The only trouble with the defence business, lamented a chief financial officer of a company that built a new facility to supply components, is paucity of orders. As the anticipated orders did not materialize in the stipulated time the company was unable to scale up defence business as projected, resulting in earnings estimates cuts last year.
The orders did eventually materialize. But they are not yet large enough to be commensurate with the new facilities built up. This, in short, captures the situation of the companies that depend on the defence sector for their business.
There are a few listed companies (Bharat Electronics Ltd) that are completely dependent on the defence sector for business. But as the government stepped up its indigenization plans, several companies, including L&T Ltd, Tata Power Co. Ltd, Ashok Leyland Ltd and Bharat Forge Ltd, began pursuing the defence business with new vigour. Companies like BEML Ltd, Solar Industries India Ltd and Premier Explosives Ltd are seeing the defence business as a growth avenue.
The benefits, however, have been slow to come. Bharat Electronics’ revenues grew just 6% in 2015-16. In the first half of the current fiscal year, they are up a mere 1.6%, as execution lagged. The company has a huge order backlog. For others, time consuming procedural delays and approvals mean orders are lumpy or slow in materializing.
Due to the complex procurement process, defence manufacturing historically has been a long gestation business. Further the sharp rise in manpower costs means capital expenditure (capex) has been under pressure. The revenue to capital expenditure ratio has seen a notable drop from fiscal 2011-12, points out the standing committee report on defence.
However, with the government stepping up local manufacturing and modernization efforts, the hope is that capex will gather pace from 2017. The defence ministry is said to be aiming for “enhanced” allocation for armed forces in the coming budget. Jane’s Defense Budget report by IHS Markit forecasts India to re-emerge as a key growth market for defence suppliers over the next three years.
But there are doubts if defence capex will see the kind of boost many are envisaging. “Very doubtful to say. Money is a constraint and economic growth has weakened as recent data readings show,” said Laxman Kumar Behera, research fellow, Institute for Defence Studies and Analyses (IDSA).
Further, the challenge for the defence ministry is not budget allocation but execution. An examination of past defence budgets by the standing committee revealed that the government’s ability to spend has come under repeated pressure. In the previous four years, the ministry of defence is said to have surrendered about Rs35,000 crore from its capital allocations.
Worse, the ministry has been consistently under-spending the acquisition budget with recent years lagging the targets by as much as 10%. “This is a peculiar problem. Capital procurement is invariably a complex process. So one can understand a 2% to 3% under-utilization of capital acquisition budget. But a 5% to 10% under-utilization needs strengthening of the procurement process,” Behera of IDSA adds. The chart has the details.
While this calls for better planning and execution, the expectation is that the various efforts (such as strategic partnerships) by the government should begin to reflect on capex from the current year onwards.