Tuesday, 3 April 2007

Capital spending on defence: no legislative control

by Ajai Shukla
Business Standard, 3rd Apr 07

On the 1st of April, the Ministry of Defence will start spending Rs 41,922 crores, allocated in the defence budget for capital acquisitions, or the purchase of arms, equipment and vehicles above a certain value. Compared to Rs 37,458 crores allocated under the capital head last year, this year’s hike of Rs 4,464 crores apparently raises the capital budget by 12%, just enough to match inflation on defence equipment. But, since the MoD will surrender over Rs 3,000 crores of unspent money on 31st March 07, the actual increase over last year’s revised estimates is a sizeable 22%.

Defence Minister AK Antony has indicated that last year’s surrender of funds was an aberration, declaring that India’s defence modernisation was 15 years behind schedule and that “we will make sure that not a single rupee is left unspent” from the budget this year. An understanding of how the capital budget is spent is necessary for grasping the implications of Mr Antony fulfilling his promise.

The most striking thing about capital expenditure is that most of it is pre-committed. Like in a household that has financed the purchase of too many goods, 75% of India’s annual capital allocation goes on instalments for contracts entered into in previous years. Half the capital budget, some Rs 21,000 crores, will go to Indian suppliers: the 39 ordnance factories, the 8 defence PSUs and, to a lesser extent, to private Indian companies, for equipment like the thousands of heavy trucks that the army buys each year. That will leave about Rs 21,000 crore ($5 billion) in the capital account for foreign arms corporations this year.

Some 80% of this amount too is pre-committed. Since major defence purchases are paid for over 7-10 years, India will pay instalments this year for earlier purchases like Sukhoi fighters, the Gorshkov aircraft carrier, T-90 tanks, Talwar class frigates, Scorpene submarines, the Phalcon Airborne Early Warning System and for dozens of smaller contracts that add up to enormous sums. After these instalments are paid, a modest Rs 3600-4500 crores ($1 billion) will be available for new contracts this year.

But foreign arms vendors will still flock to Delhi. These one billion dollars are merely the 25% down payment on new deals. In other words, with $1 billion in hand, the MoD can actually sign contracts this year for four times that amount, or about $4 billion, with the balance amount paid over following years. And like this year, future defence allocations will have no choice but to fork out the annual instalments.

Noteworthy is the total absence of legislative control over allocating and spending the capital budget. Each year, the legislature unquestioningly allocates the amount committed in previous years’ arms contracts, with a hefty amount added for signing new contracts. Partly due to its own ineptitude in matters of defence, Parliament asks no questions and the government gives no explanations. Unlike other democracies where the legislature scrutinises each contract for their financial effect on future defence spending, in India all this is the exclusive preserve of the executive --- the military, the MoD, the Finance Ministry bureaucracy, and the cabinet. The only check on the MoD in India is the Finance Ministry. The latter, aware that the expanding dynamic of arms deals will force it to allocate funds in future years, tracks the future budgetary implications of deals signed each year. 

In a couple of months, the same MoD that returned over Rs 3000 crore on 31st March, will be asking for additional capital allocations this year for defence modernisation. Their argument: the allocations already made will be largely consumed by previous years’ contracts. The MoD made exactly this argument in 2003-04 in a secret letter to the MoF that has been reviewed by the Business Standard. Allocated Rs 18,050 crores for fresh capital expenditure that year, then Defence Secretary Subir Dutta demanded from the MoF an additional Rs 8679 crores. His calculations (see table) were impeccable: committed liabilities, or instalments on previous years’ arms purchases, were Rs 16,843 crores. That left just 1,206 crores for new contracts in 2003-04. Mr Dutta tabulated the contracts that had already been negotiated with arms companies. His demand for an extra Rs 8,679 crores for the current year’s outgo involved paying over Rs 40,000 crores in the following years. It was taken for granted that parliament would unquestioningly sanction that amount.

Finance Minister P. Chidambaram assured parliament that whatever is needed by the defence services would be made available. While that was a political rather than an economic statement, the MoD’s additional demands will soon be on his desk. The effects of these could continue to be felt over the next decade.

Capital budget: additional demands
Financial year 2003-04

Capital allocation : Rs 18,050 crores
Committed liabilities : Rs 16,843 crores

Balance available for capital acquisitions : Rs 1,206 crores
Outgo on contracts ready for signing by Oct 03: Rs 9885 crores
Hence additional demand : Rs 8679 crores

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