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Private Sector Battles for Indian Market

Apr. 2, 2012 - 08:48AM   |  
Critics say Indian Defence Minister A.K. Antony favors giving government-owned companies an edge over private ones in acquisition.
Critics say Indian Defence Minister A.K. Antony favors giving government-owned companies an edge over private ones in acquisition. (File photo / Agence France-Presse)
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NEW DELHI — India remains the largest importer of weaponry in the world, receiving an estimated 70 percent of the $100 billion market sent overseas each year. Experts say India will remain the leading importer for five more years.

But after that, this market could be up for grabs by India’s emerging technological powerhouses in a range of key technologies.

“Private industry is really motoring here, it really is,” said Gerald Howarth, Britain’s minister for international security strategy.

The key to a shift is a combination of looser government controls on private industry and foreign direct investment, and maturing technological and manufacturing capacity in local industries.

Said one senior official in the Ministry of Defence, “Poor inflow of both capital and technology and a slow pace of development of infrastructure is the main reason for the high level of import content.”

Others blame intransigence within the government, and Defence Minister A.K. Antony for favoring the status quo, giving government-owned companies an edge over private ones. Antony’s political roots grow out of a union base, and he has kept the brakes on efforts to open competitions to private domestic companies.

But industrialists here argue that trusting local commercial entities to produce military systems rather than choosing between only government-run suppliers and foreign firms is essential for developing the local industry. Waiting for offset revenue or some fraction of assembly work is not what India needs, one said.

To tap the $100 billion defense market in the next five years, more than 100 firms flocked here to Defexpo-2012, India’s biannual land and maritime systems show. They arrived as the local MoD found itself ensconced in scandal, with the minister and Army chief squaring off over the chief’s rightful retirement date, the Army’s state of readiness and the source of a leaked memo about readiness.

At one moment, the memo looked like a quick end to Gen. Vijay Kumar Singh’s tenure, and the next had Singh and Antony in agreement, calling for the leaker of the memo to be tried for treason.

Many industry players, both inside and outside India, say the key to bringing defense production in-country is giving foreign suppliers more incentive to buy into India. Industry players want to increase the share of a company or joint venture that can be foreign-owned from 26 percent to 49 percent. Some see the current limit as a disincentive, dissuading foreign firms from transferring their best technology to India.

But any hope that Antony would use Defexpo as a stage for such an announcement were dashed when Antony said the limit on foreign direct investment (FDI) would remain at 26 percent.

Boost Foreign Investment

Nikhil Gandhi, chairman of India’s four-year-old Pipavav Defence and Offshore Engineering Company, the nation’s largest commercial shipyard and an emerging industrial powerhouse, is among those urging a higher FDI limit, arguing for a hike to 49 percent that would be approved on a case-by-case basis.

“India definitely needs FDI in defense because global conglomerates spend millions of dollars in defense [research and development] and want to be part of success stories on an equal basis,” he said.

He suggested that the MoD could experiment with selective approvals of higher FDI limits on an individual basis, noting that in the defense sector, the long lead times in development and long maintenance tails of most programs make higher FDI limits sensible in this category.

“I’m not saying across the board, but on a case-by-case basis,” Gandhi said. “It is very important so India can attract the world-class technology, and it also opens up the door for the technology owner to make money, and the end game is that the government of India will get the top-class products on a timely basis without cost overruns, which is the need of the government, and new jobs will be created.”

On the other end of the spectrum is MBDA of France, which is supplying a variety of missiles to Indian defense forces.

“Our aim is to work with Indian defense industry on a long-term basis, and we accept Indian rules on FDI limits,” said Mati Hindrekus, MBDA’s marketing and communication manager. “We are talking to private companies in India to set up joint ventures for a wide range of defense products.”

“The only way to reverse the trend from imports to homemade weapons is by strengthening the domestic defense sector, especially the private sector, through tax incentives and capital investment,” said Nitin Mehta, a defense analyst.

Amit Kalyani, executive director of Bharat Forge, agreed, saying his firm is moving ahead without waiting for the government so it can be prepared, and that a stable government and consistent, predictable laws are more important than specific ownership levels.

“Indigenization can be increased in India only if there is a stable long-term policy and decision-making of the government,” he said. He noted his company recently made a major investment.

“To bring core technologies in India, we have recently acquired the entire plant and machinery of Ruag Defence of Switzerland to build self-propelled artillery guns and vehicles at Pune in India,” he said.

Private-sector companies account for just $200 million out of a total procurement budget of $13 billion, said an executive with the Federation of Indian Chambers of Commerce and Industry (FICCI), an industry group in Delhi. There are more than 5,000 small- and medium-scale defense companies hoping to get a piece of the offset market.

“Some small-scale players in India feel that joint ventures with foreign companies in the defense sector will not lead to indigenization, and core technology would still be controlled by the foreign partner,” said Uday Kumar, technical manager of the Bangalore-based small-scale manufacturer Advanced Micronic Devices.

State-Owned Preference

One of the biggest worries among private defense companies is the MoD’s preference of state-owned companies, which get big-ticket projects based on nominations.

In February, the Indian government allowed joint ventures to be established between state-owned and private-sector defense companies. However, the joint venture proposed through a memorandum of understanding late last year between private shipyards Pipavav and Mazagon Docks for building submarines and warships has yet to be cleared by the government.

An executive with private-sector company Larsen & Toubro (L&T) complained the government has not done enough to encourage private industry to join the competition for building new ships for India’s Navy. He would like to see commercial shipyards build submarines.

They will. It just isn’t clear yet how many they will build and for what purpose.

Indeed, the Indian Navy is expected to float a global tender this year to acquire six submarines with air-independent propulsion technology at a cost of more than $11 billion. However, only two submarines will be acquired from the selected overseas shipyard and the remaining four are to be built at Indian shipyards, and only publicly owned defense shipyards will be considered in the tender. L&T, Pipavav Defence and ABG shipyards are not in the running for building submarines.

L&T executives questioned the logic of keeping them out of the tender despite the fact that the company had been involved in the classified nuclear submarine project for more than a decade.

Gandhi, of Pipavav, said “the private sector has to demonstrate skill in building infrastructure ... to get defense orders.

“The government can only take the bold step to invite the private sector if the private sector demonstrates its serious and long-term commitment by making serious investments and builds world-class facilities to give confidence to the armed forces and the Ministry of Defence. Many large private companies expect government to give them the order and then they will build the facilities, which is hard to accept for the government. If you don’t believe in the sector, you don’t go for it, and if you believe, put your money where your mouth is because they want serious investments.”

His firm has invested $1 billion in building the nation’s largest dry dock, big enough to service an aircraft carrier and build two large naval platforms simultaneously. Gandhi credited the government for moving at steady pace in recent years, and did not complain about any perceived uneven playing field.

But others did.

“The state-owned defense companies get orders on a single-vendor nomination basis and, in turn, become importers of the defense products,” said an executive with a private-sector defense company who did not want to be named. “This does not lead to technology transfer,” he added.

Last year, the Indian Defence Ministry decided to earmark network-centric warfare projects for state-owned Bharat Electronics, effectively walling off those programs for Bharat and keeping the domestic companies out, a decision government representatives called “strategic.”

But an executive from another private defense company said this kind of practice undermines the nation’s best interests.

“It is not possible to draw a business model in the long run if the defense market earmarked for the private sector is not sure,” he complained.

The Indian Defence Ministry has now made it mandatory for overseas defense companies to execute offsets to the tune of 30 percent of the total value of the defense contract. The defense offset market is now estimated to top $12 billion in the next five years, but overseas defense companies are finding it difficult to execute the offsets because the domestic defense industry is not able to service and absorb $12 billion in offsets. Last year, the Indian Defence Ministry allowed offsets to be carried out even from the civil aviation sector.

Despite the rigid policy of the MoD on foreign direct investments, the overseas companies will have to come to India, where the defense market is expected to rise further as the country looks to challenge both China and Pakistan, Mehta said.

Still, Gandhi said the government has made progress, citing two important steps: adopting a different procurement policy in 2011 allowing private-sector participation in the defense sector, and a recent policy to form public-private partnerships.

“This will ensure private-sector participation without stepping on the toes of the government and the government PSUs,” he said. “It is a good two-step process.

“I am one of the severe critics of the government on many things,” he added, “but I am today the biggest supporter of the government policy because what has happened in the last 14 months hasn’t happened in the last 64 years.”

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