India: Strategic Partnership - The Many Flaws And The Way Ahead

Last Updated: 20 April 2018
Article by Kanishk

I. BACKGROUND

A committee of experts constituted by the Ministry of Defence ("MoD") under the chairmanship of Shri Dhirendra Singh ("Expert Committee") first mooted the strategic partnership model ("SP Model") in its report submitted in July, 2015 ("Expert Committee Report") for creating capacity in the private sector on a long-term basis in six strategic segments such as aircraft/helicopters, warships/submarines, armoured vehicles, missiles, command control systems and critical materials. The recommendation was accepted by the MoD and a task force under the Chairmanship of Dr. V.K. Aatre was constituted to lay down the criteria for selection of strategic partners ("Task Force").

The Task Force submitted its report to the MoD in January, 2016 ("Taskforce Report"). After considering the report and consulting with the various stakeholders including the industry, the MoD published Chapter VII of Defence Procurement Procedure, 2016 ("DPP-2016") titled Revitalising Defence Industrial Ecosystem Through Strategic Partnerships on May 31, 2017 ("SP Chapter").

After decades of endemic and painful delays in procurement which created unreliable defence infrastructure, severely crippling the defence preparedness of the country, the Strategic Partnership Model ("SP Model") was seen as the last hope.1 Unfortunately, the final form in which it has been introduced was drastically different from what was initially conceived by the Expert Committee. At best, the SP Chapter appears to be a hybrid and a difficult to implement variant of the existing procurement structures with all the flaws and no comparative advantage.

This paper analyses the various flaws in the SP Chapter and suggests the best mechanisms to plug the urgent needs of India's armed forces over the next few years. It would be meaningless to list the various shortfalls in the Indian defence infrastructure and the fairly straightforward reasons for the same. This has been widely and regularly reported in the national media and analysed by think tanks2. For this paper it should be sufficient to note that the Indian defence and security infrastructure remains weak, insufficient and unreliable. This is largely due to inefficient defence public sector entities and virtually non-existent private sector. This in turn was caused by consistently flawed policies including importantly procurement policies of the Indian government.

II. THREE MAJOR DEPARTURES AND ITS IMPACT

Instead of listing down all the shortcomings that the SP Chapter suffers from, I intend to concentrate on its three big flaws to demonstrate that it is not significantly different from the current procurement procedure. It is unlikely to either effectively equip the armed forces or create a robust private sector in defence manufacturing. If implemented, the outcome is expected to be as unsuccessful in achieving the identified goals as the previous procurement procedures.3

2.1 Flaw No. 1. – Back to L1 model

The Expert Committee explicitly suggested the cost plus mechanism of funding4 for the SP Model. Simply put cost plus model envisages that compensation to the manufacturer or the vendor would constitute of the cost incurred by the manufacturer and an assured rate of profit5. It further stated that the lowest bidder model based on invitation of commercial bids was not desirable and therefore should not be followed. It noted that "We are aware that most such criteria are used for selecting the best offer in commercial bids. Our model stops short of commercial bids...." "The Committee is conscious that its recommendations relating to the Strategic Partners which would be applicable to the 'Buy and Make' category, is of considerable import. Such a recommendation goes against the accepted grain of thinking which prefers competitive bids involving technical and commercial parameters." 6

The Expert Committee realised that a long term partnership which presupposes assured and repeat orders cannot be based on contract wise competitive bidding and therefore chose the cost plus model.

The Task Force also appeared to favour the cost plus model. While stating that "The pricing methods used for Acquisition Contracts may include cost plus method" it gave the flexibility to the MoD to finalise the pricing methodology.7 This was re-iterated by the Task Force in its recommendation for setting up an Audit wing in the MoD where it stated "There are several cost plus models internationally known and the procurement contracts will require specified cost plus structures which will have to be pre-approved by MoD."

In addition to explicit recommendations of two committees, there is sound rationale for not adopting the lowest bidder model for the SP Model. While describing this model of procurement the SP Chapter states that this model will require the private sector partner to make necessary long term investments in manufacturing infrastructure.8 If the procurement remains a onetime exercise based on one specific contract no long term investment will be made by any vendor due to inherent uncertainties. Only in a long term cost plus structure new products can be developed. In a competitive scenario where each procurement is through a specific Request for Proposal ("RFP") with one company winning one RFP and a different entity winning the next one in the same segment (such as aircrafts), there is no incentive for investment in research and development ("R&D"). In a competitive bidding scenario vendors look to reduce costs and R&D costs are usually first to be slashed. On the contrary, in such a scenario Indian entities are likely to enter into one time tech transfer/collaboration agreements with foreign partners in the context of a specific contract. In such a case the Indian industry will not carry out independent product development but will always remain dependent on foreign players. The SP Model was expected to change this. However, contrary to the recommendations, even though the SP Chapter retained the expectation of long term investments, it removed what was supposed to be the primary driver for such investment- the cost plus model. In terms of the SP Chapter, the selection of the strategic partner ("SP") shall be on the basis of lowest bid, segment-wise9. This essentially means that the bidder quoting the lowest price (L1) will be granted the contract.

The change from cost plus model to a lowest bid model has converted the long term SP Model to an item by item or a contract to contract procurement, which is not different from the current system under buy and buy and make structures. Therefore, such a model will have all the flaws with which the current procurement procedure suffers.

In this context it is remarkable that though the cost plus method has been rejected, the audit rights associated with cost plus method10 have been retained in the SP Chapter by the MoD. In a lowest bidder scenario why would MoD need the "right to conduct special audit of all certifications and costs relevant to the Segment at all or any stages (tiers) of manufacturing/ production/ assembly"11, remains a mystery as MoD is unlikely to pay a rupee more even if the cost escalates many fold. A close audit of costs is essential only in cost plus scenario.

2.2 Flaw No. 2. – Assured orders: The Missing bedrock of the SP Model

After the issue concerning pricing methodology, the second big concern is in relation to orders from the MoD. MoD orders for large equipment are unpredictable, marred by delays and few and far between. The SP Model was recommended on the presumption that the MoD would provide assured orders and on the basis of such assured long term orders a private sector partner can invest and develop state of the art products for the Indian armed forces.12 In this process, the Indian Strategic Partner was expected to create a large eco-system thereby building a defence manufacturing infrastructure in the private sector. The SP Chapter completely undermines this principle and instead of envisaging a long term relationship with multiple orders to one entity it contemplates an RFP13 to RFP or a contract to contract model.14 Along with the issue concerning pricing methodology, this departure completes the process of converting the Strategic Partnership into a per contract relationship akin to existing procedures under the DPP.

As regards the concept of providing assured long term or repeat orders thereby incentivising the SP to invest in infrastructure and research and development, the SP Chapter states that "subsequent acquisitions in the identified segment/platforms should ideally be carried out from Indian companies under Buy (IDDM), Buy (Indian, Buy and Make (Indian) and Make categories of acquisition under the DPP"15. This clarifies that there would be no preference to the SP, no repeat orders will be preferentially given to the SP and an SP will have to compete like any other player. In such a scenario why would the SP invest even a rupee more than required to satisfy the single contract granted to it. Though MoD clearly has high hopes, SP should be expected to behave exactly like any other player in the industry.

2.3 Flaw No. 3. – Merely a Policy Statement

The third debilitating weakness in the SP Chapter relates to the content and the spirit of the chapter. The MoD had announced its intention to introduce a new strategic partnership model of procurement well in advance. The SP Chapter appears to have been issued in haste solely to meet this commitment. It is not in a form which can be implemented. A good example of this is absence of prescribed form of contracts.

A number of procurements fail due to the vendor and MoD not reaching common ground on the procurement contract. The MoD is reluctant to change the standard form contract under the relevant DPP and this thinly populated standard form contract often fails to capture the nuances of modern contracting leading to parties not signing the procurement contract even after selection of a vendor as the lowest bidder - L1. In this context it was critical that the MoD not only made a policy announcement relating to the SP Model but provided all the bells and whistles required to make it successful. Unfortunately, this is not the case.

The SP model visualised a long term relationship with mutual obligations and support over a long period of time thereby reducing the procurement time and uncertainties for both parties involved. This could have been achieved only by a long term contract between the MoD and the SP. The Expert Committee Report16 recommended such a covenant and the Taskforce Report not only detailed the concept but also provides a format of a long term covenant. Along with junking the long term nature of the relationship, even the concept of the long term covenant has been ignored in the SP Chapter.

Additionally, no specific or unique contents have been prescribed for the procurement contract under the SP Model. Therefore, it appears that the standard contract document as prescribed in DPP-2016 would be followed thereby further reducing the SP Model to a buy or a buy and make type of a model.

III. THE WAY AHEAD

The previous section tries to identify the leading reasons why the SP Model in its current avatar is unlikely to be the answer that the country has been looking for in relation to defence sector procurement and preparedness of the forces. Given that it has taken the MoD many years to come up with this initial policy statement, improving it to a level which may be workable is expected to take many more years. Therefore, the answer to India's woes lies elsewhere.

Traditionally, Russia has been the largest supplier of defence stores to India. In the last few years USA and Israel have moved in along with countries like France and Germany.17 As regards the mechanism of procurement, the Government to Government ("G to G") procurement has been the swiftest and the most successful mechanism of procurement. Tender based competitive bidding have a significant share but most of the pre-contract signing delays relate to this type of procurement. According to some commentators 70% of defence procurement is undertaken through the G to G route.18 This does not appear to be surprising as most of the purchases from Russia are through this route and of late a number of G to G contracts have been entered into with USA19 and France20.

The G to G procurement largely circumvents the procurement procedure laid down in the DPP. It is the procedure laid down in the DPP which has led to repeated delays and complications in procurements.21 Every few years attempts are made to improve the DPP. As a result, after the first DPP in 2002 subsequent iteration have been issued in 2005, 2006, 2008, 2009, 2011, 2013 and 2016 with many amendments and correction in between two DPPs. DPP 2016 is the most recent iteration which was expected to introduce a new and revolutionary procurement procedure being the SP Model. As discussed, the SP Model is unlikely to speed up or simplify the procurement procedures. Consequently, the government of the day would have to fall back on the G to G route under paras 104 and 106 of DPP 2016 to plug the critical and urgent requirements of the armed forces. Only the mundane and non-critical items should ideally be procured under the DPP. As it takes many years before a proposal reaches the stage of approval by the decision making authorities, one would think most if not all the purchases approved by the MoD would be of critical and urgent requirements only. A "good to have" becomes a critical need in the 5-10 years that it takes from a proposal to be finally approved by the decision making bodies.

It is also worth noting that though the MoD has recently attempted to focus on procurements from Indian vendors, the share of procurements from foreign vendors is greater in terms of value as compared to Indian vendors.22 This trend is expected to last atleast a few more years in one form or the other. Even if indigenization is made compulsory in RFPs, foreign origin products will continue to be the products of choice for the armed forces.

Therefore, in addition to having strong sales and marketing teams, all defence manufacturers across the world need strong teams to liaison and lobby with their own governments such that these foreign governments make proposals to the Government of India at the highest levels and conclude government to government sales. Some of the most successful companies and countries are already doing this.23 Companies which are not using their governments to lobby with Indian government are effectively limiting the size of the Indian opportunity to around 20-30 percent of the entire import requirement. This is primarily because competitive bidding is unlikely to have a larger portion than 20-30% in the total procurement of imported defence equipment and stores24. Therefore, for the MoD the G to G route is likely to remain the preferred route if it wants to speed up procurement of large equipment and foreign vendors are required to use their strong relationships with home country governments to be successful in India.

Footnotes

1. Press Information Bureau, Press Release, "the Strategic Partnership (SP) policy has been promulgated on 31.05.2017 as Chapter VII of the Defence Procurement Procedure (DPP) – 2016 titled as "Revitalising Defence Industrial Ecosystem through Strategic Partnership" with an aim to institutionalize a transparent, objective and functional mechanism to encourage broader participation of the private sector, in manufacturing of major Defence platforms. It will serve to enhance competition, increase efficiencies, facilitate faster and more significant absorption of technology, create a tiered industrial ecosystem, trigger innovation, promote participation in global value chains as well as exports leading to reduction in dependence on imports and gradually ensure greater self-reliance and dependability of supplies essential to meet national security objectives" (February 7, 2018) available at (http://pib.nic.in/PressReleseDetail.aspx?PRID=1519476). This information was given by Raksha Rajya Mantri Dr. Subhash Bhamre in a written reply to Shrimati Ranjeet Ranjan and Shri Rajesh Ranjan in Lok Sabha (February 7, 2018) available at (http://164.100.47.194/Loksabha/Questions/Qministrysearch.aspx).

2. See, The Hindu BusinessLine, 'Firing up our defence industry' (August 3, 2017), available at (https://www.thehindubusinessline.com/opinion/firing-up-our-defenceindustry/article9800992.ece;Observer Research Foundation, 'Streamlining India's Defence Procurement System' (July 8, 2014), available at http://www.orfonline.org/research/streamlining-indias-defence-procurement-system/?wb48617274=929A2E15 ; Vinod Mishra, 'Core Concerns in Indian Defence and the Imperatives for Reforms' (2015), available at (https://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=17&ved=0ahUKEwiylbPms7nZAhXMxbwKHRaQAUM4ChAWCEgwBg&url=https%3A%2F%2Fidsa.in%2Fsystem%2Ffiles%2Fbook%2FBook_CoreConcernsinIndianDefence.pdf&usg=AOvVaw24QhoAgbhohILJkZ01cay8

3. Press Information Bureau, Press Release, "Till February 7, 2018 only three Requests for Information (RFIs) had been issued under the SP Model for Submarines, Naval Utility Helicopter and Future ready Combat Vehicles (FRCV)", (February 7, 2018) available at (http://pib.nic.in/PressReleseDetail.aspx?PRID=1519476 ). This information was given by Raksha Rajya Mantri Dr. Subhash Bhamre in a written reply to Shrimati Ranjeet Ranjan and Shri Rajesh Ranjan in Lok Sabha (February 7, 2018) available at (http://164.100.47.194/Loksabha/Questions/Qministrysearch.aspx ).

4. Ministry of Defence, Expert Committee Report, para 3.3.09, page 48, (July 2015) available at (https://mod.gov.in/sites/default/files/Reportddp.pdf )

5. This model normally entails strong audit rights and frequent reviews by the procuring entity to ensure that costs disclosed by the manufacturer as not unreasonable or artificial.

6. Ministry of Defence, Expert Committee Report, para 3.3.10, page 48, (July 2015) available at (https://mod.gov.in/sites/default/files/Reportddp.pdf )

7. Ministry of Defence, Report of the Task Force, para 8.1, page 65, (January 2016) available at (https://mod.gov.in/dod/news/report-task-force-selection-strategic-partners-chaired-dr-vk-aatre)

8. Ministry of Defence, 'Chapter 7 – Revitalising defence industrial ecosystem through Strategic Partnerships', para 3, pages 1-2, available at (https://mod.gov.in/dod/sites/default/files/Chapterdppn_0.pdf).

9. Ministry of Defence, 'Chapter 7 – Revitalising defence industrial ecosystem through Strategic Partnerships', para 36, page 10, available at (https://mod.gov.in/dod/sites/default/files/Chapterdppn_0.pdf).

10. Ministry of Defence, Expert Committee Report, "Lest there be lingering doubts on the compensation package to the SP ('taking the MoD for a ride') – a rigorous audit, including cost audit mechanism would be instituted. The contract would allow for inspection of books for the purpose.", (July 2015) para 3.3.08, page 48, (https://mod.gov.in/sites/default/files/Reportddp.pdf )

11. Ministry of Defence, 'Chapter 7 – Revitalising defence industrial ecosystem through Strategic Partnerships', para 43, page 12, available at (https://mod.gov.in/dod/sites/default/files/Chapterdppn_0.pdf).

12. See, Ministry of Defence, Expert Committee Report, para 3.3.09(i), Page 48; See also, para 3.3.05 (iii), available at (https://mod.gov.in/sites/default/files/Reportddp.pdf)

13. Request for proposal (i.e. tender document).

14. This is contrary to para 3.3.01 of Expert Committee Report which notes that "...fostering a constructive, long term partnership is considered not just sound economic option but a strategic imperative to minimize dependence on foreign vendors. It is a known fact that larger and sustained production volume of any system leads to optimization of cost as well as improved production efficiency." available at (https://mod.gov.in/sites/default/files/Reportddp.pdf).

15. Ministry of Defence, 'Chapter 7 – Revitalising defence industrial ecosystem through Strategic Partnerships', para 45, page 12, available at (https://mod.gov.in/dod/sites/default/files/Chapterdppn_0.pdf). For details on Buy (IDDM), Buy (Indian, Buy and Make (Indian) and Make categories please see Defence Procurement Procedure 2016 pg 1-3 available at https://www.mod.gov.in/dod/sites/default/files/dppm.pdf_0.pdf

16. Ministry of Defence, Expert Committee Report: "Long term covenants between Government, Strategic Partners and tierised partners to guide not only the first contract (after determination of the segment and SP) but subsequent ones to follow, so that resources are utilised optimally over long periods of time", 3.3.09 (ix), page 40, available at (https://mod.gov.in/sites/default/files/Reportddp.pdf).

17. Stockholm International Peace Research Institute, 'Trends in International Arms Transfers, 2016', SIPRI Fact Sheet (February 2017), available at (https://www.sipri.org/publications/2017/sipri-fact-sheets/trends-international-arms-transfers-2016).

18. Ritika Behl, 'Government to Government Deals: Playing Safe', Indian Defence Production and Acquisition News, available at (http://www.defproac.com/?p=3961).

19. In 2016, BAE Systems received a $542 million contract from the U.S. Department of Defense to provide 145 M777 ultra-lightweight howitzers to the Indian Army through a Foreign Military Sale between the U.S. and Indian governments. Available at (https://www.baesystems.com/en/article/bae-systems-receives--542-million-contract-for-india-m777-howitzers); In 2016, India signed an agreement with the US Department of Defense to acquire Stinger air-to-air missiles made by Raytheon. Available at (http://www.livemint.com/Politics/9TNyS9Xe9fsVCA4tC2LZYP/India-to-acquire-Raytheon-Stinger missiles.html).

20. The Hindu, 'India, France ink €7.87 billion agreement for 36 Rafales', (September 23, 2016) available at (http://www.thehindu.com/news/national/India-France-ink-%E2%82%AC7.87-billion-agreement-for-36-Rafales/article14995775.ece).

21. Ministry of Defence, DPP-2016, "There may be occasions when procurements would have to be done from friendly foreign countries which may be necessitated due to geo-strategic advantages that are likely to accrue to our country. Such procurements would not classically follow the Standard Procurement Procedure and the Standard Contract Document but would be based on mutually agreed provisions between the Governments of both the countries", para 104, page 29.

Para 106, Page 30, DPP-2016 "106. Procurement on Strategic Considerations. In certain acquisition cases, imperatives of strategic partnerships or major diplomatic, political, economic, technological or military benefits deriving from a particular procurement may be the principal factor determining the choice of a specific platform or equipment on a single vendor basis. These considerations may also dictate the selection of particular equipment offered by a vendor not necessarily the lowest bidder (L1). Decisions on all such acquisitions would be taken by the Cabinet Committee on Security (CCS) on the recommendations of the DPB."

22. Press Information Bureau, Press Release, 'Self Reliance in Defence Production' (February 7, 2018) available at (http://pib.nic.in/newsite/PrintRelease.aspx?relid=176303 ). This information was originally given by Raksha Rjya Mantri Dr. Subhash Bhamre in a written reply to Shri Ramesh Chander Kaushik and others in Lok Sabha on February 7, 2018, available at (http://164.100.47.194/Loksabha/Questions/Qministrysearch.aspx).

23. The Hindu, 'France pushes for Rafale deal', (June 30, 2014) available at (http://www.thehindu.com/news/national/france-pushes-for-rafale-deal/article6163539.ece); The Hindu, 'Trump, Modi to discuss defence, trade on sidelines of E. Asia summit', (November 3, 2017) available at (https://www.thehindubusinessline.com/economy/policy/trump-modi-to-discuss-defence-trade-on-sidelines-of-e-asia-summit/article9942686.ece)

24. See Ritika Behl, 'Government to Government Deals: Playing Safe', Indian Defence Production and Acquisition News, available at (http://www.defproac.com/?p=3961).

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