Indian Aerospace & Defence Sector : Recent Changes And Their Impact: Part 1.

Legal News & Analysis - Asia Pacific - India - Shipping Maritime & Aviation

7 April 2021
 

The Indian military aerospace and defence (A&D) industry has seen a slew of policy decisions being taken and implemented during the Covid era. From increasing the automatic route limit for foreign investment in the sector, to imposing a ban on import of various defence items, it is clear that the Government is focused on the growth and development of the sector. This two-part post analyses the various policy decisions taken recently and their impact on the various players in the A&D ecosystem. In the first part, we analyse the existing A&D sector landscape and its evolution so far. In part two, we analyse the impact of the various recent policy changes and the changing role of the players in the sector.
 

Aerospace & Defence Sector Landscape 
 

Prior to 2001, the A&D sector was reserved as the exclusive domain of the Government, with private sector participation being prohibited. The only players in the sector were Defence Public Sector Undertakings (DPSUs), such as Hindustan Aeronautics Limited (HAL), Magazon Dock Shipbuilders Limited (MDL) etc., the Defence Research and Development Organisation (DRDO) and various Ordnance Factories Board (OFBs). Being the first movers in this space, DPSUs have today managed to become original equipment manufacturers (OEMs) for indigenously designed systems. Several platforms like Air Defence Missile System ‘Akash’, Light Combat Aircraft ‘Tejas’, Main Battle Tank ‘Arjun’, Ballistic Missiles like ‘Prithvi’ and ‘Agni’, Multi Rocket Launcher System ‘Pinaka’ and Central Acquisition Radar have been designed and produced indigenously.[1]

 

In May 2001, the Government for the first time permitted private players to enter the A&D sector by allowing manufacturing pursuant to licensing[2]. Initially, private players emerged in the small arms and ammunition manufacturing space, mostly comprising micro, small and medium enterprises (MSMEs). MSMEs also started participating in the manufacture of parts and components for defence products. The R&D base, however, remained nascent and the Government continued to rely on imports to fulfil more sophisticated needs of the armed forces. New fighter aircraft such as the Sukhoi 30 MKI were inducted into the Air force[3], Russian submarines made their way to the navy[4] and howitzers such as the BOFORS system were purchased for the army, all through imports[5].
 

In 2001, foreign participation upto 26% in the A&D sector was also permitted under the Government approval route[6]. The Government’s offset policy (which requires foreign sellers to invest back in India, a part of the price paid by the Government for defence imports) led to the formation of some joint ventures (JVs) between foreign OEMs and Indian players. These JVs were typically only licensed simple component technology by the foreign OEM, to enable the JVs to become part of the OEM’s global supply chain. The FDI in the sector was progressively liberalised. In 2015, the government allowed foreign investment up to 49% in the A&D sector under the automatic route[7]. The OEMs, however, continued to shy away from licensing sophisticated proprietary technologies to their Indian JVs, claiming their inability to control such JVs as a deterrent. This has made the Government re-think its hard policy stance requiring A&D sector companies to be Indian owned and controlled. Consequently, on May 16, 2020, the Finance Minister announced a hike in the automatic route FDI limit in the A&D sector to 74%.
 

The Defence Procurement Procedure (DPP), which lays down the rules for capital procurements by the Government, specifies the priority for procurement categories.  Progressive iterations of the DPP emphasised on priority being given to procurements of indigenously designed and developed products over imports. With the introduction of the Make procedure in the DPP in 2006, private players were incentivised to develop and integrate high-end technologies in India, for which Government funding would be made available. Relying on manufacturing expertise gained over the years, established players such as Tata, L&T and Bharat Forge started taking on the role of system integrators of sophisticated defence equipment. As a result, in 2011, the Defence Acquisition Council (DAC) approved development of a Battlefield Management System (BMS) as a ‘Make in India’ project, and two Indian consortia (one led by Tata Power-L&T and the other by Bharat Electronics-Rolta India) were selected to be the development agencies[8]. Then, in 2015, a joint bid submitted by Tata in association with Airbus of France for the ‘Avro Replacement Program’ was approved[9].
 

That said, India has also seen instances where our own armed forces have shown reluctance in inducting indigenously designed and developed systems. In 2016, the Navy had rejected induction of the home-grown Light Combat Aircraft, “Tejas”, being dissatisfied with the level of technological sophistication.[10] Then in 2017-18, the Army rejected OFB manufactured assault rifles due to their poor performance during trials.[11] In both cases, the armed forces wished to instead go for imports.
 

Changing Policy and Mindset
 

On May 12, 2020, in a bold clarion call to the nation, the Prime Minister announced the ideal of a self-reliant India, with a specific focus on our self-reliance in the A&D sector. This is a strong move, and some might view it as over ambitious, given our present state of preparedness. However, looking at the entire gammut of announcements made by the Government over the past few weeks, it has become clear that the Government is astutely aware of the sophistication of the sector, formulated through in-depth discussions with the industry, DPSUs and wings within the MoD. The announcements show that a multi-pronged approach is being adopted, not only to reduce India’s dependence on imports, but also to increase our exports. The Government has been cognisant of the fact that as of today, India still needs to rely on global imports for high-end technologies and that foreign OEMs have an important role to play in the growth and development of the sector in India. To this end, announcements have been made to incentivise FDI and transfer of technology. At the same time, the Government has formulated a progressive plan for Indian corporates to achieve certain levels of sophistication over the coming years, including through tie-ups with OEMs, which would result in a corresponding reduction in reliance on imports.
 

These policy changes are aimed to revitalise the A&D ecosystem and spur R&D and sophisticated manufacturing in India. In Part 2 of this post, we analyse how these policy changes will impact the sector and change the way players in the sector traditionally viewed their roles.

 

 

For further information, please contact:

 

Anuj Prasad, Cyril Amarchand Mangaldas

[email protected]

 

[1] Defence Production Policy, 2018

[2] Press Note 4 (2001 Series) dated May 21, 2001

[3] “Sukhoi-30MKI jets inducted into IAF” – The Times of India (September 27, 2002)

[4] “India inducts Russian made nuclear submarine into Navy” – The Times of India (April 04 , 2012)

[5] “Defense Minister Nirmala Sitharaman Inducts M777, K9 Howitzers into Indian Army” – IndiaWest (November 9, 2018)

[6] Press Note 4 (2001 Series) dated May 21, 2001

[7] Press Note 12 of 2015 dated November 24, 2015

[8] “Tata, BEL consortia get Rs 40k-crore ‘battlefield management system’” – Business Standard (February 27, 2015)

[9] “DAC approves new aircraft carrier, nod to Avro replacement” – Business Standard (May 14, 2015)

[10] “Navy rejects Tejas, says ‘overweight’ fighter does not meet its requirements | India News – Times of India” The Times of India (December 2, 2016)

[11] “Indian Army rejects Made in India rifles for 2nd year in a row after they failed miserably during trials” The Economic Times (July 14, 2018)