Preference for Local Industry in Defence Contracts: What India Can Do
(Source: Institute for Defence Studies and Analysis; issued May 22, 2017)

By Laxman K Behera
In a significant development, the Ministry of Finance (MoF) has included a new enabling provision in the revised General Financial Rules (GFR) with the intention of favouring domestic industry over foreign companies in government procurement contracts.

The new provision, under Rule 153 (Reserved Items and other Purchase/Price Preference Policy) of GFR-2017, arms the central government with the power to “provide for mandatory procurement of any goods and services from any category of bidders, or provide for preference to bidders on the grounds of promotion of locally manufactured goods or locally provided services.”1

The broad policy framework is part of the government’s ambitious Make in India initiative to accelerate the share of manufacturing in the country’s gross domestic product. While the new provision is applicable to all government procurements, one area where its implementation is likely to have a far-reaching impact is defence procurement. Unlike procurement by other ministries/departments, that of the Ministry of Defence (MoD) is immune from international trade restrictions.

The operationalisation of the new provision by the MoD, however, requires, a suitable tweaking of the existing procurement procedures to bridge a vital gap that exists in India’s attempt to push forward the Make in India initiative in defence manufacturing.

International Trade Norms and Protectionism

The World Trade Organisation (WTO), to which India has been a party since 1995, generally prohibits protectionism in international trade. However, it does provide several exemptions for member states with regard to various restrictive trade practices such as offsets and other forms of counter trade, preferential treatment to local industry and domestic content requirement.

Two areas where the WTO is silent on restrictive practices are: arms trade, and government procurement outside the framework of the Agreement on Government Procurement (GPA) – a plurilateral agreement to which 19 out of 162 WTO members are presently party. GPA promotes free trade among member states in so far as government procurement contract is concerned. India is not yet a member of the GPA, but has had observer status since February 2010. Even within the framework of the GPA, there is a clear provision that allows member states to take measures to prohibit foreign participation in public procurement on national security grounds.

Many countries, including those party to the GPA, have exploited the above mentioned exemptions provided in the WTO, and devised suitable laws and provisions to promote their domestic industrial interests. Israel, for instance, has a law that allows a price preference of up to 15 per cent for the local industry in a government procurement tender open to non-GPA members. The price preference, in essence, artificially inflates the price bid of a foreign supplier when its bid price is found to be the lowest among all the bidders. The artificially increased price is then compared with the lowest offered price of a domestic supplier so as to find whether the said domestic supplier can match the price of the foreign supplier.

In case the domestic bid price is found to be lower than or equal to the artificially increased price, then the contract is awarded to the domestic bidder. This allows the government to keep the tax payers’ money confined to the furtherance of local business and employment.

The country with the longest history of protectionism in government procurement is, however, the United States, which has a number of laws to favour American business and labour. Three specific laws that are widely used to the advantage of local industry are the Buy American Act, the Berry Amendment and the Speciality Metal Restriction. The Buy American Act is by far the oldest and best known statute that discourages procurement of foreign products in federal procurement contracts. Enacted first in 1933, the Act requires federal agencies to procure domestic end products and construction materials in contracts exceeding a certain value (usually USD 3,500).

As implemented, the 84-year old Act establishes a price preference for domestic bidders. The price preference usually varies from six per cent (in case the lowest domestic bid comes from a large US company) to 12 per cent (when the US bid is from a small company) and 50 per cent (for defence procurement). The highest price preference for defence procurement is a clear indication of the importance attached to preserving the domestic defence R&D and manufacturing base.

The Berry Amendment and the Speciality Metals Restriction, whose origins also date back to the first half of the 20th century, are, on the other hand, specific to defence procurement and intended to insulate the US defence industrial base by prohibiting the procurement of certain items from foreign sources. These two laws are also intended to bridge a crucial gap in the Buy American Act, which treats a product as domestic so long as it is a commercial-off-the-shelf (COTS) item or if the cost of a product’s parts and components mined, produced or manufactured in the US is more than 50 per cent. Both also do away with any concession and require items to be fully indigenous in origin.

As implemented in the public law, the Berry Amendment mandates the Department of Defence (DOD) to purchase such items as food, clothing, tents, certain fabrics and hand and measuring tools to be entirely “grown, reprocessed, reused, or produced in the United States.”2 The Speciality Materials Restriction prohibits the DOD from purchasing aircraft, missile and space systems, ships, tank and automotive items, weapon systems, ammunition or any components thereof if they contain any speciality metal that is not melted or produced in the US. It defines a metal as speciality metal if it includes “certain types of steel; certain metal alloys made of nickel, iron-nickel and cobalt; titanium and titanium alloys; and zirconium and zirconium alloys.”3

It is to be noted, however, that all the three above mentioned US laws regulating domestic content requirements have certain exemptions under which federal agencies (including the DOD) can purchase foreign products. These waivers are provided under certain conditions that include unavailability and obligation under international treaties, among others. However, obtaining an exemption is easier said than done and when it comes to defence procurement waivers are few and far between. Consequently, almost all the defence contracts issued by the DOD are bagged by US defence companies.

In 2015, only a mere four per cent of all DOD procurement contracts was placed on foreign entities, with the rest being monopolised by US defence companies. It has been argued by many that these laws have been used effectively by US policy makers to nurture, preserve and develop what now exists as the most powerful defence industry in the world.

What India Can Do

The new enabling provision in GFR-2017 provides the MoD a chance to amend its own procurement document and include a provision of production reservation and price preference for domestic industry. For product reservation, the MoD may like to identify a list of items including strategic materials that would be the exclusive purview of the domestic industry and subject to maximum indigenisation.

And for price preference, the MoD may like to factor it particularly in ‘Buy (Global)’ procurement contracts in which the nascent Indian private sector companies are often exposed to overwhelming competition from giant global companies.

The crux of the matter is that defence industry worldwide is the most protected sector and India should not shy away from taking measures that others have adopted for long.

-ends-




prev next

Official reports See all