Two months ago the MOD issued new procurement rules for capital and revenue purchases in voluminous pages. Posted below is a summary courtesy Asian Military Review December edition.

DEFENCE BUSINESS IN INDIA AND THE NEWLY ISSUED MOD PROCUREMENT RULES EXPLAINED

By Ranjit B Rai

The pursuit of Defence Business is generally regarded to be more challenging and unpredictable than others, gestation periods can be long, but profits margins are high, and once a weapon system is supplied, follow on business in upgrades and spares is assured. Defence budgets of nations range between 3 to 5% of GNP and there has been a dip in defence spending in most countries in Europe after the end of the cold war, while USA ($ 402 bill), China ($ 60 bill?), and Middle East have witnessed large increases. India has been allocating only 2.6% of its GNP for defence and the 2005-6 budget stands at $ 19.3 bill with an import quantum of almost $ 5 bill though allocations for nuclear, space and pension elements are not depicted in the defence estimates. In India the budget runs from 1^st April to the next 31^st March and the revised estimates are tabled in December when Parliament approves additional sanctions, if required by MOD, but in the recent few years the MOD had surrendered unspent funds. This is not likely any more and India’s defence budget is set to escalate. Dr Manmohan Singh the Prime Minister has committed in October this year that it can to be increased to 3%. If the ambitious Naval plans for 21 ships on order, Maritime Aircraft, Helicopters and Akulas on lease and ATV nuclear submarine, and Air Force aspirations for induction of 126 top of the line fighters from abroad fructify as planned, the present allocation will not be able to sustain the costs, since revenue spending is on the rise in India, and the Armed Forces are already experiencing short age of manpower. Salaries in India have suddenly risen with a spurt in the economy and employment. With the gallop in technology, defence equipment is becoming more costly but will remain essential and defence budgets will always find a place in a nation’s priority list, especially in these times of uncertain threats, and a world dominated by Adam Smith’s economic philosophy out lined in the Wealth of Nations.

The methodology of doing defence business in India has hitherto been secretive, serpentine and undefined, but there are changes taking place for more transparency. India’s defence slowly opening up to the world, and US Military Industrial giants have recently entered the fray, to give traditional Russian and other suppliers a run for their money. The Official Secrets Act in India is of 1923 vintage. It is an impediment as it is very rigid in not sharing even the minutest of defence details or QRs with suppliers, but is being treated with a Nelsonic eye by officials and Armed Forces, as it is definitely out dated in this day and age. The requests for information ie RFIs, from foreign and Indian suppliers, meeting with visiting prospective suppliers and communications through India’s Defence attaches abroad in connection with defence purchases is now more open. The Navy has gone ahead and appointed a Rear Admiral (Foreign Cooperation and Transformation) who has under him three Directorates of Foreign Cooperation, Liaison and Concepts to deal with foreign agencies and Governments.

As India globalises, Adam Smith is being quoted often and his name even saw mention in Delhi’s High Court when its Chief Justice advocated it in November to the Navy, in a submarine battery case. The IN has supported development and is procuring submarine batteries from just one captive source, Exide (formerly Standard) Batteries, for its large under water fleet of HDW and Kilo class submarines and the case are cited later in this article, as it is relevant. The Armed Forces are also aware of the transformation and globalisation of Defence and Aerospace Industries in Europe and USA, noting that major firms have teamed, up transgressing secrecy needs, and national boundaries for production, R and D and exports. It is now evident no nation save USA can sustain a large aviation or ship project alone. Joint production and common programmes for ships (Horizon frigate and Franco British aircraft carrier), planes (Typhoon Euro fighter and MTA) and tanks are already in place abroad. In India till recently only the eight Government Public Sector Units called defence DPSUs, like HAL, BEL, Bharat Dynamics, Mazagon Docks etc and the 39 Ordnance factories were tasked to supply all major defence equipment on comfortable “cost plus” basis, but the scene is fast changing with private players gaining market share, and offering supplies at competitive rates and even large projects like ships, submarines and systems with foreign collaboration. In cases of soft ware solutions and commercial of the shelf COTs purchases the Armed Forces have little choice but to lean on civil suppliers.

The Coast Guard took the first step by ordering three large 3000 ton Pollution Control Ships and smaller vessels on private yards against competition from Government yards, and if the deliveries and quality match, it will be a trend setter. The Government has permitted 26% foreign direct investment in defence firms opening up what it earlier called the ‘restricted strategic industries’. To force the pace and to usher transparency the Ministry of Defence has recently issued a some what long and complicated but explicit set of Procurement Rules for defence business in India. The rules have been framed separately under the head Revenue for items below $ 75 million, and Capital for all larger outlays including details of how ships are to be ordered on yards and the mode of inspection, trials and payments including performance bonds and associated bank guarantees. For imports from abroad above $ 75 million there is now a very significant clause that stipulates that 30% of the value of the contract has to be in offsets, and is inked in to the rules, besides the multi tender system, to avoid single vendor purchases except in emergency requiring higher sanctions. To avoid charges of favoritism and corruption, which every large deal in India (Bofors, HDW etc) has been smudged with, leading to legal actions but with no results, a very stringent Integrity clause is also stipulated, and firms are now being very careful not to dole out money to lobbyists and facilitators. Appointing of Defence Agents has also been made legal, but the rules are very restrictive, so most foreign companies have been obliged to open offices in India and recently even Northrop Grumman and Lockheed have followed Raytheon. India is for the first time displaying seriousness to join the world in defence exports and is keenly looking forward to clinching an order for 30 ALH Dhruv helicopters to Chile worth $ 75 million which will be the largest ever defence export order. It is being pursued by the Defence Minister Pranab Mukherjee himself. Smaller soft ware and non lethal provider firms are already exporting products, and firms like Tata Power, Mahindra Defence and Larsen and Tubro that are already suppliers to the Defence are pressing for more openness and level playing field. However the Communist Party in the UPA Government holds 60 seats in Parliament and are strong supporters of the PSUs.

India’s Defence Expenditure: In INR (Crores) (Rs 4.5 crores = $1m)

A list of the larger payments and near term projected procurement list of the three services is appended. The details of expenses of the nuclear command are not available and separation of civil and military nuclear facilities as stipulated in the President Bush and PM Manmohan Singh agreement signed on 18 July in Washington DC will need to be funded.

Army: Smerch multi-barrel rocket launchers from Russia, additional UAVs and large order for 155mm self-propelled and towed guns. Denel has been blacklisted. Helicopters to replace the Cheetak Allouttees in final stages. Upgrading of infantry and NBCD equipment and indigenous missiles with import content for BMD. A group of BrahMos missiles have been ordered and the Army has pitched for battlefield helicopters.

Navy: Progressive payments to yards for 21 ships on order, Scorpene submarines, Gorshkov and 16 MiG 29Ks. Advanced Light and imported ASW Helicopters, deep submerged submarine rescue vehicles, mine hunting vessels, advanced offshore patrol vessels, 2 P 3C Orions ( on lease) and 2 IL 38s, TU 142 M and possibly USS Trenton. Derby and Barak or other anti missile missiles Krivacks are ordered from Russia as the Navy plan envisages ships from Indian yards and abroad.

Air Force: Payment for 66 Hawk deal. IL 78 tankers and balance Mirage 2000 deliveries, 3 Phalcons due delivery in 2006/7, 2 Embraer 135s, Low-level Quick Reaction Missiles, Heron UAVs from Israel and Low Level Reporting Radars, Radar Systems and in due course for 126 fighters. Up grades of aircraft calling for imports of avionics. Large payments to HAL for SU 30MKI and HJT 36 deliveries and LCA activities.

PROCUREMENT RULES ISSUED BY MOD ---- CAPITAL PURCHASES

As per the Kargil committee report recommendations, a full fledged Defence Procurement Board DPB has been set up in MOD which has acquisition wings for the three services with Acquisition Managers and Financial advisers from the bureaucracy, and Technical managers from each service to coordinate the purchase of systems approved by the appropriate authority/committee. The first step specified in the new rules is how to become a supplier to Indian defence, and the manner in which to get registered. It is by filling up a detailed form provided in the rules as a representative or an Agent in India. The rules run in to 113 pages and are voluminous and include paragraphs on Service QRs, warranty clauses, explanation of transfer of technology TOT and offsets, repair and maintenance philosophy, modus operandi to list spares and technical literature, explanations on discounted cash flows and escalation, payment procedures, contract negotiation procedures and the standard clauses to be executed when the contract is finalised. The details of which Government owned Indian Banks, the Bank guarantees are to be executed along with the 5% stipulation for performance bonds and the method of termination and arbitration clauses are spelt out. The mode of sea shipping of goods through Ministry of Shipping’s specified carrier through Transchart organisation is also explained as also rules for supply by air. Some important clauses are appended and discussed in brief.

Mode Of Annual Budgeting. Theoretically the rules stipulate that the HQ Integrated Defence Staff IDS will work out the annual requirement of funds for capital acquisitions taking into account the schemes listed, the services demands and those proposed for the year ahead, carryovers, operational exigencies and proposed changes in priorities recommended by the respective Service Headquarters, by 31 December of each year. The details of these requirements would be scrutinized in the Acquisition Wing of MOD and then forwarded to Defence (Finance) for budgetary projections and allocations. Based on the budgetary projections and allocations the annual projection will be formulated by the respective SHQs and approved by the DPB by 15 April of the relevant Financial Year. The Annual Acquisition Plan is to be based on a two years acquisition cycle and is to cater for adequate cushion to safeguard against surrender of funds.

Induction Process and Trials. For induction, the manual states it will require trials and alludes to transfer of technology in cases. The manual states it will involve the Services Qualitative Requirements (SQRs), Acceptance of Necessity (AoN), Solicitation of offers, Evaluation of Technical offers by Technical Evaluation Committee (TEC), Field Evaluation, Staff Evaluation, and Oversight by Technical Oversight Committee (TOC) for all acquisitions above Rs 300 Crores ( $ 75 mill). These will be followed by commercial negotiations by the Contract Negotiation Committee (CNC), approval by the Competent Financial Authority (CFA), award of contract / Supply Order (SO) and contract Administration and post-contract management.

Solicitation of Offers/. Single Stage Two Bid System. Solicitation of offers will be as Per Two Bid System. It will imply that a ‘Request for Proposal’ would be issued soliciting the technical and commercial offers together, but in two separate sealed envelopes. This system safeguards against the possibility of the vendor increasing his commercial offer consequent to development of a single vendor situation after evaluation. At this stage, the vendor will give a written undertaking to meet the offset obligations laid down in the RFP, as part of the technical offer. This undertaking will be binding and failure to discharge offsets at any stage of the acquisition process will disqualify the vendor from any further participation and his offer will be treated as null and void. The vendor will under no circumstances delay the execution of the main contract on the plea of failure of Indian Industry in executing various offset contracts. Once the SQRs have been finalised, the sources of procurement of the weapon system/stores shall be ascertained and short-listing of the prospective manufacturers/suppliers carried out by the Service HQ. The short-listed vendors will be the Original Equipment Manufacturers (OEMs)/ Authorised Vendors/ Govt Sponsored Export Agencies (applicable in the case of countries where domestic laws do not permit direct export by OEMs). This clause refers to USA where many items are exported by the Foreign Military Sales FMS. In cases involving TOT, the short-listing of the vendors would take into account their ability to transfer requisite technology for license production. The list of short-listed vendors may be supplemented by the Technical Managers in Acquisition Wing for which a data bank will be maintained by them. Wherever possible, keeping the security and other relevant aspects in view, appropriate publicity may be given to the proposed procurement with a view to generate maximum competition.

Request for Proposal (RFP) and Offsets. The RFP applicable to all acquisitions is to be a self-contained document with a number of details that can enable vendors to make their offer after consideration of full requirements and parameters of the acquisition and includes the offsets stipulation. This subject is still to be refined as to whether the off set will be confined to defence industry, or open ended for Indian industry. The 314 Bofor FH 77 Howitzer contract signed as early as 1987 had off set clauses, but the contract was never fully implemented due to corruption charges and is likely to be revived if the future contract for 155mm Howitzers goes to Bofors who have performed well in trials. The RFP in selected cases would spell out the requirements of transfer of technology TOT depending upon the depth of the technology which is required, and whose range could cover technology for repair and overhaul; production from CKD/SKD kits and production from raw material and components level. Aspects which are to be included in the RFP in case production is from CKD/SKD/IM kits are specified and the rules require care should be taken to spell out the selection criteria clearly. The nominated Production Agency (PA) for the receipt of technology is to be closely associated in the preparation of RFPs. A standardised RFP document is given in the manual. At this first stage itself, the vendor is obliged in reply, to give a written undertaking to meet the offset obligations laid down in the RFP, as part of the technical offer. This undertaking will be binding and failure to discharge it at any stage of the acquisition process will disqualify the vendor from any further participation and his offer will be treated as null and void. Thereafter the Acquisition Wing will ask from those vendors, whose equipment has been short listed, to submit detailed offset offers in a sealed envelop within six weeks. These offers shall be evaluated by the CNC prior to the opening of the commercial offers already submitted by the vendors. Commercial offers of only those vendors whose offset offers are found to be in order, will be opened. The vendor has to undertake offset contracts amounting to 30 % of the commercial proposal. The technical offer is to include a compliance statement to this effect.

Technical Oversight Committee (TOC). TOC provides expert oversight over the technical evaluation process. Defence Secretary will constitute TOCs for selected acquisition proposals in excess of Rs 300 Crores ($ 75 mill) and any other case recommended by the Defence Procurement Board. The TOC will comprise of 3 members, one Service Officer, one DRDO scientist and one representative of DPSU preferably not involved with that acquisition. The TOC will be tasked to see whether the trials, trial evaluations, and other parameters have been met.

Standard CNC Composition Above $ 5 mill. The CNC will comprise the Acquisition Manager as Chairman, and the members of the committee will be the Technical Manager, Finance Manager, Advisor Cost, DG Quality Assurance representative, Procurement Agency representative, User representative, representative of Contract Management Branch at SHQ, Repair Agency Representative, Under Secretary concerned and Member Secretary to be nominated by the Chairman. If transfer of technology is involved then additional reps of Department of Defence Production, DRDO and Production Agency are to be included.

Integrity Clause/Pact IP. Further the rules stipulate that signing of an ‘Integrity Pact’ would be considered between government department and the bidder for schemes exceeding Rs 300 Crs( $ 75 mill). The Integrity Pact is a binding agreement between the agency and bidders for specific contracts in which the agency promises that it will not accept bribes during the procurement process and bidders promise that they will not offer bribes. Under the IP the bidders for specific services or contracts agree with the procurement agency or office to carry out the procurement in a specified manner. The essential elements of the IP are given in detail .

TECHNOLOGY LEADER--THE NAVY AND THE RULES

The new rules have opened many avenues of improvements and competition in India’s defence industry. To give an example of the progress the Armed Forces are now even seeking help of educational institutes on the lines that UK does in Cambridge and USA in Universities etc. All three service HQs recently joined hands with the Indian Institute of Technology, Kanpur (IIT-K), to design advanced encryption algorithms for strategic communications systems and data links used by block cipher systems, the Navy being the first off the mark to link ships at sea. This follows IIT-K’s successful development of the Trinetra (third eye) encryption security standard for the Navy that allows warships to exchange voice, data and imagery with each other as well as with facilities on shore in a secure environment. The Navy is also equipping its three existing Project 15 Delhi-class guided-missile destroyers with on-board control/imagery interpretation stations required for undertaking round-the-clock maritime surveillance operations over the high seas with shore-launched IAI/Malat-built Heron II medium-altitude high-endurance UAVs. The UAV control stations are even transferred on board small Leanders like INS Vidhyagiri and have proved successful in operations. The Navy is raising three squadrons for dedicated UAV operations while Israel announced the Armed Forces are buying 50 more Herons worth $ 250 mill. The DRDO and Navy are progressing to build midget submarines and a proto type is being delivered by Larsen and Tubro Ltd for approval. When the vessel is approved it is planned to be fitted out with equipment from abroad. Atlas Elektronix is in dialogue with L and T, which engineering giant has also offered to build Amur class submarines. Another firm Mahindra Defence is set to manufacture mines for the Navy, while a number of other projects are alive for indegenisation in the private sector which has become pro active under the new procurement rules. The rules are also being misused to delay some projects. A small battery firm HBL Nife Life went to court and won its case in the High Court of Delhi claiming it could supply submarine batteries of quality to the Indian Navy who have been captive customers of single suppliers Standard Batteries. The Navy argued that the new supplier’s batteries would need time to test and the Navy’s need was urgent for operational reasons. Kilo class submarines are being sent to Russia for modernisation and conversion to fire the 3M Klub 54E missiles, and batteries are supplied from India. The Navy is likely to appeal to the Supreme Court to ensure single source supplies continue for the present.

CONCLUSION

Considering the regional security environment, the Revolution in Military Affairs (RMA), and the impact of technological changes on battlefield environment, there will be added demands on the Indian military to restructure and re-orient their defence planning in terms of organizational and force structures, training, operational planning, fiscal resources, and even weapon acquisitions, which are still not joint. Therefore, the challenges that face the military in the future are those of conducting joint operations within the realm of optimal utilisation of scarce resources. Prof Tanhem and Cloughly have tabled an analysis of the Indian military. It reads that India’s armed forces may find it difficult to prove their tactical and technological superiority against their Pakistani rival if a full-fledged conflict were to occur, even though India has conventional superiority in arms. Pakistan has a ready nuclear strategic command and in India’s case the nuclear and ballistic missiles capabilities are  controlled by civilians and the Defence Research and Development Organization (DRDO). This DRDO has consumed huge resources and is involved in a large number of indigenous projects, and only few have been completed successfully. The DRDO is also a manufacturing systems and that may need correction. The Indian Armed Forces still do not have a system of calculating life-cycle costs of equipment. In the past, this has led to situations when maintenance costs escalated even though equipment from Russia was initially cheaper but led to eventual increased financial wastage. However the MOD procurement rules as they are framed are a very large step forward in specifying the system of procurement.