Posted by: John Elliott | July 2, 2012

Indian private sector gets first big defence industry opportunity

While most Indian media attention has been focussed on Pranab Mukherjee and what the end of his unproductive time as finance minister might mean for economic progress now that prime minister Manmohan Singh has taken over the job, a significant liberalisation move has been made by the usually moribund Defence Ministry.

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A.K.Antony (right), the defence minister, has shied away from as many reforms as he can since he took the job in 2006, slowing down plans that were being backed by his predecessor  – ironically Mukherjee. But ten days ago he allowed a landmark initiative to go ahead on the modernisation of India’s inefficient and often corrupt defence manufacturing industry when the Indian Army invited a private sector group to compete against the public sector for the design and development of an important internet-based advanced technology project, the Tactical Communication Systems (TCS).

The private sector companies involved are Larsen & Toubro (L&T), Tata Power SED and HCL – the first two are specialists in high technology precision engineering and HCL is a leader in information technology. They will compete against Bharat Electronics (BEL), a defence public sector corporation (DPSU).

This is the Indian private sector’s first significant opportunity to show that it has the capability to beat deeply entrenched public sector defence manufacturing companies that often rely on re-assembling imported foreign components as high cost Indian products without any significant gain in technological and manufacturing know-how.

That practice has become widely publicised in recent months following allegations made by General V.K.Singh, who retired as army chief of staff a month ago, that he was offered a bribe to back excessively over-priced Tatra army trucks . These trucks (no link with the Tata group) have been produced for the past 26 years by the public sector Bharat Earth Movers (BEML) with components imported from a foreign company. The army chief alleged that only 60% of the components had been indigenised in the 26 years – even the left-hand drive had not been changed. (The BEML executive chairman has been suspended, and the Ministry of Defence decided ten days ago to end the nominated contract system used, without any competitive tendering, for the Tatra trucks and many other public sector purchases.)

The TCS project, which is provisionally estimated to cost Rs10,000 crore ($2bn), is the first “make” programme under the government’s defence procurement procedure. This is aimed at bringing in private sector companies to develop India’s very limited ability to produce advanced defence equipment. The government will cover 80% of development costs and the remaining 20% will come from the private and public sector companies involved, which have to produce prototypes with at least 30% Indian made components.

Public sector pressure

Eventually, after more than two years of design, development and testing, it is intended that the government will award the production contract to one of the two contenders. At that stage however, if BEL is not winning, there will be intense pressure to give the public sector a significant role.

The US and other countries use the same sort of “make” procedure, and it was included in the government’s defence purchasing procedures in 2006. However the defence establishment has lobbied strenuously against it, especially on the TCS project which BEL wanted so that it could prove itself able to handle advanced internet communications technology. That however would have led to a massive amount of imports, probably without India gaining the technical and development know-how that should be generated by the private sector companies.

India’s manufacturing private sector has proved its international competitiveness in the past decade, especially in the auto industry, and some companies like L&T have been working in high technology space and missile manufacturing for decades. But the defence establishment, which includes the defence ministry, parts of the armed forces, the public sector corporations, foreign suppliers and defence agents, all connived to block private sector development.

Pressure however is growing and the Planning Commission has recently called for Indian companies to be prime contractors for all major contracts under the “make” and similar provisions.

India has an annual defence budget of $40bn, including capital expenditure of $15bn, and is the world’s biggest importer of defence equipment according to a report earlier this year, accounting for 10% of global arms imports between 2007 and 2011. Its defence imports are officially put at 70% of total purchases, but the actual figure is far higher at maybe around 85% if  component imports done by the DPSUs are included.

Antony is not a reformer. He has blocked the designation of about 12 big companies, including Tata, L&T, HCL and Mahindra, as defence “champions” capable of becoming internationally recognised systems integrators. He has apparently been persuaded by small and medium sized companies that they would be left out, whereas they would actually gain as suppliers to the 12. He has also bowed to defence establishment pressure and watered down offset plans that would force foreign suppliers to make up to 40% of their equipment in India.

Much as he may have wanted to, he had little opportunity of reversing procedures that led up to the TCS announcement because it would have caused an uproar, especially from the army that wants to break free from the public sector dominance. The battle is far from over however. The next “make” project in the pipeline is for a futuristic infantry combat vehicle (FICV) where the developers have yet to be named.

The defence public sector will continue to try to block further private sector advances on this and other projects and will often be successful while Antony is defence minister. And the private sector now has to prove that it can deliver to international standards.

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