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India’s aerospace and defence landscape looks ideal for investment

Mr. Gaurav Mehndiratta, Partner and Head, KPMG India, is an expert in understanding of companies operating in the aerospace and defence sector. Over the last decade, he has worked on some of the marquee transactions and with most of the prominent companies in this area. He shares his insights with GE on India’s aerospace and defence policy landscape while navigating growth and investment opportunities.

1. What are the key reforms undertaken to increase aerospace and defence manufacturing in India?

After the Government’s clarion call for ‘Make in India’ with defence being a focus sector, there have been various policy changes signaling end of an era of import dependence and aim to promote India as a preferred global manufacturing destination for foreign OEMs/Tier vendors. To illustrate, a few key reforms introduced by the government in last 2 years include:

- Introduction of an updated Defence Acquisition Procedure 2020 (DAP 2020) with substantial changes in the defence policy framework including, raising the levels of Indigenous Content (IC) to a minimum of 50% across various categories, introduction of new categories like ‘Buy (Global– Manufacture in India)’, etc

- Earmarking approximately 68% of the budgeted capital expenditure in Defence budget
2022-23, for domestic defence procurements

- Introduction of three positive indigenisation lists with a total of 310 items earmarked for Indian industry already and three Defence Public Sector Undertaking (DPSU) lists to minimise imports by DPSUs. These lists include defence items that shall be indigenously manufactured in the near future and shall only be allowed to be procured from Indian Industry beyond the indicated timelines

- Institution of innovations for Defence Excellence (iDEX) scheme involving Micro, Small and Medium Enterprises (MSMEs) & start-ups

- Implementation of Public Procurement (Preference to Make in India) Order 2017

- Establishment of an indigenisation portal namely SRIJAN to facilitate indigenisation by Indian defence industry including MSMEs

- Simplification of the process to obtain Industrial license with a longer validity period

- Reforms in offset policy with thrust on attracting investment and technology by higher multipliers coupled with FDI relaxations

- Establishment of two Defence Industrial Corridors, i.e., in the state of Uttar Pradesh and Tamil Nadu which provides multiple fiscal and other benefits to the investors

- Various other State Governments introducing exclusive policies for aerospace parks

While the policy reforms appear to be laid down perfectly on paper, its success largely depends on the practical implementation and industry’s response to the same.

2. What is the landscape for aerospace and defence manufacturing looking like for India?

One of the world’s largest and lucrative markets, Defence Sector in India has a long term 10-year pipeline of over USD 223 Bn aerospace & defence capex with an estimated spend of USD 130 Bn to accrue in the medium term.

Focus is now being laid on development of state-of-the-art cost-effective products/technologies that not only caters to domestic needs of the nation, but also fulfils international requirements. In the last 4-5 years, Indian defence imports have come down by about 21 percent.  In addition, exports have grown 7 times in the last eight years. Indian defence exports stood at INR 13,000 crores (USD 1.62 Bn) last year.

70% of Indian army equipment were considered obsolete in 2018. The four existing squadrons of the old single-engine MiG-21s are also expected to retire by 2025. Considering the same and in the backdrop of geo-political upheaval across the globe, there is an urgent demand to augment the strength of the Indian defence forces. With such domestic needs knocking the doors coupled with increased impetus on self-reliance, MoD has already contracted for in-country manufacture of the 123 Light Combat Aircraft (LCA) to be used by Indian defence forces.

Draft Defence Production and Export Promotion Policy (DPEPP) was also released in 2020, wherein, an ambitious target to scale up defence turnover of about INR 80,000 Crore (USD 10 Bn) in 2019-20 to about INR 1,75,000 Crores (USD 21.87 Bn) including export of INR 35,000 Crore (USD 4.37 Bn) by 2025 has been taken up. To achieve the target, well-defined implementation mechanism is expected to play the key role. However, industry is still awaiting the final version of the policy and its actual enforcement in the sector.

In the last 5 years, from being the manufacturer of simple defence parts and accessories, the indigenous production has witnessed addition of certain complex equipment, systems and even certain platforms, with the latest entrants being INS Vikrant and the Prachand LCH. 

Emphasizing on in-country manufacturing, Defence Acquisition Council (DAC) approved cancellation/closure of Acceptance of necessity (AoN) for 9 proposals under Buy (Global) category worth INR 46,695 crores (USD 5.8 Bn approx). Likely movement of certain mega defence projects like procurement of 114 multirole fighter aircraft (MRFA) to ‘Buy Global – Manufacture in India’ with indigenous production in phased manner is also an outcome of the same.

India’s response to a Request for Proposal (RFP) against tender released by Royal Malaysian Air Force (RMAF) for supply of 18 Light Combat Aircraft shows growing confidence of the world in Indian defence manufacturing capabilities. Not only this, countries like Argentina, Australia, Egypt, USA, Indonesia, and Philippines have also shown interest in the indigenously developed LCA Aircraft.

For the manufacturing capabilities required to be developed by India, increased focus is continuously being laid down on public private partnerships. A notable example of such partnership can be development of fifth generation Advanced Medium Combat Aircraft (AMCA).

To the government’s call to the private sector for collaborations, one can witness varied responses from distinct foreign defence players. The large foreign OEMs are still concerned about the stringent and ambiguous policy framework, irregular grant of orders, lack of demand along with commercial feasibility of small orders, scarcity of resources and skilled manpower to meet the sensitive requirements of the sector, supplemented with lack of economies of scale in production and long gestation periods. Considering the same, foreign OEMs are taking India a step-by-step approach and not making huge investments yet, barring a few JV’s and technology centers.

In turn, it is the mid-level foreign companies and SMEs that are expected to setting up manufacturing capabilities in India. Certain Indian conglomerates are also venturing into the defence sector.

Overall, the landscape of aerospace and defence manufacturing in India looks optimistic and is expected to grow significantly in the times to come.

3. What are the foreign direct investment reforms that make India’s aerospace and defence sector ideal for investment?  

India’s current capabilities in defence manufacturing require external support in the form of investments and advanced technologies. Acknowledging the same, to ensure the much-needed support, reforms as brought in by the government are as below:

- Under the revised FDI policy, FDI limit in defence manufacturing under automatic route has been raised from 49% to 74% (for fresh investments requiring industrial license) permitting foreign companies to set up manufacturing units with higher ownership and control.

- 100 per cent FDI is permitted for defence manufacturing post seeking government approval.

Foreign OEMs shall now be able to exercise ownership and control in Indian ventures which was earlier a key area of concern particularly from an Intellectual Property (IP) protection standpoint.

In addition, 100% FDI has been permitted for undertaking any activity where defence industrial license is not required, including aviation products, thus, permitting foreign OEMs to set-up units for engineering, design, technology, research and development and undertaking dual use and pure aerospace manufacturing.

- Higher multipliers have been assigned in offset policy to attract investment and Transfer of Technology for Defence manufacturing.

Further, the defence corridor projects have also been instrumental in attracting foreign investments. The nodal agency for Uttar Pradesh Defence Industrial Corridor (UPDIC) has signed 69 Memorandum of Understanding (MoUs) with potential investment of INR 10,545 crore (USD 1.32 Bn) of which, actual Investment of INR 1,767 crore (USD 220 Mn) has already been made. The nodal agency for Tamil Nadu Defence Industrial Corridor (TNDIC) has signed 42 MOUs with potential investment of INR 11,359 crore (USD 1.42 Bn) of which, actual Investment of INR 3,176 crore (USD 400 <n) has already been made.

The liberalization of FDI policy is a positive measure and has been an ask of the overseas players for a very long time. It has led a lot of foreign OEMs back to the drawing board to re-evaluate their long-term Indian presence. However, there are investor concerns around lack of clarity in certain aspects of contracting, IP ownership etc. In case the government successfully addresses existing concerns, the sector is likely to see a substantial investment inflow. Additionally, the large ‘Make in India’ defence deals, which are expected to be the game changer for the sector are still under discussions.

4. What is the industry’s expectation going forward from the government?

While the Government has taken several constructive measures to actualize its dream of an ‘Aatma-nirbhar Bharat’ (i.e., Make in India), from industry’s perspective, it would not be wrong to say that a lot still needs to be done before we can claim the coveted title of a defence manufacturer.

With the fine print of draft DPEPP still awaited and lack of redressal of practical impediments to the newly carved out policy reforms, the ultimate plan of movement from a nascent stage to manufacturing platforms doesn’t seem to be fructifying at the desired pace.  The government also needs to acknowledge the fact that, before the complete platforms could be indigenously built, the entire eco-system needs to be in place.

Such eco-system can be set up with manufacturing of smaller components/sub systems, indigenous development of required technologies, expansion of in-house R&D capabilities, etc. It can foster only when public funding is appropriately being made available.

Further, it is expected that the Indian government should resolve the practical challenges being faced by the industry. To list a few:

- Currently, elements like design support, skill development are not included in the definition of IC. This in turn disincentivize companies to make initial investments. Government should consider widening of the definition of IC to include engineering support, design support, after market support, skill development & trainings, new technology insertion and development happening in India for global products irrespective of program (military or commercial).

- To track the IC achieved vis-à-vis the IC obligation, a clear monitoring process needs to be laid down and OEM dashboard may be designed.

- During the initial years of operations/production, a lot of OEMs will face challenge in achieving the ambitious IC percentages as laid down in the policy. Accordingly, it is expected that for at least the first 5 years of operations when the local JV contributes to global supply chain then, the local supply chain requirement should be deemed to be met for IC purpose. Further, IC should be implemented in a phased manner, initially meeting IC at lower percentages and gradually aiming to be met at higher percentages.

- As each program has a different scope, schedule, quality ask and primarily involve different technologies. Therefore, flexibility in IC stipulations should be granted.

- Production Linked Incentives (PLI) have been instrumental in expediting development of various sectors. Similar schemes should be implemented for manufacturing defence products as well.

- The recently drawn issue of wholly owned subsidiaries not eligible to be the Indian offset partner for the same Foreign Vendor, requires urgent government attention.

- More tax concessions should be provided to defence MROs to provide boost to the high growth potential industry.

- Fast Track Procedure should be implemented effectively to ensure expeditious procurement for urgent operational requirements of the Armed Forces.

In an era, where a lot of focus has been placed on IC, collaboration is going to be the key. To a certain extent, the policy groundwork appears to be laid out for enhanced foreign participation. However, government’s redressal of the practical policy impediments, availability of public funding for ecosystem development and private partnership of major global players will be the key to the actual implementation in the times to come.

(This article is compiled by GE based on inputs from KPMG India.)

GE’s LM2500 engines power INS Vikrant

India’s first indigenously designed and built aircraft carrier – Indigenous Aircraft Carrier (IAC-1), was recently commissioned as INS Vikrant at Kochi, powered by GE’s LM2500 Gas Turbines. For over three decades, GE has worked with Hindustan Aeronautics Limited (HAL), which assembles, inspects and tests all LM2500 gas turbines built for the Indian Navy. The Indian Navy’s newest carrier was commissioned with four LM2500 engines powering the ship with 88 MW giving it a maximum speed of 28 knots.

The addition of the Vikrant to the Indian Navy’s fleet is a significant accomplishment for the ‘Make in India’ vision, as 76% of the parts are indigenously manufactured. The Navy now has 18 GE engines in service, with additional engines in production to support the ongoing Project 17A ship construction.

Between August 2021 and July 2022, the Vikrant underwent four phases of sea trials to check the equipment and systems. It has been built with a high degree of automation for machinery operation, ship navigation, and survivability. The carrier is 262 meters long, has 14 decks, can hold a crew of 1,700 people, and can operate 30 planes. It has been designed to accommodate an assortment of fixed-wing and rotary aircraft. The ship will be capable of operating an air wing consisting of 30 aircraft comprising MIG-29K fighter jets, Kamov-31, MH-60R multi-role helicopters, in addition to the indigenously manufactured advanced light helicopters (ALH) and light combat aircraft (LCA). According to the Indian Navy, the IAC is equipped with a ski-jump for launching aircraft and a set of arrester wires for their recovery onboard, using the aircraft-operation mode known as Short Take-Off but Arrested Landing (STOBAL).

The addition of the world’s most market-dominant gas turbine gives a unique advantage to the Indian Navy, whether onshore or at sea, with interoperability benefits with other allied ships. GE has delivered gas turbines onboard 633 naval ships worldwide and provides 95% of the commissioned propulsion gas turbines to the United States Navy fleet. With the LM2500’s outstanding track record of being ready for combat, coupled with its ease of maintenance and global support, the LM2500 continues to be the gas turbine of choice for navies globally.

(This article is compiled by GE from publicly available information.)

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