The Reality of Defence Procurement
(Source: Institute for Defence Studies and Analysis; issued April 16, 2012)
The past few months have seen considerable activity, and inneundos and accusations bandied back and forth, on a number of issues between Army Headquarters—the Army Chief in particular—and India’s political leadership, including the Ministry of Defence (MoD).

The latest are the charges on the procurement of the Kolos-Tatra heavy-duty cross-country operable vehicles at high cost through Bharat Earth Movers Limited (BEML). The fact of the matter is that controversy about procurement is not a new phenomenon, and there are systemic reasons for its repeated outbreak.

Over the past three decades, the Services have generally been pressing for imports ‘off-the-shelf’ as against indigenous production because of perceived voids in front-line holdings vis-a-vis those of likely adversaries and the consequent need to fill the gaps, notwithstanding in many cases, of high prices, unfavourable down payment conditions imposed by foreign suppliers and lack of commitment on the part of the latter to supply spares sufficient for our needs.

This position of the Services have had to be accepted by the MoD because of the inefficient production costs of Defence public sector undertakings (DPSUs) and Ordnance Factories (OFs) , their high overheads , etc. and the systemic problem of the Services, on most occasions , unwilling to offload long-term orders on DPSUs and OFs .

That the DPSUs as well as the Ordnance Factories—these alone employ nearly 100,000 people—are not the most efficient, is a reality. However, these organisations, or at least some of them, have shown a marked improvement in their capital-output ratio, labour productivity, and pricing mechanism over the past few years, compared to the position prevailing in the 1970s and 1980s. The built-in processes of the DPSUs and OFs—term it inefficiency or otherwise—impinge on the prices of their products. This, in turn, affects the buyers of their products, that is, the Defence Services.

There are apparently two options open to the Services: to either import, albeit in quite a few cases, at lower cost, or buy through the captive DPSUs or OFs at comparatively higher cost. This scenario has been in play over the past four decades. Different Raksha Mantris and the MoD have had to persistently contend with this phenomenon.

The Services were made conscious of their responsibility on price, i.e., to be aware and appraise the prices of the supplies/products of the Ordnance Factories, by the MoD and the Ministry of Finance in the late 1980s, when the concept of ‘free issues’ by OFs were done away with. As a result, the value of the purchases of the services were debited or charged to their respective budgets. Consequently, the value of purchases (sales or issues by OFs) was reflected as “recoveries” in the budget of the OFs within the overall Defence Services Estimates.

The institution of annual pricing discussions between the Services’ HQs and the Ordnance Factory Board was also introduced as a concomitant. The Services, which were till then enjoying OF supplies as “free issues”, were not favourably disposed towards this change. They held the fallacious notion that OF supplies were basically in-house transactions and financial adjustments were therefore not necessary, failing to realise that OFs, under the new system, had to be accountable for the prices and offset the production expenditure by deducting the value of their supplies (‘the recoveries’ to the Services).

It may not be incorrect to opine that the Services were apprehensive that within the budgetary allocation cap imposed by the MoD and Ministry of Finance, with a substantial component diverted for supplies from Ordnance Factories, a large quantum of funds for imports may not be available.

The point to note is that the Services should have themselves advocated such a system to compare the prices of OFs vis-à-vis ex-import or even purchases from the Indian market. But the fact remains that financial inputs or rather consciousness in the decision-making process at the level of Services’ HQs, particularly of the Army, have traditionally been inconsequential or of a very low order. In any event, over the past few years, greater involvement of the Services in decision-making, like for instance in pricing of DPSUs and OFs, have been instituted.

Further, both the MoD and the Services have their representatives in the Board of Directors of DPSUs. There is therefore no valid reason to construe that the prices of DPSUs’ supplies (including the recent instance of Tatra vehicles) were not duly considered and accepted by the Services. Pricing by the supplying DPSUs, clearances by Defence Acquisition Council/Defence Procurement Board, and the indents (firm demands) by the Services duly vetted by Integrated Finance of the MoD representing the Ministry of Finance, are de facto part of a continuum. Therefore, blaming any segment of the decision-making process would be a misrepresentation of facts.

What demand scrutiny are causes of the high or inefficient pricing, mark-up pricing, etc., by the DPSUs and OFs. Managerial reorientation, change of product-mix, and even partial disinvestment have to be considered not only in strict economic terms but also keeping in mind the impact on the overall logistics of our Defence forces and their operational preparedness. For example, it is often stated that operating OFs to supply clothing, tentage, and related stores to the Services apparently lacks logic.

Existing market conditions seem to indicate that procurement as per the requirements of the Services is feasible at lesser prices from trade sources than those obtainable from OFs. However, total dependence on trade sources may be injudicious because the supplies may be available only at fluctuating prices on many occasions especially if the Services’ were to fail or express their disinclination to firm up a long-term commitment, work out contractual commitments and place orders concomitantly on private sector firms.

The Services do not seem to have considered these issues; neither have trade sources been forthcoming on long-term tie-ups, where their margins may not necessarily be the highest always, in the present national and international economic scenario.

In the case of lethal equipment, had we not set up the DPSUs and OFs, India may not have been able to obtain the systems which met the base-line operational requirement of the Services, and was also deemed financially optimum. The foreign powers and their sources could not have been oblivious to the fact that we had the scientific and industrial capability to contend with their technology denial postures and less-than-optimum prices. The very capability to indigenously manufacture was a factor leading to the offer of foreign systems during the Cold War period.

It may be worthwhile to analyse the consequences of not having licensed manufacture through Hindustan Aeronautics Limited, BEML, Bharat Dynamics Limited, Naval Dockyards, and the OFs. There is also no reason to surmise that agents would have been less active with outright purchases vis-à-vis transactions involving manufacture from completely knocked-down components and licensed production.

Defence procurement of mega financial and administrative implications seems to have become a matter latent with a myriad of consequences, to be left to the discretion of the Services` HQs as an in-house matter of the MoD. It is necessary to revamp the procurement process from time to time. In this regard, former Raksha Mantri, Pranab Mukherjee and incumbent Raksha Mantri, A. K. Antony, have particularly brought about significant transparency and institutionalised arrangements in the procurement activities.

However, it appears that there are still grey areas which provide scope for suspicious accusations and lack of accountability for obfuscating decisions. These have to be rectified. It may be judicious to take the procurement process above a particular threshold, say, for cases to be sanctioned by the Government on the recommendations of the Cabinet Committee on Security, outside the fold of the MoD.

Entrusting the final appraisal of financial attributes to the Ministry of Finance—for example, by a Procurement Committee of theirs, consisting of eminent officers having expertise in Defence Finance, Audit, Command of Field Army/Battle Groups and management of Industrial Enterprises—may bring about a more open, dispassionate, integrative, and authoritative decision-making system.

The author, Gautam Sen, is a former Additional Controller General of Defence Accounts. He is presently serving as Adviser to the Government of Nagaland.


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