Indian Defence Review

Sikorsky S92

Clearly the aerospace needs of India, civilian as well as defence, are growing. The public sector which has so far been tasked to meet these needs has failed to deliver. What’s more, as aerospace production becomes more complex, the public sector is likely to fall even further behind in the race. Vested interests have long fostered the myth that private sector companies are less likely to uphold the national interest than the PSUs. The private aerospace industry has been kept in a stranglehold and not allowed to realise its potential. Isn’t it strange that reputed firms like Tata, Birla and M&M have been given the cold shoulder because HAL is supposedly more trustworthy when it comes to defence matters? Yet Boeing is a reliable partner in America’s defence, Airbus in Europe’s and Embraer in Brazil’s. The government must realise that both public and private sectors are national assets; both are necessary to achieve self-reliance in the shortest possible time.

Is aerospace manufacturing the next sunrise sector of the Indian economy? The signs are promising. Years of robust economic growth (notwithstanding the current slowdown) coupled with increasing demand for aviation services from the country’s teeming millions mean that a massive expansion of aerospace activities is probably imminent. Airbus Executive Vice President of Strategy and Marketing Kiran Rao says, “India has one of the world’s greatest aviation growth potentials” and is a “strategically important market.” His words are not just marketing hype. A joint report by the global consultancy KPMG and the Federation of Indian Chambers of Commerce and Industry (FICCI) published in March 2014 states, “India has the potential to become the third largest aviation market by 2020 and the largest by 2030.”

Several factors also favour the development of a vibrant domestic aerospace manufacturing sector. India has a well-educated, highly-motivated and talented workforce and rising prowess in Information Technology (IT). And it has a strong and growing low-cost manufacturing base. According to analysts, the country offers cost advantages of between 15 and 25 per cent in manufacturing.

Till now aerospace demand has been overwhelmingly met by imports but it is only a question of time before the Indian industry grabs emerging opportunities with both hands. And while businesses will naturally seek mainly civilian openings, at least to begin with, aerospace manufacturing cannot be neatly divided into military and civilian. The continuing liberalisation of defence procurement, together with huge offset requirements, makes the manufacture of military aerospace components and equipment particularly attractive. However, many hurdles remain to be crossed.

The Sad State of Indian Aerospace

To begin with, the country’s aerospace knowledge base is still small. Hardly any universities offer degrees in aviation technology. India’s leading industrial houses such as Tata Sons, Mahindra & Mahindra, Reliance Industries and Larsen & Toubro might so easily have become Tier 1 suppliers of integrated aerospace assemblies – like Japan’s Mitsubishi Heavy Industries and Kawasaki Heavy Industries, both of which are closely associated with global aerospace giants. Yet only a handful of private businesses have ventured into aerospace manufacturing. Over the last five or six years, for instance, a few Tata companies and Mahindra & Mahindra’s aerospace division have been acquiring competence in producing parts like the aircraft fuselage and tail section, besides aeronautics design, aerospace technology and electronics. While M&M owns an Australia-based aerospace company that produces small civil aircraft, Hyderabad-based Tata Advanced Systems has a joint venture with Sikorsky Aircraft Corporation to manufacture Sikorsky S-92 helicopter cabins and other airframe components in India.

However, such items are the easiest part of the aerospace production chain; other components such as engines and flight avionics are far more complex. Despite the stated intention of the government to integrate private parties in aerospace, its policies actually favour the public sector. The private sector on the whole is a peripheral player, restricted to low-tech items and components.

India still has to import most of the raw materials necessary for aerospace manufacturing and lacks adequate capability in new material technologies. Partnerships with leading international aerospace entities can help Indian companies acquire competence in cutting-edge technologies like the production of composites. However, the short-sighted government policy on Foreign Direct Investment (FDI) limits overseas Original Equipment Manufacturers (OEMs) to just 26 per cent stake in domestic aerospace manufacturing. Even critical sectors such as telecom and banking have much higher limits. This naturally makes the OEMs unwilling to partner Indian companies in advanced aerospace manufacturing. The OEMs are content to order some low-tech items and services merely to meet their offset obligations.

Defending the Indefensible

India’s aerospace manufacturing sector is highly fragmented. Various public and private sector organisations are blissfully unaware of what the others are doing. For instance, the activities of the Defence Research & Development Organisation (DRDO) and Hindustan Aeronautics Limited (HAL) are confined to the defence sector while National Aerospace Laboratories (NAL) and a few civilian companies are mainly limited to the civil sector and are probably ignorant of the progress being made in defence aerospace. This results in wasteful duplication of effort. On the other hand, the world’s largest aerospace entities such as Airbus, Boeing and Embraer are active in civilian as well as military aerospace, sharing the capabilities and knowledge of their various divisions and synergising their efforts thus yielding benefits to all.

In 2001, the Ministry of Defence (MoD) realised that defence production could not meet the country’s needs so long as all its eggs were in the public sector’s basket. Defence production was deregulated and ostensibly thrown open to private companies. But on the ground little has changed regarding many critical defence items and practically nothing when it comes to aerospace. Besides being cold-shouldered for most aerospace deals, the private sector faces a disadvantageous taxation regime that lowers its competitiveness vis-à-vis public sector and foreign companies. For instance, an overseas company executing a defence supply contract enjoys various tax concessions. But an Indian private manufacturer producing the same item may end up paying more than 30 per cent extra tax.

The much-hyped self-reliance in defence aerospace remains a distant dream. One reason is that licensed production or assembly is often passed off as indigenisation. Another is that equipment purchased from Indian suppliers used to be reckoned as indigenous, even if it contained 80 to 90 per cent foreign components. The indigenous content of the Tejas Light Combat Aircraft (LCA), for instance, is just about 60 per cent. However, with the Defence Procurement Procedure (DPP) 2013 now in force, import content in the products supplied by sub-vendors does not reckon towards indigenous production. This is an important step to make organisations like HAL more accountable and committed to genuine indigenisation.

LCA Tejas

Finally, infrastructure and government support – both essential ingredients of success – are sorely lacking. Neither is there clear government backing for private aerospace manufacturing nor policy direction. Recipients of most transfer of technology deals are invariably Defence Public Sector Undertakings (DPSU), even though a private concern may be more competent to absorb and employ the technology. All major deals are signed directly with foreign producers and the public sector continues to get bulk orders, ostensibly under Transfer of Technology terms. There appears to be lack of commitment to authentic indigenisation involving the private sector.

Due to these shortcomings, and despite the best of intentions, defence aerospace manufacturing has not really taken off. Overall defence imports are inching upwards towards 75 per cent, instead of falling towards the desired 30 per cent and most critical aerospace items have to be imported. Many believe that HAL is at least partly responsible for this state of affairs.

HAL’s Mixed Report Card

Since Independence, state-owned behemoth HAL has been practically synonymous with Indian aerospace. It has 19 Production Units and ten Research & Design Centres at eight locations across the country. It has an impressive product track record – 15 types of aircraft manufactured with inhouse R&D and 14 types produced  under licence mainly for the Indian Air Force (IAF), its largest customer. It has built up comprehensive skills in design, manufacture and overhaul of fighters, trainers, helicopters, transport aircraft, engines, avionics and system equipment. It also delivers life-cycle and product support services.

However, to say that HAL is unable to meet the needs of the IAF is an understatement. Practically every IAF project it undertakes is subject to massive cost and time overruns and unmet operational requirements. Moreover, since it is under the rigid control of generalist bureaucrats, who are more interested in meeting short-term targets than in fostering design competence and technological growth, it has not succeeded in providing leadership and momentum to Indian aerospace. The exclusion of commercial expertise keeps it perpetually behind the times. This partly explains why India, despite its impressive advances in space exploration, telecom, and IT and software services, has made very little progress in aerospace manufacturing.

HAL-LCH

HAL thrives primarily due to its monopoly and government patronage, rather than any inherent excellence. It is happy with being indispensable. A sense of complacency is generated by a plethora of captive orders from the defence forces. While its domestic sales are steadily increasing, exports – a more accurate measure of competence – are few and far between. Competition serves to make any industry more efficient but HAL has never faced serious competition. In fact, it appears reluctant to compete with the private sector.

Licensed production, that HAL hankers after, stifles original thinking and innovative design skill. It also hugely increases costs. For instance, a Sukhoi 30MKI fighter comes for about $55 million if imported from Russia. However, the price of the same aircraft when assembled by HAL soars to $68 million. As a result, HAL has neither been able to build a genuine expertise base nor the technological infrastructure necessary to design and produce advanced combat aircraft.

To cap it all, though HAL is embroiled in the development and production of many different types of military aircraft, it wants more. Its fighter production facilities are fully committed to the Su-30MKI and the Tejas LCA, so much so that satisfactory product support for the Su-30MKI fleet is reportedly lacking. HAL is also in various stages of manufacture or development of the Hawk Advanced Jet Trainer (AJT), the Dhruv Advanced Light Helicopter (ALH), the Rudra Light Combat Helicopter (LCH), the Light Utility Helicopter (LUH) and the Dornier-228 light transport plane. Many of these projects are experiencing significant delays. Yet HAL is angling for another slice of the defence aerospace pie – the Avro replacement project.

Replace in Time to Save Nine

In industry circles, the HS-748 Avro replacement deal is emerging as a test case of the government’s sincerity about involving the private sector in defence aerospace manufacturing. The twin-turboprop Avros with a payload capacity of 5.1 tonnes were acquired from Britain’s Hawker Siddeley from 1964 onwards and later produced under licence by HAL. About 56 aircraft remain in service, well past their useful life. They are in urgent need of replacement in order to pre-empt emerging flight safety issues. A global tender valued at about $2.5 billion for the supply of 56 new aircraft was issued in May 2013. These aircraft are to be bought from a foreign OEM who must tie up with one or more Indian private sector partners and nominate an Indian Production Agency (IPA).

Avro HS748

While 16 aircraft will be bought off-the-shelf from the selected vendor, 40 must be produced in India. The Request for Proposal (RFP) was sent to eight foreign manufacturers – Airbus Military (Spain), Alenia Aermacchi (Italy), Boeing and Lockheed Martin (United States), Antonov (Ukraine), Ilyushin (Russia) and Embraer (Brazil).

However, an objection was later raised on the grounds that the PSUs (read HAL) were supposedly being denied an opportunity to submit their own proposals. This flew in the face of the fact that HAL is heavily overloaded with existing commitments. Besides, since the idea is to encourage the private sector to make a beginning in the aerospace industry, the Avro replacement deal seems tailor-made for the purpose. It is a typical entry-level project, neither strategic nor requiring advanced technology.

Chandrajit Banerjee, Director General, Confederation of Indian Industry (CII) has warned that revisiting the programme at this advanced stage will not only stall the project but also discourage private industry from investing in future defence projects. The deadline having been twice extended any decision now awaits the new government.

Time to Go Private

Clearly the aerospace needs of India, civilian as well as defence, are growing. The public sector which has so far been tasked to meet these needs has failed to deliver. What’s more, as aerospace production becomes more complex, the public sector is likely to fall even further behind in the race.

Vested interests have long fostered the myth that private sector companies are less likely to uphold the national interest than the PSUs. The private aerospace industry has been kept in a stranglehold and not allowed to realise its potential. Isn’t it strange that reputed firms like Tata, Birla and M&M have been given the cold shoulder because HAL is supposedly more trustworthy when it comes to defence matters? Yet Boeing is a reliable partner in America’s defence, Airbus in Europe’s and Embraer in Brazil’s. The government must realise that both public and private sectors are national assets; both are necessary to achieve self-reliance in the shortest possible time.

While structural discrimination against the private sector needs to be addressed without delay, the purpose is not served by junking HAL. Synergising efforts is imperative to overcome the hurdles on the road to the indigenisation of defence aerospace manufacturing. HAL has excellent infrastructure and manufacturing facilities and a highly experienced personnel base. The private sector can contribute advanced technology, financial management and marketing skills. Quality assurance is another critical area where it is better paced to deliver. And the Public – Private Partnership (PPP) model of joint ventures can leverage the potential of both sectors.

However, as the Avro replacement deal highlights, private enterprise is unlikely to be attracted by small piecemeal contracts. Huge investments are needed to set up a new indigenous production line, train workers, and establish supply chains, and the proposed order of 56 aircraft seems insufficient to reap the benefits of economies of scale. Unless the government makes a long-term commitment and provides some assurance of follow-on orders, what rational entrepreneur would be willing to invest in an expensive venture of this kind?

Indian aerospace firms are already strongly competitive albeit at the lower end of the value chain in offering quality products at reduced cost. However, HAL’s 2,400 suppliers, for instance, are all of Tier 3 category. They need to be encouraged to move up the value chain and become Tier 1 and Tier 2 suppliers. Aerospace and defence Special Economic Zones (SEZs) are a promising way to achieve this. SEZs save time and expense by accommodating many vendors in close proximity where they can interact and synergise their efforts to set up a precision engineering and manufacturing ecosystem. Their nearness also helps to save time and money that would otherwise be wasted in moving materials and components from one place to another. The SEZ site can be strategically chosen to make use of low cost of land, infrastructure, power and water. Raw materials development capability also needs to be gradually built up in the close vicinity.

Take the Outstretched Foreign Hand

Aerospace is a highly specialised industry with only a handful of global players. Analysts believe that India’s private aerospace industry may be some years away from being able to undertake complete assembly and systems integration of a medium transport aircraft like the Avro. However, it needs to make a start. And foreign collaboration is the quickest and best way to energise the sector.

Globalisation and liberalisation have created a network of interdependence across the global aerospace scene that is mutually beneficial. Joint ventures with foreign corporations can help the domestic aerospace industry in rapidly building aerospace knowledge and introducing state-of-the-art manufacturing processes, thus catalysing growth. However, the lurking suspicion of the ‘foreign hand’ needs to be overcome first.

For Indian private aerospace manufacturing to flourish, the FDI limit needs to be raised to at least 74 per cent. Chronic opponents of FDI will immediately object, “What about indigenous industry? What about security in this sensitive sector?” Truth be told, the domestic aerospace industry is in no position to achieve modern production standards without foreign investment, expertise and high-end technologies. Security concerns can be rationally addressed by including necessary clauses in the initial licence – including the right to take over a facility if the terms and conditions are breached. Actually when it comes to assurance of uninterrupted supply, especially in an emergency, indigenous production under licence is far superior to pure imports.

If properly leveraged, the government’s Defence Offset Guidelines can also provide major impetus to the private aerospace manufacturing sector. In November 2013, Air Marshal P.P Reddy, Director General (Inspection & Safety) disclosed that the service is likely to procure equipment and platforms worth $150 billion over the next 15 years. Since the Guidelines specify that any foreign defence contract valued at Rs 3,000 million or more will entail an offset obligation of between 30 and 50 per cent, the total value of offsets accruing can only be imagined.

For instance, the deal with Dassault Aviation to acquire 126 Rafale Medium Multi-role Combat Aircraft (MMRCA) may generate $10 billion through offsets. Offset obligations can be met either through direct purchase, investment or technology transfer. The government needs to ensure that they are not frittered away but are used by industry, especially the private sector, to acquire innovative aeronautical technologies and gain expertise in the vital areas of aerospace design, development, and precision manufacturing. This would satisfy the primary aim of the Guidelines “to foster development of internationally competitive enterprises”.

Finally, it goes without saying that aerospace products are highly engineered and all production processes must be meticulously certified. From the smallest screw to the largest integrated assembly, each part needs to be traceable and everything must precisely meet specifications and stringent quality controls. Otherwise safety could easily be compromised. That is why no country today dreams of manufacturing aerospace assemblies all by itself. Even the world’s leading conglomerates such as Airbus and Boeing source components and sub-assemblies from several countries. They find it cheaper, faster and more efficient to obtain items from locations that have specialised in their production and in rigid quality control. Why should India’s private aerospace industry be any different?