New Privatisation Policy: Are The Defence Ministry’s Concerns Justified?

The push-back, supported by Defence Minister Rajnath Singh who is among the most senior in the Narendra Modi administration, came despite the sector being labelled as strategic under the new policy. Citing “national interest”, the ministry sought special exemption and argued that all state-owned firms dealing with defence production remain under government control, a letter written with the approval of Singh shows.

The communication is part of BloombergQuint’s investigation of the Modi government’s New Privatisation Policy, which was first announced in May last year and detailed by Finance Minister Nirmala Sitharaman in the Union Budget presented in February. The investigation is based on RTI documents accessed. Officials in the finance ministry’s Department of Investment and Public Asset Management, in charge of this new policy, declined to comment on the story.

Defence Ministry’s Argument

In its letter, the defence ministry stated that private industry has not “evolved enough to match the requirements of the Armed forces” and “ceding control” of the state-owned units to private players will “seriously jeopardise country’s security.”

“...Privatisation of PSUs will create a private sector monopoly which may be detrimental to the national security” the ministry argued.

It said the argument for privatisation, which is that it will help achieve economies-of scale and improve productivity, may not be valid in the case of state-owned defence companies as “their area of operation involves manufacturing of technologically-advanced and customised product range especially in case of shipyards where the product has a long gestation period with limited market”.

The letter further made an argument that state-owned firms play a complementary role to one another, rather than competing against each other.

There are a total of nine state-owned defence production companies. Divestment is already underway for Bharat Earth Movers Ltd., where the government intends to prune its stake from about 54% to 28%.

In the case of four PSUs — Hindustan Aeronautics Ltd., Bharat Electronics Ltd., Mishra Dhatu Nigam Ltd. and Bharat Dynamics Ltd.—the ministry argued that there are no comparable peers and hence these companies should stay with the government. It further added that the four shipyards—Mazagon Dock Shipbuilders Ltd., Garden Reach Shipbuilders & Engineers Ltd., Goa Shipyard Ltd. and Hindustan Shipyard Ltd.—are critical for creating a “Blue Water Indian Navy”. A blue water navy is defined as one capable of operating across the deep waters of open oceans.

Another key concern raised by the department was that of inter-country transfer of critical defence technologies. “There is always some degree of comfort associated with transfer of technology through G2G (government-to-government) route,” the letter said.

BloombergQuint’s email to the Defence Ministry spokesperson and message to the office of the defence minister on March 19 were not answered.

‘No Merit’

Those familiar with the sector, however, find little merit in the stance taken by the defence ministry.

“It’s true that defence is a specialised sector with unique requirements. But there is no justification to the argument that all the firms need to be retained under government control,” former Northern Army commander Lieutenant General DS Hooda (retd.) said. “One has to look at particular companies to see where the government hand-holding may be required there.”

Hooda said there is sufficient expertise in the private sector to compete with firms such as Bharat Dynamics, which produces missile systems, and Bharat Earth Movers, which supplies high mobility vehicles to the forces. If the government is looking at promoting indigenous aircraft then it may want to remain invested in Hindustan Aeronautics Ltd., Hooda said.

‘Only To Keep Control’

The arguments made by the ministry suggest “they just want to keep control over these firms,” Former Army chief General (retired) VP Malik, who headed the Army during the Kargil War of 1999, said.

One of the other concerns raised by the Defence Ministry was that the ecosystem around PSUs in the sector, which includes small businesses, will be hurt by privatisation. To this, Malik said that MSMEs selling their products to defence PSUs, will continue to do so even if the company is in private hands. “This is also how major manufacturers like Tata, Mahindra or Ashok Leyland get their products,” Malik said.

Malik said the lack of competition in the defence sector, which the ministry cites as an argument against privatisation, has resulted in no improvement in quality and technology, leading to higher costs. “If the private sector is already manufacturing major weapon systems, such as multi-barrel rocket launch systems, how can you say they have not evolved themselves?” Malik said.

He, however, said that the government should control the transfer of technology to and from abroad and the export of critical items, like weapons.

‘Capacity Constraint’

Rajeswari Pillai Rajagopalan, a distinguished fellow and head of the Nuclear and Space Policy Initiative at Observer Research Foundation, said state-owned defence firms face a severe capacity constraint.

“There are serious questions over the ability and capacity of state-owned firms to deliver to the Indian armed forces in a timely manner. We cannot rely on them with the kind of adversarial neighbourhood that we have,” Rajagopalan said, “But there needs to be appropriate regulatory framework through which you can engage with private sector since sensitive security information will be shared.”

She said that that defence PSUs do not have the incentive to let private players in as they want to enjoy monopoly and a top-driven political approach to improve efficiencies in the defence sector.