• Prashant Mara

Make in India: Policy and Regulation in the Defence Sector

(Prashant Mara and Devina Deshpande)


I. Introduction


The Indian government, in recent years, has ramped up efforts towards ‘Make in India’ – an initiative geared towards facilitating global investment into India and strengthening local manufacturing and employment. An area of major focus for indigenisation has been India’s defence sector, which also has obvious strategic objectives. In recent times, a number of sector-specific regulatory measures have been rolled out to promote the broader Make in India agenda within the defence sector (with the ultimate aim of achieving self-reliance in defence). The Ministry of Defence has made its preference for bids qualifying as Make in India very clear. In fact, we understand that defence tenders are increasingly being geared only towards vendors who are able to meet indigenisation requirements.


To remain eligible and competitive in the long-run, defence vendors may have no choice but to manufacture in India. However, it can be confusing for vendors to determine exactly what these indigenisation requirements are (i.e. the general Make in India policy encouraging local investment and manufacturing versus the specific regulatory requirements that will ensure qualification for a defence tender). This confusion is only exacerbated by the already convoluted defence procurement framework, particularly for foreign vendors and OEMs.


This article accordingly seeks to provide some clarity by exploring the regulatory provisions that extend Make in India principles to the specific context of the defence sector. These measures will be relevant for companies (both Indian and foreign) that propose to make the most of the government’s preference for Make in India in defence procurement.


II. Local Procurement Preference


In furtherance of Make in India objectives, the Public Procurement (Preference to Make in India) Order, 2017 grants general purchase preference in government tenders to local suppliers. Specifically:

  1. Purchase preference is awarded to “Class I local suppliers” (i.e. suppliers with minimum 50% local content or ‘Indigenous Content’ (“IC”)).

  2. In certain tenders only Class I local suppliers will be eligible to submit bids (and, to this end, a list of 24 items has been released for which there is local capacity and competition and procurement must be undertaken only from local suppliers, irrespective of the purchase value).

  3. In tenders where the Class I local supplier is not the lowest bidder by price (i.e. the ‘L1 bidder’), they will be allowed the option to match the price of the L1 bidder (provided their initial price is within a specified range of the L1 price). [1]


The objective of this order is to procure locally as much as possible, with a view to achieving maximum indigenisation across sectors and industries. Apart from the provisions above, this is also achieved via restrictions under the order against requiring foreign certifications, brands or models under the tender documents (which could disqualify local suppliers) and a reciprocity provision which disqualifies foreign entities from participating in Indian public procurement if their home jurisdictions do not allow Indian suppliers to compete (directly/indirectly) in their domestic procurement. Subsequent amendments to this order have also placed restrictions on procurement (both directly and via sub-contracting) from certain sensitive countries which share borders with India (essentially China and Pakistan).


All government ministries and departments are required to adopt the local preference framework under the order (or its equivalent) for application to their respective tenders.


III. Indigenous Production under the Defence Acquisition Procedure, 2020


For defence procurement, the local procurement preference discussed above, is achieved via certain prioritised categories of procurement – i.e. Buy (Indian-IDDM) (i.e. Indigenously Designed, Developed and Manufactured) and the ‘Make’ procedures of procurement, as discussed below. These are ostensibly an application of Make in India principles to the defence sector.


For context, the Defence Acquisition Procedure, 2020 (“DAP 2020”) which governs capital acquisition for the defence sector, sets out certain categories (methods/routes) under which the Ministry of Defence undertakes capital procurement. These categories are ranked in order of procurement preference, with the purchase of indigenously designed, developed and manufactured products being the highest priority and outright purchase of fully formed equipment being the lowest priority.


Qualification under each of the various categories of procurement will depend on a number of factors - again, these tie in to the indigenisation demands of Make in India and include the amount of IC (i.e. local content) in the product/service, the contracting entity (i.e. local/foreign and who holds shareholding/control in this entity), IPR control etc.


1. Prioritized categories of procurement


As mentioned initially, the Buy (Indian-IDDM) category holds the highest procurement preference.[2] It envisages:

  1. The acquisition of products designed, developed and manufactured in India, with a minimum IC / local content of 50%.

  2. The product may be developed via in-house R&D or under the Make procedure (discussed in the next section).

  3. Only ‘Indian vendors’ (i.e. entities incorporated or registered under Indian laws) are eligible to participate in tenders under this category. Further, ownership and control of the vendor entity must lie with resident Indian citizens.

  4. The Indian entity must own the IPR or design of the main equipment and should have technology and capability to implement equipment upgrades. Indigenous design will be verified (via documents/on-site inspection) by the Ministry of Defence.


It is evident from the attributes of this procurement category that the intention is to promote indigenous design and development of defence equipment as well as to ensure that control over the manufacturing entity and IPR resides with resident Indian citizens. The second highest category of procurement – Buy (Indian) - is not as stringent in this respect, but continues to promote indigenisation through a high threshold of minimum local content / IC.


Under Buy (Indian):

  1. No indigenous design and development is required. Instead, local manufacture of the product in collaboration with, or via transfer of technology (“TOT”) from, the OEM is sufficient.

  2. Indian vendors (incorporated/registered in India) are eligible, and there are no restrictions on ownership and control.

  3. That said, this category mandates a minimum of 60% IC.


It is relevant to note that when computing IC, outflows from India (such as costs of imports, fees to foreign citizens/entities, royalties, licensing or technical fees etc. paid out of India) as well as taxes and statutory levies in India are to be excluded. Before a company outsources production or services to foreign person/entity, it is advisable to work with financial advisers/accountants to ensure that the minimum IC is met (particularly so in the case of Buy (Indian), given the high IC threshold).


Even with the remaining schemes of procurement, the preference for local manufacture and TOT is clear, with categories that envisage TOT and some amount of production in India ranking higher than an outright purchase of equipment from either Indian or overseas vendors (and with offset obligations attracted in the case of the latter).


2. Make’ under DAP 2020


In addition to the categories for purchase of equipment, the DAP 2020 also envisages the ‘Make’ procedure of procurement which promotes indigenous design and development of prototypes of military equipment. The aim here, in line with the wider Make in India policy, is to develop long term defence capabilities (rather than simply an immediate acquisition of equipment which, in the defence sector, is typically from overseas vendors).


Once products are designed and developed under Make, they are procured by the Ministry of Defence under either the Buy (Indian-IDDM) or Buy (Indian) category (as applicable). Hence, the required attributes of the relevant procurement category (as set out above) will need to be met by the vendor/product to ensure eligibility for procurement.


The Make procedure is further sub-divided into 3 categories:

Make I (Government funded)

Make II (Industry funded)

Make III

Overview

Envisages government funded projects for indigenous design and development of products. Funding is released in a phased manner.

Envisages products that are indigenously designed and developed (the Indian entity owns the IPR or the design of the main equipment).

Products need not be designed and developed indigenously, but must be manufactured in India either in collaboration with, or via ToT from, the foreign OEM.

Vendor eligibility

Only Indian vendors are eligible to tender. However, it is sufficient for the entity to be Indian registered / incorporated and it need not be under Indian ownership or control.

Same as Make I

Only Indian vendors are eligible to tender. However, it is sufficient for the entity to be Indian registered / incorporated and it need not be under Indian ownership or control.

Procurement category

Acquisition of the product is under the Buy (Indian-IDDM) category (highest procurement preference) and requires a minimum 50% IC.

Same as Make I

Products are purchased by the Ministry of Defence via Buy (Indian) (the second-highest category of procurement). The products must have 60% IC.

Miscellaneous

The Ministry of Defence will have the right to inspect accounts of the vendor pertaining to the project and has wider rights pertaining to ownership and use of IPR here.

To encourage participation, a number of industry friendly amendments have been introduced to previous iterations of this procedure including relaxation of eligibility criteria and provisions for considering proposals suggested by the industry.

The aim of Make III is import substitution of products currently in service with the Indian Armed Forces.



As such, when a company seeks to qualify for Make in India benefits/procurement preference in the defence sector, this would typically mean either qualifying under one of the Make procedures or for the product to directly qualify under Buy (Indian-IDDM) or Buy (Indian) - which in turn would require the specific attributes of the category of procurement to be met by the vendor, product and design/manufacturing process.


Other Defence Sector Initiatives Pursuing Make in India Objectives


In addition to the categories and procedures of procurement set out in the sections above, the following measures are geared towards boosting indigenous capabilities in defence production, in line with Make in India. These may be relevant when structuring investment into, and operations in, India:


  1. Increased foreign direct investment (“FDI”) allowance: The maximum amount of FDI in defence manufacturing has been increased from 49% to 74% with the aim of encouraging local investment and access to supplementary capital and state-of-art-technology. This higher FDI limit is under the ‘automatic’ route – i.e. no government approval is requirement for foreign investment up to 74%. However, the investee company must be self-sufficient in product design and development and have maintenance and life cycle support facilities.

  2. Ban on import of certain weapons: The Ministry of Defence has notified an ‘embargo list’ of weapons/platforms which the Armed Forces cannot import in fully finished form. This equipment may only be procured under the Buy (Indian - IDDM) and Buy (Indian) procurement categories (as well as under the Buy and Make (Indian) and Buy and Make (Global – Manufacture in India) categories, provided that the ‘buy’ quantities here are zero), thereby completely excluding off the shelf procurement of these items. The list presently includes 101 items including artillery guns, assault rifles, anti-submarine rocket and rocket launchers, corvettes, sonar systems, transport aircraft, light combat helicopters and radars, and will come into effect over a 5 year period.

  3. Strategic partnership model under the DAP 2020: Envisages the establishment of long-term strategic partnerships between Indian entities and foreign OEMs through a transparent and competitive process for TOT to set up domestic manufacturing infrastructure and supply chains.

  4. Innovations initiatives providing R&D funding: The DAP 2020 also envisages procurement of products designed and developed by start-ups, micro, small and medium enterprises, individual innovators and R&D organisations through (a) ‘Innovations for Defence Excellence’ (which provides grants for defence and aerospace technology development); (b) Defence Research and Development Organization’s ‘Technology Development Fund’ (which supports defence projects by Indian MSMEs and start-ups); and (c) internal research and development by the armed forces organisations. The products are (largely) produced under the Buy (Indian- IDDM) category.

  5. Easing of licensing requirements: The list of defence products requiring an ‘industrial license’ (to be obtained prior to commencing manufacture and as part of FDI conditionalities) has been rationalised and the validity of the industrial licence (where required) has also been increased from 3 years to 15 years.


Conclusion


In keeping with the objectives of the broader Make in India policy, the Ministry of Defence has made the prioritization of developing indigenous capacity and self-reliance amply clear with the measures above. To this end, recent defence sector tenders expressly focus on Make procedures and procurements via Buy (Indian-IDDM) and Buy (Indian) category. To remain eligible and competitive, both Indian and foreign vendors will need to ensure compliance with these indigenisation initiatives.


That said, these measures have been introduced on the assumption that foreign licensors will transfer the latest technology to India and that Indian manufacturers have the capacity to absorb this technology in time to service the critical needs of the Armed Forces - something that has proved a challenge in the past. It is therefore critical that local industry be allowed time for a phased absorption of transferred technology so as to effectively achieve the aim of self-reliance.

[1] These restrictions are beyond the scope of the present article and have not been discussed in detail. However, we would be glad to assist you with this information if required. Please reach out to us at practicemanager@btg-legal.com.


[2] For brevity and relevance, we have not discussed all categories of procurement in this article. However, we would be glad to assist you with this information if required. Please reach out to us at practicemanager@btg-legal.com.