Mar 29, 2012

Joint Ventures – Entry Route to Indian Defence Industry

General
In the inaugural address at the DefExpo 2012, India’s Minister of State for Defence Dr. MM Pallam Raju announced that the Government would encourage Joint Ventures. The Minister also stated that the joint venture route was the most promising for partnerships for co development of products in the country. Dr Pallam Raju stated, “We are looking for partnerships and co-development arrangements and formation of Joint Ventures in the Critical Technology Areas”.

The government has also issued guidelines for establishing joint venture companies by the Defence Public Sector Undertakings (DPSUs). The JV appears to be a continuation of the Defence Production Policy January 2011 which had opened the way for formation of consortia, joint ventures and public private partnerships within the Government approved framework.  This will open the opportunity for companies jointly develop products with DPSUs in India. The DPSUs in India with their product profile are Hindustan Aeronautics Limited (HAL) – Aircraft and Helicopters, Bharat Electronics Limited (BEL) – Electronics and communication Equipment, Bharat Earth Movers Limited (BEML) – Heavy Vehicles, Mazagon Dock Ltd (MDL) – Ships, Goa Shipyard Limited (GSL) – Ships, Garden Reach Shipbuilders and Engineers Limited (GRSE) – Ships, Hindustan Shipyard Limited (HSL) – Ships, Bharat Dynamics Limited (BDL) – Missiles, Mishra Dhatu Nigam Limited (MIDHANI) – Minerals.

The Opportunities
The range of products manufactured by  the DPSUs provides facilitates joint ventures mainly in the field of aviation, electronics and communication, B Vehicles, ship building, missiles and mineral development. While the field of missiles is regulated, other areas include both high and low technology which include a wide array of products which will provide sufficient scope for Joint Ventures by Indian and foreign private sector players. The advantage of Indian defence is larger off takes. For example with over 350 infantry battalions, the Indian Army can be a huge customer for walkie talkie radio sets, a small but essential item for soldiers in varied operations. BEL will be the lead DPSU for the proposed joint venture by any firm which may generate a huge production line worth thousands of walkie talkie sets. This does not include the FINSAS programme or Future Infantry Soldier As A System under consideration by the Indian Army which is likely to generate huge volumes for various types of say electronics and communication equipment.

Ship building is another promising area where there is scope for a number of joint ventures. Given that the Indian Navy has set into motion a very large modernization programme with  46 ships "on order“ including two aircraft carriers, six submarines, seven guided-missile destroyers, four anti-submarine warfare corvettes, nine naval off-shore patrol vessels and eight amphibious craft there is a paucity of shipyards. Presently four shipyards have been included in the DPSU category. While a JV between defence shipyard Mazagon Dock Ltd (MDL) and private shipyard Pipavav was under finalization it was placed on hold and is also likely to get the go ahead by the Defence Ministry now.

In a speedy follow up of the JV proposal, Defence Minister Shri AK Antony on 29 February asked the Hindustan Aeronautics Limited (HAL) to realign its business processes for strategic alliances and joint ventures, as also, to step up R&D efforts to remain globally competitive. Addressing a meeting of the Parliamentary Consultative Committee attached to his ministry, Shri Antony said HAL should partner with design laboratories like DRDO and CSIR for the development of indigenous aircraft, engines and systems. He said, what is more, HAL should adopt best practices followed by the global leaders in the field of project management, quality control systems, vendor deployment and supply chain management.

HAL, the leading Defence Public Sector Undertaking, has a turnover of over Rs.13, 000 Crores and is set for a quantum jump with the planned acquisition and production of Light Combat Aircraft, Light Utility Helicopter, Medium Multirole Combat Aircraft, Fifth Generation Fighter Aircraft, Multirole Transport Aircraft, and Basic Trainer Aircraft in its assembly lines in the coming years. However without a JV route it is unlikely to develop top of the line products to meet the vast requirement of the Indian defence sector where the number of helicopters alone may exceed over 1000 in the coming years.

The key advantages of establishing JV for Indian and foreign private sector majors are as follows:-

1. Speedy entry into the Indian defence sector by exploiting the potential offered.
2. Large PSU order book that is full with limited capacity for fulfillment in the near term.
3. DPSU’s get orders by nomination which can be a route for entry of private players       thus avoiding the tedious process of competing for defence procurement.
4. For the DPSU, high technology intervention will be facilitated.

Brief of the Guidelines
As per the Guidelines issued by the Ministry of Defence on 17 February 2012, DPSUs may consider formation of suitable partnerships both with Indian as well as foreign companies in order to harness new opportunities to augment indigenous production (Para 2.1).  The route adopted could be varied from, “outsourcing, subcontracting, formation of consortia, project – specific special purpose vehicles (SPVs), formation of JVs, etc.” This gives sufficient flexibility to the DPSU for selection of the best mode of collaboration with private sector partners to create additional capacities without allowing the existing capacity to idle.  (2.2). However there are restrictions in terms of the capacity to be utilized and orders which are said to be in terms of the, ““Minimum Economic Quantities” (MEQs)”. (2.4).

The JV route also facilitates absorption of, “propriety technologies and/ or projects with the DPSU as the offset partner etc.” (4.1). Thus companies with a strong technology background and able to provide cutting edge skills in various fields have a good scope to be the preferred partner with the DPSU through the JV.

Given the nature of the industry and its strategic implications, a suitable Non-Disclosure Agreement (NDA) is required to be signed with prospective partner(s) before sharing any confidential information concerning the DPSU. (4.2). This may also be applicable for the DPSU where technology is shared by a private entity. When undertaking a JV with an Indian or a foreign company all provisions of the Companies Act, 1956 and the Foreign Exchange Management Act, 1999, as amended from time to time would govern the JV Company and the corresponding share holding agreement (SHA) will be drawn up. (4.5). Suitable exit provisions have also been incorporated in the JV Guidelines providing for safety and security of the capital and interests of the DPSU.

Implications of Guidelines
Introduction of the processes for joint ventures applicable to the private sector to the defence within the overall laid down limits of the guidelines laid down by the Department of Public Enterprises; Government of India should pave the way for entry of private players in JVs. The overall ceiling on such investment in all projects put together shall be 30% of the net worth. The ceiling on equity investment shall be 15% of the net worth in one project limited to Rs 1,000 Crores (USD 200 million) in case of Nirvana companies this includes only two, HAL and BEL and Rs 500 Crores (USD 100 Million) in case of Miniratna Category-I companies which includes all other PSUs less the HSL. This restriction may prevent any major project being undertaken through the JV; however the route may be open for smaller companies including technology incubators for productionalising their ventures.

Given the national security implications the guidelines for JVs has given the, “affirmative right,” to DPSU for key JV decisions to include, “amendments to the Articles of Association of the JV Company, declaration of dividend, sale of substantial assets, and formation of further JVs/ subsidiaries.” The affirmative rights of DPSUs have been extensively covered in the JV Guidelines (3.2). This may restrict the flexibility available to the JV partner though it provides for control of the JV in strategic interest.

Given that the orders are to be for MEQs how much this would induce the foreign suppliers to form JVs with the Indian DPSU with restricted numbers being sought remains to be seen. Thus there may be inherent challenges faced for formation of JVs in terms of scope for investment total as well as in a JV and also the supply orders that can be generated.

Comments and Analysis
Joint Ventures in the public sector defence undertakings are the route that has been proposed by the government to open up defence sector for private firms. This  may provide scope for even foreign firms to gain an entry into the protected defence sector in India for there have been many proposals that could not move forward due to challenges faced of restrictions of 26 percent FDI in defence. This is a slow and steady step that has been taken to open up the defence sector and should provide an impetus for overall growth and a road map for entry for many private players. With 9 PSUs many of whom are making huge profits due to captive markets there should be scope for entry of the private sector in the days ahead. On the other hand the government has quietly dropped the proposal for nomination of private sector companies at par with the public under the RUR or Raksha Udyog Ratna category.

An important aspect of India’s defence production capability is Ordnance Factories. As Laxman Behera of the Institute of Defence Studies and Analyses indicates, the main thrust for modernization and indigenization has to be the Ordnance Factories for which JVs for an important route which has not been considered in the Guidelines. Hopefully the Ordnance Factories will be included in this paradigm in the days to come.

As India grapples with the challenge of indigenisation of defence production without whole sale privatisation of defence industry the route adopted now appears to be a JV between DPSUs and private players. These JVs would have greater autonomy vis a vis the parent PSU and should provide scope for private enterprises participation in the defence sector. While it has been felt by the private players that the DPSUs are having unfair advantage as they have the monopoly and first rights on all defence contracts, the challenge may to an extent be overcome as a JV with a DPSU would provide scope for more fair play. On the other hand this would bring into public sector better technology, greater accountability and efficiency which have been the bane of the past.

On the whole India would have to work out a Defence Production Indigenisation Strategy in the long term thereby providing measurable milestones towards achieving full scale indigenous R & D and defence production capability over the next two to three decades. While there is a lot of debate on an autonomous national strategic trajectory, till defence indigenisation is achieved, this will remain taps on the armchair strategist’s keyboard.[For detailed guidance on joint venture establishment email rkbhonsle@gmail.com]

Related Tags

• India
• Joint Venture
• DPSU
• Indigenisation
• Production

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