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July 18, 2018

Legal Capsule: Defence & Aerospace: Analysing the Opportunity in India by Economic Laws Practice

Driven by an ambition of creating a local military-industrial complex in India, Defence & Aerospace has been a priority sector for the government over last several years and has been the subject of frequent policy and regulatory updates in response to various industry concerns. Along with large procurement programs, the urgent need to focus on war preparedness – as highlighted by an internal report submitted by Minister of State for Defence last year – is expected to boost the business case for creating an even more enabling framework for private sector participation. 

There are several encouraging signs:

Swifter decisions by Defence Acquisition Committee for purchasing equipment for the armed forces (many of these purchases are being made from Foreign OEMs and Ordnance Factories to enable quicker deliveries, followed by a ‘Make-in-India’ purchase)
Delegation of power to Secretary (DP) for Tier I sub-vendors in certain specified scenarios, and to Army Commanders for securing bases of armed forces
Formation of a high-level ‘Defence Planning Committee’ under the Chairmanship of National Security Advisor and membership of the Foreign Secretary, three Service Chiefs, and the Secretary (Expenditure), Ministry of Finance, to draft the national security strategy and facilitate a comprehensive and integrated planning for defence matters, including in-country capacity creation
In a clear indication of its desire to focus on exports of indigenous equipment, India invited all of its 44 ‘Defence Attaches’ posted across the world for a specialised briefing along the side lines of the recently concluded DefExpo 2018, for exploring new markets for indigenous defence equipment and promoting ‘Make-in-India’ (India is already in talks with Vietnam for export of its Akash Surface to Air Missile)

Emerging opportunities for the industry

The Government has taken many encouraging steps to bring the defence manufacturing sector out of its present state of inertia; however, the effects of these steps will only be felt in the medium to long term. The present focus on purchase of arms and ammunition is succinctly limited to addressing the immediate war preparedness. This, however, will not yield the desired results for the market stakeholders – India’s Ministry of Defence(“MoD”)and Armed Forces to achieve the much-elusive self-reliance and the Industry (both foreign and Indian) to have enough orders to keep their factories running. To this end, the following developments are noteworthy:

FDI liberalisation: A much-awaited decision pertains to increasing the FDI cap from the present 49% to now 74% - this proposal is contained in the Defence Production Policy 2018, a draft of which was circulated by Department of Defence Production (“DDP”), Ministry of Defence for comments to the public. However, the draft has not yet been notified in light of conflicting views from the industry. If this proposal gets notified, a significant number of concerns envisaged by foreign defence manufacturing companies are likely to be addressed under India’s corporate laws framework applicable to 74% holding structures. Concerns of domestic industry, however, are not misplaced and will need to be resolved. 
Swifter discharge of offset obligations: The government has invited comments on Draft Modifications to Defence Offset Guidelines wherein the Ministry of Defence has proposed three additional avenues for discharge of offsets (investment in Specified Projects, invest in defence manufacturing through equity investment, and investment in specified SEBI regulated Funds for Defence, Aerospace and Internal Security), which, if notified, are likely to ease access to funds and technology and benefit foreign vendors by providing quicker ways of discharging offset obligations. Furthermore, a draft amendment modifying the Offset Procedure proposes very high multipliers (4/5) for all investments made in the Defence Industrial Corridors towards discharge of an OEM’s offset obligation.
Announcement to setup Defence Industrial Corridors: In February 2018, Government of India announced setting up of Defence Industrial Corridors (“DIC”) in two states in India (Tamil Nadu and Uttar Pradesh). Investment in these Corridors is likely to attract many incentives such as 10-25% reimbursement of land cost, 70-90% GST reimbursement, etc., details of which are under finalisation- Defence Production Policy 2018 - This Policy was expected to be publicly announced and notified at DefExpo 2018 in Chennai earlier this year. When notified, the Policy has several measures including Competency Mapping of Indian Industry, simplifying MAKE II procedure, liberalising licensing norms, including lifetime support for large platforms which would enable making a credible business case for Industry, etc. and stands to benefit all the stakeholders in the industry.

The Road Ahead

While there are several positive developments that signal the Government of India’s increasing business-friendly attitude toward this sector, legacy issues persist. The government had earlier introduced the ‘Make’ procedure under DPP 2006 for boosting indigenous defence manufacturing – as it happened, not a single program was finalized under this initiative. The recent ‘Strategic Partnership’ model – introduced with much fanfare as the ‘mother of all out-of-box policies’ – seems set for a similar fate with the first RFI issued under this program already awarded to Mazagon Dock Shipbuilders Ltd, a Defence Public Sector Undertaking. 

These developments have further boosted the industry’s scepticism on the government’s intent and have been quite a pushback to Government’s intent to induce pace in this sector. While focusing on immediate preparation for a worst-case scenario of a two-front war is critical, Government of India will need to be mindful of its long-term aim for the sector at large and thus will have to take concrete, definitive steps to reassert its intent to the Industry.

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