A Critique of MoD’s Joint Venture Guidelines

In a major policy initiative, the Department of Defence Production (DDP) of the Ministry of Defence (MoD) has articulated a set of guidelines for establishing joint venture (JV) companies by the Defence Public Sector Undertakings (DPSUs) with companies in India and abroad. The policy initiatives, effective from February 17, come nearly two months after the MoD “put on hold” the first ever JV formed between the Mazagon Dock Ltd (MDL), a DPSU, and Pipavav shipyard, a private Indian company. The Guidelines deal with a number of issues including: (1) the need for setting up a JV, (2) protection of interests of DPSUs, (3) fair and transparent procedures for formation of the JV, and (4) exit provisions. The objective of the new policy is to harness the “emerging dynamism of the private sector” and exploit the “increasing opportunity to obtain advanced technologies from the foreign sources” in order to “augment the national effort of producing defence products” within the globally-competitive price lines and timelines.

The intention of the JV guidelines notwithstanding, the policy document suffers from certain weaknesses which may impact its objective of enhancing national defence industrial capability. First, the policy document’s major emphasis is on legalizing and institutionalizing the outsourcing part of the existing orders of the DPSUs to the private sector or foreign companies, in a move to ensure that contract execution becomes faster. Suffice to say that the policy document does not talk of JVs competing for orders on their own strength. It must be noted that DPSUs, particularly Hindustan Aeronautics Ltd (HAL) and MDL, have accumulated a disproportionate amount of orders that are beyond their capacity to deliver within an acceptable delivery date. The Guidelines can now be used as a means to expedite the work which the DPSUs are supposed to do on their own but, are constrained due to their inherent weaknesses.

It is also noteworthy that the bulk of the existing contracts of the DPSUs has been handed over to them in a non-competitive (or on nomination) basis in order to protect their commercial interests, with scant regard to competitiveness. The faster execution of contracts by a JV selected through fair and transparent process does not necessarily translate into efficiency in execution, given the inherent inefficiencies of the DPSUs. Even if the JV succeeds in faster execution of contracts, it can be further used as a pretext by the DPSUs or the administrative head in the MoD (that is, the DDP) to lobby for more defence contracts on a nomination basis (the nomination approach has often been a major point of discord between the DDP and other stakeholders). If the nomination process continues and becomes a norm in eternity, the participation of the Indian private sector, which the government is encouraging to play a major role in defence production, including system integration, will remain as a mere policy thinking rather than becoming a reality.

Second, the JV Guidelines run into direct conflict with the existing defence Foreign Direct Investment (FDI) policy, as far as formation of partnerships with foreign companies are concerned. There are two reasons for this conflicting situation: One, the very limit of FDI inflows permissible into the Indian defence industry. The current limit, which is pegged up to 26 per cent, has dissuaded many foreign companies to part with sensitive technology to an Indian company in which it has little control. This has been the major reason why, after over a decade of opening up of the defence production to international companies, very little FDI has come into Indian defence industry. The situation cannot be expected to change by mere articulation of JV Guidelines without suitably changing the FDI cap.

Two, the limited existing FDI cap also caps the amount a DPSU, which is guided by government regulations, can invest in a particular JV. As per the current guidelines, the DPSUs are not permitted to spend more than 15 per cent of their net worth on a particular JV. The 15 per cent investment freedom is also limited to Rs 1,000 crore in case of Navratna companies (HAL and Bharat Electronics Ltd. [BEL] among the DPSUs) and Rs 500 crore for Miniratna companies (Bharat Dynamics Ltd. [BDL], BEML, Garden Reach Shipbuilders & Engineers Ltd. [GRSE], Goa Shipyard Ltd. [GSL], MDL, and Mishra Dhatu Nigam Ltd. [MIDHANI], among the remaining DPSUs). Under these restrictions, the JV that can be formed will be small, at least in terms of financial worth. For example, the net worth of MDL, the biggest defence shipyard in India is Rs 1,140.02 crore (2010–11). Assuming that MDL wants to invest 74 per cent in the equity share of a JV by using the entire 15 per cent of its net worth, its financial contribution would amount to Rs 171 crore; the JV would be valued at Rs 231 crore, and the foreign partner’s contribution of the remaining 26 per cent would be Rs 60 crore. With such a small JV, it would be difficult to execute the huge contracts that the MDL has accumulated in a time-bound manner.

Third, the policy document is ambitious and, at the same time, self-contradicting when it comes to the protection of the DPSUs’ interest. The Guidelines maintain that while forming the partnership with other entities, the DPSUs are required to retain their “independent ability and commitment” to meet the requirements of the armed forces. It is not clear why a DPSU would form a partnership if the complementarities it looks for in a partner are to be developed on its own. Instead of looking for a partner, it would be logical on the part of the DPSU to invest in building those complementarities which it lacks. From the partner’s point of view, if the DPSUs are required to maintain the same capability that the JV is supposed to have, there would always be a fear that the concerned DPSU may compete with its own JV for future contracts. This fear would lead to a situation in which the partner would be expected to behave in a manner unlike that expected from a strategic partner.

Last, the Guidelines, in its present ambit, do not include the Ordnance Factories (OFs) to exploit the same benefits that are extended to the DPSUs. It is a fact that OFs also need as much partnership as their DPSU counterparts for the execution of contracts in a time-bound manner. It has been a perennial complaint by the armed forces of the OFs’ inability to meet their demands in a required time frame. Moreover, the OFs need to form partnerships with foreign companies not only to produce quality products but to break into the export market. In the past, there were some attempts by the OFs to partner with Israeli companies to form partnerships for this very reason. Given this scenario, it is quite logical that the JV Guidelines should be extended to the OFs as well.