The Indian government opened defence production to the private sector in May 2001 as an outcome of the recommendations of the post-Kargil Review Committee. Accordingly, issuance of Industrial Licenses to the private sector began in mid-2002, thereby opening the doors for Indian private sector companies, with a track record in manufacturing to prove their mettle against the well-entrenched monolith- Defence Public Sector Undertakings (DPSU). It allowed 100 per cent private equity with 26 per cent Foreign Direct Investment (FDI). It was a major policy change. Subsequently, the Department of Industrial Policy and Promotion (DIPP) issued detailed guidelines for the issuance of licence for the production of arms and ammunition. Currently, foreign investment up to 49 per cent is permitted under the automatic route, foreign investment beyond that up to 100 is permitted through government approval.
The Department of Industrial Policy and Promotion (DIPP), in consultation with Ministry of Defence, has so far issued several letters of intent for the manufacturing of various types of defence hardware which include armoured and combat vehicles, radars, electronic warfare equipment, warships, submarines, avionics, military aircraft, safety and ballistic products, armaments and ammunition. Despite the above measures, there has been no discernible change in the ground situation.
More than 18 years after defence manufacturing was opened up to the private sector, DPSUs still rule the roost, contributing four times more than the private defence manufacturers. In July this year, the Defence Ministry in a statement given to Parliament said that the annual turnover of private sector companies in the defence and aerospace sector is close to Rs. 15,000 crore, with public sector undertakings over four times as large at Rs 63, 208 crore. The data pertains to the Financial Year 2019 and reflects the known trend of private sector participation in defence not having moved at the expected pace to make it the cornerstone of the Make in India initiative.
While the private sector has been moving up since defence manufacturing was opened up post-2001, and a slew of policies initiated to ease licensing and procedures taken since 2014 when Modi government came into power, industry insiders rue the fact that it has been an uphill battle to get a level playing field with the public sector undertakings.
Top private sector companies that have ventured into defence sector and have invested heavily, have written to the government in the past four years, pointing out unfair advantages being given to the DPSUs. They have protested against nomination state-owned undertakings for large defence contracts.
Level Playing Field: Issues to be Addressed
Opening up of the sector encouraged Indian private sector companies, and a few long term and larger players amongst these made follow through investments to expand capacities to harness these capabilities. Such companies had already invested – specifically for the segment -in resources, technologies, facilities creation, and built capabilities through partnerships with Defence Research Laboratories during the decades of “Reserved for the State” era.
However, with no major orders being placed, private sector companies ended up with mounting losses. The Government-owned sector not only benefitted from nominated orders for all major programs without competition but also received financial grants, grants for Capex and compensation against inflation as well as forex risks. Certain issues that need further elaboration are:
- Budgetary support to DPSU/OFB for creation of assets and capacities: The Government has been providing and continues to provide financial grants in aid for creation of assets in DPSUs/OFB either through budgetary support or part of capacity addition/enhancement funding, as part of nominated contracts to create new/improve assets, capabilities, skill development as well as obtain multiple Transfer of Technologies (ToTs) in the past.
- Government-funded assets enable the state-owned companies to deploy these assets, and capabilities without asset servicing costs, leverage learning curve benefits gained from past programs (in a way allowing cross-subsidizing them) for competitive bidding against the fledgling private enterprises who have to make investments in infrastructure, capacity creation as well as more comprehensive ToT, and in-addition servicing these over the program tenure. Thus, an environment is created that exposes them to the risk of becoming non-competitive.
- Large nominated contracts provide for years of capacity booking of the DPSUs. Further, these are awarded by taking into account the entire operating costs of the DPSUs over the contracted period.It enables DPSUs to cross-subsidise fixed operating costs and overheads for bidding competitive contracts that would run concurrently to the nominated contracts, while simultaneously bidding against private Industry more competitively.
- The PSUs/DPSUs have surplus cash, accumulated over years due to advance received from large nominated orders; a dipstick survey on the delivery performance of nominated programmes will bring out the delays in induction. Multiple reports from CAG bear this out. These delays have continued to be compensated by the Government in the form of inflation indexation even beyond contractual delivery schedules. Citing CVC guidelines, DPSUs deny sharing advances with tiered vendors who get paid only on delivery. This also enables DPSUs in building a huge cash surplus. Additionally, this cash surplus earns interest for the DPSUs. The large cash surpluses also help cross- subsidisation on competitive contracts. Bank Guarantees to DPSUs at negligible cost for competitive programs further tips the scale against the private.
- In any case, there is no requirement of bank guarantees for nominated contracts that allow public companies to provide corporate guarantees at nil cost.
- All major nominated contracts grant the DPSUs stage payments while the same is denied to private sector companies. Case in point is there is a separate chapter (Chapter 3A of DPP) that applies to warship building contracts nominated to DPSU Yards while auxiliary shipbuilding contracts are awarded to the private sector under Chapter 2 (Global Competition) as well as Chapter 3B (Indigenous Competition) of DPP.
Suggestions for implementation of Level Playing Field
- Stop Nomination of Orders to DPSUs/OFB
- Nominations create non-level playing fields and are discriminatory resulting in restricted capability building & underutilisation of private sector capacity.
- All procurements by MoD to be only on a competitive basis in the interests of real price discovery.
- All cases where AoNs were granted on nomination basis but RFPs have not been issued either due to AON requiring revalidation or due to gross delays should be made open for participation by private sector companies.
- Creating level playing field in competitive bids.
- To grant perfect Level Playing Field to the private sector, the competing PSU/DPSU bids for competitive contacts must be loaded for:
- The cross-subsidy arbitrage in the form of free access to Govt Funded assets & past repeated ToTs loaded by equivalent interest and depreciation costs while comparing competitive bids.
- The proportional share of operational overheads should be allocated to the program underbid and not solely recovered from the currently running nominated programmes.
- Appropriate comparison with costs under different heads for programmes nominated versus those where they are competing
- Inflation escalation beyond the contractual date (delays allocable to the PSUs) be stopped.
Creating escrow accounts for large projects including nominated contracts can prevent the direct cash cross-subsidisation from the past nominated orders while bidding for competitive programs, thus ensuring MoD funds are utilised only for the specific program and also accelerate project execution and benefit the user. This can be done by seeking audit certification of overheads allocation and ensure cross-subsidy across nominated contract to competitive contract is avoided.
Level Playing with Foreign OEMs
Indian OEMs face many policy and procedural differentiation as compared to Foreign OEMs. These are:
- Payments to Foreign OEMs have been, and continue to be made against Letter of Credit through the banking system, while payment to Indian OEMs is remitted against invoices backed with supporting documents viz. Despatch Clearance Certificate/I-Note/Pre-dispatch Inspection etc., that get routed through multiple agencies, adding to delays.
- The Indian OEMs then wait in a payment queue at the CDA and face lengthening of working capital cycles. The payment realisation delays are at least two to three times the contractual commitment of MoD resulting in severe cash crunch compelling the Indian OEMs to borrow more and for longer periods and incur associated costs on receivables contractually due to them. This has been a major issue that distorts the level playing field concept. Granting LC payment to Indian vendors at par with Foreign OEMs would make the process efficient, besides saving time and costs to Indian OEMs making them, even more, cost competent to serve the MoD.
- Foreign OEM goods are tested in their country and many tests are waived by accepting paper certification that is based on “Good for Use by that Country”. Indian equipment faces repeated and extended testing. Given NCNC costs the cost of trials for Indian OEMs are much larger
- Foreign OEM equipment is accepted based on paper certification/self-certification basis and with minimal intervention of user inspection agencies while Indian equipment is actually pushed through multiple stages of inspection Hold Points as well as extended equipment trials; sometimes repeatedly. While for FOEMs, inspection is restricted to end product functionality and met through self-certification, while in the case of Indian bidders, detailed inspection (up to component level) is carried out by DGQA/ Government designated inspection agencies with large number of hold points for inspections subjecting them to additional cycle times, delays and face Liquidated Damages at the whims and fancy of quality inspectors. Indian OEMs, at least select long term players, ought to be mandatorily allowed self-certification at par with Foreign OEMs.
- While Foreign OEMs get paid in foreign currency, the Indian OEM has to bid and get paid in INR and until recently (DPP 2016) was denied Exchange Rate Compensation against part of the contract value in foreign currency that was incurred on government nominated equipment imports.
- DPP 2016 granted FERV to Indian companies under all categories of procurement. This was not the case under earlier DPPs under which many programs are still in the execution pipeline. In the interim, Rupee has devalued substantially against international currencies (US Dollar). For all the under execution programs, Private Industry is not allowed FERV as contracts are Rupee denomination, although with Foreign content of the same was defined for the purpose of Customs Duty Exemption, prevalent till 2016. On the contrary, FOEMs are paid in foreign currency, and the Indian Government. bears FERV cost on the date of payment, if FOEM were to be the winners in competitive bidding. The same is denied to Indian OEMs although they would have partial import content against full contract value on which the same is paid by MoD to Foreign OEM
- The release of payment for FOEMs is based on the proof of despatch-CIF basis as the case may be. While for Indian suppliers, the release of payment is done after the range of detailed tests and acceptance of the same by relevant authorities, delivery at the specified depot and Joint Receipt Inspection, altogether adding to not less than 6 months to a year of delay post readiness of dispatch.
- Indian Cost of Capital is among the highest and Indian OEMs bear that cost. Competing Foreign OEM gains competitiveness with the cost of capital being much lower in their countries.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of BharatShakti.in)