Budget should focus on defence modernisation, address concerns over Make in India

India has been ranked as the country with the fourth largest budget expenditure in defence, following a 13.1 percent increase in its 2016-17 budget . While the base numbers appear impressive, a deeper look suggests that a substantial part of the increase in the budget expenditure has occurred to accommodate increase in pays, pensions and perks for defence personnel. Some have argued that this has come at the cost of capital expenditure. [caption id=“attachment_2649586” align=“alignleft” width=“380”]  Representational image. Reuters[/caption] The table below provides a comparative analysis between the allocations made in 2015-16 budget compared to 2016-17 budget numbers in capital and revenue expenditure.

The table above clearly indicates that resources focused growth has slowly started to eat into the capital expenditure which is essential for modernisation of the defence services and for successful implementation of procurement contracts. While the increase in revenue expenditure spending by the government is understandable, given the emphasis of the government to increase the manpower of defence services and the rising costs associated with it due to the increase in salaries. An examination of actual spending vis-à-vis allocation of the government in capital expenditure throws up interesting statistics. In the last four years, the government has not been able to spend the allocated capital and modernisation expenditure and has inevitably underutilised the allocated amount.

While the recent liberalisation of Defence Procurement Policy in 2016 (DPP 2016) is a welcome move by the government, there are still concerns that remain. For the ‘Make in India’ programme, DPP 2016 has restricted the participation to ‘only Indian vendors including Association of Persons’. However, only entities with majority resident Indian holding would be eligible for ‘Make in India’ projects. In other words, joint ventures having foreign equity of more than 49 percent are not eligible. FDI Press Note 12 of 2015 has created an ambiguity by the requirement that any increase in foreign equity or a transfer of shares to a new foreign investor in a company that does not require or hold an industrial licence is subject to the approval of the Government of India. On the face of it, this appears to be a measure to bring the supply chain under the careful gaze of the regulators. This condition should trigger only in the case where the dual use product has an exclusive military application but does not require an industrial license. A clarification specifying that the condition would not apply for dual use products with non-military application is awaited and required. The government intends to procure benefits for the local defence industries in both public and private sector. However, the current DPP policy is perceived by many foreign players to be restrictive as the scope of offsets is generally considered to be narrow. Global players have been lobbying for a considerable time and have been pitching for increased privatisation of the defence sector. Such privatisation will go a long way in enhancing India’s technical and manufacturing potential in defence. Hopefully, the forthcoming budget should actually be a year in which real budget expenditure is allocated towards capital expenditure and for modernisation of resources. Further, all the allocated expenses must be used in the acquisitions and capital expenditure space to generate jobs and promote investments in the defence sector. (Bharat Anand is Partner; and Satish Padhi, Associate - Corporate and Defence Practice Group, KCO Delhi. They can be reached at Bharat.anand@khaitanco.com and Satish.padhi@khaitanco.com) For full coverage of Union Budget 2017 click here.