Defence procurement: Abundance of good intentions; time now for action

By PwC
Updated: Aug 29, 2016 06:47:12 PM UTC

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To instil confidence and build the government’s credibility it is now needed is the award large programmes to Indian companies

India ranks among the top 10 countries in the world in terms of its military expenditure and is the world’s largest importer of defence equipment. In order to achieve the goal of self-reliance in defence production, the Government, under the umbrella of “Make-in-India” campaign, has rolled out several policy initiatives in the last two years to lower entry barriers and improve ease of doing business: significantly simplifying conditions for FDI into the sector and allowing up 49% on the automatic route, relaxing norms of industrial licensing and defence exports, bringing flexibility in discharging offset obligations and providing a level playing field for private players. It has also made more fundamental changes that have long term implications. Taken together, these policy changes have created an environment that will provide multiple opportunities for private industry. What is now needed is the award of large programmes to Indian companies to instill confidence and build the Government’s credibility.  But let us first review some of the key changes.

The Defence Procurement Procedure 2016 (DPP), which was made effective on 1st April 2016, has introduced a key new acquisition category called Indigenous Design Development and Manufacturing (IDDM), which has been given the highest priority. Technological development is essential for gaining strategic and competitive advantage in defence and thus, IDDM is a game changer as it would provide the necessary incentive to the private sector to invest in research, design & development activities and also compel foreign companies to explore partnerships with Indian companies. However, achieving 60 % indigenization would be difficult, given that most Original Equipment Manufacturers (OEMs) are struggling to achieve the existing 30% prescribed under earlier programmes. Hence the timing to achieve such a target will require a degree of flexibility. There also does not appear much justification in having two levels of indigenous content, since a 40% indigenous content reduces the distinction between IDDM and Buy and Make Indian categories.

The “Make” category has not taken off in the country so far.  Thus, the changes in the “Make” procedure in DPP 2016 are a welcome step towards reducing investment risks. The new Make procedure has been split into two – Make-I (government funded projects) and Make-II (industry funded projects) with special focus on micro, small and medium enterprises (MSMEs). It has increased the provision of funding of projects under Make-I category to 90% from 80% and also reserved low value projects for MSMEs. Additionally, up to 100% of project costs will be refunded in case of delay in issuance of RFP by more than 24 months. The list of schemes to be taken up has also been shared with the industry.

Another important change is moving beyond the traditional ‘L1’ approach and allowing ‘essential’ as well as ‘enhanced performance’ parameters. The vendors who meet enhanced performance parameters will be provided additional credit score during evaluation of their product cost. The new DPP also ensures that the procurement process does not get derailed by single vendor situations which have led to a large number of delayed or cancelled programmes.

There has also been a welcome change in the mind-set in the government.  The Department of Defence Production, which was perceived as favouring DPSUs/OFB, has become extremely proactive in attracting private domestic investment. Along with the end users (the armed services), it has been conducting seminars highlighting the requirements of the forces’ and opportunities for Indian companies.

The Government has exhibited its good intentions and taken many positive initiatives. The time now is for action: by the Government in awarding the first large programme to Indian private industry. For its part, industry too now needs to move from making demands for further changes to concluding partnerships and building capability in identified areas so that it can participate in future programmes (over 90% of the “Acceptance of Necessity” in the last two years have been to programmes in which Indian companies will be prime).  Companies will have to lay emphasis on setting strong foundations to their businesses to capture value as the Indian aerospace and defence market matures over the next decade. In doing so, stakeholders need to understand the distinct nature of the market, their participation in the value chain, nuances involved  in building capabilities in niche areas and, most important, investing for the long run.

- By Dhiraj Mathur, Partner, PwC India

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