Introduction

As part of the ongoing modernization drive of the Indian armed forces, the central government has increased the allocated expenditure in the defence sector to US$ 37.3 billion approximately. Of this, USD 12.5 billion is allocated for direct defence capital acquisition and US$ 15.73 is allocated for capital expenditure which is an increase of approximately 12% from the previous assessment year.¹ In addition to the increased momentum of capital expenditure, the Ministry of Defence (“MOD”) has released the Defence Procurement Procedure 2011 (“DPP 2011”) which supersedes the DPP 2008 w.e.f. January 1, 2011.

The DPP, which has now been revised six times, was first released in 2001 to tackle the conflicting requirements of expeditious acquisition of defence goods, promoting and developing domestic defence production capabilities and transparency and public accountability. However, despite several beneficial changes brought about in 2008, several considerations of the vendors still needed to be addressed.

Furthermore, the MOD has also released the first Defence Production Policy which is an indicative policy for procurement. This policy outlines the preference to indigenously designed or manufactured products while acquiring capital defence related equipment.

The present defence bulletin focuses on the salient features of the DPP 2011 and the significant changes brought in by it along with the implications of the same on the domestic and foreign vendors and defence acquisitions in India.

1.0 Highlights of the DPP 2011

1.1 Offsets

One of the most significant changes introduced is with regard to offsets. The DPP 2011 has expanded the scope of the offset policy by permitting investment in “civil aerospace”, “internal security” and “training” within the ambit of eligible products and services for discharge of offset obligation. The list of eligible offsets now covers almost all aspects of civil aerospace, e.g. airframes, aero-engines, components, engineering, technical publications, flying and technical training, to name a few. For internal security, a wide range of weapons and services for counter-terrorist activities have been included.

This has been a long standing request of the vendors owing to the co-existence of these sectors and the confusion that prevailed in bids in the past. These changes introduced have a dual impact on the domestic sector as apart from broadening the scope of offset activities and increasing vendor participation, it will also encourage the building up of the domestic civil aviation sector with indigenous defence production capabilities for both internal security as well as the armed forces. On the flipside, it is likely that by including services such as “training” within the scope of offsets, foreign vendors may overprice the same affecting the benefit from offsets.

1.2 Shipbuilding Procedure

Shipbuilding is a capital intensive industry in its own right. Taking into account the requests of the ship-building industry, a separate Chapter III under the DPP 2011 covering shipbuilding activity and a separate procedure for designing, construction and acquisition of ships for the armed forces have been laid down. The existing Chapter III has been overhauled to provide for shipbuilding on a competitive basis for private and government-owned shipyards as well as on nomination basis for solely state-owned shipyards.

The changed procedure under Chapter III now clearly provides a stepwise acquisition process, several clauses that strengthen the contracting mechanisms with payments now linked to stages of construction. The ultimate goal for making the changes is to promote development in the domestic shipbuilding sector as well as to increase the competitive edge of both the private and public sector domestically.

1.3 Other Commercial Changes

Besides the specific changes for leveling the playing field for private defence manufacturers, several provisions of the acquisition procedure have been tweaked based on past experiences and feedback to make the process more vendor-friendly and efficient. Some of the important commercial changes are briefly mentioned below:

• Bank guarantees under the Integrity Pact have now been linked to the validity of the Commercial Offer submitted by vendors and are, therefore, no longer indefinite.

• Instead of furnishing separate financial bonds for performance of contract and warranty of equipment, a single Performance-cum-Warranty Bond would be required at 5% of the contract value. These practical inputs will substantially trim down the commercial quote of the vendors leading to a benefit to the State.

• In an effort to place the private sector at par with the Defence Public Sector Undertakings (“DPSUs”), the Exchange Rate Variation clause has now been made

applicable to all Indian vendors when they compete with their foreign counterparts under the “Buy Global” category, which allows them the benefit of any variation in foreign exchange. Furthermore, the Base Rate of RBI has replaced Prime Lending Rate.

• A significant change is the removal of the stringent clause for blacklisting vendors for delay in delivery of equipment under fast track procurement, with marginal enhancement of liquidated damages to ensure greater accountability. The increase in economic liability on the vendor will provide a realistic remedy to the MOD.

• TOT for maintenance infrastructure from foreign vendors now references any company including the DPSUs. The reference only to RUR’s has now been removed opening up this area to private entities.

Conclusion

The revisions carried out under the DPP 2011 clearly denote a serious intent to develop domestic defence capabilities, industry and competition. In the process of evolution, the MOD has in fact addressed several concerns of the stake holders; however the DPP 2011 is still fraught with problems. Some of the windows for improvement include, primarily, the absence of a single dedicated procurement body which covers the gamut of functional heads. Currently there is an overlap of responsibilities within the various departments in the MOD which need to be streamlined in order to efficaciously take decisions and effect policies. An integrated system would check the mammoth delays in acquisition, improvement in formulation of QRs, trial and technical evaluations.

To augment the confusion are the numerous overlapping categories of procurement with distinct conditions in each which needs to be simplified. The DPP 2011 has also failed to address critical concerns of the vendors relating to short time- frame for banking of offsets and TOT of strategic knowledge which is vital for indigenization.

Lastly, no steps have been indicated for modifying the FDI policy which is critical to eliminate the limitations of the procurement and offset policy. Holistically, while there has been evolution in the DPP since 2001, in view of largely procedural amendments being affected rather than structural issues and the continuing lack of clarity on procurement policies, it is unlikely that the changes brought in the recent DPP 2011 will have a far-reaching impact for the vendors.

Authored by:
Ashutosh Chandola

¹ “Union Budget 2011: 11% hike in defence allocation” The Times of India, electronic version, as on February 28, 2011 by IANS.