An Outlook for the Indian Strategic Electronics Sector in Defence

Electronics is the fastest growing segment in the defence sector and this situation is expected to remain so in the coming years. However, India may face serious challenges in becoming a significant player in strategic electronics unless a vibrant domestic sector is created – one that includes MSMEs

The strategic electronics (SE) sector in India has the potential to become a sunrise industry in India over the next

10 years. It is estimated to grow at a compounded annual growth rate (CAGR) of 20 per cent to 30 per cent. The sector accounts for six per cent to seven per cent of the overall Indian electronics market with the government as the sole buyer and market maker for defence electronics.

Contrary to the general perception, defence electronics has undergone a paradigm shift due to the participation of private players along with public sector undertakings (PSUs), even though a major part of the market is yet to be explored as the industry requires high-quality input materials, production processes as well as testing, and the right strategy to ensure participation of micro, small and medium enterprises (MSMEs) to increase Indian content in SE.

Opportunities galore

The SE sector offers unprecedented opportunities, more so in the defence sector. As per industry estimates, electronics production in the sector in India reached ₹ 120 billion during 2012-13 and exceeded ₹ 138 billion during 2013-14, recording a growth of more than 15 per cent.

As per The International Institute for Strategic Electronics Studies, India’s defence capital expense quadrupled from US$ three billion in 2000 to US$ 12.2 billion in 2010, making it the sixth largest spender on defence worldwide during the same period. It is expected that India’s US$ 12 billion defence market will continue to grow, and capital expenses are expected to reach between US$ 18 billion and US$ 20 billion.

India is the largest importer of defence equipment, importing thrice as much as China and Pakistan each. The volume of Indian imports of major weapons rose by 111 per cent between 2004 and 2008 and again between 2009 and 2013, and its share of the volume of international arms imports increased from seven per cent to 14 per cent. Major suppliers of arms to India in 2009-13 were Russia (accounting for 75 per cent of imports) and the USA (seven per cent).

Large-scale modernisation of defence forces is on the anvil. The next decade is likely to see an exponential growth in combat systems as well as non-platform based SE programmes, with requirement for the 12th Plan (2012-2017) being pegged at over one trillion rupees. These would include:

• Tactical communication systems
• Battlefield management systems
• Network-centric warfare systems
• Future infantry soldier as systems
• Tank electronics
• Air defence systems
• Avionics, navigation equipment, radar and sonar
• Night-vision devices
• Host of associated and embedded electronics

The ‘Report of Working Group on Defence Equipment’ estimates the requirement of defence electronics to be of the size of ₹ 257 billion. This amounts to about 25 per cent of the capital expenditure projections of the working group by 2016-17. Thus, looking from the offset perspective, opportunity for Indian electronics manufacturing is huge.

SE is a niche segment characterised by high-cost and sophisticated technologies. A solid base of research and development (R&D) is required in order to remain at the forefront. Department of Electronics & Information Technology (DeitY) holds essential expertise complemented by a sturdy infrastructure to undertake R&D activities in this pivotal sector. The key thrust area is to develop state-of-the-art technology for designing, developing and upgrading mission-critical systems in defence and civil domains.

R&D labs and institutes of higher learning are restructured with state-of-the-art technology and infrastructure. The primary goal is to cater to the strategic needs of the sector essentially for the indigenisation of products as well as technologies, getting rid of hindrances in terms of unavailability of advanced technology and propel growth in this segment.

Electromagnetic wave applications, intelligent sensors, RFIDs, micro-robotics, intelligent materials, microelectronics systems, micro systems for manufacturing nano-materials, convergent technologies (nano-bio-infro-cogno-socio), deep space and others are some of the newest technologies being promoted.

Defence procurement: Key growth driver

“Today, Ministry of Defence (MoD) aims to create conditions conducive for domestic manufacturers, both public and private, so that they can play an active role in the SE domain. We are aiming at expediting decision making, as well as simplifying contractual and financial provisions to establish a level playing field for Indian companies to compete with foreign firms,” says Rao Inderjit Singh, honourable minister of state for planning (independent charge) and minister of state, Ministry of Defence.

Defence procurement in India is undertaken by Ministry of Defence under two heads: capital procurement and revenue procurement. Capital procurement of new equipment is governed by Defence Procurement Procedure 2013 (DPP 2013) while revenue procurement is dealt by Defence Procurement Manual 2009 (DPM 2009).

Government initiatives such as Defence Offsets and Defence Procurement Policy have opened a host of opportunities for industry players to gain from greater domestic value addition and indigenisation, respectively. Offsets have the flexibility in fostering partnerships with foreign majors and reduce the country’s heavy dependence on imports.

Post-independence, the defence industry in India was placed under the reserved list, thus entitling only state-owned companies to participate in defence production, which included nine defence PSUs (DPSUs), 39 OFs and 50 plus DRDO labs. The sector was opened to private sector in 2001 with a restrictive 26 per cent FDI cap. The FDI policy has, however, now further liberalised to an FDI cap of 49 per cent in 2014.

A technology perspective and capability roadmap (TPCR) based on a long-term integrated perspective plan (LTIPP) has been issued to the industry to help plan its R&D and infrastructure creation. Based on the approved LTIPP, equipment, weapon systems and platforms required in the coming years are expected to be developed/integrated/made within the country. Sub-systems/equipment/components may be imported, ensuring their availability at all times but design and integration of the platform/TPCR system are likely to be undertaken within the country.

Provisions have been made in DPP 2013 as well as DPM 2009 to support participation of MSMEs in the procurement process, particularly multiplier norms that provide steady business to them.

DRDO has issued a list of critical technologies to be developed or acquired. There may be a few Indian companies that could potentially pick up a few of these. This opportunity would also come to Indian companies in the shape of offsets as DRDO may source these from foreign OEMs.

In addition, DRDO has also come out with guidelines for transfer of technology (ToT) to the Indian industry and these will be made available to the industry at a small fee. This could be an opportunity as high as one trillion rupees or more, since most of the technologies fall in the SE domain.

The defence procure procedure is being refined continuously to create a level playing field between the private and public sector, and to expedite the procurement process as a whole. The current DPP 2013 is under review and a committee of experts has already submitted (July 2015) its final report to the defence minister. Currently, the emphasis is on giving a boost to the Indian defence industry, both in the public and private sector, by according a higher preference to Buy (Indian), Buy and Make (Indian) and Make (Indian) categorisation, bringing further clarity in the definition of Indian content and simplifying Buy and Make (Indian) procedure.

These amendments have seen an expansion of the categorisation process from only Buy cases to Buy and Make through ToT, Buy and Make (Indian) and Make (Indian) categories as well as refinements in offset policy guidelines and introduction of a new chapter on ship-building.

“There are huge opportunities for collaboration and creation of joint ventures in the defence electronics sector in India. However, the window of opportunity linked with it must benefit from big-ticket acquisitions and offset opportunities. Major companies in the global aviation industry are keenly watching the local market in India and scouting for design partners for aerospace and defence (A&D) products as India is fast emerging as a centre for engineering and design services,” explains Rao.

He adds, “The time is right for catapulting India into the league of technologically-advanced nations and I invite you all to respond to the call and move along with us on this cause of Make in India.”

Current industry scenario

The industry is dominated by defence PSUs and ordnance factories, which contribute about 90 per cent of the total domestic manufacturing. Combined, the DPSUs and ordnance factories have played a critical role in building a domestic industrial base in this sector as they typically outsource 20 per cent to 25 per cent of their production requirements to private companies.

In addition to public undertakings, there is a small but growing number of medium and large private companies that have already entered or are seriously evaluating opportunities to enter the market. These are in addition to 6000 MSMEs that work closely with DPSUs and the private sector.

SE, especially in defence domain, is a sensitive area and the current dependence on imports is a cause for concern. These systems are a key contributor to delivering the necessary competitive edge in conflict situations and thus, are a very important aspect of nearly all weapon systems, platforms and equipment. As a result, it is also one of the most protected industries around the world.

The Indian defence preparedness had to pass through a tough phase for several decades due to the sanctions imposed by the West. The situation was further complicated by the lack of a strong industrial base in the country, inadequate testing and other facilities and the shortage of trained/skilled human resource. Efforts in the country were limited to DRDO and DPSUs [Hindustan Aeronautics Ltd (HAL) and Bharat Electronics Ltd (BEL)] until recently.

Observing the huge potential ahead, domestic as well as global private sector companies are making inroads into the huge SE market, thrown open due to huge modernisation and acquisition programmes and offset opportunities.

Indian companies like Tata Power SED, L&T, M&M Defence Systems and Rolta are now competing with foreign established companies with global outreach. Several Tier 2 vendors such as Alpha Design, Astra Microwave and Data Patterns have also found their way into the value chain.

Despite these commendable efforts, the country still lacks the capabilities required to develop the core electronic segment of compact systems. These systems such as advanced radar technologies like AESA radar, C4ISR system and electronic warfare systems can tilt the scales either ways in a conflict scenario.

SE requires strong and sustained R&D and investment support to enable faster growth in this segment and to encourage domestic players to acquire, adopt or create new technologies.

Unless a vibrant domestic sector is created—one that includes MSMEs—procurements by the Indian government will only help create and maintain jobs in other countries. To be self-reliant and also be able to export, India will have to utilise the opportunity to make in India, to not only defend herself but also earn valuable foreign exchange.

Rao Inderjit Singh, hon’ble minister of state for planning (independent charge) and minister of state, Ministry of Defence

“Today, Ministry of Defence (MoD) aims to create conditions conducive for domestic manufacturers, both public and private, so that they can play an active role in the SE domain. We are aiming at expediting decision making, as well as simplifying contractual and financial provisions to establish a level playing field for Indian companies to compete with foreign firms.

Rahul Chaudhry, CEO, TATA Power SED

“Many a time, Make in India in defence boils down to replacing entire assembly shops of ToT in DPSUs with joint ventures or private sector assembly shops.

Philip Jacob, executive director D&E, Bharat Electronics Ltd

We have empanelled 146 private players as our partners in defence R&D and 64 of them are MSMEs. We have specific vendor development programmes under which we conduct training especially for quality improvement, as quality plays a critical role in defence electronics.

N. Ramachandran, managing director, MEL Systems

“Hand-holding and guaranteed buying programmes along with allocation of development fund by the government for select MSMEs on the basis of their capacity and expertise in the defence segment will be helpful for the SE industry. This selection can be done through defence RFI procedure.

Recommendation for creating a conducive environment for MSMEs in SE

Usefulness of policy interventions like offset norms and TPCR: Availability of TPCR and multiplier norms has the potential to improve MSME participation in the defence procurement process, under the provision of defence procurement offset norms. Offsets have increased participation of large integrators in defence procurement and the TPCR has also helped.

TPCR needs to give a realistic vision or roadmap. It should be more focussed on technologies leading to business opportunities and be able to give direction to an industry’s R&D efforts.

Understanding offset norms: More clarity is required regarding offset norms, particularly in determining what is local and what is foreign. For example, offset norms emphasise the need to source from domestic vendors instead of supporting domestic manufacturing. So multipliers should not be calculated on the basis of value addition rather it should be done on the billing value of the Indian partner as import content of the Indian partner may exceed 80 per cent and go up to 90 per cent.

Stage-wise calculation of value addition makes it very difficult to calculate how much local value addition is possible. This process needs further study and clarity.

It is currently not possible to meet all component requirements of the manufacturing process through domestic sourcing. Thus, to make it more feasible for domestic companies to participate, there should be clarity on the manufacturing value chain and licences such as SCOMET and procedures to issue such licences should be simplified.

Ensuring participation of MSMEs: There is an urgent need to deal with the losses that MSMEs incur when pitching for defence contracts. Clauses such as no cost no commitment (NCNC) should not be applicable to MSMEs manufacturing in India. Cost of the prototypes must be paid to MSMEs.

Similarly, the study recommends certain indirect financial support to MSMEs. These include lowering the cost of capital, offering an interest subsidy, dealing with issues relating to payment delays, need for securities/guarantees, blockage of funds, etc. The study recommended establishing a mechanism or policy to cover various financial bottlenecks in order to help MSMEs focus on manufacturing and R&D.

Other recommendations include setting up a development fund for select MSMEs, establishing a smoother procurement process for them to participate in tendering and promoting greater collaboration among MSMEs on projects. Another important recommendation is the need to review investment limits that define MSMEs as given in the MSMED Act 2006 and its Amendment needed to be inflation-adjusted.

Procurement: There are a number of recommendations to simplify the procurement process. These relate to identification of Indian offset partners (IOPs) by foreign companies, delay in finalising contracts resulting in technology obsolescence caused by the time lag between tendering and actual procurement, participation of the financial advisor and other decision makers in the procurement process, applicability of same import duties, central excise and sales tax (local taxes) for all vendors, demand for bank guarantees and requirement for detailed drawings from all vendors foreign or domestic, among others. All these issues need to be addressed.

Payment terms: The Indian private sector needs to be treated at par with DPSUs, ordinance factory board (OFB) units and foreign vendors. The private sector should have the same terms for payments and cost comparisons including applicable taxes and foreign exchange variations. Currently, preferential treatment is given to foreign companies. Domestic vendors must also be paid on the same terms applicable to foreign vendors, or through banks, where payments are tied to performance and not delayed due to procedural issues. Delays in payment should attract payment of interest to vendors.

Common ground as DPSUs: Private companies are seeking a level playing field, as is provided to DPSUs. Areas of concern include deals where transfer of technology is negotiated, taxation patterns for DPSUs vis-à-vis private companies, treatment in open tenders and transfer of technology from DRDO.

(Source: ELCINA study on Opportunities and Challenges in Strategic Electronics in Aerospace & Defence Sector with Focus on MSMEs, which was supported by EFY as research partner)

Favourable government policies

• The government has launched the Make in India initiative to promote manufacturing in the country. According to competitive assessment, 25 thrust sectors including manufacturing, relevant infrastructure and service sectors have been identified, spanning a number of administrative ministries and departments.

• Defence acquisition proposals worth more than ₹650 billion have been categorised under Buy (Indian) and Buy and Make (Indian).

• Various policy initiatives to promote and encourage entry into defence manufacturing have been put in place such as:

  1. Cap on FDI in the defence sector increased to 49 per cent via approval route

  2. To improve access to state-of-the-art technology, this cap can be increased even further with Cabinet Committee on Security (CCS) approval

  3. Requirement of single largest Indian ownership of 51 per cent of equity has been removed. This has been a long standing demand from the domestic industry

  4. Portfolio investments are now permitted up to 24 per cent in automatic route

  5. Liberalisation of industrial licensing policy by taking out all component parts, raw

• materials, testing equipment, etc

• Companies planning to manufacture dual-use items no longer require industrial licences and will also not be subjected to FDI ceiling of 49 per cent.

• Initiatives for R&D investment through technology development fund and tax incentives have been initiated.

• Policies for the MSME sector have been enabled.

By: Sudeshna Das