For indigenous defence output to take off

India ranks among the top 10 countries in the world in terms of military expenditure and has established itself as a prime importer of defence equipment. India allocates about 1.8 per cent of its gross domestic product (GDP) towards defence spending, of which 40 per cent is annually allocated to capital acquisitions.

However, only about 30 per cent of the equipment is manufactured in India, mainly by public sector undertakings, with the private sector playing the role of an outsourcing base. Even when defence products are manufactured domestically, there is a large import component at both system and sub-system levels.

The Indian defence industry’s import-export ratio is inferior to countries with a much smaller defence industrial base. India’s arms imports are now almost three times as high as those of the second and third largest arms importers—China and Pakistan.

India is also among the top five arms importers, besides China, Pakistan, the UAE and Saudi Arabia. The industry is largely dominated by defence public sector undertakings (DPSUs) and ordnance factories which contribute about 90 per cent of the total domestic manufacturing output.

There has been a heightened focus on indigenisation and “Make in India” after the new government assumed office. The government has stated its goal to boost manufacturing in order to create a domestic defence industrial base.

In line with its commitment, the government has announced the following policy decisions in the last six months, including raising the FDI cap to 49 per cent in defence manufacturing; issuing list of equipment requiring industrial licence and liberalising regulations; the issue of a Security Manual for defence companies and the notification of a strategy for export of defence products.

The government has initiated the process of transforming the Aerospace and Defence (A&D) sector in order to reduce the dependence on imports. However, there are some key hurdles which need to addressed to achieve this objective.

Though the sector was opened for private, domestic and foreign investment more than 12 years ago, the level of domestic as well as foreign investment has been way below its potential. India has managed to receive a meagre FDI of $ 4.94 million since April 2000 to November 2014.

India’s historical dependence on imports may possibly be one reason for the limited focus on developing intellectual property. Presently, access to technology and in-house capability development has been a bottleneck for manufacturing.

The government’s initiative for indigenisation in the A&D industry in India requires complementary initiatives affecting the A&D eco-system. To truly leverage the combined potential of one of the largest defence acquisition programmes of the world, a liberal offset policy and India’s advantage in low-cost manufacturing and skilled manpower, it is essential that government policies create synergies rather than contradictions.

In order to facilitate the “Make in India” campaign, procedural simplification is needed. Though the FDI cap has been recently increased to 49 per cent, it may not succeed in bringing investment and advanced technology into the sector. In order to facilitate inflow of capital and setting up of entities of OEMs and their suppliers with transfer of technology, it may be desirable to allow either 100 per cent or, at least 74 per cent FDI in the sector.

There is also a need to provide tax incentives to accelerate the pace of indigenisation. Defence PSUs are able to claim exemptions from input tax and levies for their sub-contractors. Therefore to provide a level playing field, import duty exemptions should extend to the private sector.

Further, in order to encourage an ecosystem that stimulates investments and to achieve value for money, it should be ensured that all contracts are allotted competitively, and not by nomination.

The creation of a large defence sector will hinge on building capabilities of the private sector through partnerships, technology transfers and in some cases fundamental R&D initiatives. This will require a change in mindset from the government in terms of partnering with the private sector for long-term programmes.

The writer is Associate Director - Aerospace and Defence, PwC India