Policy delay keeps defence firms grounded

Govt is struggling to forge consensus on policy for selecting strategic partners for defence prodn

Defence Minister Manohar Parrikar, even after repeated unfulfilled promises, has been unable to formulate a policy for nominating “strategic partners” — or private companies pre-selected as the defence ministry’s production agency in ten different technology areas such as warships, submarines, aircraft and others.

While the new Defence Procurement Procedure of 2016 (DPP-2016) was promulgated on March 28, it has a gaping hole where Chapter VI should be. This is the chapter on strategic partners, the policy for which has still not been finalised.

The idea of strategic partners was mooted by the Dhirendra Singh Committee, which, in July 2015, recommended amendments to the Defence Procurement Procedure of 2013 to smoothen the path to producing more defence equipment in India, thus lowering imports.

Defence production through strategic partners relates to the “Buy & Make” procurement category, which, in essence, amounts to building foreign defence equipment in India with technology provided by a foreign vendor. An Indian company nominated as the strategic partner would be the automatic production partner in India. If the Indian Air Force contracted to buy Gripen E fighters, then its manufacturer, Saab of Sweden, would go straight to the designated strategic partner and jointly manufacture in India.

In the joint venture, the foreign company is allowed a stake up to 49 per cent. This could be problematic, like during negotiations with French vendor, Dassault, for building Rafale fighters in Hindustan Aeronautics. Dassault declined to take responsibility for the fighters the Indian company built, since it did not control the company.

The nomination of strategic partners was meant to bring clarity and predictability to defence contracting. Overseas vendors would know which Indian firm to negotiate with and build long-term capability that might come in use during production. Most importantly, private firms nominated as strategic partners would be able to invest in building capability, having been assured of business over the coming years.

Comparing two plans

While superficially resembling the Vijay Kelkar Committee’s 2005 proposal to designate “Raksha Udyog Ratnas” (RuRs) from amongst the most capable private sector companies, the notion of strategic partners is different in important ways. First, the RuRs were not intended just for licensed manufacture, but to also design and develop indigenous defence platforms. Being designated an RuR placed a firm on the defence ministry’s “go-to shortlist”, on par with the defence public sector units. 

In contrast, strategic partners will merely be a production partner for foreign vendors, enabling in-country manufacture of a large enough share of the system to meet the modest indigenisation requirements of a “Buy and Make” contract. Nor would this involve building futuristic defence technology, since a “Buy and Make” contract, by definition, is for proven weapons systems that are already in service. Separately, the strategic partner would be expected to absorb maintenance technologies from the foreign vendor, enabling it to provide “life cycle support” to the equipment it had part-manufactured. While the strategic partner would develop a level of maintenance  capability, it would have to work on its own to  acquire design and development capabilities needed for futuristic defence weapons. With the foreign partner holding 49 per cent stake, it would be likely to block the development of a rival capability in India.

Another vital distinction was that, with a number of RuRs bidding for each tender, there was an inbuilt element of competition. A strategic partner, on the other hand, would enjoy a near-monopoly for a decade or two. Essentially, a private sector strategic partner only replaces a public sector monopoly with a private sector one. 

Unfortunately, the idea of strategic partners has been contentious from the outset. Defence firms vie bitterly to be nominated as strategic partners; they see it as a “golden key” to entitlement, with automatic benefits flowing from India’s foreign arms procurements. This has generated cutthroat competition, with private defence vendors lobbying frantically for guidelines that would enhance their prospects for selection.

Meanwhile, defence ministry bureaucrats have steadfastly undermined the strategic partner policy, for fear that the exercise of discretion in selecting privileged winners might— as in the spectrum and coal block allocations — place even honest officials in the cross-hairs of corruption investigations later.

There is equal apprehension, both in the ministries of defence and finance, about any strategic partner-like arrangements that would subsequently involve granting contracts without going through the process of price discovery.

In order to smoothen the process of selecting strategic partners, Parrikar appointed a body under VK Aatre, a former Defence R&D Organisation chief. The VK Aatre Task Force submitted its findings in January 2016, laying down two sets of eligibility criteria for evaluating firms. A “financial gate” was specified to ensure a company has deep pockets to support its equipment for the duration of its service life, often decades long. Separately, a “technical gate” required applicants to be capable of building systems with multiple technologies.

While the Dhirendra Singh Committee recommended selecting one strategic partner for each “strategic segment”, the Aatre Task Force rearranged the segments into two groups. It recommends selecting one strategic partner for each segment in Group I, which includes aircraft, helicopters, aero engines, submarines, warships, guns and artillery, and armoured vehicles. For another three segments in Group II — metallic material and alloys; non-metallic materials; and ammunition, including smart munitions — the Aatre Task Force recommended selecting two strategic partners for each.

Adding to confusion

Controversially, it has been recommended that a single company should be selected as a strategic partner for no more than one segment. For a company like Larsen & Toubro, which has been deeply involved in several areas of defence, this amounts to an unacceptable curtailment.

With little agreement between prospective strategic partners, Parrikar last year created five working sub-groups, headed by defence industry leaders, to submit recommendations. Four sub-groups recommended policy for appointing strategic partners for impending contracts relating to armoured fighting vehicles; aircraft and helicopters; submarines; and ammunition. A fifth sub-groups deliberated upon the policies and differentiators for selecting strategic partners.

Business Standard has reviewed the recommendations of the fifth sub-group, which, even while presented as a consensus, also serves to highlight the chasm between prospective strategic partners.

A key recommendation, which is based on a legal opinion affixed to the report, restricts all the companies in a single promoter group to just one segment in Group I. That means that big groups like the Tatas would be restricted to just one of the companies that they control. This is likely to be sharply contested.

As contentious is the recommendation on the minimum annual revenue needed to be a strategic partner. While the Aatre Task Force recommended a minimum turnover of Rs 4,000 crore for each of the last three financial years, there has been argument over whether companies like Tata Motors, which has a major share of its income from an overseas entity — Jaguar Land Rover — is entitled to count that consolidated turnover. The sub-group recommends that if the entity gets more than half its turnover from India, it could add the overseas income to its turnover, but not if more than half comes from abroad.

The report reflects the opinion across all stakeholders that many more segments need to be created: the fighter aircraft segment should be separated from transport aircraft; the helicopter segment should be split between marine and land-based helicopters and armoured vehicles segment should be split between light and heavy vehicles.

Although more than six months have elapsed since these recommendations were presented to the defence ministry last June, the strategic partner policy is nowhere in sight. Meanwhile, uncertainty dogs a host of important overseas acquisitions like that of a single-engine fighter.

“We want to start cooperating with whoever the defence ministry nominates to build a single-engine fighter; and to start building aerospace components in India. But we can only do so when a company is nominated as the aerospace strategic partner”, says a senior Saab official, who hopes to build the Gripen E in India.