MAKE IN INDIA AND CHALLENGES BEFORE DEFENCE MANUFACTURING
INTRODUCTION
There is a distinctive buzz about PM Modi’s new campaign for Make-in-India. The thrust is
to increase share of manufacturing from the current level of 15% of GDP to 25% and create
additional employment opportunity of 10 million per year. This has led a few cynics to
observe that “there is a lot of sizzle but where is the steak?”. Columnists like Swaminathan
Iyer are of the view that Make-in-India is only an outcome and not a policy, while the RBI
Governor Rajan is of the view that the government is putting too much of thrust on export led
growth and should give primacy to “Make for India”. Discerning writers like Debasis Basu,
however, feel that what is germane to the debate is the “cost of doing business” in India.
Defence manufacturing came out of the stranglehold of PSU-OF monopoly with
major liberalization coming up in 2001 with 100% private sector participation and recently
announced 49% in foreign direct investment. The policy footprints like Defence Procurement
Policy (DPP) 2013 has created a level playing field for the private sector, Defence Production
Policy 2011 which aims at higher self reliance in critical technology and Offset Policy 2012
which seeks to leverage our big arms’ acquisition to bring in state-of-art technology, and long
term partnership with OEMs. The Self Reliance Index of our defence acquisition, however,
remains at a wobbly 30% despite spasmodic policy posturing to improve our
indigenization.
Defence industry is a subset of nations’ concern to ramp-up manufacturing capability.
This paper aims at examining the capability of our Defence Industry in terms of value
addition, self reliance in critical technology & policy initiatives so far & their impact
and seeks to bring up a possible synergy between Make-in-India policy and Defence
Industry capability.
DEFENCE MANUFACTURING AND CHALLENGES FOR SELF RELIANCE
The defence services account for nearly Rs.2.29 lakh crores of the central government budget
which accounts for nearly 2.5% of the GDP and 13% of the central government expenditure.
The trend of allocation to revenue and capital acquisition schemes is given below.
Table 1- Service/Department-wise break up of Defence Expenditure (Rs. Cr.)
2011-12 Actuals 2012-2013 Actuals 2013-14 Actuals 2014-15 (BE)
(Rev+Cap)
(Rev+Cap)
(Rev+Cap)
(Rev+Cap)
ARMY
84081.29
91450.51
99464.21
118377.62
NAVY
31115.32
29593.53
33393.21
37808.46
AIRFORCE
45614.01
50509.13
57708.63
54217.52
DDP-DGOF
(-) 456.37
(-) 267.86
1298.39
2481.99
-DGQA
665.19
695.67
766.02
831.49
R&D
9893.84
9794.80
10868.89
15282.92
TOTAL
170913.28
181775.78
203499.35
229000.00
Source: Annual Report 2013-2014, MOD
It would be worth to note that while the increase in the revenue allocation roughly
matches with the wholesale price escalation, the capital acquisition budget has witnessed
significant growth of around 20% per year, far outstripping the overall trend of increase in
defence expenditure. Capital Acquisition constitutes nearly 40% the defence budget of
which the value of production of the Defence PSUs and the Ordnance Factories account for
the following.
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Table 2- Value of production and value addition PSUs and OFB (Rs. In Crore)
Name of PSUs
2011-12
2012-13
2013-14
Value Addition
HAL
12693.19
14201.82
15296.00
39%
BEL
5793.58
6290.00
6140.00
41%
BEML
4077.19
3359.70
3201.32
39%
MDL
2523.69
2290.64
2709.00
23%
GRSE
1293.80
1529.37
1550.83
35%
GSL
676.40
506.62
512.24
37%
BDL
992.94
1177.00
1793.43
50%
MIDHANI
496.00
537.37
555.04
57%
HSL
564.04
483.84
403.22
OFB
12390.72
11984.00
11234.00
85%
TOTAL
41501.55
42360.36
43395.08
50%
Source: Annual Report 2013-2014, MOD
It would be seen from the above that while the average yearly increase in VOP of
Defence PSUs is around 5% per year, in case of the OFs it is only 2%. It would be interesting
to note that the value addition of different defence PSUs vary between 23% to 57% while
it is very high (85%) for OFB. PSUs like HAL and MDL show a poor level of value
addition as they are largely system integrators, while Midhani & BDL have contributed
handsomely to indigenization. The higher indigenization in case of OFB is largely
attributable to the low end technology.
India has been historically availing of technology through licence agreements from
Russia and a smattering of western countries. The exceptions are some of the missile systems,
small arms and their ammunition and tanks where technology has been indigenously
developed by the DRDO. The LCA with Final Operational Clearance (FOC) will hopefully
be a major Make-in-India platform. It must be mentioned that indigenization has effected
substantial reduction in cost of the systems due to India’s labour arbitrage, good
facilities and fairly well trained labour force.
The following table brings out the cost saving of a few major products through the
technology transfer route.
Table 3-Indigenization & Cost Savings through TOT
Product
Indigenization
Cost Saving
Milan
71%
60%
Konkur
70%
30%
HAL
SU-30(Air Frame)
55%
45%
SU-30 Engine
65%
45%
HAWK
40%
18%
MEDAK
ICV
90%
50%
MIDHANI
Titanium Alloy
60%
15%
BEL
Sonoboys
70%
30%
Source: Table prepared by Author based on data obtained from DPSUs/OF
DPSU/OF
BDL
SELF RELIANCE TRENDS
The self reliance trends in defence acquisition show a dismal picture. A committee under Dr.
APJ Abdul Kalam, the then SA to RM, had recommended India should ramp-up this quotient
from 30% (1995) to 70% by (2005). The following table, however, brings out how the self
reliance index has remained sticky around 30%.
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Table 4-Total Acquisition and SRI: Trends
Total Acquisition
Indigenous Acquisition
Self Reliance %
Cost (Rs. Cr)
Cost (Rs. Cr)
1993-94
399
1200
30%
2000-01
11164.5
3400
31%
2005-06
24464
7828
32%
2009-10
38258
12251
32%
2012-13
49578
26260
35%
Source: Table Prepared by Author based on data obtained from Ministry of Defence
Year
The principal reason for this state of affair is our poor design capability in critical
technologies, inadequate investment in R&D and our inability to manufacture major
subsystems and components. The technology transfer route has provided India with the know
how without providing the clue for know why. It is because of this reason that even for an
upgrade of the systems, the defence PSUs are critically dependent on the original licensors. A
case in point is SU-30 upgrade where the Russians often take HAL to ransom.
The following table brings out the gaps in critical technology of different systems.
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Table 5- Critical Technology & Gaps
System
Gaps
Gas Turbine Engine
(a) Single Crystal and Special Coating in Turbine
Blades FADEC
Missile
Uncooled FPA seekers
Aeronautics
Smart Aerostructures
Stealth Technology
Material
Nano Material, Carbon Fibres
Naval Systems
Super Cavitating Technology
Sensors
AESA, Radar, RLG, INGPS
Communication
Software Defined Radio
Avionics
Gen III, II Tubes
Surveillance
UAVs, Satellites
Source: DRDO, BEL and HAL
From the foregoing it would be seen that the major deficiency in terms of capability
are in the areas like propulsion, weapons and sensors. Some of the critical technologies
where the progress made by DRDO has been abysmally poor are Focal Plane Array (FPA),
Active Electronically Scanned Array (AESA) Radar and Stealth Technology India is
presently engaged in design and production collaboration for a Fifth Generation Fighter
Aircraft (FGFA) with the Russians for a stealth aircraft.
PROCUREMENT, PRODUCTION & OFFSET POLICY IN RETROSPECT & THEIR
IMPACT
The Defence Procurement Policy 2013 envisages higher preference to Buy (India), Buy and
Make (India), and Make options over the earlier thrust towards Buy (Global) or the
import option. It ostensibly looks at creating a better level playing field between the public
and private sector with greater impetus towards indigenization. A major departure from the
previous policy is allowing the private Indian industry to avail of technology transfer which
was the exclusive domain of DPSUs/Ordnance factories earlier. The policy also encourages
Joint Venture with OEMs. PM Modi’s Make-in-India campaign has added another
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category to Defence Acquisition though it would include cases coming under the
panoply of ‘Buy’ and Make and ‘Make’ where technology is indigenously developed.
The Offset Policy guidelines (2012) have for the first time has allowed TOT through
the JV or through non equity route. It has also allowed multiplier for critical technology areas
like FPAs, Nano Technology based sensor, fiber laser technology & THZ technologies,
which was alluded to above.
The Defence Production Policy (2011) aims at achieving substantive self reliance in
design, development and production of critical subsystems by forming consortia, JVs by
involving academia and R&D institutions. It also promised to set up a set up a defence
technology fund to support public, private sector as well as academic and scientific
institutions for pursuing high end research.
The impact of all such policies on FDI inflow, export, augmentation and long term
partnership has been quite disappointing. The reasons are enumerated below.
FDI Policy
The OEMs for setting up business in India in partnership with public/private players want to
have a major say in the management of manufacturing. While the announcement to upscale
the FDI limit from 26% to 49% in the last budget has been a step in the right direction, it is
unlikely to enthuse reputed global manufacturing houses to set up manufacturing bases and
bring in front end technology though some joint venture intents has been evinced for
companies like the TATAs. On the other hand countries like China and South Korea have
become major manufacturing hubs in aeronautics and ship building technology by being very
liberal in their FDI policy and providing high modicum of ‘Ease of Doing’ business
compared to India.
R&D Allocation
Besides the FDI policy, inadequate investment in R&D and lip service to technology funding
by making a token allocation of Rs.100 crore to Defence Technology Fund in the last budget
is adequate commentary on our lack of seriousness in the area of research and development.
The allocation to DRDO remains sticky around 6% of defence expenditure though successive
parliamentary committees have recommended a minimum allocation of 10%. The
private sector giants like the TATA, L&T and Mahindra and Mahindra invest less than 1% of
their turn over in R&D unlike countries like France where corporate invest more than 10% in
R&D. It would be also be interesting to note that the overall allocation to R&D is
significantly lower (0.85%) in India compared to advanced countries which spend in the
range of 2.2% to 3.5%. The following table would bring out the trend.
Table 6-Major R&D Spenders in the World Vis-à-vis India
Country
2012
2013*
GERD (PPP
R&D as % of
GERD (PPP
R&D as % of
US$ Billion)
GDP
US$ Billion)
GDP
US
418.6
2.68
423.7
2.66
Japan
159.9
3.48
161.8
3.48
Germany
90.9
2.87
91.1
2.85
South Korea
55.8
3.45
57.8
3.45
France
50.4
2.24
50.6
2.24
India
40.3
0.85
45.2
0.90
Note. *: Figures for 2013 are forecast; GERD: Gross Expenditure on R&D
Source: Battelle and R&D Magazine, 2013 Global R&D Funding Forecast, December 2012.
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Manufacturing
It accounts for 14-16% of GDP with 85% of employment in unorganized sector, with a
‘missing middle’, unlike manufacturing hubs in Korea, China, Germany and Japan where
50% of the firms are large with benefit of economy of scale and 20% are SEMs. Value
addition in global value chain for India was only 1% in 2009 as against 9% by China
and Germany. National manufacturing Zone (NMZ) 2011 policy is limping big time in the
absence of Centre State synergy, tardy land acquisition and long drawn environmental
clearance. Subir Gokran has rightly observed that increase in Incremental Capital
Output Ratio (ICOR) from 3.1% (2005-2006) to 5.9% (2012-2013) is largely
attributable to supply constraints like power-coal imbalance and in ordinate project
delays.
Export Promotion
The following table provides a trend analysis of exports by Defence PSUs and Ordnance
Factories since 2008-09
Year
2008-09
2009-10
2010-11
2011-12
2012-13
2013-14
Table 7-Export Performance of DPSUs/OFs (Rs. Crore)
VOS
% Increase
Exports
27237.1
15.0
854.38
33995.9
24.8
477.7
36537.9
7.5
653.6
40499.4
10.8
730.0
40956.2
1.1
755
41001
0.1
768
Source: Annual Report, MOD
% Increase
36.0
-44
36.8
11.7
3.5
1.7
Of the PSUs/OFB, HAL & BEL account for 66% of exports. Export as share of
VOS has remained around 3% for HAL and around 3-4% for BEL thereby showing the
policies so far have not impacted on their export performance.
Raghuram Rajan sounds a note of caution regarding the obsession for export led
growth by heavily subsidizing inputs at the cost of fostering domestic demand. His call for
Make for India to supplement Make-in-India is an extremely welcome alternative.
Impact of Offset Contracts
After promulgation of this policy in 2005, 24 contracts have been signed for $4.8billion.
However discerning analysts observe that the expected benefit in terms of FDI inflow, high
end technology, increased export and outsourcing have not taken place. The C&AG in its
performance audit of Fleet Tanker Contract (2010) has brought out how full benefit of offset
provision has not been availed from the OEM. Further C&AG’s comprehensive report of
2012 on offset contracts severely castigates the inept contractual arrangement that underlay
such offset arrangements and additional cost implication.
MANUFACTURING, MAKE IN INDIA POLICY AND DEFENCE MANUFACTURE
The sectoral share of primary, secondary and tertiary segments show a tectonic shift since
liberalization wafting through the corridors since 1990s. The share of agriculture in GDP
shows a significant reduction while the share of industry has remained stagnant and the
service sector showing the way as the sunshine sector.
The following table brings out the trends in the compositional shift.
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Sector
Primary
Secondary
Tertiary
Table 8-Sectoral Share of GDP
1950-1951
1990-1991
55
33.1
14.7
24.2
30.3
42.7
Source: CSO
2013-2014
15
25
60
A disaggregation of the secondary sector shows that the share of manufacturing sector
has remained constant around 15% which is now targeted to increase to 25%. The experience
of manufacturing giants like Germany, South Korea and China reveal that manufacturing
account for 30% of their GDP. Therefore the thrust of the government to encourage Make-inIndia option by facilitating the enabling environment to manufacture, improving ease of
doing business, encouraging creation of national manufacturing zones in tandem with the
states and investing one trillion dollar through PPP route in the infrastructural sector make
eminent sense. Prof. Basu rightly observes out that the success of the Make Indian policy will
critically hinge on cost of doing business in India.
The two critical factors for this would be the quality of human resources and cost
of capital. India’s education system is presently mired in a mess and need millions of skilled
workers coming out of ITI with quality training. While access to education at the primary
level through Right to Education has improved access significantly, the quality deficit, both
in the primary segment and higher education is palpable. While the private sector has
contributed handsomely to the growth of technical and management education, the quality of
education and lack of research impact on the employability of students adversely despite the
global opportunity.
As regards cost of capital, the following table would bring out the distributing trend of
exorbitant cost of capital in India compared to the developed countries.
Table 9-Cost of Capital: Global Comparison
Country
10 years Govt. Bond
Inflation (CPI)
USA
+2.16
+1.7
Japan
+0.41
+2.7
Euro Area
+0.68
0.5
Brazil
Russia
India
China
12.5
12.44
7.91
3.67
Source: The Economist- 13th December, 2014
6.3
7.6
7.3
2.1
What is interesting also to note that most of the BRIC countries are bedeviled by high
cost of capital and unacceptable level of inflation accentuating their “Misery Index”.
Importance of Total Factor Productivity
Prof. Solow, a Nobel Laureate, in his seminal paper had brought out the importance of factor
productivity. His equation Q=A * K∆ Lβ where Q is the production function, A is the level of
technology and scale, K & L are factors of production ∆ & β are factor efficiency has
demonstrated how US has become the premier technological hegemon after the second world
war. A case in point is the phenomenal growth in China from 1979 as would be evident from
the following table. Almost 50% of the GDP growth is attributable to total factor productivity
growth.
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Table 10- Sources of Growth in China
Parameter
1953-1978
1979-1994
Output Growth
5.8
9.3
Capital Input Growth
6.2
7.7
Labour Input Growth
2.5
2.7
TFP Growth
1.1
3.9
Contribution of Production
18.0
41.6
Source: A.P. Thirlwall - Economics of Development-Theory and Evidence
LESSONS FOR INDIA’S DEFENCE INDUSTRY
The defence industry in India cannot be impervious to these trends. It has to be sensitive to
the skill requirements in order to absorb high technology which comes as part of TOT. One
of the predominant reasons for Japan’s phenomenal growth since 1950s has been their highly
skilled labour force which could absorb front end technology from US quickly and adopt
them to harness commercial success through dual use technology. The success of Japan in
electronics and automobile is testimony to this.
In India, on the other hand, the TOT experience reveals that the technology absorption
has been inordinately slow leading to continued dependence for our foreign collaborators
well beyond the originally contracted period. Experience of HAL in terms of production of
MIG series Aircraft and SU-30, and MDL for producing Scorpion submarines are grim
reminders of our poor high skill absorbing capability.
CONCLUSION
India is witnessing a significant stickiness in its manufacturing sector which is bedeviled by
huge presence of small scale and informal sector that are bereft of requisite skill levels and
economy of scale. Their access to capital is also seriously constrained. However the
manufacturing sector provides a wonderful opportunity for India to be part of the global
supply chain and generate high levels of employment opportunity to absorb around 10
million young Indian who will come to the market in search of employment every year. They
also need to be properly skilled and trained and networked with their global peers. The
defence industry, be it public sector or private, has to be part of the national manufacturing
policy mosaic. Unfortunately the defence sector often chooses to distance itself in its
interface with other civilian sectors. There is opportunity aplenty in sectors like Aerospace
and Ship building where there is considerable civilian and military market. Lack of
design capability to manufacture critical subsystems remains a huge handicap. DRDO
remaining mired in inordinate delay, huge cost over runs and deficient in critical technology
areas like ‘seekers’ and ‘stealth’. Tokenism like Rs.100 crore allocation towards
Technology Acquisition Fund or a lip service to FDI policy by increasing to 49% are not
the way forward. Public private partnership, joint venture with foreign OEM and
design houses will require bolder policy like higher FDI ceiling higher than 50%, a
political will to mentor and hold hand of different stake holders who are often at cross
purposes. The new PM has set his foot in the right place; the defence ministry, however, has
to match his steps, shed its ghetto mentality and strive for better synergy with other
manufacturing sectors to make “Make-in-India” the piped piper in the days ahead.
Dr. S.N. Misra, Formerly, JS Aerospace, MOD
(Views expressed are personal)
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