Make in India-Defence opportunities for MSMEs and start ups

The defence sector offers significant opportunities for start-ups and Indian enterprises. India is one of the world’s largest importers of defence equipment and the defence budget for 2017-18 is approximately INR 3.6 lakh crore. The government is increasingly focusing on manufacturing, research, and development, through its Make in India campaign. The Defence Procurement Procedure, 2016 (“DPP 2016”) has, with the aim to improve efficiency in the procurement process, to promote growth of the domestic defence industry, to increase indigenisation and boost competitiveness of Indian defence industry, provided ample avenues for tapping by start-ups, Micro, Small & Medium Enterprises and information technology companies.

The DPP 2016 has simplified the procedures for Indian defence enterprises as part of ease of doing business in India. To encourage local players and help achieve the objectives of the Make in India campaign, the DPP 2016 provides for higher levels of indigenous content requirements and accords highest priority to bidders qualifying for the newly introduced Buy Indigenously Designed, Developed and Manufactured (“IDDM”) category, which refers to (a) products from Indian vendors that have been indigenously designed, developed and manufactured with at least 40 percent indigenous content, or (b) 60 percent indigenous content on cost basis, for products which have not been designed and developed indigenously.

In categories where defence equipment is to be obtained from foreign vendors, the DPP 2016 imposes offset obligations pursuant to which a foreign vendor is required to invest in India through the purchase of eligible products manufactured and/or services provided by Indian enterprises, foreign direct investment in joint ventures with Indian partners, investment in “kind” through the transfer of technology, or through the provision of equipment and services to eligible institutions. Thus, offset obligations are aimed at boosting the capacity and capability of domestic defence players and for employment generation.

Implementing offset obligations also enables Indian enterprises to gain access to foreign defence technologies. In 2015, Russia agreed to transfer technology in relation to 332 components of the Sukhoi Su-30MKI fighter aircraft under the Make in India programme and a majority of the aircrafts under the deal were made in India by Hindustan Aeronautics (HAL).

Similarly, Boeing under a joint venture with Indian enterprise - Tata Advanced Systems has set up a facility in Hyderabad, for the manufacture of Boeing AH-64 Apache helicopter fuselages and other equipment. This facility will eventually be the sole producer of AH-64 fuselages globally.

Currently, the Indian government is pushing for a full-scale transfer of technology and related “benefits” for the multi-billion dollar joint development and production of a fifth-generation fighter aircraft (FGFA) with Russia.

Many Indian companies are expected to enter into joint ventures with foreign manufacturers. Given the above opportunities, Indian enterprises engaged in the manufacture of eligible products and/or provision of eligible services may, in addition to being offset partners for foreign vendors, provide indigenous content to foreign original equipment manufacturers (“OEMs”).

It is also important to note that while there were some ambiguity in the past regarding whether Indian subsidiaries of foreign companies would qualify as Indian enterprises for the purpose of indigenous content requirements and discharge of offset obligations, the DPP 2016 specifically clarifies that such subsidiaries would qualify as Indian enterprises for all defence procurement purposes.

Under the “make” category, the DPP 2016 has granted micro, small and medium enterprises (“MSMEs”) the first right to undertake projects, where the estimated cost of prototype development is not in excess of INR 10 crores in government-funded projects and INR 3 crores in industry-funded projects. Further, the eligibility criteria for MSMEs has also been simplified to enable them participate more easily in “make” projects.

Importantly, the DPP 2016 also specifies that a multiplier of 1.5 will be allowed in cases where MSMEs are the Indian offset partners, thereby increasing the appeal of such entities as offset partners. Thus, foreign OEMs are increasing the use of Indian MSMEs to discharge their offset obligations, owing to the multiple advantages available to Indian MSMEs.

Ambiguities surrounding the need for industrial license to qualify as an Indian defence offset partner have been clarified by the Department of Industrial Policy and Promotion (“DIPP”) and it is now clear that an industrial license is required only by entities engaged in the manufacture of goods specified under DIPP Press Note 3 of 2014 and that holding of an industrial license is not a pre-requisite to act as an Indian defence offset partner.

Thus, Indian enterprises manufacturing eligible products and/or providing eligible services that do not require an industrial license will qualify to provide defence offsets and indigenous content.

Further, as an icing on the cake, the caps and conditions provided in the Foreign Direct Investment Policy (FDI Policy) applicable to defence sector would only apply to companies that manufacture defence products and require an industrial license. Therefore, Indian enterprises that do not require an industrial license will not attract the foreign direct investment caps and conditions applicable to defence sector entities.

Although start-ups in the e-commerce and service sectors have been taking up more of the spotlight, the time is ripe, especially given the push to the Make in India campaign, for start-ups to explore the defence sector.

It is important to note that opportunities for start-ups in the defence sector do not only include the manufacture of equipment but also the provision of technical support and integration services in information technology, maintenance, repair and overhaul, communication and navigation, among other areas.

The quantum of Offset obligations under defence contracts are also increasing. The Rafale deal signed with France contains a 50 percent offset obligation condition. Similarly, the governments of Germany and Indian are in talks for the supply of HDW 214 submarines which is expected to have significant offset obligations. Offset obligations in defence contracts open up a wide array of opportunities for Indian entities mainly for MSMEs and start-ups interested in the defence sector.

It is also important to note that India is yet to test and achieve progress in the lucrative defence export industry. However, once Indian players develop the capacity to manufacture defence equipment, start-ups and MSMEs are expected to have opportunities globally.