MSMEs For Pushing Defence Indigenisation In India: Roadblocks And Recommendations

The Indian defence industry has for long remained in its infancy. Whether one attributes this fact to the “self-sufficiency” doctrine adopted by India post-independence or the sheer incompetency of the military-industrial complex to absorb technology, the result is that India is in a vulnerable position to defend its territory and interests.

The threats are dynamic, and the adversaries more hostile than ever. China’s increasing influence in the South-Asian region and its military might pose the most formidable threat to our sovereignty. Internally, the increase in the number of non-state actors raises alarming concerns. Therefore, it is imperative for India to shift gears and drive itself towards “self-reliance”. Military has to be put in a position to “project power”, and that can happen convincingly through a strong domestic defence industry.

India has a defence budget of over Rs 2 lakh crore and spends more than 40 per cent of it in capital acquisitions. Nearly 70 per cent of its needs are met through imports. The business emanating from the offset arrangement is projected to reach a whopping $15 billion mark in 10 years’ time. There is a pertinent need to leverage these offset benefits that will be in the offing in the coming decade. Naturally, the role that the private sector, and micro, small and medium enterprises (MSMEs) in particular, will have to assume will be pivotal in realising India’s dream of having a strong domestic defence industry. The needs, and hence opportunities, are going to be endless.

The MSMEs have been at the mercy of ‘not-so-friendly’ policies floated by the Government of India for many years. Even though Defence Procurement Procedure (DPP) 2013 took a giant leap in broadening the level-playing field, it seems like it has affected only the big players like Tata group and Larsen & Toubro. The MSMEs have been forced to stay small in size, and have not received any real opportunities to make it big. Nonetheless, they have had a major say in the manufacturing sector as a whole. The MSMEs contribute nearly 8 per cent of the 16 per cent share that manufacturing sector occupies in our gross domestic product.

Even without reaching its true potential, MSMEs in the defence sector employ nearly 2 lakh people directly and 6 lakh people indirectly. The pillars of growth for MSMEs have been the power of knowledge, collective learning to beat the lack of resources and innovation to cut the costs. These traits, when extrapolated, represent what the defence industry exactly needs right now. The MSMEs, therefore, can deliver the most sought-after combination of low-cost manufacturing and cutting-edge solutions under one roof.

There are two routes through which the MSMEs can be brought under the umbrella of defence equipment manufacturing. The first is through purchases made under the “Buy (Indian)” and “Make” categories that will allow them to directly bid and win contracts. The second is through purchases made under “Buy and Make with ToT (Indian)” and “Buy (Global)” categories, where the offsets will come into the picture. (ToT is an abbreviation for transfer of technology.)

But the inherent difficulties associated with each of these routes attract lukewarm responses from

i) Small vendors and entrepreneurs, in terms of getting into the defence sector, and

ii) Foreign suppliers, in terms of finding an Indian offset partner and setting up a business in India

Major impediments

Certain aspects like policy hurdles and licensing and regulation hassles need a separate discussion and are not included here. In this article, we take a look at other roadblocks that the MSMEs face currently.

Lack of understanding

The request for acquisitions projected by the armed forces are esoteric in nature and cannot be understood by MSMEs. For example, in the list of eligible products for defence production, following products appear:

1. Bombs, torpedoes, rockets, missiles, other explosive devices and charges, related equipment and accessories specially designed for military use, equipment specially designed for handling, control, operation, jamming and detection
2. Energetic materials, explosives, propellants and pyrotechnics
3. Small arms, mortar, cannons, guns, howitzers, antitank weapons and their ammunition including fuzes

What a small vendor can make of these high-tech terms isn’t enough to motivate him to take the next step.

The lack of understanding also discourages the foreign supplier, as the Indian partner becomes more of a liability than a partner.

Lack of prior information

Defence ventures take more time to realise than any other commercial ventures. The private industry and MSMEs have no prior knowledge of acquisition plans. They come to know about it only when requests of proposal are invited. This doesn’t allow the industry to carry out a feasibility study and find a foreign vendor to enter into a memorandum of understanding or set up a joint venture.

Moreover, the private industry and MSMEs aren’t represented on procurement-related decision-making bodies like Services Capital Acquisition Plan Categorization Higher Committee (SCAPCHC), DPB and DAC, which bereaves them from any kind of participation.

Access to finance

The development and production of defence machinery is a cost-intensive affair, and credit has always been a roadblock for MSMEs. Sufficient credit must be made available to support any developmental activity taken up by MSMEs in the defence sector.

The cost of finance and, more importantly, access to finance are also major challenges. Even if these hurdles are overcome, another nagging issue will be the recovery of debts. The procedures followed to designate a loan as non-performing or bad makes it difficult for the vendor to pool the extra money that can possibly help him avoid a trough.

Service quality requirements

The defence industry is subjected to stringent quality standards and assessments. An average MSME lacks the discipline to satisfy these requirements. The testing guidelines and military standards are exhaustive and naturally causes disinterest to the interested. Support from Defence Public Sector Undertakings (DPSUs) in educating this fraction of the industry is inappreciable. There are also no training and assistance cells in helping MSMEs understand the requirements.

Mapping of the supply chain

A large fraction of the industry is disjointed, and there is no mapping of the enterprises that can potentially become defence manufacturers. The Department of Defence Production has been mandated to “identify and map prospective agencies for development and/or manufacturing”, but the efforts so far have been inadequate.

Protection of intellectual property

India lacks a robust mechanism to protect the intellectual rights of foreign vendors. This is a huge drawback since it will compel foreign suppliers to commit everything but for state-of-the-art technologies that are dearly sought. No original equipment manufacturer (OEM) wants to part with its core technology, and this results in poor quality of incoming offsets.

Quality of offset benefits

One major objective of the offset policy is to have transfer of technology, and to increase exposure and skill-up the domestic industry. The Vijay Kelkar Committee has made some important observations with respect to the Indian ToT model.

1. It is confined to DPSUs and OFs.
2. The depth of technology transfer is inadequate.
3. It essentially comprises transfer of drawings and processes for manufacturing and assembly, and no real transfer of technology. Adopting the ToT model for the manufacturing of imported equipment through licensed manufacture has not been a success.
4. The dependence on OEMs for upgrades has only increased, not decreased.

For the facilitation costs that it incurs, points ‘a’ and ‘c’ add fuel to the debate on whether offsets really help the Indian industries in indigenisation. Of course, MSMEs only mean and need business, but let’s not forget the agenda, i.e., achieving self-reliance.

No guarantee on returns on investment

No minimum order quantity upfront is a non-starter. Under such circumstances, the development costs make the business proposition a risky one, which the small vendors will hesitate to take.

The mindset

Indian entrepreneurs perceive defence manufacturing as an impractical business proposition, and feel unprepared and incompetent to execute a project.

Key recommendations

Creating a comprehensible requirements document

The Technology Perspective and Capability Roadmap (TPCR) must be translated to a more easily understandable document. It must ultimately help in creating a “Directory of Needs”, which a vendor can readily refer, and orient his business plans. (An attempt will be made in the next part of this series to demonstrate the same with the help of an example.)

Nationwide seminars must be conducted by inviting prospective manufacturers and designers, explaining the modernisation plan and what is expected out of the industry. The possibility of creating a National Defence Archive, an online repository of defence equipment aimed at educating the MSMEs on various warfare machinery, must be considered, obviously, without risking security. The Defence Acquisition Council must have representation from the private and MSME sector while deciding on acquisition plans in the future.

Easy entry and exit

The MSMEs should be encouraged to take up defence manufacturing by providing them with ample financial and technical support to start their ventures. There shouldn’t be too many or too few regulations. There must be better regulations. The fear of not getting out of a business at will also precludes small investors from investing in defence ventures and hence, the exit also has to be smooth.

The need for a bankruptcy code for defence manufacturers is strongly felt. A safety net must be in place to help a vendor avoid breakdowns that cannot be overcome. If such circumstances are inevitable, capital acquisitions, which grab a major share in one’s investment, must be brought back at a competitive price.

The absence of a minimum order quantity was a major factor that blocked small businesses from entering the competition. To beat this, the current government recently decided to bear the developmental costs up to as high as 100 per cent, which is a positive move.

Higher lending

Defence manufacturing requires large amounts of investments up front, and so the lending must go up. Between 2012 and 2015, MSME loans went up by nearly 70 per cent, which is a positive trend. What is not clear is how much of it was granted to defence ventures.

The banks have to be liberal in assessing threats of non-repayment. Indians do have a good credit performance, and so repayment should be viewed with minimal caution. The interest rates for lending must be brought down. Ease of access to finance should be improved. The Reserve Bank of India licensed as many as 14 new payment banks in the last two years. This should help and improve accessibility.

Defence ventures have to be given a leeway while deciding upon their non-performance. Designating a loan as non-performing prohibits the vendor from giving the needed stimulus and get out of a rough patch. Investigations must be carried out to find out if it’s commercial non-performance or technical non-performance. The possibility of subsidising a loan where commercial non-performance is seen can be envisaged. Banks see hand-holding as a liability; only few do it out of the value that it adds to their brand. Nationalised banks must be directed to finance at least five defence ventures per state in the coming year.

Cost of doing business

“Ease of doing business” is a slightly overrated index in the Indian context. What we should be really focusing on is the cost of doing business. The cost of land, the cost of human resource, the cost of other resources like electricity and connectivity. To allocate these resources swiftly will require centre-state synergies. Even though the task of developing MSMEs is entrusted to the state government, defence is a Union subject. Hence, cooperation at all levels is necessary.

A predictive tax regime will help immensely in forecasting a more accurate cost of doing business. The corporate tax for Indian firms is about 32.5 per cent while that for foreign players is 42.5 per cent, which is quite high. The ‘plough back’ cannot happen at multiple levels, and a level-playing field cannot be on just one side. The effect of reducing the corporate tax for foreign players in the defence sector must be studied, and if that promises to yield a positive dividend, like gaining the intangible investor confidence, it must be lowered.

Export promotion will be another avenue which can reduce the cost of doing business. To promote exports, consortia should be built and missions and delegations must be sent to foreign trade fairs and asked to attract business. Domestically, the restrictions imposed by the Director General of Foreign Trade (DGFT) could be looked at again.

Backward integration of the supply chain

On the lines of the Secretary of Defence - Office of Small Businesses, in the United States, an agency which is dedicated to mapping, integrating and forming clusters of companies must be realised. The cluster must be based on the businesses that MSMEs are already doing. A secretary must head each of these clusters, and their duty must include bringing business to their designated cluster.

A registry of “good performers” in the MSME community must be created and made public to create a competitive atmosphere and also increase awareness on the opportunities that exist. The Defence Offsets Management Wing should also start building strong links with the industry as it is specifically mandated to “assist vendors in interfacing with Indian industries”.

Technology development fund

In DPP 2013, a Defence Technology Fund was envisaged and started with a token allocation of Rs 100 crore to support defence research and development (R&D). This finally came into effect only in December last year. The guidelines set for the utilisation of these funds are rather unrealistic. Defence R&D is a crucial avenue for indigenisation, and the changes that this segment needs will be discussed in depth in the next part of the series.

Role of DPSUs in helping MSMEs

The DPSUs are best placed in our structure to educate MSMEs on the principles of defence production and service quality requirements. Vendor development programmes must be taken up more rigorously. The MSMEs must be given access to test facilities after due security checks, and they also must be invited during certification processes. This will help a designer from an MSME have a wider appreciation for what is expected out of him and help him craft his design likewise.

The Tier-3 suppliers of DPSUs shouldn’t be restricted to “drawing reading and manufacturing” without the understanding of the product. An outreach programme must be launched to encourage MSMEs to bid and win sub-contracts coming from DPSUs.

Single-window clearance for MSMEs

An environment must be created wherein a vendor walks in with the proposal in a given template and walks out with all the clearances and the credit in his hand in a couple of visits. For this purpose, creating a new daughter bank under Small Industries Development Bank of India, “Defence-MSME Development Bank”, should be considered.

New MSMEs must start small

At any given point, there are about 130-140 schemes for procurement that are active, and nearly 40 per cent of them are worth less than Rs 150 crore. This window for business will be a good starter for new MSMEs. Depending on the acquisition costs, Defence Acquisition Council must intimate the secretary of the MSME ministry about the opportunity with sufficient lead time and not at the time of issue of a request for proposal.

Transparency

Transparency has to be brought in while awarding offset contracts. Right now it happens within closed doors. The parameters to select and award an offset contract will bring much more clarity to a vendor on what he needs to do in order to bag a contract.

The MSMEs and reforms clearly have a long way to go. However, Indians, by nature, are very enterprising and are sure to fight their way out. But inculcating a mindset in MSMEs that doesn’t think of defence production as exclusive to DPSUs and big players and removing the notion that defence production is not similar to any other production are perhaps going to be the underlying challenges that only awareness and education can resolve.

Meanwhile, what MSMEs will be required to do is become more disciplined and reach out for opportunities until they are more easily available to them.

The next part of the series will be dedicated to what must be the most undermined aspect of defence indigenisation, the R&D culture and infrastructure.

References

• DPP 2013
• The Vijay Kelkar Committee Report for the changes in acquisition procedures and enabling a greater participation of private sector in defence production
• “Defence Indigenisation: Made in India, by India, for India”, Bikramdeep Singh, Journal of Centre for Land Warfare Studies
• “Make in India: Challenges Before Defence Manufacturing”. S N Misra, former Director, DRDO, for Indian Defence Review
• Challenges of Indian MSME participation in the defence sector, FISME and Koan Advisory Report, 11 June 2015
• Indian Defence Offset Policy -- Does it Help Boost Indigenisation? Manekshaw Paper No 51, 2014, Centre for Land Warfare Studies
• MSMEs in Defence Production: A Neglected Sector, Air Marshal Dhiraj Kukreja, Vol. 30, 4 October-December 2015
• Potential For MSMEs in Defence Sector, website of the Confederation of Indian Industry
• “Defence Reforms and National Security: Managing Threats and Challenges to India”, Brig Gurmeet Kanwal (retd), Institute of Peace and Conflict Studies.
• Press Information Bureau, Government of India