages, including FET stage. This condition flows from the DPP 2013.   How do we prove the design? The onus of proving that the equipment design is indigenous, rests with the industry, and such claims will be verified by a committee comprising scientists from DRDO and representatives from SHQs, based on documents issued by authorized agencies and presented by the vendors. The process of verifying the availability of indigenous design and development, should be completed prior to fielding of SoC( also called as the Sratement of Case, which in fact is the proposal made by the Armed Forces HQs) for categorization; guidelines pertaining to the same will be issued by the DG (Acquisition), with inputs from DRDO. Modus operandi for proof of design to certify it as indigenous or otherwise, is an activity that needs to precede the planning process for appropriate categorization.

This will be a challenge both for the MoD as well as for the industry.

Analysis

(a) The process of verification of design precedes the fielding of the said acquisition for the SCAP lower committee.

This means that invariably, the prospective vendors need to have an interaction with DRDO even before the proposal is fielded by the services. Early liaison and interaction with DRDO is called for to be eligible for placement under this categorisation.

(b) Even if design is not indigenous, a good tie-up with a foreign design source can be made and IC can be increased to be eligible under this category. Industry that intends to field a non-indigenous design, must necessarily have an intimate knowledge of the supply chain to integrate this with the design, in order that the manufacturing content is maximized.

(c) Early knowledge of proposals likely to be fielded is essential.

May need to closely follow up the RFI process and have intimate interaction with Services. How do we then see the acquisition process evolving? It will be the endeavor of industry to field their solution against an acquisition proposal in the most preferred category. What do we mean by indigenous design? Supposing, an Indian company bought off a foreign design, does it now become indigenous? Buying off a design with the know-how and know-why along with the IP rights may empower Indian industry to stake claim to participate under IDDM category. Indigenous industry has yet another option, a more interesting one, that has not optimally been exploited. There are many technologies that have been developed by DRDO and available for transfer to industry. Recently, DRDO has also promulgated the guidelines for transfer of technology to industry, the same is available on their website. Industry may like to exploit this opportunity for an eligibility under this category. DRDO may also face challenges in transferring technology to industry. If Make in India has to happen, then industry is likely to flood DRDO seeking technology transfers for those technologies that DRDO has developed. These are known as “Cat A technologies”, in DRDO’s parlance. DRDO may need to develop an ecosystem for industry interface and enabling smooth transfer of such technologies. Industry readiness to face the challenge Industry now has multiple options to meet the requirements of the Armed Forces through indigenous design and development. They could invest in design and development in an organic manner, thus investing heavily in researchers development. They could rely on DRDO for fundamental research and take on engineering design, it is still a tough call. The second option they have is to seek technology transfers for the already developed technologies by DRDO. These are technologies that have been developed, tested and ready to use, ready to go to production. This will incorporate less lead time in the production process. Domestic industry also has the option to go to a foreign OEM to seek transfer of technology.

This can be done either through the Offsets route(which incidentally is more difficult), or through a direct purchase of technology or even through formation of a suitable JV(joint venture). The latter two options are more practical and feasible. What is sought under such conditions is an unconditional transfer of technology, a full and total transfer of technology with unfettered rights. Only under such conditions can the said technology be deemed to be indigenous. When such technology is made available through a JV route there could typically be ownership rights and may not lead to “indigenous” qualification. In a more liberal manner there could be a case of teaming arrangement with the foreign partner willing to transfer technology under pre-stated business conditions, that could draw upon the Indian partner to seek IDDM status with a higher manufacturing content. In conclusion, the government has done well to incentivize industry to strive for indigenous design, development and manufacture. Indian Armed Forces are deployed in intimidating Indian conditions and for the Indian conditions they are deployed in, they require Indian solutions. Innovation is the key to meet the immediate needs of the Armed Forces and innovation can happen only when indigenous solutions are attempted. It is now for the industry to come up with models to achieve “Make in India in Defence” in its true spirit.    The Home Ministry has raised serious concern over hiking FDI cap in defence, space, telecom and a few other areas, contending that flow of funds from countries like China in these sectors may compromise country’s security. This was conveyed by the Home Ministry to the Department of Industrial Policy and Promotion (DIPP) and it is all set to dash off another letter conveying its strong opposition to any such move which may jeopardise country’s security. The Home Ministry said FDI beyond certain limit from countries like China, Pakistan, Bangladesh, Saudi Arabia and Indonesia in defence, space, telecom, information and broadcasting, civil aviation may allow people from these countries to dictate terms which could be contrary to India’s interests. “It is a serious issue. We have already conveyed our view to DIPP and will soon write another letter explaining the reasons behind our opposition in hiking the FDI cap in these key sectors,” a Home Ministry official said. FDI in these sectors needs mandatory security clearance from the Home Ministry. The recommendation of a committee to raise FDI limit to 49 per cent in almost all sectors through automatic route was also opposed by the Home Ministry saying safeguards must be put while allowing hike in FDI in key sectors. The committee, headed by Economic Affairs Secretary Arvind Mayaram, had recommended that FDI limit be raised to 49 per cent in almost all sectors through automatic route. The committee suggested that FDI in defence be raised to 49 per cent under the government approval route, from the current 26 per cent. Last week, the DIPP held first round of consultations on the proposal to raise FDI ceilings in different segments. All the concerned departments and ministries are expected to send their views on hiking the FDI ceiling to the DIPP within a day or two and subsequently it would submit a detailed report to Commerce and Industry Minister Anand Sharma by July 7.

[1] Daily Excelsior dated 07/07/2013

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