The Indian Economy Blog

September 1, 2007

Towards Building A Domestic Defence Industry

Filed under: Business,Growth,Infrastructure,Trade — Pragmatic @ 4:39 pm

The bid for procurement of 126 Medium Multi-Role Combat Aircraft at an estimated cost of Rs. 42,000 crores ($10.2 billion) for the Indian Air Force this week has generated a lot of buzz in the international defence market. The NYT reports that-

Determined to build a domestic arms industry, India is requiring foreign suppliers to make a sizable portion of any military goods in this country. In the case of the jet fighter contract, the successful bidder must produce goods worth half the contract’s value in India.

The NYT report surmises that India will be the world’s largest defence market in another five years-

Over the next five years, military analysts expect the country to spend as much as $40 billion on weapons procurement alone, more than its entire annual armaments budget today — upgrading systems as diverse as jet fighters, artillery, submarines and tanks in its largely Soviet-era arsenal.

The NYT guesstimate is only 40% of the figure provided by Dr Kiran Chadha, head of the MoD’s Defence Offsets Facilitation Agency (DOFA). In April this year, the DOFA chief claimed [as reported by Broadsword] at a CII meeting of Indian and European defence industry that India will buy $100 billion worth of military equipment over the next five years. As per India’s defence offset policy which has been promulgated as a part of the new Defence Procurement Plan 2006, every foreign defence contract worth Rs 300 crores or more requires the foreign vendor to invest a minimum of 30% of the contract value as offsets. As has been done in the case of the fighter jets, this percentage of offset obligation can be varied by the Defence Acquisition Council. These offset obligations include-

  • Direct purchase of defence products, components manufactured by Indian defence industries.
  • Provision of “Services” by any Indian defence industries. “Services” will mean maintenance, overhaul, up gradation, life extension, engineering, design, testing, defence related software or quality assurance services.
  • Direct foreign investment in Indian defence industries.
  • Direct foreign investment in Indian organisations engaged in research in defence R&D as certified by Defence Offset Facilitation Agency.

Interestingly, the first reports of the offset tie-ups have already started trickling in. Broadsword reports-

India has just finalised it first offset agreement, worth $15 million (Rs 60 crores), with Israeli company ELTA, in a deal to supply India Medium Power Radars. ELTA’s offset partners will be private companies, L&T and Astra Microwave from Hyderabad. The offset proposals for the purchase of the navy’s newest fleet tanker involve 8-10 Indian companies.

The NYT adds -

In February, Raytheon and the electronics division of the Indian giant Tata Power signed such an agreement. The same month, Boeing signed an accord with an Indian engineering firm, Larsen & Toubro, to develop new projects. And Northrop Grumman has signed on with Bharat Electronics and Dynamatic Technologies, both of Bangalore, to investigate joint opportunities.

A quick calculation to place these figures in perspective. If we assume the total defence spending for next five years to be $60 billion and 75% of that is on foreign acquisitions, the offset benefits for Indian defence industry would be $13.5 billion (Rs 60,000 crores) over next five years.

The numbers are indeed impressive. But, there are early signs of resistance from the the foreign vendors against the offset requirements. The US government has officially declared offsets as undesirable, as it believes that they increase the cost of a deal.

Till now, the MoD has stuck to its guns. It will have to continue to resist all internal and external pressures and implement the offset policy with gusto. Even then, there will be no big ticket sales and stupefying results by the Indian defence industry in the short term. These measures and government support will only aid this sunrise sector in taking surefooted baby steps.

The fledgling Indian defence industry is ideally suited to emulate the Israeli model, which was initially based on successful tie-ups with major defence manufacturers. Notwithstanding this, the Indian domestic defence industry may still not be in the major league in next five years; but it could be a significant player in the international defence market by then.

14 Comments »

  1. Pragmatic, here is some info on US policy towards offsets. In general the US is apprehensive of sharing their technology which in the case of the MRCA deal would be the Boeing F/A-18E/F Super Hornet and the Lockheed Martin F-16. In multi billion dollar defence deals offset policies are justified given the amount of money that would leave the economy and the requirement of service, maintenance and spares. Without an offset policy in place to ensure self reliance we would be asking for trouble.

    India will be joined to the hip with whoever bags the deal for the next 40 odd years and this will give the RSK MiG-35 a huge advantage as it is built on the MiG 29 platform. The evaluation process will take a few years with exhaustive testing laid down by the Defence Procurement Procedure 2006. A Boeing official has called it the largest deal in the industry for the past 15 years. The order could expand to 180 fighters after adding a possible need of the Navy’s requirements.

    Comment by Nikhil Nayak — September 1, 2007 @ 6:05 pm

  2. It is sad that even After 60 years of independence India still have to beg to western countries for its defense requirements spending billions of dollars, while its huge portion of population still starving for food. India must emphasize on being self reliant and use the money indigenously to ensure its defense readiness and uplift life of its people.

    Comment by Cybertraker — September 1, 2007 @ 8:17 pm

  3. Nikhil:

    Thanks for the inputs. The US based companies have accepted the Indian Offset policy; it is a different matter whether they like it or not. If the Indians play it right from here, these could be exciting times for the indigenous defence industry in the country.

    Cybertraker:

    I thought it was, for a change, the other way around. The western countries are actually standing with a ‘begging bowl’(to borrow your term)to seal the deals with India. Self-reliance of the kind we have had for last 60 years has not led us anywhere. This offset policy, linked with India’s planned acquisitions for its defence preparedness in the near future, is a path breaking initiative. Let us not mix food security and quality of life with the issue under consideration; they are separate subjects by themselves.

    Comment by Pragmatic — September 1, 2007 @ 9:41 pm

  4. Pragmatic, you are deluding yourself if you believe global arms manufacturers are “begging” for deals as many Indians are wont to think. Companies like Lockheed, Northrop, BAE, etc have two priorities: 1) maintaining the military technology advantage of their respective countries and 2) maximizing profit and work share for their workers. They will do whatever they can to achieve these two and will throw around tens if not hundreds of millions of dollars worth of baksheesh in the appropriate directions. In the weapons business, it is NEVER a buyer’s market as all the cards are in the sellers hands. It is one thing to demand a 50% value offset, it is entirely something else to receive it in the end.

    There is a critical difference in indigenous “manufacture” that the news does not distinguish. There is in fact no actual manufacturing involved, but rather assembly of imported components and airframes delivered as knock down kits. The radars, weapons, engines, i.e. the primary components that make an aircraft and their accompanying maintenance parts will always be sourced from the defense supplier and not made domestically in India. Some secondary or tertiary components (i.e. seat cushions for Boeing) can actually be manufactured as long as it is economically feasible to do so as well as component assembly.

    Comment by Jing — September 2, 2007 @ 3:14 am

  5. Can anyone tell me why we have done a good deal of work in satellite technology and space research but still have not gone far with an allied technology like the Light Combat Aircraft? If I am right, the development efforts have been going on for the past 20 years and we still do not have a commercialized Aircraft that we can use/sell to the world.

    Comment by Raj — September 2, 2007 @ 6:09 am

  6. Jing:

    Thanks for the inputs. The \’begging bowl\’ term was used by a visitor to this blog. Going by the pulls and pressures being applied on India by various governments and industry executives (there are myriad press reports about these)it doesn\’t seem to be a seller\’s market. Unless you are looking for a specific technology or specific equipment, there are options available. As most of the defence equipment that India is looking for is from a different generation, there are no issues of continuity and logistics support. Else, we would be still stuck up with equipment of Soviet origin.

    Having and implementing a defence offset policy is better than having none. It is a small but significant change that can have long term benefits. Indian establishment has to just play it smart now from hereon.

    Comment by Pragmatic — September 2, 2007 @ 11:24 am

  7. Cybertraker / Raj, India has tried the self reliance route already and HAL has failed in delivering the Tejas LCA project. The 126 MRCA deal is a hedge to basically make up for the LCA failure. Please don’t call it sad or anything like that because it is not. R&D in the aviation business is not easy and specially in fighter aircraft. There is nothing wrong in buying the technology from a competent source and with the technology transfers demanded by the Offset Policies we are going to get self reliance in this area.


    Read more on the MRCA News here …

    Jing, at Aero India in Banglaore this year aircraft company officials were “sufficiently subservient” if you don’t like the term begging (as they should be for a $10 billion deal). Do a Google Image search for Aero India and you will see pictures as well. Anyway I think Pragmatic used the term only in reference to CyberTraker.

    If suppliers are thinking they can wiggle out of this deal without committing to technology transfer they are deluding themselves. This is why I mentioned the MiG 35 as the front runner as the Russians have made huge commitments with India in the past in both spares and avionics. India is already in talks with Russia to be a part of the Sukhoi G-5 consortium which is a competitor to the F 35.

    Comment by Nikhil Nayak — September 2, 2007 @ 11:29 am

  8. This “offset” should have been done a long time ago. Many civilian technologies in use today, that we take for granted (including the internet), started out as defence projects. The advantage of defence projects is that the budgets are huge, there are no “quarter-to quarter bean counter hounds” on your back (as is the case in many companies today)and the trickle down effects are available to all other sectors for many years. Much of US & other western country manufacturing sector today, got its technologies from older defence projects.
    So all in all it will be a great deal for the indian manufacturers and engineering companies if they can get a slice of the pie. And the manufacturing should be really that, not just assembling. For example it is no use just assembling Radars, we must make the magnetrons, waveguides, signal processing software, everything…

    Comment by Sane Voice — September 2, 2007 @ 1:21 pm

  9. This new mantra of local manufacturing is nothing new, didn’t we built MIG 21 in huge numbers? What happened when sovent disintegrated, we grounded many MIG 21 for lack of spares!! That is after manufacturing MIG -21, what does it tell you? Did we not hear that assembling/manufacturing SU-30 is 30% more costly than purchasing, i.e not including the investment in facility.

    What did we learn from MIG-21, Jaguar assembling/manufacturing that we want to take it further with MRCA? Have we did with MIG21 like J-7 or planned to do with SU-30 like J-11B the way chinese did? NO!! All we hear is SU-30 is very complex system to assemble so we will ordering fresh 40 more, to cover of the slow pace of assembly. Now just imagine what will be the result with RAFALE OR TYPHOONE, considering we find soveit built complx( should see to bElive the quality of construction that RUSSIA did in SU-30).

    Please don’t go with the press report of defence companies waiting with “begging bowl’/“sufficiently subservient” thing, they are still out there doing the SHINNING INDIA”/super power Thingy.

    Comment by King of Hill — September 4, 2007 @ 3:05 pm

  10. King of Hill, the begging bowl analogy was just in reference to another post. At the end of the day it is big business.

    One thing that has changed from the past is the involvement of private industry. Earlier all defence deals were the domain of HAL, DRDO, Ordnance Factories etc. Private industry had no chance of bidding for these tenders. Today private industry is already doing a huge amount of work for Indian defence organizations.

    Conversely many Indian defence organizations were obliged to buy sub standard equipment/machines/technology from fellow public sector companies. This is now no longer the case and where obstacles are in place defence industry has started using private industry vendors to work around them.

    Comment by Nikhil Nayak — September 5, 2007 @ 12:38 am

  11. Nikhil, You do understand that defence is not about manufacturing, but continous improvements via R&D.Am amazed at the confidence that you have in in private sector in defence, where profit is everything when DRDO failed where leave aside profit no accountability is asked in return for massive funds provided at their disposal.

    Do yo really think they will invest moolah to do research, than churning the same copies. We have seen the private industries same ambassador, bajaj auto, rajdoot, yazdi, the list is endless.

    Again it is not about ability or funds, it is the people at the helm who should be made accountable. A person leading the Tank project for 30 years and failed is put in charge of the whole organisation as reward. That said person block the extension of service of a guy who brough finished product. This is the kind of reward and accountability present, how can an organisation succeds?

    Again whishing that private sector will achive what DRDO failed is pure fantasy. Do you think Govt will provide funds for say Tata and reliance for fighter project or Tank? If not what are they for assembling components?

    Comment by King of Hill — September 5, 2007 @ 2:38 pm

  12. King of Hill, nothing you’ve said is entirely wrong. I am pointing to the fact that times are changing.

    As a matter of fact times have changed – new policies are in place where credible private companies called “Raksha Udyog Ratnas” are being given equal access big research, development and production projects as the public sector. The likes of L&T and Godrej are in the mix and to answer your question they are doing a pretty good job.

    Link: Riding the Elephant – Defence Industry Jewels

    Link: The Hindu – 12 firms to get Raksha Udyog Ratna status

    Organizations like DRDO failed in part because of a lack of quality culture on their shop floors. These are also large organizations that are too huge to take up projects with focus. In these new environments, DRDO and other defence organizations like BDL are moving into a different roles with private industries playing the roles of actual manufacturing vendors.

    Comment by Nikhil Nayak — September 5, 2007 @ 7:04 pm

  13. We need the private sector who can handle mega projects to get into armaments in a big way(think Reliance L&T,Tata etc).We are not Russia that even today can pack off train loads of brilliant freshly minted physicists to obscure towns in siberia we have to compete with the private sector for pay packets.A scientist who works for the DRDO gets a pittance in a city like bangalore compared to his counterpart in Infosys who is probably less qualified but still gets a 15-10% hike EVERY YEAR and gets to go onsite to earn $$ and live in the first world(a huge aspiration).
    It is only the private sector that can get the best and brightest ‘pathfinders’ from anywhere in the world and pay them the moon to deliver the results.I mean we do not have to re invent the wheel most of the technology is pretty standardized (no one is asking for a F-22 Raptor)its just the inflexibility of the system and the appauling lack of value based compensation that has made the indian defense industry dig its own grave.

    You can keep giving motherhood statements like one should work for a pittance for 1/10 the salary for the sake of patriotism but 60 years after independence we all know that’s not how the world works.

    Comment by Shantanu Chatterjee — September 16, 2007 @ 4:32 pm

  14. [...] Unconfirmed reports have it that the Russians are planning to invest the unexpended portion of the rupee debt repayment back in India with a five year lock in period. This is most likely to include setting up of service centres for defence products already sold to India. More significantly, accumulated rupee debt repayment projects could also be planned as a part of the mandatory DPP-2006 requirement of 30% offset investment in indigenous production for future acquisitions.The readily available capital of debt repayment account will provide the Russians with a distinct advantage over other competitors in the ensuing defence deals. As such, the Russians have a head start over others because of India’s long history of military hardware acquisition from Russia; continuity in operation logistics and generational consistency can only be achieved by adhering to this legacy. [...]

    Pingback by The Indian Economy Blog » Russia’s Rouble Advantage — September 24, 2007 @ 10:13 pm

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