Wednesday, 3 December 2014

MoD pauses “Make” procedure to address industry concerns

By Ajai Shukla
Business Standard, 3rd Dec 2014

The new procedure for “Make” category procurements of the ministry of defence (MoD) was being rushed through at a meeting of the apex Defence Acquisition Council (DAC) on November 22. After Prime Minister Narendra Modi’s August 15 call to “Make in India”, this would have been the MoD’s first policy response.

Yet the new defence minister, Manohar Parrikar, chairing his first DAC meeting, held back the new policy to seek substantial changes. A MoD spokesperson said Parrikar “wants to make the policy more attractive for Indian companies.”

The “Make” category, first introduced in 2006, lets Indian companies compete to develop and build major defence systems for the military. With the MoD paying 80 per cent of the development cost, “Make” projects would provide Indian companies resources for costly research & development (R&D), building defence systems for which the intellectual property (IP) resides in India. This would allow Indian vendors to maintain, upgrade and export weaponry without dependency on global original equipment manufacturers (OEMs).

Over the long term the “Make” procedure aims to develop Indian OEMs that can compete with foreign vendors.

Parrikar’s decision to rethink the new “Make” procedure was catalysed by a letter received a day earlier from the Federation of Indian Chambers of Commerce and Industry (Ficci). Worried that the new “Make” policy was being pushed through in a hurry, Ficci’s defence committee pointed out major issues that need resolution beforehand.

First, Ficci requested for fool proof measures to ensure that companies benefiting from 80 per cent funding under the “Make” category are Indian in every respect, not companies controlled by foreign vendors.

The new policy proposed to dilute three key eligibility conditions mandated in the existing policy. A company was eligible only after operating for at least 10 years; the new policy proposed reducing that to 5 years. Only companies with asset bases of above Rs 1,000 crore could participate earlier; the new policy diluted that to 5 per cent of the project size. Finally, the new policy did not require a company to have a defence licence; only to have applied for one.

As Business Standard earlier reported (September 29, 2014, “Foreign arms vendors eye windfall gains from change”) the proposed eligibility conditions would allow foreign defence majors to obtain Indian R&D funding simply by forming a 49-51 per cent joint venture (JV) with an Indian business house that had a sleeping company for 5 years, and applying for a defence licence.

Ficci pointed out that the Kelkar Committee had conceptualised the “Make” procedure to create Indian system integrators. It also quoted the Defence Procurement Procedure of 2008 (DPP-2008), which states in Para 23(a): “Indian industry should not become conduit for entry of foreign companies without any significant value addition by the Indian partner.”

Indian defence companies emphasise that IP developed through “Make” category projects must remain in Indian hands. Instead, as Ficci points out, foreign export control laws would be enforced on Indian JVs where the foreign holding was more than 20 per cent, undermining India’s control over the IP created.

The US Code of Federal Regulation mandates that foreign companies in which a US company holds more than 20 per cent voting stake is defined as a “Foreign Subsidiary” of a US corporation. The US parent company, therefore, is obliged to impose US policy guidelines, laws and restrictions on its subsidiary, regardless of Indian laws and rules.

Ficci has objected: “Having indigenously developed critical defence technologies and products/systems through majority R&D funding share, these should also be available for exports, should the Indian Govt so desire, without seeking permission from any foreign country to whom destination country’s “End use Certificate” needs to be provided.”

The second concern raised by Indian private industry is the prohibitive cost of working capital for “Make” projects. Although the MoD would fund 80 per cent of the project cost, disbursement is linked to development milestones that, like all technology development, carry an element of risk. With a 7-8 per cent “risk premium” loaded onto existing capital costs of 16 per cent plus, companies in a “Make” project would pay 23-24 per cent interest on working capital.

Since working capital costs would increase the Indian development agency’s 20 per cent share to as much as 30-40 per cent. Ficci says the risk would push them towards foreign, tried and tested sub-systems rather than incurring the development risk that lies in ground-up R&D, and the creation of Indian IP.

Ficci has recommended that the cost of interest of working capital be reimbursed by the MoD. Alternatively, the MoD should use the Indian Space Research Organisation’s “tried and tested methodology”, in which the MoD would disburse payment through an escrow account set up for the project.

The MoD is currently studying these issues and is likely to discuss them afresh in subsequent DAC meetings.


Anonymous said...

This is idiotic! The companies seem to want the windfall from the 80-20% cost share but not the risk of losing that 20% if their bets fail. It is the market risk premium associated with the risk of failure which makes the investor make wise decision. If the govt decides to keep the 80% in escrow regardless of the milestone achieves by the companies then it would in essence make the 20% risk free and the remaining 80% as free cash with which companies can do whatever they want. GOI should never accept this suggestion and set 80% disbursement mechanism as successive milestones are achieved.

Anonymous said...

@anonymous 11.03,

your argument is right when there is already competitive environment in the field (aka cellular communications, IT etc). However in the defense manufacturing no such environment prevails. Hence the risk associated is a blind risk and take into account that we have a prohibitive environment for R&D in India. The milestones themselves are bound to be ambitious given that well established products outdoing the envisaged would already be available (akin to rediscovering wheel in Indian way!) and the failure should themselves be some sort of half done. It then makes sense that a bounty is accompanied to the risk taking (that is jumping into the field not achieving milestone), and freedom and flexibility in project is available with GOI taking the risk. Once a conducive environment is available the GOI can slowly roll back the funding model and market competition will kick in. Till any company shows interest in jumping in full R&D (and not screwdriver/paint job) all this proposals will remain ambitious. I am bit more optimistic about the start ups which are cocooning all around,however proven credibility would remain a bottle neck.

Sreenivas R.

Abhiman said...

Parrikar could well be the BEST Defence Minister India ever had.

God Speed to him !