Indian Defence Review

At the end of 2018, India’s defence spend was close to $50Bn. This will continue to grow at 8% – 10% for the next few years. Roughly 60% of this spend is on imported goods and services. India’s Ordnance Factories Board (OFB), responsible for producing a variety of goods and services for the Defence Sector, accounted for roughly 10% of the spend number. The remainder was produced through India’s conglomerates of MSME’s and some of the Tier II OEM’s (like Ashok Leyland, Tata Advanced Systems Ltd. etc). 

Coming out of Covid-19, commerce within India will rise. With a burgeoning middle class of 400 million people, whose penchant for spending is buoyed by its confidence in the future of India, consumption in air travel will see an uptick.  In the commercial aerospace sector, there is a ~11,000 unit global backlog (just prior to Covid-19) in just the Narrowbody segment of aircraft. India’s demand is a staggering 10% – 15% of this backlog. Boeing and Airbus will continue to remain the big players despite the recent setbacks with the 737 MAX.

The opportunity in India is the world’s envy. India should not let this opportunity go by. The Government announced in Spetember 2019 a $130Bn spend on modernizing its forces over the next few years. India would be remiss to not make this a launch pad for indigenous manufacturing. Technology to dominate this sector exists in India, both Chandrayaan-2 and Gaganyaan endeavours bear witness. Commercializing and transferring this knowledge to make it more ubiquitous in the defence and aerospace sector needs to become the focus. In addition, the spill over effects of these technologies to other sectors will be immense.

There is precedence on how to propel an industry. The Auto industry in India manufactures a range of automobiles today for the Indian market and also for exports. The support given to local manufacturers was reciprocated through the 1980’s and 1990’s and today India is the world’s 4th largest producer of automobiles. Auto suppliers, which were MSME’s at start, employ hundreds of thousands of people today. The right environment can get the Indian businesses to invest appropriately.

The Call to Action

The Indian Government can take steps to organise manufacturing in the Defence Sector in India.

a. From slogans to outcomes: With Aatma Nirbhar Bharat Abhiyan, Prime Minister Modi made a point to promote Indian manufacturing. The Defence and Aerospace sector is a poster child for this self reliance. There isn’t a better sector for the Government to mandate and enforce indigenous content in a range of products and solutions that are today being imported.

b. Foster Public Private Partnerships: Prime Minister Modi announced the corporatization of Ordinance Board factories. The resulting furor from the Labor Union was to be expected. India should expect more out of its current spend on OBF and for that, the government will have to be firm and disciplined in its approach to OBF.  Corporatisation of OBF will yield marginal gains at best as compared to privitisation which the Govermnent is not ready to take on. The Government must avoid the band-aid effect. The arms industry in the US, which is the largest in the world, has its genesis in public private partnerships. The path to nurture partnerships will be difficult on the labor front, but India must address the archaic labor laws head on.

c. From partnerships to Offset Policy: Indian Government’s last revision to the Defense Procurement Procedure was in 2018. Offset limit has been raised to INR 2,000 crores. Offset policy mandates foreign suppliers to spend at least 30% of the contract value in India.  According to industry sources, the real problem lies in implementation, not in the policy. The data coming from the program is unreliable. Regulatory and operational bottlenecks further create challenges for foreign arms suppliers. 

d. From offset to FDI:  A well run offset program should ease the use of FDI as a discharge mechanism. Raising of the FDI caps in May 2020 from 49% to 74% is a step in the right direction. This will encourage foreign entities from allied countries to invest in India – India needs financial and technological help.

e. Boost MSME’s, the pall bearers of growth: Indian Defence manufacturers lack the technological prowess to benefit from the offset policy. It is no surprise that foreign suppliers find themselves struggling to fulfill their offset commitments. While partnerships like Lockheed Martin and Tata are steps in the right direction, Tier II and Tier III must also be mobilised. MRO, Repair, System Assembly are easy places to invest in the Defence and Aerospace value chain and FDI, JV formations for manufacture of products for the Indian and export markets are necessary and sources of growth.

India has many systemic advantages

India and China have the same rank on the Global Transparency Index. Yet, since 1991, China has surpassed India in all metrics of modernization and is a far superior economic power. India’s biggest strength is that it conducted the single largest experiment in democracy mankind has ever known (roughly 700 million voted in 2018). Recent data on implementation of the GST suggests a more transparent tax structure and has brought about ease in business dealings. 

India also has the advantage of the world’s most employable generation. In 3-5 years, it is estimated that roughly 25% of the world’s population between the ages of 25 and 35 years will reside in India. Further, labor rates are lower than in China, and an Indian engineer earns roughly 150% less than his counterpart in China. The service sectors can employ only a small percentage in this sector. Not deploying the workforce into manufacturing would only create more unemployment and turmoil. 

Verticalisation of businesses is the optimal way to look at the D&A sector. For this, India must build the eco-system to support the entire value chain – Raw Materials to Aftermarket services. Once again, the auto industry has blossomed in India and is a good teacher.

Defence & Aerospace Sector in India is at an inflexion point

Yes, there will be the mishaps along the path of acceleration and some schemes will run afoul. But, a very gradual ramp is a greater risk and a bigger threat to the nation.

Regardless of an Indian’s political leanings, there are two events of the current regime that deserve mention. First, within a few hours, Prime Minister Modi announced the De-monetization scheme in 2016. Despite the pain, Indians withstood the inconvenience and voted him back in power in 2018. Second, within 4 hours, a nation wide lockdown of 130 crores of people was enforced due to Covid-19. This is unprecedented. Execution of orders of this magnitude and the enforcement thereof has few parallels in recent years in the democratic world.

India has demonstrated that the masses can be mobilized, and that execution of decisions can be delegated effectively. The threat to India’s national security and the market opportunity favor the need to harness India’s resources to hyper-grow the Defence and Aerospace sector. India must make Defence and Aerospace a High Priority Industry.