The government recently announced the sixth iteration of the Defence Procurement Policy, 2013. In its current revision, the policy explicitly backs the indigenous defence industry. Its dealing with the private sector is even-handed. This is a positive change in the outlook of the defence ministry.

The Defence Procurement Policy has made an unambiguous preferred order of categorization for defence procurement. In decreasing order of preference, it shall be: (1) buy (Indian); (2) buy and make (Indian); (3) make; (4) buy, make with transfer of technology; and (5) buy (global). The buy (Indian) mode is the one in which procurement is done directly from a domestic firm and is expected to boost local production. The hitherto prevalent mode of buy (global), that of purchasing in entirety from a global original equipment manufacturer, is now least preferred in the revised order of procurement. It is a laudable step to give top priority to procurement through buy (Indian) category. Having said that, the issue is that most Indian products lack significantly in quality compared with their foreign counterparts. The Indian private sector is in a unique position to deliver if it can achieve the twin requirements of quality and scale. However, for the private sector, the road to defence production is strewn with obstacles. Prominent among these are a lack of a manufacturing ecosystem for defence production, a distorted monopsonistic defence market (with the government as the only buyer), an ambiguous defence offset policy, abysmal investment in defence related research and development, large capex requirements coupled with long gestation periods and a shortfall of technical competence (read: technology). These need to be earnestly tackled.

The private sector has a sufficient degree of motivation in terms of a large market size to overcome these hurdles. However, it can only do so within the limits of defined government policies. The government, in turn, can do great service to the private sector by minimizing a few prominent hurdles in one stroke by better coordinating the activities of the ministry of defence with those of the department of industrial policy and promotion (DIPP). Two such issues that need to be tackled are the National Manufacturing Policy (NMP) and a National Offset Policy.

As a part of NMP, DIPP is aggressively promoting the formation of national investment and manufacturing zones (NIMZ). These would be under the Delhi-Mumbai Industrial Corridor (DMIC) being set up along with the western dedicated freight corridor. NIMZ will bring together modern infrastructure, technology, skill development centres and state of art connectivity for manufacturers. Russia and Japan will be key partners in developing these corridors and towns. The defence ministry can gain much by championing the establishment of defence production ecosystems within NIMZ. Though the NIMZ guidelines do mention defence production, there do not seem to be concrete proposals in existence. Promotion of a special defence production sector by the ministry, especially for dual-use technologies, can encourage a multi-tier development of defence production capability and enable private sector companies to invest in research and development.

The defence offset policy can incentivize joint venture companies that are formed within NIMZ by offering additional multipliers on their discharge of offset obligations and by easing the licensing norms. A pragmatic export policy with a rational tax structure for exports from NIMZ will minimize existing distortions in defence markets. It will also be easier to form a corpus of funds to provide for the development needs of a cluster of defence sector micro, small and medium enterprises within NIMZ. The Defence Procurement Policy proposes the formation of security guidelines for the Indian defence industry. The implementation of such guidelines will be better facilitated if special defence production sectors are formed. With eight NIMZ under consideration as part of DMIC, cooperation between the defence ministry and DIPP will yield rich dividends.

The defence ministry and the ministry of commerce have widely divergent views with regard to the institution of a National Offset Policy. It will be in the interest of the country if these differences could be narrowed down to the minimum and consensus reached in an important facet of national policy.

Buy (Indian) is a much desired end-state but one that will materialize only over the long term. India lacks advanced technologies such as complex metallurgy, high-end missile sensors, radars, aerostats, electronic warfare systems and complex avionics. The market for cutting-edge technology is highly oligopolistic and prices do not automatically adjust to changing market conditions. National grand strategies and other intangible forces play a major role. Also, a firm will purchase new technology only to the point where its marginal benefits equal its marginal costs. Considering the reticence of both stakeholders, the most efficient way for our government to obtain this technology is by leveraging the bargaining power of our large defence spending in terms of defence offsets. It will be in our immediate interests if the government encourages dual-use technologies and permits up to 100% FDI in defence offsets. The Defence Procurement Policy is a step in the right direction but has many audits to undergo before it can contribute significantly to defence production.

Rajiv Bhargava is associate director, Munjal Global Manufacturing Institute at the
Indian School of Business.

Close