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India’s new Defense Procurement Procedure, unveiled early this month, like its predecessor focuses on vitalizing India’s indigenous defense capabilities and moving away from the decades-old practice of importing almost all its defense requirements. But in the attempt to make the country’s defense procurement process more transparent in the murky world of arms deals, the new procedures seem to unwittingly favor foreign vendors.
From promising foreign vendors brownie points for the money they would pump in for setting up bases in India, to shutting middle men out of defense deals, to making the country’s defense procurement “more investor friendly,” the new policy, which takes effect Sept. 1, offers everything to make it easy for foreign investors to participate in India’s defense procurement, experts say.
For instance, the rules have been revised to include offset credit banking, a key request of foreign vendors. This means that money a foreign vendor may pump in to set up a manufacturing base in India would be considered as an investment, satisfying the offset clause in the new regime.
In its bid to modernize the local defense equipment industry, India introduced the “Offset Policy” in 2005, which is basically a counter-obligation that India places on foreign vendors for buying defense equipment from them. It states that foreign vendors must invest at least 30 percent of all deals they bag from the government. This can take any form, including setting up a manufacturing base or training facilities, sourcing components, sharing technology, or making use of information technology services from India-based global service providers.
Under the new procedure, investments made in India by foreign vendors before bagging a deal would be treated as banked offset credits for the tenders to be floated within two and a half years from the date of investment. Moreover, if a vendor should create more offsets than his obligations under a particular contract, the surplus offset credits could be banked as well and would remain valid for another two years following the closure of the first contract.
“This (new offset credit banking facility) enables foreign industry and their Indian offset partner to have long-term arrangements to discharge offsets and will thus enhance the capacity of the Indian industry to absorb offsets,” said Defense Minister A.K. Antony.
According to Dr. Laxman Behera, fellow at the Institute of Defense Study and Analysis, the offset credit banking is “perhaps the most significant aspect of the new DPP that provides the opportunity to a foreign vendor to partner with the Indian industry, and more importantly, facilitates them to do business with the private sector.”
But if permitting foreign vendors to bank offsets toward a future contract liability is a “sweetener,” the real music to foreign ears is that there is no place for middle men anymore in India’s defense deals.
After all, from the Bofors gun deal and the HDW submarine deals of the mid-1980s to the scandal regarding the purchase of Barak missile systems from Israel that surfaced in 2001 and still remains unresolved, scandals, kickbacks and controversies have become hallmarks of India’s defense procurements. These scandals have been primarily a result of the existence of hundreds of shady middlemen and facilitators that grease the corridors of power.
In fact lately defense deals, and thus indirectly foreign vendors, have suffered due to these scandals. For instance, succumbing to the pressures of the opposition, the Indian government had to scrap almost US$1 billion worth of defense deals last year after years of trials and negotiations.
"We have learned a lot of lessons from the past and we don’t want to repeat the mistakes. That is why every now and then, we are trying to improve the Defense Procurement Policies," says Defense Minister Antony. “We are very clear that we will not allow middlemen in defense deals.”
The other important revision, which, says Dhiraj Mathur, a defense analyst at the consulting firm PricewaterhouseCoopers, makes DPP 2008 “investor friendly for foreign vendors” is the removal of mandatory industrial licensing requirements of production for private companies. Until now, obtaining a license from the government was mandatory for all defense manufacturing in the country, making setting up a defense factory a cumbersome process and discouraging private investment in the industry.
Now that licensing for defense production has been done away with, “partnering with Indian vendors would become faster and easier for foreign vendors,” said Mathur.
The new rules are “revolutionary,” says Antony, in that they takes a big step forward in replacing the oft-accused “over-manned and inefficient government-owned” defense corporations and ordnance factories.
The need to modernize India’s armed forces was first felt acutely after the Kargil conflict, an armed conflict between India and Pakistan that took place between May and July 1999 in the Kargil district of Kashmir.
India realized that it had to reform the National Security System drastically and crafted new defense procurement management structures and systems in 2001, christened the Defense Procurement Procedure. The first DPP, which came into effect Dec. 30, 2002, was just applicable for “buy” decisions of the Indian armed forces. Its scope was subsequently enlarged in June 2003 to include “buy and make” and was again reviewed in July 2005 to include the “make” category.
This was the first step toward localization of defense manufacturing. Besides including locally made products as part of procurement procedure, the DPP 2005 was enlarged to include a fast track procedure – a faster acquisition process – and a procedure for indigenous warship building. Another revision a year later brought in the private sector under the defense procurement fold.
“Armed Forces all over the world are in a process of speedy modernization and restructuring,” says Antony, “and India cannot lag behind in this trend. We want a highly modern armed force and we need to do that fast.”
In that pursuit, India’s plans could easily make the country one of the largest armament markets in the world. According to consulting firm Frost & Sullivan, the upcoming modernization program of the Indian Armed Forces will make India the Asia-Pacific region's second highest defense spender within the next five years, and the seventh largest globally by 2016. Including maintenance, repair and overhaul opportunities, the total opportunities for procurement are forecast to exceed US$100 billion by 2022.
Other estimates suggest that India’s military equipment procurement will be worth US$50 billion in the next five years, with about $15 billion involving foreign vendors in partnership with Indian companies under the offset clause.
“Opportunities therefore exist for everybody,” says Mathur, not just big names like Stonebridge, GE, Techtron, Thales, EADS, Raytheon and the like, which are already participating in current procurements.
Despite all the improvements, one gap remains. “The bad part of this DPP is that it hasn’t addressed the foreign direct investment issue,” says Mathur. Both local and foreign vendors were hoping the document would increase the limit on foreign investment in Indian ventures from the current 26 percent.
“That has not been addressed and it is a serious issue,” Mathur says. “The 26 percent stake limit is too little going forward. There are after all 126 countries vying for global money in their defense sectors and few foreign vendors would be willing to bring in their intellectual property rights in Indian ventures where they can hold just 26 percent.”
