Defence acquisition reform in limbo
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With former defence minister Manohar Parrikar’s return to the position of chief minister of Goa, the global defence industry is asking one big question: What will happen to the defence reforms announced by him?
India faces a significant shortage of critical defence equipment, including fighter aircraft, submarines and helicopters, which India’s defence public sector undertakings (DPSUs) have been unable to address. This reality was publicly stressed yet again in March by a parliamentary standing committee on defence.
If the Indian military is to manage this challenge, critical policy issues such as defence procurement reform need to be finalized.
To address this issue, Prime Minister Narendra Modi and Parrikar introduced the concept of nominating “strategic partners” in defence production. The idea appears to be that the government should designate vetted private Indian companies to specific areas of national security importance, such as manufacture of fighter aircraft, tanks or submarines, to develop technologies and systems.
These companies would be free to partner with local vendors and foreign companies to acquire needed technology and expertise. They would, in effect, take advantage of economies of scale to become the fulcrum of activity for a particular defence requirement. Given the large capital, material and technical requirements of major weapons platforms, coupled with the likelihood that the Indian military would at least initially be the sole buyer of such systems, it’s reasonable to assume that only a limited number of companies can produce some military systems. It appears that Parrikar was looking to have the ministry of defence generate public-private partnerships to produce these strategic weapons systems.
The Defence Procurement Procedure of 2016 was released with an empty chapter—to be filled with the details of the strategic partnership arrangement. A year later, many wonder if this chapter will ever be written. This uncertainty hinders India’s overall strategy for defence manufacturing and leaves foreign capital and expertise confused about how to enter the Indian market. Defence is a capital-intensive industry with long time horizons and companies are hesitant to enter a market with potentially game-changing regulatory changes yet to be announced.
One can sympathize with the ministry of defence (MoD). Acquisition reform is a complicated issue. Thoughtful observers recognize that finance minister Arun Jaitley, who has been handling the defence portfolio since Parrikar’s exit, has a tough task ahead of him. The strategic partnership model could accelerate India’s defence capability by fostering much needed competition and mobilizing Indian and foreign capital for research and capacity expansions. But this is not without risk.
If not managed carefully, the reform could simply shift India’s defence oligopoly from public companies to private industry. The defence industry is far from a “perfect market”—a market with a large number of buyers and sellers, transparent prices and costs, conditions that provide easy entry for new companies and clear exit routes for non-performing companies, homogenous products that promote competition, etc. So it is reasonable for the government to consider interventions and regulations that manage the defence sector. However, there is always a risk when governments pick winners and losers in an economic sector—the risk of stymieing critical competition, which is essential to generating the greatest value for investment and stimulating new innovations.
And there is political risk as well in an industry with a history of corruption scandals. Politicians and bureaucrats do not want to expose themselves to charges of favouritism or create conditions that increase their vulnerability to the false perception of corruption. It is almost a certainty that those companies that are not deemed “strategic partners” will protest and their protest will provide political ammunition for the opposition.
One of the biggest challenges in defining a “strategic partnership” model lies in the number of Indian firms assigned to each area of national security importance. Initial statements from the MoD indicated a single company per area but subsequent signals indicate a willingness to expand the number of designated firms per area.
It is critically important that foreign companies have the flexibility to partner with whichever Indian company is most suited to commercial partnerships. The global supply chain that governs the defence and aerospace industry is complex. Government agencies are not well suited to manage the minutiae of joint partnerships in a manner that optimizes efficiency and value. The more freedom foreign companies have to find Indian partners, the more willing they will be to do business in India.
Successful policy reform will establish a predictable acquisition system that reflects the reality of economies of scale, fosters healthy competition, empowers Indian and foreign companies to work together and adapt their business models freely, and allows private industry to realize a return on its investment. Whether a new minister of defence continues with Parrikar’s efforts or designs an alternative system to harness private industry, the need for reform is apparent and most due. It is time to end the limbo in which acquisition policy currently lies.
Benjamin Schwartz and Sid Ravishankar manage the US-India Business Council’s defence and aerospace programme.