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Waking The Beast: India's Defense Reforms Under Modi

By Jeff M. Smith
The Diplomat
December 16, 2016


“India has done enough to simplify its defense procurement and other norms,” opined Indian Defense Minister Manohar Parrikar at a speech in Washington last December. “It is time for U.S. Government and Industry to reciprocate. It is easy to blame Indian bureaucracy but in some cases, U.S. bureaucracy is much worse.’’

 
With all due respect to Parrikar—who has been a breath of fresh air after the paralytic reign of his predecessor, AK “Mr. No” Antony—few in Washington or Delhi would agree. Fortunately, the reforms he and Prime Minister Narendra Modi have shepherded are steering India in the right direction.
 
When Modi assumed office in June 2014 he inherited a sluggish Leviathan of a defense bureaucracy and a military facing large (and widening) capacity gaps. By one estimate, India’s military is “short of some 300 fighter jets, at least a dozen submarines, over 1,000 combat helicopters, seven frigates and perhaps 3,000 artillery guns.”
 
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These shortfalls are partly the byproduct of an under-performing and highly bureaucratized defense industrial complex, and partly the result of broader contradictions in India’s defense strategy. Delhi wants to field world-class weapons capabilities as soon as possible but it wants to source those platforms from domestic producers and reduce arms imports. India wants to build a first-class domestic defense industry but has discouraged private-sector participation and foreign direct investment with counterproductive policies and regulations.
 
Building a first-rate defense industrial base is a laborious, multi-generational effort under optimal conditions and India’s experience has been anything but. As India’s Economic Times notes: “a 40-year effort by [Delhi] to develop a battlefield tank has yet to produce anything the army can use.” Its effort to build an indigenous fighter aircraft, the Tejas has by one account produced “One of the single worst fighter projects that has ever been conceived of in the history of aviation. Even as it enters service, the aircraft is obsolete.”
 
To be sure, India has made substantial strides in other areas like cruise and ballistic missile technology, nuclear submarines, aircraft carriers, and drones. Yet even many of India’s success stories are the result of co-production and co-development projects with foreign partners, or include a high proportion of imported hardware.
 
First Step: Admitting You Have a Problem
 
To Modi’s credit, he identified the scope of the problem early in his tenure. He used a speech in 2014 to implore India’s state-dominated defense industry to abandon its “anything goes” approach. “The world will not wait for us…we should not say in 2014 that a project conceived in 1992 will take some more time.”
 
Modi has since adopted a dual-track approach to defense sector reform. First, he is attempting to make India’s defense sector more competent, agile, and competitive by streamlining the procurement process, cutting red tape and, crucially, encouraging greater involvement by India’s private sector in an arena long dominated by state-owned enterprises.
 
As defense analyst Ajai Shukla notes, the Modi government has established three new committees focused  reforming India’s defense acquisitions process, including “one charged with reshaping the basic patters of defense spending; another with galvanizing defense procurement by restructuring the ministry’s acquisitions agency; and five sub-committees that evaluate how to [better involve] in the private sector.”
 
The latter may prove the most consequential. Nine state-owned undertakings and 39 state-owned ordinance factories account for 90 percent of India’s domestic defense manufacturing. Atop this hierarchy is the massive Defense Development and Research Organization (DRDO), with its 30,000 personnel and 52 research centers. Dissatisfied with its performance, in 2015 Parrikar ordered the DRDO to cease work on its growing portfolio of construction projects (which generated $735 million in revenue last year), and focus exclusively on building better weapons platforms.
 
Additionally, the Modi government has adopted several initiatives to provide a boost to India’s long-neglected private sector defense industry. This year Delhi invited representatives of 200 private defense firms to an event offering unprecedented access to the Indian military. In another first, the Ministry of Defense (MoD) listed 23 projects—including UAVs, bombs, and tank engines—specifically earmarked for Indian private firms. Notably, the MoD shared details on platform requirements and acquisitions schedules with private industry, “things that were shrouded in secrecy in the past.”
 
Finally, Delhi has unveiled a new “Buy IDDM” (Indigenously Designed, Developed and Manufactured) policy giving private Indian firms “first preference in most purchases” in six new priority defense categories. Under the new policy, “it will be mandatory for 40% of the content to be sourced locally.”
 
Ben Schwartz of the U.S.-India Business Council calls Modi’s efforts to bolster the private-sector “arguably the most significant policy shift” of his administration. And yet, it’s far too early to wave the victory flag. To date, the MoD has yet to sign a deal with any private sector firm worth more than $400 million.
 
Trouble With FDI
 
For years Indian leaders have articulated a desire to have 70 percent of the country’s defense needs met through the domestic production with only 30 percent deriving from foreign imports. For the past decade, the ratio has been frozen at nearly the exact opposite.
 
Rather than seeking to attract foreign capital and technology through financial incentives, Delhi has instead sought to force the hand of foreign defense firms with a problematic “offset” policy. Any arms sale to India valued at more than $44 million requires the seller to “discharge offsets of at least 30 percent [and as high as 50 percent] of the total value of the contract” in one of several pre-approved categories. In other words, a $10 billion arms sale to India could require a separate $3 billion investment in an Indian arms manufacturer.
 
By raising the cost of selling arms to India, the policy is directly at odds with Delhi’s desire to field cutting-edge defense platforms. This contradiction would be far less problematic if India’s defense sector was thriving and rife with lucrative projects awaiting foreign investors. Sadly, that is not the case today. From April 2000 to March 2016, India attracted a meager $5.12 million in Foreign Direct Investment (FDI) equity inflows in the defense sector, which ranked 61 out of 62 Indian industries in attracting FDI.
 
Modi has embraced India’s longstanding obsession with “indigenization” with his high-profile “Make In India” initiative. Yet, he has paired the initiative with efforts to reduce onerous restrictions on defense-related FDI.
 
Since 2008, the MoD has been gradually easing the guidelines on how much of the offset must be finalized at the outset of the initial contract and expanded the list of categories that can count as offset investments. Foreign firms can now direct offsets to “services” like research and development, or maintenance, repair, and overhaul. Foreign defense firms can also now “reopen” offset investment contracts if they find their Indian counterpart is unsuitable, and identify a new offset partner or project.
 
Additionally, in August 2014 Delhi raised the cap on FDI in defense to 49% from 26%. Exceptions for investments of up to 100% will now be granted when access to “modern” technology is involved, a slight amendment to the previous exception for “state-of-the-art” technology. Delhi has also eliminated a provision requiring a single Indian investor to have at least a 51 percent stake in any joint venture.
 
In aggregate, the moves are welcome but insufficient. One year after the revised guidelines foreign firms had submitted just six proposals valued at $15 million and only two seeking a 49 percent stake. In April 2016, Parrikar admitted India had attracted just $167,000 in defense-related FDI over the previous 18 months. Notably, any joint venture with an Indian defense firm still must be headed by an Indian chief executive. Many believe the cap must be raised to 74 percent or 100 percent to make a material impact.
 
 
Full Circle
Delhi can’t be blamed for wanting to field advanced military hardware now, or for seeking a more competent and competitive domestic defense industry while reducing arms imports. But it should recognize the inherent contradiction in giving equal priority to these competing objectives. Additionally, Delhi should continue to think innovatively about how to nurture a private defense industry still in its infancy and how to create positive incentives to capital investment and technology transfer.
 
Modi and Parrikar deserve credit for shaking the Leviathan from its prolonged slumber and setting India on the path to true defense sector reform. But given the scope of the problem they inherited, the two men still have a long way to go.

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