How commercially viable a sector is defence?

Reliance has been eyeing investing in the defence for quite some time now, so have many private giants. And with ‘Make in India’ in the scene, it is important to evaluate the commercial viability of investment in defence, now and in the future, given the critical nature of the sector.

PRIVATE SECTOR INVOLVEMENT IN DEFENCE SECTOR

     1)    Public sector undertakings (PSUs) in defence sector have a cumulative turnover of about Rs.50, 000 crores. Public sector shipyards have been given orders worth Rs 1.24 lakh crores in the past two years. In the same period, the private sector has received orders worth barely Rs 2,000 crores. Considering the high-level technical expertise required in defence manufacturing, barely 6-7 private firms in the country namely, Tata, Mahindra, Hero, Reliance group, Hinduja group and Bharat Forge, have the technological know-how and financial strength to be able to invest in defense.

      2)    Also, a major problem in the sector for the entry of private players is forced dependence only on government purchases and the forces. Public sector players are not outsourcing received orders to private players. Industry representatives pointed out that over the past two years, not a single Rs 100 crores-plus order was placed by PSUs to any private defence manufacturer. Private sector supplies to DPSU and Ordnance Factories grossed over Rs. 1200 crores and Rs. 1900 crores respectively last year. Whereas these figures signify the contribution made by the private sector, they also highlight the fact that the private sector continues to be merely an outsourcing base for the public sector. 

      3)    With the coming of 100% FDI, foreign manufacturers will prefer coming in on their own rather than going in for a joint venture and share their profits, making it even more difficult for the private sector in the domestic market.

WHY PRIVATE INVESTMENT IS IMPORTANT

Defence manufacturing, for years, has been exclusively under government for security reasons. However, since we still lag behind in the area of technology, our defense requirements had to be imported. As a result, India is one of the largest arms importers in the world.
Increased domestic private investment will serve as import substitution, leading to cost saving, self-reliance, quality enhancement and in future, even help bolster exports of defence equipment.

WHY IS PRIVATE INVESTMENT WEAK NOW?

     1.     Though the government has so far been optimistic in its Make in India vision, not many enterprises have started working on the ground. A number of licences have been granted to private parties but only around 35 have started actual production.

      2.     Requirements of the armed forces are not made known to the private sector sufficiently in advance, with the result that it does not get adequate time, either to scout for foreign tie-ups or to establish the necessary facilities. The time given for the submission of technical and commercial proposals is grossly inadequate for a new entrant in the field.

      3.     The lack of focus on two horizontals that cut across all major programmes - electronics and materials. Electronics, technology life cycles are today down to 5-7 years and hence are incompatible with a procurement model that evolves from a 20 year vision. It is usually seen that the definition of system need (qualitative requirements), changes many times over, often even before the procurement process can be effectively concluded. A dedicated differentiated focus is needed from the centre.
 

     4.     Lack of a sustained focus on R&D in the materials sciences space. Encouraging private institutes or even firms to come up with latest R&D in defence, funding of independent research or providing incentives for research will engage more and more firms in the sector.

     5.     Lack of talent availability for the industry. The current sources of supply of talent are largely from the defence PSUs and user services. Neither are they adequate in quantity nor in terms of skills and quality, when evaluated from a perspective of the magnitude of demand arising from the need to build a robust home-grown industry.

HOW TO MAKE IT MORE VIABLE?

          1.     The government needs to be commercially sensitive.

2.     Around 25% of the defence PSU (public sector undertaking) turnover can be off-loaded to the private sector. A good sign is that the ministry has already de-licensed 60-70% of the production.

3.     The centre should create categories of private investments in defence manufacturing with varying caveats of concessions and guaranteed purchases, along with hedging investments. It must also try to take into account the small industries in this field to give them a level-playing field.

Defence manufacturing in India is undergoing a step function change. There have been substantial measures taken to boost local manufacturing in India and to ensure that this capability is built in both the public and the private sector. This aim is being addressed at one level through tweaking of the policies that are redundant and at another by supporting defense manufacturing industry through orders, investments and technology.

The government has displayed a very clear focus and a mindset to tackle the issue. If it continues its reformist policies, starts providing technological know-how to the private sector and controls how the local sourcing clauses of FDI are regulated, we can expect a fruitful engagement of private sector in the defence sector in the coming years.