Tuesday, 27 March 2018

Industry expresses cautious optimism over draft defence production policy

Fleet tanker INS Jyoti undergoing refit at a private sector shipyard

By Ajai Shukla
Business Standard, 27th March 18

The defence industry has both praise and criticism for the proposed new Defence Production Policy 2018 (DProP 2018), a draft of which the government released on Friday.

Suggestions have been invited by Thursday, after which the defence ministry intends to issue the finalised DProP 2018 within a month.

The draft policy sets out ambitious goals, including making India one of the world’s top five defence manufacturers and a global leader in cyberspace and artificial intelligence; achieving self-reliance by 2025 in complex weaponry like helicopters, fighters, warships, tanks and missiles; raising defence exports to $5 billion annually by 2025, and producing defence goods and services worth ~$26bn by that year to create employment for two-three million people.

Private defence industry has welcomed the announcement of explicit targets, but points out that close oversight would be needed to achieve them.

Overall it is a good policy, with a clear vision and timelines. But the key to its success lies in how vigorously it is implemented”, says Rajinder Bhatia, who heads Kalyani Group’s defence vertical.

“Industry welcomes the DProP’s push for ‘Make in India’. But its success will lie in its implementation strategy, with strict milestones, a periodic review mechanism and ensuring accountability for non compliance”, says Vivek Pandit of Ficci

Incentivising R&D investment

Noting that India is emerging as a “top destination for R&D centres in the world”, the draft DProP 2018 proposes that this strength “be channelized for creating domestic [intellectual property] for defence needs.”

However, Jayant Patil, who heads Larsen & Toubro’s defence business, notes that R&D incentivisation across industry is falling. Earlier, there was tax exemption of 200 per cent of the R&D spend, which has fallen to 150 per cent currently, and will be just 100 per cent from 2020. Patil suggests: “There must be a higher targeted incentivisation for defence R&D and product development.”

Increasing indigenisation

Increasing indigensation content in a product has always been an important component of “Make in India”, with DPP 2016 increasing the minimum indigenous content from 30to 40 per cent. Patil proposes that industry be offered incentives – such as price preference and purchase preference – for achieving indigenous content substantially higher than the specified minimum.

Level playing field

Industry executives insist that private firms can only enhance turnover and create jobs if there is a level playing field between the private and public sector – which includes eight defence public sector undertakings (DPSUs) and 40 ordnance factories (OFs).

Private firm executives say they are willing to compete with OFs and DPSUs, but the latter continue being privileged. As an example, private firms have been invited to manufacture 21 types of ammunition out of the 87 types required by the army, with all the remaining types reserved for OFs. In December, the defence ministry permitted OFs to also bid for the 21 types assigned to the private sector, raising concerns that the OFs would cross-subsidise their bids from the huge assured orders already reserved for them.

Private executives also point to the recent tender for building lakhs of small arms (rifles, carbines and light machine guns), in which 25 per cent of the order is reserved for OFs, which can also quote for building the other 75 per cent.
 

“DProP 2018 must contain a formal commitment that orders will not be given on ‘nomination’ to DPSUs and OFs, so that there is a true level playing field”, they say.

Several private executives want DProP 2018 to explicitly specify that the Department of Defence Production represents all defence producers in the country – both public and private – and will impartially foster their development.

Export

With India’s defence budget limited in its ability to absorb the planned levels of defence production, the draft DProP 2018 plans to export $5 billion in defence goods  through assiduous marketing, offering lines of credit to buyer countries, setting up a Defence Export Organisation jointly with industry, and easing export clearances.

Even so, there is scepticism within industry that exports can be scaled up fifteen-fold in just seven years, from the current level of about $330 million.

“To boost defence exports to $5 billion, we need a body like Israel’s SIBAT, in which the military and the highest levels of government together facilitate arms sales abroad. The draft policy unfortunately limits itself to export promotion by DPSUs/OFs ”, says Rahul Chaudhry of Tata Power (SED).  

Patil suggests DProP 2018 should mention export promotion initiatives – such as providing low cost capital to defence exporters from the growing foreign exchange reserves – which could be detailed in separate “Export Facilitation Guidelines”.


Industry reactions

Rajinder Bhatia, Kalyani Group

Overall it is a good policy, with a clear vision and timelines. But the key to its success lies in how it is implemented. A level playing field for the private sector is still awaited.”


Jayant Patil, Larsen & Toubro

To incentivise higher indigenisation in defence equipment, industry should be offered incentives – such as price preference and purchase preference – for achieving indigenous content substantially higher than the specified minimum of 40 per cent.


Rahul Chaudhry, Tata Power (SED)

“To boost defence exports to $5 billion, we need a body like Israel’s SIBAT, in which the military and the highest levels of government together facilitate arms sales abroad.”


Vivek Pandit, Ficci

“While industry welcomes the contours around which the DProP is built, its success will lie in its implementation. It needs strict milestones, a periodic review mechanism and accountability for non compliance.”


Puneet Kaura, Samtel Avionics

"What the industry needs is more influx of projects. While much work has been done by the government at the policy level, on-ground action is glaringly missing. To ensure that 'Make in India' does not fade away as rhetoric, more Make-I and Make-II projects must be awarded." 

Sunday, 25 March 2018

Private warship builders live off scraps, while the figures tell the real tale

MoD claims public and private shipyards compete on equal terms, but the deck is loaded against private builders

By Ajai Shukla
Kathupalli, Chennai
Business Standard, 25th March 18

An hour’s drive north of Chennai, Larsen & Toubro’s shipyard at Kathupalli sprawls over 900 acres, a spacious, modern facility very different from the cramped precincts of defence public sector undertaking (DPSU) shipyards like Mazagon Dock Ltd, Mumbai (MDL) and Garden Reach Shipbuilders & Engineers, Kolkata (GRSE).

A fortnight ago, Kathupalli delivered to the navy a Rs 468 crore (4.68 billion) floating dry dock (FDD), which is now operationally deployed, repairing naval warships in the Andaman & Nicobar Islands.

Meanwhile, the first of seven offshore patrol vessels that L&T (Larsen & Toubro) is building for the Coast Guard has concluded successful sea trials. The new vessel is getting a lick of paint before being handed over on March 31.

Vice Admiral B Kannan (Retired), who headed the navy’s nuclear submarine project and now oversees L&T’s shipbuilding business, points out that both vessels were completed before the contracted time and within budget – a rarity in defence shipyards. Further, both were constructed entirely in-house, and designed in L&T’s Warship Design Centre at Manapakkam, Chennai.

Yet, despite conforming fully to the Make in India initiative, Kathupalli is struggling to win defence orders and the shipyard’s capacity is severely under-utilised. In three navy tenders opened in September, public sector shipyards comprehensively outbid L&T, leaving its order book worryingly depleted.

In the tender for building 16 anti-submarine warfare shallow water craft (ASWC), L&T put in a bid of Rs 1,234 crore (12.34 billion). Public sector rival Goa Shipyard Ltd (GSL) quoted Rs 797 crore (7.97 billion) and Kerala state PSU, Cochin Shipyard Ltd (CSL), won the order with a bid of Rs 674 crore (6.74 billion) – a whopping 45 per cent lower than L&T’s.

Bids for 16 x Anti-submarine warfare shallow water craft (ASWC)

Shipyard
Quote (Rs crore)
Remarks



L&T
1,234

Reliance
891

Goa Shipyard (GSL)
797

Cochin Shipyard (CSL)
674
45% cheaper than L&T

In the simultaneous tender for building five survey vessels, L&T quoted Rs 742 crore. (7.42 billion) Three public sector shipyards – CSL, GSL and GRSE – bettered that with intriguingly similar bids. GRSE won the contract with a Rs 520 crore (5.20 billion) quote – 30 per cent lower than L&T’s.

Bids for 5 x Survey vessels

Shipyard
Quote (Rs crore)
Remarks



L&T
742

Shoft Shipyard
670

Cochin Shipyard (CSL)
573

Goa Shipyard (GSL)
568

Garden Reach (GRSE)
520
30% cheaper than L&T

Finally, in the tender for building two diving support vessels, L&T quoted Rs  1,584 crore (15.84 billion). Beating it comprehensively were three public sector shipyards, CSL, GSL and Hindustan Shipyard Ltd (HSL), with the latter’s winning bid of Rs 1,010 crore (10.1 billion) being 36 per cent lower than L&T’s bid.

Bids for 2 x Diving support vessels

Shipyard
Quote (Rs crore)
Remarks



L&T
1,584

Cochin Shipyard (CSL)
1,188

Goa Shipyard (GSL)
1,086

Hindustan Shipyard (HSL)
1,010
36% cheaper than L&T


Why did L&T bid so high?

Amongst defence industry analysts, the first question this raised was: is L&T running Kathupalli so inefficiently that public sector yards can build warships 30-45 per cent cheaper than them? How did public sector shipyards win so conclusively?

Confronted with that question, Jayant Patil, L&T vice president who oversees its defence vertical explained how his company structured their bids. Working off a “basic material price”, L&T added to that labour cost and services, escalation, yard recovery, working capital costs, contingencies and a provision for warranty.

“Our final quote was about 1.7 times the basic material price, to cover the other costs. But our public sector competitors’ quotes were just 1.1 or 1.2 times the basic material price. Clearly, they did not need to factor the costs that we did,” said Patil.

What Patil left unsaid was what everyone in the industry knows: that public sector shipyards, which get most of their income from “nominated” orders from the defence ministry, enjoy enormous financial advantages in bidding against private shipyards.

DPSUs have financial buffers that accumulate from being able to cost “nominated” project lavishly, in a single-vendor environment, and obtain advance payments from the defence ministry that pile up into large cash reserves. Consequently, public sector shipyards incur no working capital costs and, in fact, earn billions in interest on their cash reserves. Last year, MDL’s cash reserves of Rs 8,363 crore (83.63 billion) generated Rs 765 crore (7.65 billion) under “other income”, turning an operating loss into a net profit. Meanwhile GRSE’s “other income” of Rs 227 crore (2.27 billion) enabled the shipyard to squeak out of the red and show a profit of Rs 12 crore (120 million) last year.

Finances of public sector shipyards

(Rs crore)
Shipyard
Turnover from operations
Profit
Other income
Profit (less other income)
Long term borrowings
Cash balance







MDL
3,524
533
765
(-) 232
--
8,363
GRSE
930
12
227
(-) 215
--
1,185
GSL
1055
177
47
130
2
504
HSL
618
54
21
33
372
230
CSL
2,058
322
163
159
123
676
(Source: Shipyards’ annual results)

Nor are PSU shipyards burdened with infrastructure costs, since those have been built up over decades with taxpayers’ money. In contrast, private shipyards like Kathupalli and Reliance Defence’s shipyard at Pipavav, Gujarat, must service debt of Rs 50-100 billion (5,000-10,000 crore), which drives up their bids. The cost of commercial borrowings, which exceeds 15 per cent per annum, amounts to over 40 per cent of the cost of multi-year shipbuilding contracts.

Also allowing public sector shipyards to get away with quoting low is the permissive oversight of the defence ministry, which has never penalised them for time and cost overruns. Parliament’s Standing Committee for Defence reports show CSL’s budget to build an indigenous aircraft carrier swelled 593 per cent from the originally sanctioned Rs 3261 crore (32.6 billion) to Rs 19,341 crore (193.4 billion), while the build time rose by six-nine years. Similarly, in Project 15A to build three destroyers, MDL’s cost burgeoned to Rs 11,662 crore (116.62 billion), 325 per cent of the originally sanctioned Rs 3,580 crore (35.8 billion).  In many such cases the defence ministry justified, and quietly paid, the excess.

Public sector: time and cost overruns

Ship type
Cost overrun
Time overrun
Sanctioned
Final cost
Rise %





Aircraft carrier
Rs 3,261 cr
Rs 19,341 cr
593%
6-9 years
P 15A destroyers
Rs 3,580 cr
Rs 11,662 cr
325%
6 years
P 28 corvettes
Rs 3,050 cr
Rs 7,852 cr
257%
5 years
P 75 submarines
Rs 13,000 cr
Rs 23,562 cr
181%
5 years
(Source: Standing Committee on Defence reports)


Private shipyard executives are confident that, with adequate orders, they can stabilise their finances and compete on equal terms with the DPSUs. But the high-value contracts for capital warships – corvettes, frigates, destroyers, aircraft carriers and submarine, with their advanced sensors and weaponry – are “nominated” to DPSUs. The defence ministry says this is because private shipyards have no experience of building capital warships.

A top navy admiral told Business Standard that “it would be too risky” to entrust a private shipyard with the impending Rs 10,000 crore (100 billion) contract to build two Russian-designed Krivak III frigates for the navy because “The Krivaks are too complex and weapons-intensive.”

Arguing that private yards should “build their skills in a graduated and calibrated way”, he said private shipyards would be allowed to compete for building the eponymous Next Generation Missile Vessels, for which the tender is soon expected.

Meanwhile, GSL is being entrusted with building the Krivak III frigates, even though it has never built a frigate before. “Different logic for the public and private sector”, rues a private shipyard executive.

This is not the first time GSL has benefited from ministry largesse. Manohar Parrikar, as defence minister in 2015, did his home state shipyard a favour by “nominating” it for a Rs 32,000 crore (320 billion) order to build 12 minesweepers – a contract worth 30 times GSL’s turnover. Since then, GSL has made little progress in discharging the order.

While the combined turnover of five public sector shipyard for the year ending March 31, 2017 was Rs 8,185 crore (81.85 billion), their order book adds up to Rs 180,000 crore (1,800 billion) – that is 22 years of production.

Defence ministry officials, in public interactions with industry, claim the days of “nomination” are over, and that public and private shipyards now compete on equal terms. But the figures tell a different tale, in which public shipyards feast at the high table with the defence ministry, with only scraps being tossed to private shipbuilders.

A Business Standard analysis of shipbuilding orders in the last twenty years indicates that 90 per cent by value, worth Rs 2,23,100 crore (2,231 billion), were “nominated” to public shipyards, while private shipbuilders were allowed to compete for contracts worth only Rs 25,600 crore (256 billion).



Even for that tiny slice of the shipbuilding pie, private shipyards had to compete with the DPSUs, eventually winning contracts worth only Rs 10,350 crore (103.5 billion).



“We don’t need orders for Rs 100-200 crore (1-2 billion) vessels. We have invested Rs 5,000-10,000 crore (50-100 billion) into state-of-the-art shipyards. We need commensurate orders,” private shipbuilders have repeatedly told the ministry, to no avail.

In December, navy chief, Admiral Sunil Lanba, said: “We have also identified about Rs 40,000 crore (400 crore) worth of [shipbuilding] projects for private shipyards”. But the wait continues.

State of private sector shipyards

Lanba stated that 23 private sector shipyards are qualified for defence shipbuilding. Amongst these, there are just four shipbuilders -- L&T, Reliance Defence, Bharti and ABG. The others, some of which have potential, are really boat building yards.

Of the four large, private shipyards, two – Bharti and ABG – are insolvent, and there is little serious interest from buyers. The other two, L&T and Reliance Defence are kept afloat by their parent companies’ deep pockets.

According to Parliament’s Standing Committee, the defence ministry has 53 warships and six submarines in the procurement pipeline. This number could increase if the government utilises shipbuilding capacity to build naval craft for our regional maritime partners. How these orders are distributed and tendered could determine the future of India’s private warship building industry.