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February 24, 2012

India needs greenfield defence investments


To begin with, there must be a reality check. The accumulated strengths of various public sector entities engaged in India’s military aerospace programmes are clearly insufficient for the challenges ahead; Hindustan Aeronautics Ltd (HAL) is an overburdened monopoly. Our long-term needs, which include multiple fighter programmes such as light combat aircraft, SU-30MKI, MMRCA, advanced medium combat aircraft and the fifth-generation fighter aircraft, plus helicopter programmes, far exceed HAL’s capacity to deliver. India’s defence preparedness has already taken a significant beating from production delays and cost overruns. Moreover, despite decades of effort and several specialized design and development organizations, gas turbine research establishment and aeronautical development establishment, we still do not have the capacity to research and design, prototype, produce, service and upgrade aircraft without depending on imports of components, major sub-assemblies and significant number of complete aircraft. There is, thus, an urgent need to create greenfield capacity to broaden the base of India’s aerospace industry and achieve higher efficiencies, cost reduction and accelerated outputs. Public sector capacity requires to be supplemented by new private sector (both domestic and foreign) participation, involving joint ventures and co-production, to ensure higher levels of technology transfer and to substantially improve the level and cost of after-sales support. This will not only take India’s technological prowess to an even higher plane, but will also have a positive spin-off on our civil aerospace needs.
Progressing reform of India’s defence industrial sector will be a good way to start. Our long-standing preoccupation with equity caps has yielded only a trickle in foreign direct investment flows since 2002. If we can purchase complete equipment manufactured by an entirely foreign-owned company based in another country, why cannot we accept the same from that company’s wholly owned Indian subsidiary? Permitting majority foreign ownership in high-technology areas will also partially reduce complex issues related to intellectual property rights and export-control regimes.
Next, we should create a level playing field for a dynamic national defence sector, whether public or private. Several private sector companies are already playing a meaningful role in India’s defence production and await an opportunity to contribute more, on their own or through partnership with foreign entities. Precisely for reasons of national security, we cannot afford to fall behind because of ideological constraints or vested interests that support the status quo of our overdependence on defence public sector units (PSUs).
As currently framed, India’s defence offset policy is suboptimal to say the least, designed mostly as countertrade to increase exports of PSU products related to defence and civilian aerospace and internal security. This policy lacks the strategic focus to link acquisitions to collaborative models involving joint production, technology transfer and manufacturing capacity that builds self-reliance. Countertrade is widely regarded as the least meaningful element of defence offsets; transfer of technology is by far the most beneficial. While it is questionable whether such large (50%) offsets can even be fulfilled—not least because of the lack of product capacity of our PSUs or the existing aviation industry—it is more than likely that this requirement will inevitably increase costs. Surely that outcome cannot be justified.
A more pragmatic approach would be to renew India’s present offset policy to enable the induction of high-technology aerospace manufacturing and services through a multi-tiered vendor base. This can be incentivized by offering flexible share-holding options for the establishment of local manufacturing units by foreign companies linked to proposed acquisitions under the umbrella of the primary supplier. Offsets should provide for the progressive localization of sub-assembly manufacturing by vendors under a phased manufacturing programme. This would imply transparently designating high-tech vendors as long-term suppliers without obliging them to tender for every subsequent order. That is the only way to ensure that the risks and costs of rapid technological development are shared. A comprehensive new offset policy that decreases costs and at the same time strengthens defence capability merits consideration.
To conclude, India needs to leverage its current and future defence aerospace acquisitions to create an indigenous high-technology aerospace industrial base that will underpin its national security and economic strength. For this to happen, the need for structural and regulatory reforms of this sector cannot be overstated.

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