Defence Budget 2015-16: The Bad, the Worse and the Good

The Indian Air Force used to have a very competent, business like and unflappable Deputy Chief who, whenever one went to him for a debrief, would say, “Give me the bad news first, the worse next and anybody can handle the good news”.

Financial Indicators

The Bad news

The bad news in this year’s defence budget is that it does not recognise that things are not going in the right direction but only the beaten track. The ratio of defence expenditure to GDP has continued to decline over the last 30 years, as is evident in the graph below.

While it is true that GDP does not reflect the resources available to the Government and may not be the best indicator to measure defence expenditure against, Non-Plan expenditure does reflect the resources being spent by the Government. The size of the defence budget is, in principle, a measure of the resources provided for defence by the political executive. The size of the defence budget also serves to identify the relative importance of the Defence Services in comparison to other organs of the state. As acknowledged by the Finance Minister in the budget speech, Interest, Subsidies and Defence Expenditure together constitute nearly 75 per cent of the Non-Plan expenditure, but even in this regard the share of defence expenditure has been gradually falling (see graph below).

Defence expenditure has two major components, Capital and Revenue. An optimal mix of the two is needed, given that capabilities have to be continuously improved through the modernisation of weapon platforms and infrastructure even as what has been acquired is operated and maintained. An old adage made popular by General Patton, “The more you sweat in peace, the less you bleed in war”, still holds good. We do not appear to have figured out the optimal ratio between the two. The result has been a skewed ratio over the years as reflected in the relationship of both these components with GDP and Non-Plan expenditure (see the successive graphs below).

 

The Worse News

While adequacy of resources is an issue, the track record of being able to utilise the resources allocated for ‘Modernisation’ at the Budget Estimate (BE) stage during the financial year is far from impressive. Only in four of the last 20 years did the Ministry of Defence (MoD) get additional funds at the Revised Estimate (RE) stage; and only in one year did it fully utilise the allocated BE. In the remaining 15 years, the MoD failed to fully utilise the funds meant for ‘Modernisation’ in the capital budget allocated at the beginning of the year (see Table below).

MODERNISATION, BUDGET ESTIMATE & ACTUAL EXPENDITURE
Year	Budget Estimates	Actual Expenditure	Year	Budget Estimates	Actual Expenditure
1995-96	6136	6910	2005-06	28470	26972
1996-97	7663	7245	2006-07	31510	27818
1997-98	7364	7661	2007-08	34515	30397
1998-99	8765	8663	2008-09	40163	32418
1999-00	10570	10219	2009-10	43816	42025
2000-01	16003	10502	2010-11	47528	50314
2001-02	17866	14430	2011-12	56625	56679
2002-03	18881	12938	2012-13	59151	59151
2003-04	18067	14584	2013-14	73868	66682
2004-05	29379	28600	2014-15*	75659
Rs 12683 crores has been withdrawn from the total Capital Budget at RE stage & major portion would be from modernisation which accounts for about 84% of capital budget

This situation appears to have gone from bad to worse in the last two years. The long list of pending modernisation schemes of the three services has been listed in the 16th Lok Sabha’s 3rd & 4th reports of the Parliament Standing Committee on Defence. Because budget allocation has been much less than the projected requirements, the ratio of funds for modernisation is heavily skewed against ‘New Schemes’ since committed liabilities are a first charge. There is a structural flaw that magnifies itself in times of adverse foreign exchange rate; while the committed liabilities are reckoned and registered at the rate of exchange adopted when the contract was signed, actual expenditure is incurred at the rate prevalent at the time of making stage payment. Defence contracts are on an average spread over five to 10 years. The implications of this in the recent past may be gauged from the rates of exchange given below (see Table).

Year	07-08	08-09	09-10	10-11	11-12	12-13	13-14	14-15
Average Rate of exchange $	40.24	45.92	47.42	45.58	47.92	54.41	60.50	61.02

Thus, the amount of committed liabilities reflected at the BE stage is in such times understated and in this scenario the figures of Committed liabilities and New Schemes at the BE stage in the last six years is tabulated below (see Table).

Modernisation – Committed Liabilities & New Schemes at BE stage- for all the three services
	Committed Liabilities		New Schemes		Total
2009-10	26565.73		11861.27		38427
2010-11	28408.67		17278.1		45686.77
2011-12	39095.48		11628.49		50723.97
All Rs in Crores	ARMY		NAVY		AIR FORCE
	Committed Liabilities	New Schemes	Committed Liabilities	New Schemes	Committed Liabilities	New Schemes
2012-13	5552.63	2500	22531.89	720.82	26433	2100
2013-14	7024.31	493.98	22295.84	442.86	35038.62	2010.44
2014-15*	20687.15		17313	4598.99	31818	2645
*Figure for the Army inclusive of Committed liabilities & New schemes

The withdrawal of substantial funds at the RE stage in the last two years is indicative of slippages in the milestone achievement in the ‘on going schemes’ or deferring stage payments due to the Defence Public Sector Undertakings (DPSU) for their contracts and a near absence of contracting ‘New Schemes’ or a combination of all the three. The ‘good record’ of utilisation of the modernisation budget between 2010-11 and 2012-13 is because of the signing of ‘Non Competitive’, Foreign Military Sales (FMS) and single source DPSU contracts. News reports of the Defence Acquisition Council (DAC) approving schemes on a regular basis suggests that the acquisition system has stabilised till the ‘Acceptance of Necessity’ (AON) stage which is internal to the MoD, but needs to be strengthened and personnel trained to handle the ‘Business end’ part of the system in terms of dealing with the external environment and finalising competitive contracts to minimise the time from initiation of proposal to signing of contract. This would be essential for ensuring greater participation of the private sector and the success of the ‘Make in India’ initiative.

The Good News
The good news is contained in the report of the 14th Finance Commission, which was placed in the public domain on 24 February 2015. In his budget speech, the Finance Minister, while referring to greater devolution of resources to the states, mentioned that the Government has accepted the recommendations of the Finance Commission. It is to be hoped that the Government has accepted the recommendations in its entirety and not selectively, because the commission has also made the following recommendations with reference to Defence Expenditure.

14th Finance commission

Submissions by MoD

• There has been a decline in the defence expenditure-GDP ratio over the years and defence expenditure allocation in the Union Budget needs to be increased to expand the acquisition of arms and improve defence preparedness.
• It has not been able to make necessary procurements because of the constraint of funds.
• A substantial part of the defence capital budget went into meeting committed expenditures.

Submissions by Ministry of Finance

• Ministry of Finance has also highlighted the need to increase defence outlays in order to modernise and maintain defence assets as well as finance defence acquisitions.

Recommendations of the 14th Finance Commission

• Defence expenditure is important and hence resource allocation would have to be done carefully by analysing the competing demands on resources from all sectors, within the overall resource envelope available to the Union Government.
• Much of the demand on resources from the Ministry of Defence has been in the nature of capital expenditure, which is beyond the scope of our assessment.
• Revenue expenditure is critical for defence preparedness and maintenance; we have kept the defence revenue expenditure-GDP ratio constant during our projection period, instead of allowing growth to decelerate, as was the case in the past. In other words, the rate of defence revenue expenditure has been allowed to increase at the same rate as the GDP, which is substantially higher than the past growth of defence revenue expenditure.

Conclusion

In an earlier commentary, this author had forecast that “the Budget Estimate for defence is likely to be around Rs. 250,000 crore, with 105,000 crore for Capital Expenditure and 145,000 Crore for Revenue Expenditure.” While the forecast nearly hit the bull’s eye as far as the total is concerned, its projection for Capital expenditure was biased by the hope of ending up at the better end of the continuum of a bad deal.

In his budget speech, the Finance Minister said that “Defence of every square inch of our mother land comes before anything else.” And he stressed on the “Make in India” policy to achieve greater self-sufficiency in the area of “defence equipment, including aircraft”. Adding that the government has been “both transparent and quick” in making defence equipment-related purchase decisions, “thus keeping our defence forces ready for any eventuality”, he stated that he has provided “adequately for the needs of the Armed Forces”. These are good words to hear for a soldier, sailor or air warrior at a lonely desolate outpost. But even as they uphold every word of this speech, they need to draw assurance from the actions and decisions of the political leadership and their military superiors that when the time comes for action, they need not look at the ‘best before date’ on the ammunition or read some special instructions written in fine print on the constraints under which to use the ‘weapon system’.

Note: All the tables and graphs are based on the IDSA database, which is also available in the recently published book Core Concerns in Indian Defence and the Imperatives for Reforms.

Views expressed are of the author and do not necessarily reflect the views of the IDSA or of the Government of India