By Anurag Garg
Since “Make in India” campaign was launched in September 2014, there have been incremental positive shifts in the Aerospace & Defence (A&D) sector to live up to its spirit – liberalised policy, improved ease of doing business, movement with pace and shift towards the private sector (click here for more details).
However, the recent announcement to allow 100 per cent Foreign Direct Investment (FDI) in A&D sector has acted as the single most effective marketing pitch for the global top-10 A&D spender, which had built a not-so-good reputation of being a tough and a slow market.
While the case for change (to shift manufacturing/scope of operations outside the home country) may also exist in the local geographies of global companies due to the need:
* to drive growth, in a scenario where budgets are declining
* to reduce cost, due to the need to be more efficient in delivering current platforms, and Research & Development (R&D) into new platforms is not happening as much
* to de-risk operations, from lack of talent due to an ageing population and limited infusion of fresh talent in engineering/factory jobs
India now offers a proposition to address all these objectives given:
* a sizeable and increasing local demand as a base case, compared to Poland/Mexico – the traditional outsourcing options for global A&D companies
* low labour cost and skilled manpower/engineering talent availability
* all this now without the risk of compromising the Intellectual Property (IP) as was the case previously with a 49 per cent FDI cap (effectively, given the ambiguous definition of cases which may qualify as “state-of-the-art” under the previous policy to be able to secure beyond 49 per cent FDI approval)
Further, with the U.S. moving to get India to a “NATO-like” nation status, beyond the logistics agreement which is already in the works, considerations towards restrictions like ITAR (International Traffic in Arms Regulations) may reduce further, though companies will need to be cautious to ensure compliance even when the situation changes.
Some positives are expected to come out of India allowing 100 per cent FDI in A&D:
(1) Up-skilling of the value chain: While there were talks of Strategic Partnerships/IDDM (40-60 per cent Indian Designed, Developed, Manufactured content), there was no credible plan to up-skill the value chain, with the:
* Indian private sector just not ready to deliver complex platform components/sub-assemblies/assemblies
* foreign companies just not willing to share critical technology under 49 per cent FDI cap that existed previously in India
Raising FDI cap to 100 per cent would help attract foreign companies, and for India to attempt to leapfrog in terms of what is manufactured/assembled locally. This would also allow companies/Joint Ventures (JV) to achieve the local content requirement in most preferred category of programmes, while increasing success probability due to increased ability to be L1 (lowest bidder) compared to a position of direct imports into India.
Further, as more and more companies come in, even the local talent (managerial/engineering/labour) will get developed with the training on job – a big positive for the growth of the A&D sector
(2) Reduction of exchange rate risk: With 70 per cent of what we procured was imported at a platform/assembly level affected by dollar exchange rate, our buying power was getting severely hampered due to a weakening rupee, while delays in procurement were not helping as inflation worsened the situation. If a lot of the platforms (via Strategic Partnerships)/tiered value chain elements are manufactured/assembled in India, our exposure to exchange rate risk would be reduced to an extent
(3) Increased competitiveness of Indian companies: Popular perception is that this move of increasing FDI allowance to 100 per cent will increase competition for the local companies and drive them out of business. While the point on increased competition may hold true in some cases, this move will rather push the Indian companies to be truly competitive, which is a positive.
Further, Indian companies must not see the incoming foreign companies as a competition, rather look to collaborate with them and create win-win situations – which would need Indian companies to think hard on the value they bring to the table leading with real capabilities, beyond the ability to sign cheques or make a land bank available.
This effectively will mean there would be no room for complacency for Indian companies, which did exist under 49% FDI cap, where foreign companies were forced to find an Indian partner and give up 51 per cent stake and potentially the IP, due to which they never came to India in a credible manner!
(4) Better supply chain control and after-sales support: As local manufacturing increases, supply chain visibility may increase and supply chains processes may become simpler, eliminating the hassle of paperwork for imports and additional tax/regulatory compliance. Local manufacturing may help ensuring availability of critical spare parts, lack of which has been severely hampering the operational availability of critical battle equipment in India.
Overall, it is better for India to be dependent on foreign companies manufacturing in India, rather than being dependent on foreign companies manufacturing outside India.
It would be interesting to see how this policy shift co-exists with the Strategic Partnerships thought process. In any case, it would be the responsibility of the government to move fast in evaluating and approving FDI proposals to build some momentum in the sector henceforth. It is good to see that the government is not linking level of FDI with issues of national security, which must be dealt with via other mechanisms/policy instruments, and enforced well.
With this major shift, it is important for global A&D companies to look at the Indian A&D opportunity in a more profound and long-term manner. Its “all or nothing” scenario, as an opportunistic or transactional play/fleeting single programme based JVs may not enable companies to covert business in India as effectively, and that’s where these companies need to articulate and test their reasons for an India entry/expansion. Some ideas come to mind (click here for more details):
* Find a platform which helps align geopolitical incentives – for example, U.S.-India incentives are well aligned to counter growing Chinese influence in the Indian Ocean Region
* Move away from “export”-oriented thinking to “regionalise”, or better still – attempt to “originate” from India as may be reflected in the operating model
* Forge credible partnerships which are beyond addressing a single programme in future with a fraction of success probability given the competition – pursue other go-to-market scenarios/global sourcing possibilities with focus on capability building which makes the partnership more real
* Invest in building a broader base on industrial partners of a size which allows adequate nimbleness (not too large) and investment appetite to grow (not too small) – this requires a detailed understanding of the Indian companies’ capabilities, as well as, thought process and aspirations of the Indian promoters
* Move beyond looking at India purely for cost arbitrage, rather leverage inherent strengths in IT (Information Technology) and manufacturing for a more value added play like ER&D (on technology side) and Strategic Electronics (on manufacturing side) respectively
* The situation is ripe for consolidation at a base level, with over 200 SMEs having done credible work in A&D sector over the last 20-25 years, but need capital and/or technology push to grow
* Don’t view indigenous programmes as competition – seek to embed yourself in the same as a collaborator for some business, but more to understand & navigate the system on other fronts
* Look at India as a test bed for/development of “emerging market strategies” – develop products/technologies more suited for the needs and budget for emerging markets, which then may not be restricted by export control regulations like ITAR
* Explore taking A&D products and technologies into adjacent applications in non-A&D sectors (for example, auto, energy, medical, and such), by transporting multiple capabilities horizontally from global firms into India. This will allow overplaying the position in India across sectors, leading with defence applications for higher scale and margins
Implications of these suggestions may vary given the level of maturity of various MNCs (Multi-National Corporations) in India. However, with the major shifts that have been proposed in the Indian A&D sector including allowing 100 per cent FDI, the game will go to the one who plays their cards right over the next three years, and keeps indigenisation at the core of the India strategy.
(The writer is Director, Aerospace & Defence Lead at PwC Strategy&. The views expressed here are personal)