Challenges in Indian Defence Technology & Needed Reforms

1. State of Technology in India & Needed Reforms16th December 2011ByRahul ChaudhryCEO – Tata Power SED

2. Preface • The Comments herein are entirely based on my personal observations • Some of the observations are anecdotal in nature, but mostly backed with examples

3. Issues with Technology in Indian Defence

4. Technology is not the “real” issue • Indian Defence Industry has proved its ability to deliver state-of-the-art technology against the odd of Global Sanctions • India’s Strategic Missile Program is completely indigenous • Dr APJ Abdul Kalam and DRDL indigenously developed a series of missiles Programs – Agni, Prithvi, Akash, Trishul and Nag from the scratch, after succeeding in SLV 3 and other Programs at ISRO • Arihant Submarine Program, launched in 1997, under the peak of sanction regime, successfully delivered under a PPP (Public-Private Partnership) model • Samyukta EW System is another successful example of a completely indigenously developed System under the PPP model

5. Technology is not the “real” issue – EW Samyukta EW System

6. Change in Industry Dynamics – “Security” Bogy • Instead of encouraging PPP, today MoD is avoiding it in the name of “Security” • BEL / DRDO did not clear IEWS – MT NC NC trials, however is being nominated for all EW Programs citing “security” reasons • L&T which gave the hull for Arihant, is denied the same for conversional Submarine • Under MAKE Programs such as TCS and Global (Buy) Programs such as MAFI, 155mm Tracked Gun, Electronic Warfare etc, Indian Companies are Prime with “Know why” - • Availability of Source Code, co-development and production is acceptable to major Defence Contractors such as Raytheon, Ultra, Rockwell Collins, Cassidian (EADS), Harris, Thales etc.

7. Access to Technology is not the “real” issue • Today, Indian Companies are Global Companies • In Defence also, these companies are quite capable of buying niche technology players abroad or create a Global Supply Chain if Indian Market is opened for Competition • However, the problem is Market Access, i.e., getting RFPs • If an Indian Company buys critical IPR abroad and want to field a Product for use of Indian Defence – its not possible under a “Single vendor Situation” • Indian Company creates cannot field a System jointly Developed abroad for NC NC trial under Buy & Make • More than 50% of Buy (Indian) Programs of ~ Rs 200,000 Cr in last three year has been nominated to DPSUs • Nomination equals channelised Imports

8. Impact of Indigenous Defence Production on Indian GDP • Defence is a Strategic Industry – more than mere commerce • Issues of obsolescence, technology denial and restricted trade operate here • Defence is Monopsony – Government is the Market and the Market Maker • In a democracy all Strategic Industries like Nuclear, Space and Defence are subject to probity, public accountability and transparency in Procurement • Most Executive branches use “Employment Generation” as part of the legislative approval process. (India no exception – Factory in Nalanda & Kerala) • Economic impact of reducing Defence imports:

9. Importance of Defence Production to GDP Growth • Effect of US cuts on Defence Spending and their Job Growth* • In BRIC countries, India is the only country who’s Defence Market will be perused by the Western Democracies • We have the macro-economic advantage, so why not exploit it? *Source: http://aerospacediary.blogspot.com/2011/10/analysis-projects-one-million-jobs-at.html

10. Where are we on our aim of Indigenisation?

11. Self Reliance / Indigenization of Indian Defence • Ample emotional responses towards the cause of “Indigenisation, very few practical measures • Our Procurement Procedures, intentionally or unintentionally, conspires to buy foreign equipment, examples • Inverted structure in Taxes & Duties: Finished Goods attract Zero Taxes & Duty while Value addition in India attracts Excise Duty, Service Tax, CST & VAT • ERV extended to Foreigners and in most cases to DPSUs, but not to Indian Private Industry • Foreigners get LC Payments, while Indian Industry is denied the same • Let’s examine each of these examples in detail

12. Inverted structure in Taxes & Duties • Finished Goods attract Zero Customes Duty while Value addition in India attracts Excise Duty, Service Tax, CST & VAT • If basic cost of an item is 100, when we purchase it from Foreigner, cost is 125.64 if Private sector does 30% value add. In case of DUSU (ED Exempt) it is 116 with 70% import but does up to 120 with 30% import. • Taxes & Duties are kept out of L1 calculations for Global (Buy) RFPs, but for all other Procurements in Buy (Indian), DPM, DRDO etc. Taxes & Duties are included in L1 calculations

13. Forex Risk Implications to the Indian Industry • Foreigners and in most cases, DPSUs get ERV, but Indian Private Industry was always denied • It’s a crippling risk being imposed on Private Industry ? Eg • Foreign Exchange Content at the Sub-System level for the stated goal for Indigenous content of Rs. 50,000 Cr is Rs. 27,000 Cr • Typically, cost of FE Variation for three year forward Cover is 17% • This translates to an additional Risk Cover burden of Rs 4,500 Cr • This renders Indian Industry unviable • In the last 100 day, US$ has risen by ~17% • SMEs will not be able to survive such Forex Risk and will certainly close down if is ERV is not extended • Large Players may still be able to manage the Forex Risk, hedging internally against their software export income. However, Large Companies absorbing the Forex risk, will have no bandwidth left to invest in technology If Private Sector absorbs the ERV risk, were is the head room to take the much-needed technology risk?

14. Discrimination in LC Payments • Foreigners get LC Payments, while Indian Industry is denied the same • Inherent MoD delays lead to additional burden on Industry, • Ex. Pinaka 1st Regiment Contract Value ~Rs 170Cr, Tata Power SED suffered an additional burden of ~Rs 33Cr, i.e. ~19%, on account of • Delay in receipt of payment of Pinaka Launchers and Command Post and delays in receipt of Buyer Furnished Items • Delay in signing of Amendment to Pinaka Contract, consequent delay in delivery of ESP and delay in receipt of payment • Financial Burden due to increased FE rates due to delay in issue of EUC by MoD

15. Some Other Examples of – I L U Foreign OEM • There is no procedure that enables a non-DPSU Indian Vendor to become a Single Vendor Supplier to MoD • Even if this Vendor gets the technology, creates the entire value chain and infrastructure, it is not possible to sell Systems to MoD • If DPP allows an Indian Co. to Prime in Buy (Global), why can’t an Indian Co. Prime in a Buy & Make Program? Fault lies in the Procedure • In Global (Buy) Procurements, if NC NC Trials are not possible, MoD accepts Simulation Trials • Ex. MRSAM, a G-to-G Development Program, purchased for Rs 10,000 Cr based on Simulation trial, while the missile is still being developed • Foreign FAT certificate of OEM is enough. • Foreigners need to give only 30% indigenous content (under Offsets), while an Indian Co. is mandated to give 50% • Clause 1.2 (Pg 44) and Clause 6.5 (Pg 47) of Appendix D of DPP 2011

16. Reality Check

17. Reality Check - Exports • a • Can India keep on importing Defence Equipment? • Can India sustain just with a Policy of Indigenising Defence Equipment i.e. reverse the 70:30 Import to 30:70? • Both India & Israel got independence in 1947 – where are our Defence Exports? • Given our world-recognised capability in ICT, it is time for India claims its rightful place in Defence Exports – this will also assist in Global benchmarking

18. Need for Indian Defence Products • IT & ITES has been a successful story in India, contributing 4% of GDP • However, it has plateaud because, IT & ITES Industry exploited only the Labour Arbitrage Where are Indian IPRs & Products ? For Indian Defence Industry “Make” Projects are steps in the Right Direction

19. Technology Denial 19

20. Modern Warfare & New Defence Industry Model New Defence Industry Model Lead Systems Integrator Or System of Systems Manager Public-Private Partnership with mission-based procurement Joint development of systems architecture Capability-based Services & component suppliers Global Supply Base Source: Centre of Technology & National Security Policy, National Defense University, DoD, USA Adopt a new approach towards the procurement of weapons and systems – One that is war fighting capability driven rather that the existing GSQR based approach. Source: JWFC Document, IDS 20

21. Defence Product Strategy & Technology Denial Technology Denial is a National and Political issue In today’s world, not everything can be done by everybody We cannot emulate the Charles de Gaulle’s France Need to select long-term Partners Need to ensure part of the system made in one country and part being made in another country F-22 Raptor denied to Japan even though the Factory is closing in the US Eurofighter – four countries coming together, all having clear Sub-systems Distribution. What is made in France is not made in Italy or Spain or else where. This ensures each country has equal power – MAD There is no substitute to Capabilities Building & Control over Product Where do we put our 5th generation Fighter Partnership? 21

22. Recommendations

23. Recommendations • “MAKE” to be the 1st choice of Categorisation • Buy (Indian) should be the 2nd option but with clearly defined Trial Directive • Trial Directive to be clearly defined in the RFP and development time period of atleast 12-18 months depending on the complexity of the system to be given to Indian Industry • Justification: If TEC takes an average of 18-24 months, Development time of 12-18 months is the minimum required • Example: TEC for Upgrade Grad BM21 Launcher took 18 months, TEC for 155mm Bofors Gun Upgrade took 36 months and finally RFP was retracted, TEC for Low Power Jammers took 6 months • Buy & Make (Indian) 3rd option. But no nomination • Extend ERV to all participating Vendors • No exemptions to any Vendor on Taxes & Duties and Basic Customs Duty to be increased to a minimum of 20% • For transition, all Taxes & Duties to be kept outside and be paid at actuals without any exemptions => this makes no difference to the ‘Consolidated Fund of India”, only in accounting parlance, a small increase in Defence Budget is perceived. Further if the import – export ratio is reversed, this budget does not go up at all • Actively leverage on ITES capabilties for Exports • If Platforms can not be made in India, atleast all upgrades to happen in India • No Nominations and Full Internal Competition and Facilitation of a PPP model • Export an equal Priority – This is not about 70% Import to be reduced to 30% import

24. PS – The Presentation did not bring up word the “Offset” or “ToT” All ToT agreements are injurious to the cause of Indigenous Defence Products