Are Things About To Improve For India’s Defense Sector?

FARNBOROUGH AIR SHOW » 2014

by  NEELAM MATHEWS

July 14, 2014, 7:00 AM

A slowdown in reforms in India over the past five years–and a virtual pause in procurement–may be about to change following renewed optimism and confidence as the new government shows, for the moment at least, that it is serious. As hectic activity takes place in the ministries of commerce, finance and defense, increasing manufacturing, exports and foreign direct investment (FDI) are focus areas of the new regime.

A proposal to increase FDI levels from the present 26 percent to 49 percent, and possibly later, 74 percent for transfer of production (build to print) and 100 percent in the case of a single-source-hub transfer, including transfer of technology, is being viewed with interest.

While India has moved steadily in automobile and automotive components manufacturing, with auto giants leveraging the country’s strengths in IT, high-tech engineering and research-and-design capabilities, its performance in the defense sector has been abysmal. A meager $4.8 million FDI came in since the initiative started in 2002, under the 26-percent limit set when the sector was opened up to private participation. It is now being recognized that FDI should be linked with exports as no business can be sustained in the long-term based on domestic orders.

Exports from India are expanding in some areas where there are natural cost advantages (engineering design) and also in areas of rapidly deepening capability (aerostructures and avionics, for example). Also, export of defense equipment is a validation of Indian capability for the government even if it was created in the first place vis-à-vis a need to address local capability gaps, explained Rahul Gangal, a principal at Roland Berger Strategy Consultants. “With the aid of a progressive regulatory regime, India could look at an annual export potential of aerospace, defense and security of more than $25 billion per annum in the next five to eight years,” said Gangal.

Recently, Tata AdvancedSystems Ltd. (TASL) announced a partnership with Germany’s Ruag Aviationto manufacture fuselages and wings for the Dornier 228 aircraft, its fourth in the aerospace sector. Meanwhile, TASL’s joint venture with Sikorsky has already delivered more than 70 Sikorsky S-92 cabins, having produced the entire cabin locally. And, its joint venture with Lockheed Martin manufactures the empennage and center wing box for the C-130J transport. “TASL has better program management skills, and in the immediate future, private industry will continue to tap resources from [the] government defense manufacturer Hindustan Aeronautics,” said an industry official.

Balancing Act

There is caution in India about the increase in FDI in the defense sector, with divergent chains of thought. “It will be a better solution to implement this change in a phased, step-by-step manner–that is, from 26 percent to 49 percent,” said Puneet Kaura, executive director of Samtel Avionics, whose locally made displays by Samtel-HAL joint venture are installed on some 100 Sukhoi Su-30 MKI fighters. “The Indian manufacturing industry is at a very nascent stage…As the industry matures to absorb more influx of technology, a decision to increase beyond 49 percent may be taken, but 49 percent is good enough for now,” he said.

A joint venture involving Thales manufacturing helmet-mounted sight and display systems and modern avionics systems, with a local partner, for the Indian and export defense markets will likely contribute to offsets for the 126 medium multi-role combat aircraft (MMRCA) contract.

The Federation of Indian Chambers of Commerce and Industry (FICCI) echoes similar thoughts that defense production should be restricted in foreign investment. “Given the strategic nature of the defense sector…100 percent FDIshould be allowed in cases such as aircraft engines, advanced missile guidance systems, seekers, production of smart materials and high-strength carbon fiber, for which investments can be justified only by volumes available through integration with the global supply chain of the OEMs,” stated the FICCI.

On the other hand, rival industry association the Confederation of Indian Industry (CII), the largest in India, has made it clear that to attract investment a higher FDI cap, with the foreign investor permitted to have majority equity, would act as a catalyst. “Higher FDI will definitely help in creating a vibrant domestic defense industrial base in the country,” saidCII president Ajay Shriram.

According to the CII, FDI is directly related to increasing manufacturing growth to 25 percent of GDP and bringing high-end technology into the country. “The associated benefits are the spin offs for the civilian market. The CIIis keen to see high-tech and highly complex system integration work being done in India, and Indian industry is ready to take this challenge,” it said.

Despite roadblocks, delayed deals are on their way to being cleared and will require offsets. The MMRCA could be announced very soon, possibly here at the Farnborough Airshow, once two major issues–one on offsets and the other on responsibility of liability by Dassault Aviation vis à vis HAL–are decided, an industry official said.

As the government looks at a focus on exports, it has marked out areas of immediate interest, including an aircraft program, shipbuilding, sustainment of munitions, revival of archaic ordnance factories and divestment of HAL.

Exports Explored

Export of missiles to friendly foreign countries is being explored, according to Avinash Chander, chief of the Defense Research and Development Organization (DRDO). “We are discussing the methodology for developing export potential as well as a policy mechanism for export of weapon systems,” he said. There is a clear interest in the region in the BrahMos supersonic cruise missile, an India-Russian joint venture. Export of sonars to Myanmar is said to be in process. “Our advantage is lower cost of production,” he said.

Aerospace-related exports were around $5 billion last year and, apart from Sikorsky and Lockheed Martin, include primarily low value items such as fasteners.

Issues in defense procurement policy remain. The exclusion of software and design and engineering services in the Defense Procurement Procedure (DPP) are a big problem. “If you transfer a simulator but cannot transfer software that is part of the package, it renders the hardware useless,” said an OEM. “We understand software was pulled out of the DPP following misuse [but] why not allow embedded software?” asked the official. Also, with design and engineering, an intrinsic part of the manufacturing and lifecycle process of a product, the exclusion in the policy is seen as a misplaced decision.

Further enhancement in the DPP on offsets has also been called for. “DPP 2013 lays emphasis on indigenization. However, force multipliers and some other provisions that support the Indian industry need to be looked into,” said Kaura.

Concerns about ownership and intellectual property remain. There is a contradiction, in part, as there is an apparent reluctance by large companies to give up ownership unless there is a brand value attached, a reason the 74-percent FDImight initially be restricted to specific projects. “We see moreFDI happening in small and medium industries that will be more willing to give up stake. However, how much foreign companies will be interested in releasing transfer of technology to them is another issue,” said a consultant.

“It is strategically prudent to allow a 74-percent FDI in defense, provided OEMs transfer the ownership of 74 percent intellectual property rights and technology portfolios to Indian defense joint ventures and the industrial ecosystem. This would spur the much-needed demand for industrial growth in manufacturing of complex aviation and defense technologies in the country,” said New Delhi-based Ajay Batra, CEO of the World Intellectual Property Rights Bank. However, lack of government readiness to measure transfer of technology, as well as the lack of an implementation agency, funding and support and export control regulations, have proved to be impediments.