Advancing the agenda of self reliance in defence production
The goal of making the country self-reliant in defence production has been a declared policy of the government. However, imports have continued on grounds of operational preparedness of Defence Forces as the domestic industrial capability was found deficient in meeting the expectations of the Forces. Most of domestic equipment manufacturing industry is about licensed production of items designed/developed abroad. It is more so in defence arena. There are myriad problems afflicting industry and indigenous R&D. Even in the products supplied by domestic manufacturers, the import content remains significantly high.
Defence manufacturing requires huge investment and a single customer industry has right to feel aggrieved if it has no certainty about getting orders and getting them regularly. So a major complaint from the domestic defence industry was the absence of a commitment from the armed forces on procuring a defence item that was developed and produced in India.
Now in a big boost to domestic manufacturing, the Ministry of Defence has notified a list of 101 weapon systems/equipment whose imports will be banned from specified months. The ban is effective for 69 items from Dec 2020, 11 from Dec 2021, 4 from Dec 2022, 8 from Dec 2023, 8 from Dec 2024 and 1 from Dec 2025. Giving a future date for import ban will give enough time to domestic industry to sort out bottlenecks.
The import embargo so announced removes competition from abroad but still gives no certainty about orders. An assurance of enough orders that would make a production line economical can only be made with joint commitment of Ministries of Finance and Defence. It is understood that such a commitment has now come in the form of CCEA approval.
MoD has brought out that 260 deals worth Rs 3.5 lakh crore ($47 billion) for products now being embargoed were contracted for the Indian armed forces between April 2015 and August 2020. Now, with the negative list, it is estimated contracts worth almost Rs 4 lakh crore ($53 billion) will be placed upon the domestic industry within the next six to seven years. This will include items worth Rs 1.3 lakh crore for the Army and IAF, and another 1.4 lakh crore for the Navy. It is a major step towards ‘self-reliant India’.
Defence manufacturing industry is dominated by Defence PSUs and OFB. In recent years, steps have been taken to attract private investment in the sector, both domestic and foreign. To be ready to meet the requirement of the Forces, the private industry needs some hand-holding.
Certain enabling steps have already been taken. A major step was providing level playing field in taxation. All imports meant for defence services are exempt from Customs and IGST, whether importer is public or private entity. For local supplies, CGST/SGST is equally applicable on all suppliers, public or private. Thus, the tax concessions earlier available only to DPSUs/OFB have been withdrawn and all defence tenders now have parity of tax treatment between public and private suppliers.
Last year, government introduced reduced rate(15%) of corporation tax for new manufacturing units. DRDO has come out with a list of its developed items with promise of cost-free technology transfer. The banking system is flush with liquidity and industry should have little problem in securing an MoD order-based finance from banks.
Here are a few suggested measures to make progress in this direction.
Using IEMs to kickstart new investor facilitation
The production units yet to be set up would require a whole range of Ease-of-Doing-Business support in getting required clearances and investment facilitation. Here is a suggested lead in proactive MoD stance to help the investors.
The Industries (Development and Regulation) Act, 1951 is administered by the Department of Department for Promotion of Industry and Internal Trade (DPIIT) in the Ministry of Commerce and industry.
This Act confers wide ranging powers to the Central government over a large list of industries, annexed in a schedule of the Act. The government may enforce compulsory registration, prior licensing to set up or expand an industrial unit, impose locational restrictions, regulate investment, especially of foreign capital and technology, regulate production capacity etc. Power was also conferred on the Central government through an amendment in 1953 to take over management in case of mismanagement. This 1953 Amendment was put in the 9th Schedule making the Amendment Act beyond the scope of judicial scrutiny.
Section 11 of the Industries (Development and Regulation) Act, 1951 prohibits establishment of any new industrial undertaking without a licence issued in that behalf by the Central Government. Section 29B of the Act authorizes the Central Government to grant exemptions, having regard to size or workforce/capital or stage of development of units or industries, from any or all provisions of the Act to any particular industrial undertaking or class of industrial undertakings or any schedule industry or class of scheduled industries, ‘subject to such conditions as it may think fit to impose’.
Invoking this power to grant exemptions, the Government has been dispensing with the requirement of prior license for an increasing set of scheduled industries. Now very few industries need prior license.
While dispensing with licensing, the government imposed a requirement (through Press Note no. 9 of 1991) that the promoters of new industrial units must submit INDUSTRIAL ENTREPRENURS MEMORANDUM to the DPIIT – – at two stages. First, the IEM should be filed (called IEM Part A) at intention to set up stage along with a fee of Rs.1000 through bank draft and second (called IEM Part B) after commencement of commercial production.
The IEMs are mere intimations to DPIIT and acknowledgement of their receipt by DPIIT does not ipso facto confer any rights on the filing entities. They have to obtain whatever clearances required under any other law, rule, regulation, order from any other government/department/agency.
The format of IEM captures information on aspects like location, employment, investment, date of commencement of commercial production (only in IEM Part B) and the items to be manufactured besides other identifying details like company registration number etc.
Since the inception of filing of IEM in 1991 till the end of September 2018, a total of 13,129 IEMs with an investment of Rs.9,74,720 crore have reported implementation against 102717 IEMs with proposed investment of Rs.119,78,414 crore filed. It shows that a large number of IEMs (Part A, intentions to invest) remained unimplemented or unreported in terms of materialisation.
The cumulative status of IEM filing during Oct 1991 to Feb 2020 was as follows:-
Part A filings since October 1991
| Year | No. of IEMs | Proposed Investment (Rs. In crore) |
| 2018 | 2173 | 458,652 |
| 2019 | 2378 | 678,852 |
| Jan- Feb 2020 | 391 | 164,482 |
Part B filings since October 1991
| Year | No. of IEMs | Investment (Rs. In crore) |
| 2018 | 1005 | 255,783 |
| 2019 | 1229 | 1796,552 |
| Jan- Feb 2020 | 209 | 58,737 |
There were no filings of IEM Part A and Part B during Jan 2018 to Feb 2020 under the head “37. Defence Industries”.
https://dipp.gov.in/sites/default/files/2020_march_sia_statistics_chapter1.3.pdf
In another report, DPIIT disclosed that total 12,880 INDUSTRIAL ENTREPRENURS MEMORANDUM (IEMs) were filed during August 2014 to February 2020 involving Rs.28,19,400 crore investment generating employment for 57,56,692 persons. Also, during this period, 248 Direct Industrial Licences (DILs) were issued involving Rs.72,857 crore investment generating employment for 64,536 persons. Direct Industrial Licences are being issued since December 2003 for items under compulsory Licensing under 5 categories.
https://dipp.gov.in/sites/default/files/2020_march_sia_statistics_chapter1.1.pdf
Part A filing
| Year | Number of IEM Part A filed | Proposed investment (Rs. In crore) | Proposed employment (no. of persons) |
| 2017-18 | 1895 | 4,34,017 | 7,06,685 |
| 2018-19 | 2274 | 400,113 | 24,48,886 |
https://dipp.gov.in/sites/default/files/sia_statistics_2018-2019_annualissue_chapter1.4.pdf
Unless government is ready to hand hold these pipeline investments, merely collecting data on investment intentions is an unnecessary exercise and may rather be discontinued. Obviously, it is beyond DPIIT’s capacity to facilitate so many sundry investors through the maze of regulatory environment. Concerned line Ministries dealing with particular industries must study these IEMs and institute mechanisms to facilitate their investments.
MoD should put in place an institutional mechanism to facilitate upcoming defence industries. A start can be made by reaching out to those who have secured licenses for manufacture of defence items and even filed IEMs with DPIIT. The information about IEMs may be shared both at SHQ and Command levels also as some of the smaller companies may be catering to procurements at that level.
Tracking of indigenous content
‘measure to manage’ is an accepted management mantra. It helps to gauge the dimension of the problem before trying to solve it. How big is the potential market for defence procurement and what is the current level of indigenous content?
Total procurement of stores and equipment by the three Services was Rs.1,10,973 crore in 2018-19 (of which Revenue ‘Stores’ Rs.34,647 crore), Rs.1,25,099 crore (of which Revenue ‘Stores’ Rs. 34,969 crore) in RE2019-20 and Rs.1,23,671 crore (of which Revenue ‘Stores’ Rs. 33,142 crore) in Budget 20-21.
No credible statistics is available as to what is the existing indigenous content in the procurements by the Defence Services.
A significant part of the orders placed in Indian Rupees on local suppliers (DPUS, OFB or private) involve import of materials, components and sub systems. A local supplier receiving direct order from MoD in Indian rupees may place a rupee order on another supplier who may resort to full or partial imports. Chasing the whole chain of vendors to find out the expenditure in foreign exchange and expenditure in Indian Rupees may be a difficult exercise. Nevertheless, it is necessary to institute a monitoring mechanism to track the imports by vendors and sub-vendors. One initial step could be to start tracking the FE expenditure of DPSUs/OFB (i.e. the direct imports by them ignoring the import by their sub-vendors).
Standardization and mapping of defence products with HSN and NATO classification
In pursuit of self-reliance, there is need to complete the work on standardization, classification and mapping of various systems, sub-systems, components etc., not just as per HSN codes used by Customs/DGFT/GSTN but also with the products included in the NATO’s database of standards and specifications. These should be embedded in the Supply orders so as to help detection of duplicate part numbers being imported and get prompters for use of comparable indigenous parts.
Special attention to conclusion and implementation of ToT agreements
As part of capital acquisitions, many TOT agreements have been signed but the DPSUs/OFB are seldom able to upgrade the items produced under license. The ToTs are basically manufacturing ToTs. The foreign OEM only gives know how to replicate an item to given drawings under given operating conditions. Know why information – the underlying data and calculations resulting in the designs, drawings and specifications are not shared. In such a ToT, they can only replicate but cannot acquire the knowledge to make even slightest modification.
During ToT implementation, DPSUs/OFB face several practical problems that need active intervention and monitoring by higher formations.
Level playing field in terms of contract implementation
It may be entirely misplaced but there is a perception that MoD/Services grant more indulgence to DPSUs/OFB as compared to private supplies. They get post-contract relaxations including rather liberal extensions. If true, this implies that DPSUs bag the orders by under-quoting and then drag on. To remove this perception, some special visible steps are required on the part of the MoD.
Reviewing the tendering system
The ‘underquote and grab order’ syndrome is a result of the traditional single round L1 system of bidding. Single round bidding is akin to lottery. It is felt that this tendering methodology does not suit complex defence tenders for which MOD should go for reverse auction. The system of multi-stage bidding process (reverse auction) needs to be adopted in high-risk, high-value projects to de-risk the bids from being loaded with excessive risks of uncertainty.
Multi round bidding allows each bidder to reassess risks and revise/refine the quote. So electronic platform-enabled spectrum or coal block auction system as bidding methodology is preferable to L1. Long ago, when the Best and Final Offer (BAFO) system was used with manual interface, there were concerns about integrity of procurement process. Those concerns can now be addressed in a digital platform. Full trail of bidding in different rounds is available. Each bidder has EQUAL AND FAIR opportunity to revise bids and the end result is better financial outcome for government in a transparent manner with a fair chance to avoid implicit lottery of single round bidding.
Incentives for startups
The system is stacked against new entrants so some policy support is needed by way of reserving a certain portion of total procurement for new suppliers or enabling placement of experimental orders for unproven items. This is essential for building up domestic capability. Where a contract is for divisible quantity, splitting L1 L2 distribution of quantity wherever stipulated in NIT as per DPP, perhaps 10 to 20 per cent quantity upfront could be offered for first time entrants, provided they match the lowest offer. This incentive can be given for a limited time say 2 -3 years for it to take off. Such a provision should be liberally used where there are large quantities and building more suppliers will be beneficial.