Prof Satya Narayan Misra in Bhubaneswar, February 22, 2023: The defense sector is a holy cow for the Finance Minister and its mechanics are often shrouded in unnecessary mystification. The reforms it has witnessed during the last two decades & their implication are often not adequately analyzed. This year’s defense budget is roughly 13% of the general budget, and 2% of our GDP, with an increase of 12% over the last year’s allocation.

The revenue component accounts for nearly 70% and capital expenditure 30%. The modernization component is significantly higher than the CAPEX in the general budget, despite the significant increase of 33% over the last year. Army accounts for 51% of the defense budget and is most revenue intensive. The IAF is the most capital-intensive accounting for 48% of the modernization budget, closely followed by the Navy (38%) and Army (22%). The DRDO, the research organization with 39 laboratories to promote indigenization & indigenous design accounts for 5% of the defense budget. The pensioners in defense out number (16 m) the active personnel (15 m) and account for 23 % of the defense budget.

A look at total military spending reveals that it has touched $2.1T (2.2% of global GDP), showing a decline of 0.7% over the previous year’s expenditure as per SIPRI Yearbook (2022) data. The USA accounts for 38% of global military spending and 60% of R&D spending.

This clearly explains the edge the USA has in terms of military arsenal & cutting-edge military technology. It is also the leading exporter of conventional arms (39%) while India leads the pack as the largest importer (11%). Our Self Reliance Index (SRI) is only 30%, i.e. ratio of indigenous procurement to total procurement, as most critical subsystems like weapons, propulsion & sensors are imported. In this backdrop, Make- in- India has assumed great salience.

While economic liberalization was embraced by different sectors in 1991, it came to defense services in 2001, by allowing full private sector participation and 26% FDI. The Kelkar Committee in 2005 strongly pitched for Public Private Partnership and level playing field to the private sector companies. The Committee also recommended that an offset policy should be introduced which will help India to leverage its Big BUY acquisition to bring in FDI, outsourcing orders, and key technology.

This is in the backdrop of the 1956 Industrial Policy Resolution which gave exclusive rights to Defense PSUs to manufacture missiles, electronics, submarines, and aircraft, and the Ordnance factories to produce tanks and ammunition. The DPSUs & OFs had also the exclusive rights to acquire technology and manufacture. The DRDO was expected to provide indigenous designs for DPSUs & OFs to manufacture. The private sector was essentially an outsourcing agency and not a partner.

The privatization & PPP initiatives had a slow start as the DPSUs &OFs have generally been resistant to competition and treated the private sector as a pariah. The Dhirendra Singh Committee (2015) was appointed by the Modi government to improve our self-reliance quotient to 70% from the existing 30% by 2027. The report envisages a Strategic Partnership model where leading private sector entities would have equal opportunity to receive technology and forge partnerships with foreign OEMs.

The FDI limit was also increased to 49% and in selected cases beyond this if they were bringing in key technologies. The offset policy also provided foreign OEMs to choose either private or public sector players as partners. In 2020, the FM also unveiled a number of initiatives for encouraging domestic manufacturing and Make in India. In the last budget, the FM proposed earmarking 25% of the R& D budget for use by the industry. She also suggested that the capital procurement budget of the services should source 68%of it from domestic sources, with or without foreign collaboration.

Despite the slew of reform initiatives for galvanizing indigenous manufacturing, the impact of FDI policy has so far been tepid. As against $ 62.38 billion which has come in different sectors like telecom, the FDI into defense is a measly $7 million so far. During the current year, only $3.2 million has come in as per a reply by the minister in the Lok Sabha.

Similarly, despite several tweaks, the offset policy has not brought any critical technology into the country. Except for certain low-tech outsourcing orders, both PSUs & private sector have not benefited much from the offset policy, barring a few facilities which OEMs have promised. The Dhirendra Singh Committee has also not witnessed any significant spin-offs in terms of Strategic partnerships. The DRDO which is the lynchpin of indigenous design has a poor record in areas like gas turbine engines, AESA radars, passive seekers, RLG, GPS, FPAs, precision weapons, and guided bombs & carbon fibers.

The Kalam Committee in 1993 had identified the above as our key weaknesses & suggested a road map in terms of facilities and capability to rev up our SRI (Self Reliance Quotient) from 30% to 70% by 2005. It has remained a pipedream in the absence of design capacity in critical technology. Kalam had, therefore, suggested Joint Ventures with Russians for producing Brahmos cruise missiles. His vision has fructified with this JV having immense export potential, apart from meeting the huge demand for the three services. He had also mooted the idea of Joint D& D with major design houses. MR SAM, a joint D &D with the Israelis has been a great success.

Countries like China have a better record in terms of value addition than us because of their greater attention to improving factor productivity. The Nobel Laureate Robert Solow flagged the importance of total factor productivity as the gateway to increasing returns to scale. Investment in R& D and innovation plays a critical role in this process.

While India spends around 0.8% of GDP on R&D, the developed economies spend 3-3.5% on it. Unlike India where the private sector players hardly spend any money on R&D, in France they spend more than 7% of their turnover on R&D. It is for this reason, both DPSUs & Private sector players play the role of assemblers & integrators.

Brazil could successfully manufacture the Embraer aircraft out of technology provided by the USA for buying F16 as an offset deal, as it pooled together all its scientific resources and the government provided tax holidays. China has become the manufacturing hub for F16 as they provide 100% FDI and create the enabling environment for OEMs to set up a production base and bring in key technology.

In India, our prevarication in loosening FDI limit and operational flexibility to OEMs is responsible for the FDI trickle in the defense sector. We need to forge JVs with reputed OEMs and design collaboration with reputed design houses, instead of reinventing the wheel.

It’s time for political leadership to seriously look at privatizing many products being manufactured by PSUs, like tanks, Advanced light helicopters, and small arms, increase FDI limit to more than 50% so that the OEMs will set up manufacturing facilities in India, bring in state of art technology & make India a global manufacturing hub. The present strategy of protecting indigenous industries will militate against quality, cost and efficiency.

Formerly Joint Secretary in the Ministry of Defence

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