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India's military shopping spree

Analysis: India plans to spend $100 billion to modernize its military. But how likely is success?

That's not the only reason the intersection of the commercial and military aerospace industries presents exciting prospects. There's a lesson in history, too. Prior to India's 1991 economic liberalization, the country's automobile sector was in much the same condition as its aerospace industry is today — with only two state-owned manufacturers, both relying on outdated designs to generate a pittance in sales.

Since opening to joint ventures and later direct foreign competition, however, India's car industry has grown more than tenfold in sales and manufacturing capacity — producing nearly 2.5 million cars a year, compared with less than a million in 2003. More than 40 Indian auto parts companies generate $100 million or more in annual revenue — supplying components to virtually every carmaker in the world. And half a dozen of the world's largest auto companies have invested $500 million or more in the past year to make India a global hub for small car manufacturing.

Aerospace could be looking at its own reform-era boom, following the government's decisions to open up the defense industry to domestic private companies and allow limited foreign direct investment in defense in 2001. Already, Mahindra Defence Systems has inked a deal with Seabird. Tata Advanced Systems has formed agreements with Boeing, Israel Aerospace Industries and Sikorsky Aircraft. And Larsen and Toubro has signed pacts with the European Aeronautic Defence and Space Company (EADS), Boeing, Raytheon, the Russian Aircraft Corporation (RAC MiG), Saab Gripen and Lockheed Martin.

"The Indian aerospace industry, both military and civil, stands uniquely poised today, on the threshold of catapulting itself into the global arena," the consultancy PricewaterhouseCoopers wrote in a recent industry report.

But both New Delhi and Washington will have to break existing paradigms for U.S. suppliers to seize the opportunity and bolster the ongoing transformation of U.S.-India relations.

For decades, India has preferred to buy arms from Russian defense companies, due to the erroneous impression that its state-owned firms are less prone to corruption — especially after allegations of kickbacks from Sweden's Bofors brought down Rajiv Gandhi's government in 1989. Moreover, Indian strategists until recently deemed American companies to be unreliable weapons suppliers, following America's gunboat diplomacy in the 1971 war between India and Pakistan, the U.S. decision to equip Pakistan's air force with the F-16 in the 1980s, and the imposition of sanctions in response to India's nuclear tests in 1998.

At the same time, America's private defense firms — in contrast to state-owned rivals — will likely have deep reservations about the demands India is making in return for access to its large and fast-growing weapons market. The terms of the multi-role combat aircraft contract, for instance, require that a massive 50 percent of the total outlay be outsourced back to Indian industry in what is known in the industry as "offsets." And the absence of any significant privately owned Indian defense companies will make meeting that requirement difficult for American firms — which unlike their Russian rivals are reluctant to form joint ventures with state-owned enterprises.

"I don't think Indian officials accept this idea that government can fund research without actually conducting it. There are no startups, no programs whereby people can come together in garages to develop new technology," said Dasgupta, who co-authored "Arming without Aiming: India's Military Modernization," with the Brookings Institute's Stephen P. Cohen. "That is something that needs to happen in order to foment the activity that breeds innovation."

To overcome those obstacles, Washington will need to cut some of the red tape associated with U.S. arms deals and begin to treat India like the "strategic partner" it is meant to be instead of a subordinate ally.

For example, India at first baulked at signing America's boilerplate logistical supply agreement and proliferation security initiative, because some Indian policymakers feared it would force India into toeing the U.S. line on foreign policy.

Meanwhile, New Delhi will need to shake off its fears about private firms in the defense sector — whether related to corruption or sovereignty. At the simplest level, that means opening defense and aerospace further to foreign direct investment and removing the remaining tax incentives and the like that give state-owned firms a cost advantage. But it also means formulating a defense industrialization policy that identifies and prioritizes the technologies and capacities it wants to acquire, and amending the existing offset policies, according to KPMG.

Currently, India doesn't offer its foreign suppliers any offset multipliers — which encourage technology transfer by giving desired technologies a greater offset value than the contract's actual dollar amount. (For example, if India assigned jet engine technologies a multiplier of 7, then choosing a local company to manufacture $100 million in components would earn the foreign firm $700 million in offsets). But most importantly, India will need to re-envision its current narrow definition of privatization — which doesn't allow for government-funded research unless one of its moribund government labs does the work.

"The biggest long-term thing is to create a procedure whereby research can be independent from the state," said Dasgupta. "If that can happen somehow the pace of innovation will get faster."