One of the reforms announced in the last instalment of the economic stimulus package by the Finance Minister relates to a new coherent Public Sector Enterprises Policy which will define the strategic sectors where PSUs will be present and all other sectors will be opened up for the private sector. The notified strategic sectors will have a maximum of four PSUs and the remaining state run strategic companies should be either merged or privatised or brought under holding companies. Private sector can co-exist with the public sector in these sectors.
The lists of strategic sectors have not been revealed so far, but defence is likely to be on the list as it is one of the sectors which cannot be fully privatised due to security implications. Consolidation of the Defence Public Sector Undertakings (DPSUs) will be a welcome move as it will bring in the much needed rationalisation. However, whether this step is able to create space for the private sector, which has so far been languishing on the sidelines, is debatable as there are a number of issues on providing level playing field which are specific to the public versus private sector debate in defence. The Ministry of Defence has taken several measures to address this issue, but it has not been able to bridge the divide between the two sectors. Defence being a highly capital intensive and technology driven sector requires substantial investments for production activity. The private sector feels that the Defence PSUs have an in-built cost advantage as they have been provided substantial support towards infrastructure development and R&D costs which the private sector finds hard to match up to. Having created the capacity in the public sector, the Government while taking procurement decisions, is invariably driven by concerns of idle capacity and gives preference to utilization of the existing capacity in the public sector. In the Department of Defence Production Dashboard the data on the Segment Wise Defence Production confirms this aspect. In 2019-20 out of a total turnover of Rs. 51,807.00 crores, the turnover of DPSUs and Ordnance Factory Board was 68.7 %; other PSUs and Joint Ventures was 8.3 % and Private Sector was 22.92%. The figures for the last four years have more or less maintained this pattern.
The Department of Defence Production probably finds it easier to exercise the default option to nominate the public sector companies for Transfer of Technology and not the private sector. Further, since past Transfer of Technology cases have been to the public sector the foreign OEMs have also developed a comfort factor and prefer to continue to deal with them.
The introduction of the Strategic Partner model was an attempt to break this impasse and bring in the private sector for manufacture of major weapons and platforms, but implementation is still at a nascent stage to assess the effectiveness of the model to boost the role of the private sector.
When the approach of capacity utilisation drives placement of orders it results in the DPSUs getting orders on nomination basis. Consequently the DPSUs are able to underwrite the prices in competitive bids as the prices in nomination cases are invariably higher since they are not based on competition. Private sector, therefore, faces a double disadvantage.
Globally there has been a trend of consolidation in the defence industry to achieve synergy and gain cost advantage due to economies of scale. At present there are ten DPSUs in the defence sector apart from forty one factories under Ordnance Factory Board. Out of the DPSUs, government has already approved ‘in principle’ for disinvestment of 29 percent of its shareholding in Bharat Earth Movers Limited (BEML) as part of its strategic disinvestment. There are four DPSU Shipyards which will benefit by consolidation to achieve more synergy. In the aviation sector there is only one DPSU Hindustan Aeronautics Limited (HAL). However the policy on PSUs should not confine itself only to the DPSUs but will need to take a holistic approach and consider the duplication of capacities between DPSUs and Ordnance factories as well. For instance, under the category of electronics equipments for the armed forces there is adequate capacity in the DPSU Bharat Electronics Limited apart from companies in the private sector which have started manufacturing these items. Therefore the production of electronics equipment by Ordnance factories results in excess capacity in the public sector to the detriment of the private sector which also has an impact on price discovery as a large chunk of the orders go to the public sector without competitive bidding
Another category is where sufficient capacity has been built up in the private sector especially for non military products like the range of transport, logistics and mobility vehicles being manufactured by private sector companies. In fact they are also showcasing military and tracked vehicles developed by them in defence exhibitions. Therefore, ordnance factories should not manufacture the logistics vehicles for which more than one source of supply is available in the private sector
Government should also take into account the investments which have been made on the vast infrastructure and plant and machinery of the DPSUs and look at ways to utilise them. Privatisation and disinvestment should be the last resort. A lease-out model can be adopted where the assets and infrastructure of the DPSU can be given out on long term lease to the private sector companies. The existing skilled staff can also be absorbed by this new entity.
For future cases there is a need is to move away from piecemeal procurements to aggregation of demand so that there are at least two sources of supply, preferably with one in public and one in private sector. The CVC guidelines permit distribution of quantities amongst vendors and allocation of quantities between L1, L2 etc. provided the L2 vendor matches the L1 price. These provisions have been incorporated in the Defence Procurement Procedure. The ratio of splitting the quantities can be pre disclosed in the RFP. This approach will ensure that the private sector gets at least 50 percent quantity even in the likely scenario of the DPSU being L1 and will lead to a balance between the public and private sector.
It is evident that in order to have an equitable balance between the public and private sector in defence there has to be a multi-pronged approach and a long term solution.
Our greatest weakness has been the lack of overall perspective towards defence manufacturing. We have being giving undue importance to institutions such as Defence Research and Development Organisation (DRDO), the premier R&D agency of the Ministry of Defence (MoD)and Director General of Ordnance Factories(DGOF) to cater to our defence requirements. These organisations do not have a laid down road map and decisions are taken in a compartmentalised environment bereft of the involvement of stakeholders. Is it not a matter of surprise that Indian Army accounts for more than 80% of its orders on OFB and still doesn’t have any member in the advisory board of Ordnance Factory Board (OFB). The absence of stake holders in the decision making process has a catastrophic effect on defence manufacturing and procurement. The Armed Forces are interested in getting the equipment in the shortest time frame, whereas these organisations have scant respect for timelines and the sanctioned budgets.
The other important aspect is the way defence procurements are done. We have a Defence Procurement Procedure (DPP) Manual 2016, which lays down how the procurement is required to be done. Unfortunately the entire process is so time consuming and bureaucratic, that from the time an item is identified for procurement till the time it is physically received is anywhere between 3 to 4 years.
The need of the hour is to get the private sector involved in defence production. The biggest hindrance in the private sector’s participation so far has been mistrust. When it comes to big contracts, procedural hurdles come in the way, making it virtually impossible for the private sector to get into complex defence manufacturing. Moreover, single source procurement from the private sector is still considered a taboo, whereas import without competition is greatly admired. There is therefore a requirement to change mindsets and treat the private sector as an equal partner. This can only be demonstrated by awarding big contracts, preferably through the ‘Make’ and ‘Buy and Make (Indian)’ procurement categories, which hold the key to the success of the private sector’s participation in defence production.
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