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India’s Second Wind for Indigenous Defence Industries

The Indian economic model for defence expenditure relies heavily on Foreign Direct Investment or ‘FDI’ and for a country that spends 1.6% of its GDP on its defence, India meets more than 90% of essential requirements via imports whereas 30% of the total budget is spent on capital acquisitions. In light of the recent Indo-China clashes in Galwan valley, where 20 Indian soldiers attained martyrdom, the focus has again shifted to India’s lackluster performance in defense production and capability over the decades.

This complexity within the Indian Defence Acquisition regime is attributed to a lack of uniform statutory guidance, for instance, unlike the USA, which governs Defence Procurements by way of Defense Federal Acquisition Regulation (FAR) and Title-32 Code of Federal Regulations (CFR), India does not have a codified and designated entity to govern Defence Procurements. Instead, all the capital military acquisitions are governed by way of the Defence Acquisition Procedure, 2020 in consonance with the inter-operability of the Ministry of Defence and the Defence Acquisition Council, once the government procurement objectives have been defined via Rule, 116 of General Financial Rules (GFR).

In the last few decades, one of the significant components of the DPP and subsequent defense procurement agreements initiated by India has been the ‘’Offset Clause”. An offset, by definition, is facilitated by way of an unconventional contract which requires one of the economic activities to be transferred from the vendor to the purchasing entity’s government as a prerequisite for the sale of goods or services in the procuring entity’s market. Thus, mandating the foreign vendor to set up assembly or sub-assembly in India. Offsets were initially incorporated to improve the status quo of India’s nationalized defense companies or DPSU’s by enabling the transfer of technology, reassuring scientific advancements, opening doors for employment opportunities, and enhancing the skillset of the involved workforce by training and introducing them to better avenues of operations. 

However, the recent Comptroller and Auditor General Report only summarized to the press and not available in the public domain has highlighted the obvious shortcomings of the flawed offset clauses. India’s controversial acquisition of 36 Dassault Rafale multi-role combat jets from France, was the final nail in the coffin. The deal that was originally signed in 2013 for 136 Rafale jets, yet it had to be purportedly re-worked to substitute the then Indian offset company for another private entity in 2015 after Dassault cited its state-backed Indian offset partner, HAL’s, lack of commitment and manpower to manufacture Rafales in India. The CAG report, nonetheless observed that the French company has failed to meet the reworked offset requirements and further noted in Para 2.2.(a) 

Under these [offset] contracts, by December 2018, Rs 19,223 crore worth of offsets should have been discharged by the vendors. However, the offsets claimed to have been discharged by them was only Rs 11,396 crore, which was only 59 per cent of the commitment. Further, only 48 percent (Rs 5,457 crore) of these offset claims submitted by the vendors were accepted by the Ministry of Defence,” 

In an attempt to redress the flawed defense acquisition policies, the Indian government recently hiked the FDI limit in defense manufacturing to 74% from 49% under the automatic route, and infusion beyond 74% will now be subject to government approval if the foreign OEM promises transfer of technology or any other advancements. This push for indigenization of defense manufacturing was substantiated with the release of Defence Acquisition Procedure, 2020, [DAP] the newly designated focal point for defense procurement in India.

The DAP envisages a plethora of reforms within the Indian defense regime and is provisioned with the idea of boosting home-grown manufacturing rather than the traditional approach of relying on Government-2-Government military acquisitions. For instance, the DAP has notified 101 items and equipment that will no longer be imported to India including assault rifles, sonars, and artillery guns, and others as provided in the negative list of imports to accelerate contract allocation to private Indian companies that are equally viable for fulfilling the required lacunae. The DAP further introduces leasing of equipment for the defense forces under Lease (Indian) and Lease (Global) categories enabling short-term access to military equipment that are exorbitantly priced and aren’t essential beyond a certain period of time. Leasing further aids in access to equipment that requires high maintenance and operational costs, and are viable only for specific engagements, and do not endorse all-weather applicability as illustrated by India leasing the Russian Akula-1 Class nuclear submarine for a period of 10 years in 2019. In order to boost the domestic manufacturing industries, the DAP has enhanced the indigenous content (IC) requirements for acquisitions from Indian manufacturers to more than 50% whereas mandating a 30% contribution from an Indian vendor in case of foreign OEM acquisitions along with setting up of a Procurement Management Unit (PMU) for monitoring defense procurement contracts on a regular basis and timely implementation of the agreements. 

However, one of the significant reforms brought about by the DAP is the removal of offset clauses in inter-governmental agreements or G2G contracts, wherein defense procurement is carried out without any IC considerations or indigenous manufacturing compliances. Offsets in International Law are governed under the provisions of the WTO Agreement of Government Procurement (GPA). The GPA outrightly bans offsets in covered procurements under Article IV (6)  which says that any party to the contract, including the procuring entity, is prohibited from seeking, imposing,  or enforcing any form of offset. Until now, India has managed to circumvent the offsets embargo via the provisions of Article III (1) which excludes defense procurements if they are to be made under security and defense sect, stating that the parties acquiesce from strict adherence to the agreement if it precludes them from taking any action or retaining any information that might jeopardize its national security or defense policy.

Amending the offset clause is a coherent approach considering their poor implementation and India’s lack of obtaining any vital technology or amplification of its indigenous defense industries as highlighted in the CAG Report discussed above. Removal of offsets from IGA’s takes away the sole, and long-disputed incentive of enriching the Defence Public Sector Units (DPSU’s) and shifts reliance exclusively on the competitive skirmish between DPSU’s and the Private sector entities. The DAP supplements this measure by expediting masse defense procurement and simplifying the trial procedure of equipment, a process that usually takes 6-8 years to complete before the government formally places an order. Under the DAP, only physical operational parameters will be tested and any simulations submitted by the manufacturers will be accepted, earlier performance and technology assessment tests were conducted in phases that often resulted in a delay of procurement owing to prolonged repairs and alterations.

Whereas the long-overdue measures to reform a stagnated indigenous defense sector are a welcome change for the national defense manufacturing industries, there are still considerable challenges in the pipeline that may undermine a complete overhaul. In the present post-offset’s scenario, the government should facilitate access to superior technology and capital infusion to these defense manufacturers that was earlier promised by foreign OEM’s via contractual offsets, since they have no remedies for enforcing the offsets that are still continuing and probably won’t see the light of day anytime soon. Secondly, there is an urgent need for the corporatization of the existing DPSU’s that have enjoyed the complacence granted to them by state-backed autonomy and guarantee of large-scale defense contracts as maximum accountability and lack of dominance in the market is the only way ahead beyond their decades-old, monopolistic rut. It is also imperative to deal firmly with any attempts seeking to sustain the traditional model, as observed in the latest effort to corporatize India’s sole ammunition manufacturer, Ordnance Factory Board (OFB). The final straw in rectifying the ailing defense industries from Covid-19 induced losses is to entrust them with large orders for fulfilling the existing and upcoming requirements, whilst also ensuring time-bound implementation of contracts under the un-tested waters of DAP, 2020.

Ultimately, the framework of any formidable defense force in the world requires an intimidating mosaic that is structured with an equally firm economic stronghold, encapsulating all the wings of national security, irrespective of their mode of engagement and obvious distinctiveness. This economic citadel can only be constructed through sound policies and vision, coupled with impeccable diplomacy and proactive global presence to attain a stable model of systemic economic means and their military-politico ends. The Defence Acquisition Procedure, 2020 lays stress on the transfer of technology and indigenization of defense manufacturing, yet there are reasonable apprehensions regarding its implementation, and the silver lining will only reflect over the next decade. At the end of the day, the only question that remains unanswered is whether the Indian government ready to substitute its long-trusted albeit subpar DPSU’s for teething private entities that outmatch the former in every characteristic barre experience?

 

Varun Pandey is a law student at the School of Law, University of Petroleum and Energy Studies, Dehradun, India. 

 

Suggested Citation: Varun Pandey, India’s Second Wind to Indigenous Defense Industries, JURIST – Student Commentary, November 6, 2020, https://www.jurist.org/commentary/2020/11/varun-pandey-defence-industry/.


This article was prepared for publication by Vishwajeet Deshmukh, a JURIST staff editor. Please direct any questions or comments to him at commentary@jurist.org.


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