There has been renewed vigor in the Indian defense establishment since the inauguration of the Narendra Modi government in May. This started with a more liberal policy on foreign direct investment (FDI), which increased the cap from 26 percent to 49 percent, and also allowed FDI beyond 49 percent in cases that allow access to state-of-the-art technology.
In those cases, the policy allows foreign companies to set up base in India and relaxes the stipulation that management of the applicant company be in Indian hands. While the liberalized FDI regime is welcome, results have not yet been seen and further liberalization of the policy may be required in 2015.
Over the past six months, the Defence Acquisition Council (DAC) has approved proposals in the range of US $12 billion to $15 billion, including long pending proposals to build six new submarines and procure artillery guns. These decisions have generated optimism in Indian private industry. However, considerable time will elapse between DAC approval, issue of a request for proposals and finalization of contracts. It would be another three to five years before investment begins to materialize.
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One of the major gaps in India's defense procurement policy regards the suspension and debarment procedures. Immediate blacklisting of vendors comes at the slightest whiff of payment of bribes or agency commissions. The blacklisting policy has been counterproductive and requires course correction.
The recent blacklisting of AgustaWestland for alleged transgressions in the procurement of helicopters has raised a dilemma about blacklisting all Finmeccanica companies. This in turn has made procurement of completely different weapon systems, such as submarines, from other group companies difficult, eroding defense preparedness.
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The past decade has been replete with such instances of indiscriminate blacklisting of the parent company and its subsidiaries due to transgressions by a single entity. The policy guidelines adopted by the Pentagon as well as other leading industrial powers need to be examined and a fresh set of guidelines issued enabling punitive action against the company at fault, without necessarily punishing the parent company or other group companies.
While the FDI regime for defense manufacturing has been liberalized, in many cases defense original equipment manufacturers cannot transfer technologies without approval of the parent governments. Enterprise-level relationships under the FDI policy therefore need to be backed by government-to-government dialogue. Strategic choices need to be made to enter agreements for co-development and co-production of weapons. The FDI policy needs to be supplemented by strategic direction.
One of the key attributes of defense manufacturing is monopolistic and oligopolistic industrial structures, with procurement often being confined to a small vendor base, sometimes to a single vendor. Defense business also entails the need for placing repeat orders on the same vendor.
India has followed the easy option of placing orders and repeat orders on Indian defense public sector enterprises, a safe strategy because these are government companies. The key challenge is to move away from this model and encourage the Indian private sector to get into defense manufacturing. Without price discovery through competitive bids, the only option is to resort to cost-plus pricing, which entails cost structure analysis.
The US found a solution to this problem in the 1960s when it set up the Defense Contract Audit Agency (DCAA). This strategy has also been followed by other countries. India needs a similar strategy and the cost analysis capabilities of the Indian Ministry of Defence needs to be upgraded.
The government also needs to take a hard look at the structure of the Ordnance Factory Board and its group of about 40 ordnance factories. Several committees have recommended the factories be corporatized. This could be a major initiative to be taken up in 2015.
Lessons learned over the past decade are clear and there is an excellent opportunity for course correction in 2015, given the forceful articulation by the present government about the need to boost indigenous defense production and preparedness.
