kno wle dge .whart o n.upe nn.

e du

http://kno wledge.wharto n.upenn.edu/article/whats-ailing-indias-defense-secto r/

Whats Ailing Indias Defense Sector?

No v 14, 2013 Law and Public Po licy Asia-Pacific India

Public Policy

In February 2010, Italian helicopter maker Finmeccanica won a contract f or 12 helicopters f rom the Indian government. T he $750 million contract f or AgustaWestland helicopters was the biggest f or the company in recent times. For Finmeccanicas CEO Giuseppe Orsi, it meant that the company stood a good chance of getting the Indian Navys $250 million light helicopter deal as well. As it turns out, the AgustaWestland deal stands cancelled. Earlier this year, Orsi was put in jail by Italian authorities in Milan f or paying bribes to secure the agreement. Bruno Spagnolini, who reported to Orsi and headed the helicopter unit, was put under house arrest. Indian def ense minister A. K. Antony has said the company, in the race f or aerospace contracts worth $12 billion in India, might be blacklisted. With Pakistan in the west and China in the east both of whom India has f ought wars with India is relying on def ense equipment that is more than 20 years old. T hat puts the countrys def ense preparedness at its lowest since the 1980s. India relies on f oreign players f or 70% of its def ense needs. Blacklisting major def ense companies and we have already done that with six would mean [that] we cant modernize our armed f orces. T hat would be disastrous, says a senior of f icial in the Indian army. T he main worry in Indian def ense circles is that contracts take years to be signed, and then sudden controversies crop up, preventing deals f rom going through. Ultimately, no one wins. To date, blacklisted companies include Rheinmetall Air Def ence, part of Germanys Rheinmetall AG, Israel Military Industries and Singapore Technologies Kinetics. All have been barred f rom def ense deals f or the next decade.

Blacklisting major defense companies and we have already done that with six would mean [that] we cant modernize our armed forces. Senior Official in the Indian Army

In the 1980s, the government of Prime Minister Rajiv Gandhi collapsed over charges that the Swedish gun manuf acturer Bof ors paid bribes to supply Howitzer f ield guns to the Indian Army. Af ter that, India did not purchase any guns until last year, when the government signed a deal with U.K.-based BAE systems. T hat means f or 20 years the Indian army did not have the Howitzers it needed to combat even low-level attacks f rom across the border. Dealing with Corruption While Antony is known f or being honest, he has been extremely slow at making decisions and designing better policies. A top executive at Boeing told Knowledge@Wharton, It does take time with other governments as well, but in India the process of decision making in def ense deals is extremely slow. T he companies are not going away, though all want a share of the $100 billion that India is expected to spend on def ense over the next f ive years. T his is not the f irst time that allegations of corruption have stalled a deal with no alternative in the works. In 2003, India issued an order f or 197 light helicopters worth between $500 million to $600 million. Sixty helicopters were to have been purchased outright, with the remaining 137 being built under license by Hindustan Aeronautics Limited (HAL). Eurocopters AS550 C3 Fennec and Bell Textrons 407 competed in the second and f inal round of summer trials, and as 2007 ticked toward a close, it looked like Eurocopter would emerge the winner. But then reports of corruption emerged, and the deal was derailed. To date, another deal has not been signed. T hat has delayed the armys modernization ef f orts. India will f ind it dif f icult to match up to China at this rate, given [the latter's] ongoing modernization and massive capacitybuilding. In the next f ew years, there will be a big gap in deterrence, notes Rahul Bhonsle, a def ense analyst based in New Delhi. T he problem now is two-f old: How to weed out the corruption bef ore entering into a contract, and how to speed up decision-making once such cases have been f ound. A def ense ministry of f icial says that one of the causes f or delay in f inalizing contracts is dif f erences between the ministry bureaucrats and senior of f icers in the Indian armed f orces. Unlike countries such as China or Russia, where senior def ense ministry of f icials have prior experience working in the armed f orces, Indian bureaucrats come f rom a separate cadre. Army of f icials allege that these bureaucrats have no experience and little knowledge of the industry. However, the def ense ministry of f icial says that matters are made worse by involvement of def ense personnel in corrupt deals. In the helicopters deal, f or example, the Central Bureau of Investigation (CBI), the f ederal investigative agency, named a f ormer air f orce chief as one of the accused. T he slow process of investigation means that Antony is moving ahead based on what others tell him rather than on a f irm f ooting. He recently said that Finmeccanica and Augusta might both be blacklisted. T hat was bef ore the CBI submitted its report. On the other hand, Femeccanica has sent a bill to the Indian Finance Ministry f or the three helicopters it had already delivered bef ore the scandal broke, since no charges of corruption were actually proved. Under an integrity pact signed with AugustaWestland, India can still cancel the contract and bar the f irm f rom bidding f or any government contracts f or at least f ive years.

India will find it difficult to match up to China at this rate, given [the latter's] ongoing modernization and massive capacity-building. Rahul Bhonsle

Sikorsky, part of United Technologies, was in the running f or the helicopter deal. One its top executives, a retired air f orce of f icer, says that the def ense ministry needs to be f ar more inf ormed at an earlier stage about corrupt practices. In its quest to guard against corruption, Indias def ense procurement system is now extremely complex, bureaucrats [have] become risk averse and the military was not getting the equipment it needed, Harsh Pant, an Indian def ense expert at Kings College in London, said in an interview with Bloomberg. Winds of Change Saikat Chaudhuri, executive director of the Mack Institute f or Innovation Management at Wharton, says that two things need to be done to clean up the system and introduce transparency. First, introduce a lobbying system like in the U.S., which essentially regulates and makes transparent the basic human behaviors that lead to corruption. Af ter all, it is not that corruption doesnt exist per se in the West, it has just been recognized that such human tendency f or power and money is innate and must be regulated as it is impossible to eliminate. According to Raj Kadyan, a retired army general and def ense analyst, transparency in the process is critical. What you need right now is f or the process to be transparent f rom the bidding process to the actual signing of the deal. Just blacklisting companies without taking other steps wont stop corruption, says Kadyan. T he second step, more specif ically related to def ense, notes Chaudhuri, is to nurture a healthy private sector to partake and eventually f orm a substantial part of the Indian def ense industry. T his will help build the capability base and also prevent everything remaining within the government ambit, including all procurement processes. I wish to stress, however, that blind privatization or transf er of work to private f irms is not the answer. It must be accompanied by a change in system like the introduction of lobbying.

It is not that corruption doesnt exist per se in the West, it has just been recognized that [it] is innate and must be regulated as it is impossible to eliminate. Saikat Chaudhuri

It does seem that things are changing, though slowly. T he main reason is that the government-owned industries like Hindustan Aeronautics Limited (HAL) or Bharat Electricals Limited (BEL) have f ailed to deliver the contracts they won, and with huge cost and time overruns. T he best example is the Arjun Tank, which remained in development f or over a decade. Finally, the army ordered new T-90 battle tanks f rom Russia. A 2012 report by Boston Consulting Group said productivity of public sector def ense companies in India was half the national average and lowest among all industries. According to John Elliot, a British journalist based in New Delhi f or the past 20 years, many f orces have colluded to stall private players f rom making a mark in this space. Elliot noted in his blog: T he Indian def ense establishment, which includes the def ense ministry, parts of the armed f orces, the public sector corporations, f oreign suppliers and def ense agents, have all connived in the past to block private sector development. Opportunity for Private Players While the public sector f irms are still trying their best to protect their turf , their shortcomings are becoming harder to ignore. Last year, f or the f irst time in years, the Indian Army invited a private sector group to compete f or a contract to build a new tactical communications system. T he private sector companies involved are Larsen & Toubro, Tata Power SED and HCL. T he f irst two have been def ense suppliers in smaller capacities f or years and specialize in high-precision engineering. HCL is one of the major Indian sof tware f irms. T hese three f irms will compete against Bharat Electronics, a def ense public sector corporation.

T he biggest push to get more private players involved came last year when the Planning Commission called f or Indian companies to be prime contractors f or all major contracts. T his is a big opportunity f or private sector companies, which currently account f or just 20% of Indias def ense spending. T he new procedures have a buy and make Indian provision which means only local companies, including joint ventures with overseas companies, can enter bids f or contracts. Since the new procedures were announced, Mahindra & Mahindra, Indias biggest tractor maker, set up a joint venture with Israel-based Raf ael Advanced Def ense Systems f or naval weapon equipment. Mahindra, which currently has negligible revenue f rom its def ense business, expects sales of about $500 million in the next 10 years, vice chairman and managing director Anand Mahindra said at that time. Wipro, Indias third largest sof tware exporter, has signed a deal with European consortium EADS to manuf acture aerospace precision engineering components. Reliance Industries, the Mumbai-based operator of the worlds biggest oil ref inery complex, entered into an agreement last year with Frances Dassault Aviation. Dassault is negotiating with the Indian government to sell 126 Raf ale f ighter aircraf t, the worlds biggest such contract in the last decade. Of course, this by itself doesnt mean corruption will go away. As Whartons Chaudhuri says, lobbying must also be permitted to make the process more transparent. A strong political leadership and will is of course desirable to develop the nation in all respects. It is tragic and inexcusable that even national security in India is compromised due to a lack thereof , notes Chaudhuri.