In her budget speech last year, Finance Minister Nirmala Sitharaman had flagged defence manufacturing as one of the ten thrust areas in the government’s vision for the coming decade. The budget outlay of 2019-20, however, belied that vision as the gap between the requirement projected by the services and the amount allocated to them exceeded Rs 88,000 crore.

About two-thirds of the shortfall was under the capital segment of the budget, which caters for acquisition of new equipment and payment on account of all ongoing capital acquisition contracts. The Standing Committee on Defence (SCoD) considered the allocation to be so scant as to warn that the Ministry of Defence (MoD) may end up defaulting on making contractual payments.

 

Though MoD somehow managed to avoid that ignominy – albeit at the cost of withholding payment to the state-owned Hindustan Aeronautics Limited (HAL), and probably some other vendors too – no one asked, and the Ministry did not care to explain how this feat was achieved. Even SCoD – never shy of making censorious observations on such issues – avoided asking this inconvenient question.

It is no different this year. There is a gap of more than Rs 1,03,500 crore between the projection and allocation for the FY 2020-21, of which about 58 per cent is on account of capital expenditure. It will not be surprising if MoD manages to scrape through this year also, but the long-term impact of persistent underfunding, both under the revenue and the capital segments of the budget, cannot be glossed over.

 

While the officials continue to push acquisition proposals for aircraft, helicopters, submarines, guns, drones, armoured vehicles, and the like, where the money is going to come from is the last thing that seems to be on their mind. This, in fact, makes one doubt whether all this talk about insufficiency of funds even for making payments against the on-going contracts is for real.

But, for real, it is. With an increase of just about three per cent in the allocation of capital expenditure over the revised estimates for 2019-20, the financial crisis may be more imminent than ever before. In the circumstances, some of these ambitious capital acquisition programmes could get delayed, or worse, fall through at some stage because of financial constraints.

 

Shortage of capital budget could also possibly impact development of infrastructure, acquisition of land, and raising of cyber and aerospace agencies as well as the special operations division, just as financial constraints were one of the main factors that put paid to the sanctioned project of raising the mountain strike corps a couple of years ago.

Revenue budget does not present a very different picture. As a matter of fact, inadequacy of funds for revenue expenditure has a more insidious impact. With the rising share of pay and allowances – anywhere between 65 to 70 per cent of the revenue budget 2020-21 of the armed forces – and other obligatory expenses on ration, clothing, etc, there is not much left for meeting the operational requirement.

At Rs 33,142.00 crore, the allocation to the three services for 2020-21 under the ‘stores’ budget head which, apart from the expenditure on ration and clothing, also caters for procurement of spares, ammunition and maintenance of equipment, etc, is about Rs 2,500 crore less than the allocation for 2019-20. This is also true of the ‘works’ budget head which caters for the revenue expenditure on repair and maintenance of the existing infrastructure. The implications are self-evident.

The services are probably justified in asking for more funds than what they have been getting, but it is a fact that the successive governments have found it difficult to meet the requirement as they face various constraints, ranging from the inability to generate more revenue through taxation and borrowing to overlooking competing demands from other sectors like health, education, agriculture, internal security and infrastructure – not necessarily in that order.

All eyes are now set on the Fifteenth Finance Commission (FFC) which was asked by the government in July last year ‘to address serious concerns regarding the allocation of adequate, secure and non-lapsable funds for defence and internal security of India’. It was a desperate attempt to postpone taking hard decisions about sustainability of the rising defence expenditure – including the expenditure on defence pensions which has risen from less than Rs 7,500 crore in 1999-2000 to Rs 1,33,825 crore in 2020-21.

It will be naïve, though, to expect the commission to come up with a magical solution, not least because any recommendation that even marginally reduces the states’ share in the central revenues to carve out a corpus for defence and internal security could be contested by them, especially in the aftermath of Covid-19, the effects of which on the economy and incomes will unravel in the coming year(s).

In the face of the ongoing financial crisis, all this talk about indigenisation, self-reliance and India becoming a defence manufacturing hub sounds a bit incredible. Defence is a monopsony with just one major buyer who has limited funds to promote and sustain these efforts. To add to this, there is a lack of clarity about how this goal is to be achieved.

A classic example of this ambivalence is the recommendation made by SCoD in its seventh report submitted to Parliament in March 2020, that the MoD should explore the possibility of ‘earmarking some percentage of funds while allocating annual funds for acquisition from (the) Indian sources’.

First, indigenisation is not about acquisition of items from Indian sources but about the extent of indigenous content in an item. Second, defence budget is meant primarily for equipping the armed forces and not for promotion of the indigenous industry by earmarking a portion of already deficient outlay for that purpose. That cannot be the overriding priority.

Most importantly, in the environment of competitive tendering, indigenisation depends on commercial viability of the effort. It makes no sense to indigenise if it makes the product costlier than the cost of the imported item, unless a system is put in place under which the buyer absorbs the additional cost incurred by the supplier in the process of indigenising a product. As of now, no such system is in place.

Paradoxically, among all this despondency, India has become the 23rd largest arms exporting country in the world, according to a SIPRI report of December 2019. It would be imprudent, though, to see this as being representative of an irreversible trend.

For one thing, the exports still account for 0.2 per cent of the global arms market and 85 per cent of the export is to Myanmar (46 per cent), Sri Lanka (25 per cent) and Mauritius (14 per cent), which offer a limited potential for any substantial increase in the total volume of exports. In the circumstances, it will take more than repeated expression of intent, to achieve the arms export target of US$5 billion in the next five years.

– The author is Ex-Financial Advisor (Acquisition), Ministry of Defence