Inside India's new defence establishment

SECRETS, POLITICS, ARMS DEALS, dogged journalists, slick brokers...The Bofors kickback scandal of 1987 had all the elements of a potboiler. But now, almost three decades after the order for the 410 155 mm howitzers was first placed with Swedish armaments giant AB Bofors, we can introduce one more element to the story: Farce.

Ask Gen. V.K. Singh, the outspoken and often controversial former army chief and now a Union minister. In 2009, while still with the army, he was once discussing the need for long-range guns with the Ordnance Factories Board. “When we said we’d get it from outside, they said, ‘No, no! We can make them’.”

Singh found that the board had been quietly sitting on the Bofors blueprint, which the Swedes had shared, for more than 25 years. “Like good babus you locked them up and said thank you very much,” splutters Singh. “The design was lying in the gun carriage factory in Jabalpur. It was just lying there!” He’s proud that he was the one who got the design out of the filing cabinet and on the factory floor; the Defence Research and Development Organisation (DRDO) agreed to make two prototypes of the gun for the Army to test, before bulk production. The tests are still underway.

As this drama was unfolding, a couple of private sector companies (Tata Power’s Strategic Electronics Division, or SED, and Bharat Forge) were experimenting with gun manufacturing. When SED showed off an indigenously made howitzer at an army seminar late in 2012, the response was mixed. While nobody openly critiqued the effort, some government officials claimed that the technology had been sourced from companies on the Ministry of Defence’s blacklist.

Today, it seems strange that the government is not encouraging the likes of SED or other conglomerates that have shown an interest in defence equipment production. Those who have known India before 1991 will recognise the fell hand of a protectionist state. Praveen Swami, security analyst and editor of Force, a monthly magazine that focusses on national defence and security, says defence is clearly the country’s “most lucrative industry”. And given its importance, both in terms of money and security, he adds, “the government is not willing to loosen its control”.

The money involved is massive. In the next 10 years, the country will be spending around $150 billion (Rs 8.8 lakh crore) to $200 billion on defence equipment. According to global consulting firm KPMG’s recent study Unlocking the Potential—The Indian Aerospace and Defence Sector, the Air Force alone will be spending more than $80 billion between 2010 and 2015 for 1,000 aircraft and other equipment, including a much publicised $10 billion on medium multi-role combat aircraft. Then there is a huge need for repairs and refits of existing aircraft, ships, and submarines.

In February, former defence minister A.K. Antony gave the green signal to a host of projects, including 4,000 handheld thermal devices (Rs 1,800 crore); 44,000 light machine guns (Rs 1,328 crore); 5,000 thermal imaging sights for tanks and infantry combat vehicles (Rs 2,825 crore); and modernisation of five ordnance depots (Rs 1,800 crore).

A back-of-the-envelope calculation shows that the defence industry will require $40 billion to $50 billion every year to meet its growing needs; some 40% of this is capital for acquisitions.

Production of defence equipment is controlled by about 10 defence public sector undertakings (DPSUs) and 50 ordnance factories. Their combined turnover in 2011 (data on these companies is notoriously difficult to get, given the sensitive nature of the industry) was Rs 39,000 crore, with a workforce of 2 lakh. An estimate shows that the government spends close to Rs 88,000 crore a year on defence equipment—which means that close to Rs 50,000 crore is spent on importing equipment.

IT'S A HUGE OPPORTUNITY and the DPSUs are not going to be able to take full advantage of it. As Madhukar V. Kotwal, wholetime director and president, heavy engineering, L&T, says: “The PSU shipyards are so full with orders that they are unable to cater to requirements for new builds and repairs.” It’s the same story elsewhere too.

It seems like a no-brainer to expect private players to step in; after all, they have enough expertise in the manufacturing and hi-tech sectors. And several of them have been subcontracting to the DPSUs for years. Except that it’s not happening. One of the big reasons is the presence of an arms lobby—middlemen who play broker between foreign arms manufacturers and Indian buyers (read government). Officially, these brokers don’t exist; the law is clear that any arms deal has to be directly between the government and the company. After the Bofors scandal, the laws were tightened even more. But clearly not tight enough, because in 2013, another case of corruption in defence deals was exposed. The government accused brokers or “consultants” of Italian arms manufacturer Finmeccanica of bribing ministers and army officials trying to get a deal for Finmeccanica’s AgustaWestland helicopters.

These are just the most high-profile cases; defence insiders say there are dozens more that happen on a regular basis but since the middlemen fly below the radar, there’s little for investigative agencies to follow. For these “defence consultants”, strong private sector participation will mean the government will spend less on importing equipment, and therefore, their jobs could be in jeopardy.

There’s also the fact that the private sector was not too keen on entering this space till recently. Saurabh Joshi, defence analyst and editor of Stratpost.com, a website on South Asian defence and strategic affairs, says this was because “the government’s approach to defence procurement is really short-sighted. Defence procurement should be about best procurement, not about supporting the public sector defence units.”

There are strategic advantages of creating a thriving domestic defence industry. According to a report by the Boston Consulting Group and CII in 2012, India could create more than a million jobs, directly and indirectly, in five years if indigenous production advanced by an average of 30% a year. More important, says S.P. Shukla, chairman, Mahindra Defence Systems, part of the M&M group, domestic manufacture of Indian defence imports has a tremendous ripple effect on GDP, trade deficit, and fiscal deficit, apart from leading to job creation and technology absorption. “In the past three years, India’s import bill on defence was Rs 2.35 lakh crore. This is about Rs 80,000 crore per year. A 50% import substitution can reduce that bill by Rs 40,000 crore, as against an annual trade deficit of about $140 billion. A 20% cost saving led by this will stand at Rs 16,000 crore, on a fiscal deficit to the tune of Rs 500,000 crore a year,” he explains. And if defence exports pick up, the positive impact on trade deficit will be even more. “With a large part of defence production taking place in India, a boost to GDP by 0.2% to 0.5% is, therefore, entirely feasible,” he adds.

India Inc. needs to move more definitely into the $13 billion domestic defence space. According to data from the CIA, India spent a tad under 2.5% of its GDP in 2012 on defence. Much of that money goes in importing weaponry and technology, making the country the biggest importer of defence systems in the world (accounting for 10% to 13% of global import); India imports 70% of its armaments needs.

This PSU bias, says Swami, means that private companies have no incentive to invest large sums in setting up the infrastructure needed to manufacture defence equipment. “Why should they spend Rs 30,000 crore on setting up a new assembly line when they are not sure of orders?”

For things to improve, says Swami, the government must do away with its “policy of segregation between the private and public sector and think of it like a national defence industry”. Perhaps the new government at the Centre will help private players. If the manifesto of the Bharatiya Janata Party (BJP) is anything to go by, the party will “modernise the armed forces, and increase R&D in defence, with a goal of developing indigenous defence technologies and fast-tracking of defence purchases”. It will also “encourage private sector participation and investment, including FDI in select defence industries”, and says “technology transfer in defence manufacturing will be encouraged to the maximum”.

While a few steps have been taken to bring the private sector into the industry, these are not nearly enough. The hope is that the more hawkish BJP-led government will do more about defence procurement. At the time of going to press, the government announced Arun Jaitley as Defence Minister. On his first day in charge, Jaitley (who is also in charge of the ministries of finance and corporate affairs) told the media that he was concerned about the slowdown in decision-making in defence during the Congress-led UPA regime, and expediting procurement and modernisation in the armed forces would be a top priority of the new government.

The commerce and industry ministry under the Modi government has already circulated a draft Cabinet note for inter-ministerial comments on graded investment in defence. It has suggested a cap of 49% FDI for companies that do not transfer technology, while for those willing to transfer knowhow, the government intends to allow up to 74% FDI. There will be no cap for companies engaged in manufacturing state-of-the art equipment and machinery, or undertaking modernisation projects. There are already some objections to this on the ground that FDI will stifle the domestic industry.

“It’s an important ministry and needs urgent decisions,” said Jaitley, adding that a full-time defence minister would be announced in a few weeks.

THE PRIVATE SECTOR'S reluctance to enter defence manufacturing does not mean it has no exposure to this sector. Over time, the DPSUs had created an ecosystem of sub-contractors—over 800 private partners, including the likes of Tata, L&T, M&M, Bharat Forge, and Pipavav Defence and Offshore Engineering, or the erstwhile Pipavav Shipyard. But given the tight controls, these biggies have mostly acted as suppliers of low-value components. But many of them have learnt the ropes, and see the opportunity to grow here—if the government deals with an even hand.

The government has a different reason for its dominance of this sector. Ravi Kumar Gupta, scientist ‘G’ and director, Directorate of Public Interface, DRDO, says the imbalance between private players and DPSUs was not of the government’s making. The private sector, he says, was not willing to invest in defence. “Till the ’90s, it was difficult even getting a water tank built by the private sector,” he claims. A possible reason for this was the licence raj, where a government licence was needed to produce anything. The DRDO, therefore, began researching everything for the armed forces—from shoe laces to strategic missiles—and makes them all.

So, why did the private sector not invest in capacity for making defence equipment? To understand that it’s useful to have some idea of how the industry works.

From the 1950s to 2005, the defence procurement procedure was mostly guided by the concept of self-sufficiency and indigenisation, relying on DPSUs, government shipyards, and ordnance factories. Imports—mostly from the then Soviet Union—were acceptable, only if they were accompanied by technology transfer and import substitution.

However, there was little movement forward: The country saw negligible advancement either in terms of new weapon systems or the induction of new technology. It was the Mumbai attack of 2005 that came as a wake-up call. The tide turned, with global majors participating in Indian defence supplies. The Defence Procurement Procedure (DPP), first formulated in 2006, would invite bids from global manufacturers when it needed equipment. The lowest bidder won the order—on condition that 30% of the manufacturing would be outsourced to Indian companies. DPSUs got most of their work this way; there was little by way of technology transfer, unless it was bought. ( The first time the private sector was allowed in the defence sector was 2001.)

There’s also a conflict of interest as far as defence procurement is concerned because the Department of Defence Production also represents the Ministry of Defence on all policy bodies, production boards, procurement decision-making bodies, and DPSUs. So, plum deals would almost automatically go to the PSU companies.

Rajesh Kapoor, director, defence, aerospace and security, Confederation of Indian Industry (CII), believes that one solution is for the DRDO to “offload small-scale production to the 800 suppliers it has, and concentrate on high-end technologies.” But is that really the answer? After all, the private sector also has the capabilities and the resources to manufacture hi-tech equipment. This is something the government recognised in its DPP 2013, to “infuse greater efficiency in the procurement process and strengthen the defence manufacturing base”.

Under the revised policy, the government specified that the first stop for sourcing defence equipment had to be India; if domestic companies (private or public) were not able to make the necessary products, the know-how should be sourced and the manufacturing done here. It’s only when both options fail (in the case of extremely sensitive equipment, for instance) that the buyer can look at buying from foreign companies. It also specifies levels of indigenisation, seeks explanation as to why a particular product should be completely imported, and imposes stiff penalties on the state for order delays. The private industry hopes that the DPP 2013 will help even out the imbalance between private players and DPSUs. Rahul Chaudhry, CEO of Tata Power SED, is optimistic. “If DPP 2013 is implemented in letter and spirit, the time is not far when a Boeing or a Lockheed will be born in India.”

It’s not as though the private sector has been passive till now; it’s because of the increasing interest companies have shown in growing their share of the extremely lucrative defence pie that the DPP 2013 stresses on private participation. So, what exactly have private companies done, and how have they managed without too much government support?

AN ANSWER CAN BE found in Bangalore’s famed Electronics City. Never mind the information technology biggies such as Infosys and Wipro who have their large glass-fronted offices here. The real action is in a modest blue and white building that looks more like a house than an office, a stone’s throw from the Infosys headquarters. This is Tata Power SED’s nerve centre—and inside, it looks like a battle zone from the 1980s. Huge trucks are lined up in the compound; many sport camouflage patterns, and all of them bristle with missiles and all manner of antennas and aerials.

We’re told that the weapons mounted on the trucks are high-precision Pinaka multi-barrel rocket launchers and Akash medium range surface-to-air missiles. The rocket launchers, developed by the DRDO, were used successfully in Kargil in 1999. They can launch 12 rockets in less than 40 seconds. Each rocket can carry a payload of 100 kg for a distance of 40 km. The launchers use state-of-the-art technologies for delivering superior combat performance. For instance, rockets can be fitted with a wide range of warheads including pre-fragmented high explosives, and anti-tank warheads. In March 2006, the Indian Army placed a $45 million contract with Tata Power SED and Larsen & Toubro to deliver 40 Pinaka multibarrel rocket launchers.

The SED facility in Bangalore is both a factory and an R&D centre. While weaponry such as the Pinaka and Akash sound like traditional whizz-bangs, they are guided by extremely smart sensors and electronics—all developed and produced here. Tactical field communication, mission-critical software for rocket launchers, night-vision devices, sonobuoys, unmanned aerial vehicles—the list of intelligent warfare equipment that rolls out of the SED is impressive.

Tata Power SED is one of several innocuous-looking compounds across the country, each home to private defence contractors filling orders for the armed forces—or even for export. Several hundred kilometres away from Bangalore, on the Mumbai-Pune highway, some 20 km from Pune, is L&T’s Strategic Systems Complex at Talegaon. This is where L&T is developing the advanced Air Defence Fire Control Radar system to replace the aged Russian air defence systems that the Air Force uses now. While the radars for the new system will come from its joint venture partner, Cassidian, part of the Airbus Group, L&T will build the air-conditioned shelter, the command and control system, as well as system integration and power supply for the radar.

Building the housing for a radar is not as hi-tech as building the radar itself, but L&T is no laggard in the high-technology race. In a unit away from the radar housing and systems integration site is a top-secret facility where L&T is building an anti-submarine rocket launcher, which can fire rockets to a distance of 6 km and up to a depth of 300 metres. Of course, this is what the officials tell us, since the facility is so secret even L&T staff cannot enter without several rounds of clearance. Close by, at Chakan, M&M early this year opened its latest Naval Defence Systems factory on 40,000 sq. ft. It is building light-weight, triple-tube, undersea torpedo launchers, sea mines, and surface-to-air decoy launchers for the Indian navy. “M&M is gearing up for Rs 60,000 crore to Rs 80,000 crore of orders from the armed forces in 2015,” says Shukla.

Then, in Hyderabad, another Tata group company, Tata Advanced Systems (TASL), makes aerostructures (frames and the like for aircraft) and systems integration for aircraft (ensuring that all mechanical and electronic systems work together). The company has chosen to partner global arms majors such as Israel’s IAI ELTA System for defence electronics. TASL’s vice president Sukaran Singh says learnings from its joint ventures will help it play a big role in reducing the country’s dependence on foreign help. Other officials claim that the same learnings could be used to manufacture transport aircraft to begin with, and other defence systems such as radars and missiles.

After all, says Singh, major aircraft manufacturers do not have all the technologies themselves. Rather, they depend on an ecosystem of vendors, each of which manufactures critical sub-systems. What’s really important is systems integration, something TASL has learnt over the years.

Both L&T and Tata have been a part of the DPSUs’ ecosystem of contractors, and over the years, have learnt the ropes and are today well placed to compete with the PSUs.
TASL is now ready to set up a second aircraft assembly line; it’s just waiting for the results of a ‘request for proposal’ made by the Indian Air Force to replace its fleet of ageing Avro aircraft.

The Avro replacement project has come in for criticism and praise, almost in equal measure. The Air Force had specified that the job would go to a foreign airframer which would work with an Indian partner or consortium of local players. But in a move that has DPSUs up in arms, the big government-owned aircraft manufacturer, Hindustan Aeronautics (HAL), has been barred from the project. It can only have a shot as one of the partners in a consortium. This is seen as the government’s way of evening out the playing field, by letting private players full access to a key project. However, at the time of going to press, there are signs that the government may give in to pressure and allow HAL to participate.

Apart from the reaction from the DPSUs, the government is apparently unhappy with the lukewarm response from private players. Only TASL seems enthusiastic. At M&M, the deal has seen little excitement, since the company was miffed about the fate of the Rs 70,000 crore Future Infantry Combat Vehicle project. Launched by the Army more than three years ago, this was intended as a public-private partnership programme to develop and manufacture a light armoured carrier. Tata, M&M, and L&T had bid for this, as had the government-owned Ordnance Factories Board. M&M had entered a joint venture with BAE Systems, but defence analysts say this was scrapped “as nothing was moving”.

Other players are content with making a less dramatic contribution to the armed forces. For instance, $13 billion TE Connectivity (earlier Tyco), is a major manufacturer of cables, relays, and other connectors. It’s the market leader in Indian aerospace and defence connectivity products. Says Sanjay Handu, one of TE’s directors: “We even make the humble tag for wires. Imagine thousands of cables running under the hull of a nuclear submarine, and they have no tags. How do you distinguish one from the other?”

CLEARLY THERE ARE hits and misses, but what’s keeping the private sector still in the defence business is the fact that the military has to update its fleets; the Avro, for instance, is a relic of the 1960s, and close to 40% of the weaponry used today is of Soviet Union vintage.

But till Indian companies, public or private, manage to get the technology for modern weaponry, can they arrive in the global arms market? Till that happens, the country will still be forced to import at least the know-how, which, as Lars-Olof Lindgreen, former Swedish ambassador to India and chairman of aerospace company Saab India, says is unlikely. He’s clear that no foreign player would be willing to part with its IPR unless it has a majority stake in the joint venture company. The new government’s policies could help here.

There is also increased realisation in the Indian private sector that it can win against the more established and favoured players like the DPSUs when there is open bidding. TASL has shown the way; it was the lowest-cost bidder for designing and developing a complex command-and-control system for the 70 km medium range surface-to-air missile, against the likes of Bharat Electronics.

Things seem to be finally moving in the right direction. L&T’s Kotwal suggests that one way to get the public and private companies together is to set up something along the lines of DARPA (Defence Advanced Research Project Agency) of the U.S. This agency is responsible for the funding and development of new technologies for use by the military. DARPA has freedom from bureaucratic impediments and seeks talent and ideas from universities, industries, laboratories, and individuals. It neither owns nor operates labs or factories, and the overwhelming majority of research is done by universities or industry. Perhaps a similar set-up in India will help private players. And then, perhaps, there will be no more cases of weapons plans staying hidden for decades.