India in the Global Supply Chain: Can Domestic Demand

and Technology Skills Help It Catch Up?

Published: February 15, 2007 in Knowledge@SMU

In the global economy of the early twenty-first century, the division of labor between
Asia's giants is clear. China, the world's factory floor, makes things--everything from
shoes to computers. India, the world's back office, does things--from fixing software
glitches to chasing down credit card debt.

India's services sector may be red hot, but the same can't be said for its manufacturing.
Hampered by poor infrastructure, bureaucratic red tape and restrictive labor laws, it has
failed to make its presence felt globally. Between 1990 and 2005, industry's contribution
to the economy remained more or less stagnant, crawling from 25% to 27%. Over the
same period, the share of services ballooned from 37% to 52%. According to experts
from the Boston Consulting Group, in 2005 India's manufacturing exports were 6% of
GDP ($37 billion) compared to 35% for China ($712 billion). About 60% of Chinese
manufacturing exports are by firms headquartered outside China.

"To date, India has not begun to play a big role in the manufacturing footprint of
multinationals," says Sachin Nandgaonkar, a director in BCG's New Delhi office. "Though,
if you compare it to five years ago, things are improving."

Beneath the surface, however, things have begun to change rapidly, according to
experts at BCG and Wharton. Driven by the emergence of a vast domestic market and
relatively low-cost workers with advanced technical skills, more and more multinationals
are setting up manufacturing operations in India. Ford, Hyundai and Suzuki all export
cars from India in significant numbers. LG, Motorola and Nokia all either make handsets
in India or have plans to start, with a sizeable share of production being exported. ABB,
Schneider, Honeywell and Siemens have set up plants to manufacture electrical and
electronic products for domestic and export markets.

In addition, a clutch of globally competitive Indian manufacturing companies -- many of

them in the automobile industry -- have inserted themselves into the global supply
chain. Sundram Fasteners makes generator caps for General Motors. New Delhi-based
Moser Baer has established itself as a global manufacturer of data storage media such as
DVDs and CDs. An aggressive group of pharmaceutical companies -- India has about 60
plants that meet the stringent quality standards of the U.S. Food and Drug
Administration, the largest number outside the U.S. itself -- are opening new markets
around the world.

"Over the past five or six years, many firms have restructured their manufacturing
operations and implemented world-class practices," says Arindam Bhattacharya, director
and head of the industrial goods practice in India in BCG's New Delhi office. "Slowly but
surely they have started building a globally competitive manufacturing base in industries
like pharmaceuticals, auto components, cars and motorcycles."
Domestic Demand

India's potential manufacturing renaissance is still in its early stages, but it's already
clear that it will look very different from China and East Asia. Dalip Pathak, a managing
director at private equity firm Warburg Pincus, which has investments in both China and
India, says China's world-class infrastructure and a government that is focused on
employment generation by smoothing the way for manufacturers makes it an excellent
choice for long-term investment in manufacturing.

In India, the sailing isn't quite as smooth. India's literacy rates continue to lag East
Asia's and average unskilled labor productivity in India is lower than in China or Vietnam.
However, there are many instances where average productivity is much higher due to
superior management practices, says Bhattacharya. Restrictive labor laws -- companies
that employ more than 100 workers need government permission to fire them -- make
India a poor choice for large labor-intensive industries such as shoes and toys. Some
parts of the economy, such as handlooms, remain reserved for inefficient small-scale
industry. Expensive and unreliable electricity, poor roads, clogged ports and red tape
add to the disincentives.  According to the International Finance Corporation's
September 2006 rankings, it takes 35 days to start a business in India, compared to 5
days in the U.S. and 18 days in the U.K. India, however, is in the same league here as
China (35 days) and Thailand (33 days), but way ahead of Brazil, where it takes 152
days to start a business.

As a result, says Saikat Chaudhuri, a professor of management at Wharton, global

manufacturing in India is being driven largely by domestic demand. He points to mobile
phone manufacturers such as LG, Nokia and Motorola and car companies such as Ford,
Hyundai and Toyota. Some of that is changing, though. As an example, Bhattacharya
offers Hyundai, which has designated its Indian plant as its only plant worldwide to make
small cars, and it is shifting production from Korea to this facility. The gradual scrapping
of import licensing, lowering of tariffs and a liberalized exchange rate regime have all
contributed to a sustained domestic, consumption-led boom. According to BCG
estimates, annual domestic car sales have shot up from 265,000 in 1995 to 820,000 in
2005; in the first eight months of the current fiscal year, domestic car sales were nearly
870,000. Indians buy more than three million new cell phones each month.

"Where domestic demand has grown, it makes sense to build a supply chain," notes
Chaudhuri. "That will be the model until India can improve its infrastructure and attract
more FDI." The acute price sensitivity of the Indian market also adds to the incentives to
manufacture locally. Bhattacharya says the government's focus on increasing
manufacturing growth through special economic zones, private participation in ports and
massive investments in roads, among other things, is already paying dividends.

David Snyder, executive director for business development for Ford Asia Pacific,
estimates that India's auto market, including utility vehicles, will double over the next
ten years, from about 1.4 million vehicles to 2.8 million. This is a quarter of the growth
-- in units -- Ford expects in China, but more than the growth of 1.3 million new vehicles
it expects to see in the Asean (Association of Southeast Asian Countries) over the same
period. With sales in North America, Europe and Japan expected to remain flat, Asia-
Pacific as a whole -- with a focus on China, India and the Asean -- are Ford's priority
growth markets.

Auto Parts: India's Showcase

As the success of firms such as auto-parts maker Bharat Forge shows, India's
competitiveness lies in relatively high-end manufacturing. Indian universities turn out an
estimated 400,000 engineers a year, second only to China.

In auto parts, India's showcase in manufacturing, more and more firms have upgraded
their technology and processes and emerged as reliable suppliers of parts to
multinationals. Over a dozen, among them Sona Koyo Steering Systems, Sundaram
Clayton, and TVS Motor, part of the Chennai-based TVS group, have won the Deming
prize, a prestigious Japanese award for quality. While most auto parts exported from
India are simple, Toyota has begun shipping transmissions from its plant near
Bangalore. Nandgaonkar points out that the decision was prompted as much by quality
as by cost. "If I can have Japanese quality at a much lower cost, then why not?" he
says.

In addition, India's pool of scientific talent allows its companies to de-automate, and
locally design and procure, some of the more expensive aspects of auto parts
manufacturing. BCG estimates that such process engineering can cut capital costs of
component plants by 40-60%.

"There's limited competitive advantage in structural terms if you look at the economy
compared to China," says Bhattacharya of BCG. "But a combination of strong leadership
and an ability to harness brainpower in an innovative way makes these firms
competitive."

Global trends may also favor India as more companies in the U.S., Japan and Europe
outsource manufacturing to keep down costs. Besides auto parts, telecom equipment
and pharmaceuticals, India has the potential to be competitive in such skill-intensive
industries as fabricated metal products, high-end chemicals, consumer electronics and
computer hardware.

Nandgaonkar of BCG says recent improvements in infrastructure and a move toward

greater efficiency in Indian export parks make him optimistic. He also sees the
emergence of a new generation of young entrepreneurs with global ambitions and the
savvy to realize them. Pathak of Warburg Pincus adds that the lowering of interest rates
in India in recent years and the advantage of well-regulated and efficient capital
markets, rated among the best in Asia, also add to India's lure. "In ten years, India will
have a meaningful footprint in global manufacturing," says Pathak.
"I see the story of manufacturing unfolding in India through a combination of growing
domestic demand and skill-driven export competitiveness," says Nandgaonkar. "If you
look at the proposed and new investments in the manufacturing sector, you'll see the
numbers grow rapidly over the next five to ten years."

Chaudhuri, too, is optimistic. "Every major company has India on its radar screen," he
says. "It's just a matter of timing."

Indian textile Industry: Brand strategy and export

competitiveness
ABSTRACT

In today’s market economy, which is characterized by a very changeable environment and strong, intense
competition caused mainly by enlarging globalization; it is becoming more and more difficult for an enterprise to
maintain long-term success. Using techniques such as simply maintaining low costs or innovative solutions are
losing their importance. That is why the significance and meaning of brands have been growing recently. The
brand is a strategic resource of every firm. Possessing a brand, and knowing how to keep it and manage it well,
are becoming keys to reaching success in the market, a source of competitive advantage. “The dismantling of the
quota regime represents both an opportunity as well as a threat. An opportunity because markets will no longer
be restricted; a threat because markets will no longer be guaranteed by quotas, and even the domestic market
will be open to competition”. From 1st January 2005, therefore, all textile and clothing products would be traded
internationally without quota-restrictions5. And this impending reality brings the issue of competitiveness to the
fore for all firms in the textile and clothing sectors, including those in India. It is imperative to understand the true
competitiveness of Indian textile and clothing firms in order to make an assessment of what lies ahead in 2005
and beyond. The aim of this paper is to show that a properly used brand strategy is the enterprise’s most
valuable asset and to evaluate export-competitiveness of the Indian textile and garment exports.

INTRODUCTION

Textiles account for 14 per cent of India’s industrial production and around 27 per cent of its export earnings.
From growing its own raw material (cotton, jute, silk and wool) to providing value added products to consumers
(fabrics and garments), the textile industry covers a wide range of economic activities, including employment
generation in both organised and unorganised sectors.

 Manmade fibres account for around 40 per cent share in a cotton-dominated Indian textile industry.
India accounts for 15% of world’s total cotton crop production and records largest producer of silk.

 It is the second largest employer after the agriculture sector in both rural and urban areas. India has a
large pool of skilled low-cost textile workers, experienced in technology skills.

 Almost all sectors of the textile industry have shown significant achievement. The sector has shown a
3.66 per cent CAGR over the last five years.

 India’s cotton textile industry has a high export potential. Cost competitiveness is driving the penetration
of Indian basic yarns and grey fabrics in international commodity markets. Small and flexible batches of
apparels can be manufactured in India and can provide a larger variety of casual wear and leisure
garments at significantly lower costs.

 Besides natural fibres such as cotton, jute and silk, synthetic raw material products such as polyester
staple fibre, polyester filament yarn, acrylic fibre and viscose fibre are produced in India.

IMPORTANCE OF BRAND

The constantly changing market poses new challenges to clothing enterprises, and the clients’ demands are also
continually rising, and so it is necessary every now and again to offer them a higher added value. This added
value is a properly planned brand strategy, the so-called branding. Firms without any distinct features, without a
clear vision or specific mission, or without permanent values, will sink in the mass of messages hitting the
market.

A brand image is defined through its selected symbolic patterns. The most important among these are the
brand’s name, logo, and composition of graphic elements and colours all associated with the company. It is
crucial for a brand built on these elements to give a clear message to the customer about the kind of company he
is dealing with, what its product is and who the clients are. All the elements comprising a brand image have to be
closely related to the idea and goals of the company. This certainly helps its positive identification, and as a result
a strong and distinct image is created in the customers’ mind. It is important that the customer’s mind should
absorb and retain as much information about a brand as possible; some time later this is translated into the
reconcilability and prestige of a brand on the market. A brand product offers a sense of safety, and guarantees
quality and reliability. Brand values are features that appeal to the emotional sphere of human perception.

Indian Auto Industry Shows Significant Growth Despite

Global Gloom
Last Updated: 2009-12-25T15:57:54+05:30

As per the reports, the Indian auto industry showed a significant growth by announcing new models despite
global gloom in economic growth. Most of the global companies collapsed during 2009 and the auto majors were
also in backtrack due to the depression.
 
During the year 2009, several new commercial launches happened, but the significant one was the commercial
rollout of the world's cheapest car, Tata Nano. We also saw some of the most expensive models like Phantom
(about $750,000) and the Ghost ($250,000) from Rolls Royce and Volkswagen's famed Beetle ($40,000).
 
During the year, the overall car market grew around 15 % over 2008, and a similar pattern is expected in the
coming year too.
 
Neeraj Garg, Volkswagen India group sales director, said, "Car manufacturers are betting on hatchbacks in the
B+ segment. We expect the segment to constitute nearly 75 percent of volumes in the coming years."
 
According to Garg, the B+ segment is expected to grow 30% by virtue of new launches from Nissan (unnamed
model), Ford (Figo), Volkswagen (Polo), and General Motors (Beat).
 
Spark, the compact car from General Motors, will now come in an electric version. It has tied up with Bangalore's
Reva Electric Car Co. to come up with a new version.
 
"We expect the electric Spark to be launched next November. We will provide the battery kit and use GM's dealer
network to distribute our models," said Reva co-founder Chetan Maini.
 
A slew of other models have also been launched this year apart from Tata’s Nano.
 
The auto market also saw a series of other models including Jazz (Honda), the multi-purpose Xylo (Mahindra and
Mahindra), Grande Punto from Italy's Fiat. Apart from that, Tata Motors had also introduced the iconic British
brands including Jaguar and Land Rover into other markets.  
 
The other big companies like Maruti Suzuki, Hyundai and Toyota also marketed their new models. Maruti Suzuki
debuted its Ritz, while South Korea's Hyundai launched the diesel i20 and the Czech Republic's Skoda
showcased the new Laura. Japan’s auto major Toyota introduced the latest version of sports utility vehicle Land
Cruiser in the same year.
 
As per Ernst and Young’s report, the Indian passenger car market is expected to grow at 12% annually over the
next five years and the annual production may also touch 3.75 million units by 2014 from the present.89 million
units.
 
Several analysts forecast, "The industry's turnover is estimated to touch $155 billion by 2016."
 
If the trend continues like this, then the Indian auto industry would be the seventh largest auto industry in the
world. It would also be the third largest in that sector by 2030, after China and the US.
 
As per India’s Automotive Mission Plan, India can be the leading car maker within the next five years. At present,
Indian car industry contributes over 5% in that sector and it can then touch to 10% by 2016.
 
In the coming years, India is also expected to strengthen its position as an automobile hub, with the sale of about
2.75 million units in the overseas and about one million units in the domestic market.
 
Pawan Goenka, president of the Society of Indian Automobile Manufacturers (SIAM), said, "India and China are
the only markets that have remained profitable."
 
It has been noticed that, the Indian auto industry is growing at 15-25% annually for the past five years, due to
market demands from the class people. It might be due to growing disposable incomes in the people.
 
The auto industry expects the government to supply more funds for roads and highways, which would also boost
the industry sector. The two-wheeler industry is leading the growth chart with scooters and motorcycles.
 
Some of the companies including Mahindra and Mahindra also learnt to be quitting the two-wheeler business.
Still, some of the market players in the commercial vehicles segment are also upbeat about the market revival.
 
"With the economy reviving and growth predicted at over 7%, commercial vehicle segment can expect good
times ahead," said Ashok Leyland COO Vinod Dasari.
Where next for India's automotive industry? 
India’s automotive industry is booming. Expectations are rising. But can it
become a significant player in the global automotive industry?

This is the question raised by a new publication, KPMG in India's

Automotive Study 2007.

The industry currently contributes about U.S. $34 billion to the Indian
economy, equivalent to five percent of GDP. It produces over 11 million
vehicles a year. Directly and indirectly it employs more than three million
people.

Burgeoning home market

Growing mainly off burgeoning domestic demand, the industry has been
expanding at around 16 percent annually over the past five years.

KPMG in India interviewed 40 senior executives from various sectors of

the Indian automotive industry to try to determine whether the industry
can translate this success into a significant international presence.
 

Some believe the Indian automotive industry could emulate the Indian IT
sector, which has emerged as a leading supplier of low-cost, high-quality
IT services to the world. Is this realistic, given that India has to compete
with fast-developing auto industries in China, Brazil and Eastern Europe?

The Indian automotive executives who talked to KPMG are optimistic it

can.

They expect domestic growth to continue, fuelled by rising disposable

incomes and increasing consumerism. They also believe that global
automakers will continue to allocate an increasing proportion of their
foreign direct investment into India, initially into manufacturing and then
later into auto engineering and R&D.

And why not?

India is a billion-citizen economy where vehicle usage and ownership are

still very low by world standards. The Indian automotive market is now
one of the fastest-growing in the world.

However, companies recognize that their labor cost advantage is eroding

as both shop floor and management wage costs rise. They plan to offset
these labor cost increases through automation and improved
management efficiency. Whether this can be achieved remains to be
seen.

Good reasons for caution

But there are good reasons for caution.

India’s ramshackle infrastructure is retarding the industry, particularly its

ability to increase physical exports. The auto industry also lags sectors
 such as IT and financial services in management training, reward and
retention.

India’s fragmented component industry needs more consolidation if it is to

achieve critical mass. Distribution and marketing remain relatively
rudimentary.

Internationally, Indian automakers and component manufacturers accept

that they need more alliances in distribution and marketing. They need to
make more well-chosen acquisitions, especially in the components sector.

Critically, they acknowledge that to attain truly global scale the industry
must build persuasive global brands.

Critical turning point

Yet the overall impression of these discussions has been that India’s auto
industry has passed a critical turning point.

The inherent strength of India’s manufacturing economy — an exceptional

human resources base, the capacity to deliver high quality engineering
products and a strategic geographic position — is being reinforced by a
strong domestic economy and the readiness of global auto manufacturers
to make key investments in the subcontinent.

The challenge is no longer to create the opportunity but to manage it.

Introduction

Chemical industry is one of the oldest industries in India. It not only plays a crucial role in meeting the daily needs of
the common man, but also contributes significantly towards industrial and economic growth of the nation

                    (Last updated on 03.03.2008)

Global Scenario
The global chemical` industry, estimated at US$ 2.4 trillion, is one of the fastest growing sectors of the
manufacturing industry. Despite the challenges of escalating crude oil prices and demanding international
environmental protection standards now adopted globally, the chemicals industry has still grown at a rate higher than
the overall-manufacturing segment.

As per industry reports the pharmaceutical segment contributes approximately 26% of the total industry output and
approx. 35-40% is dominated by the petrochemical segment.

Commodity chemicals is the largest segment in the chemicals market with an approx. size of $ 750 billion while the
specialty and fine chemicals segment accounts for $ 500 billion.

Some of the major markets for chemicals are North America, Western Europe, Japan and emerging economies in Asia
and Latin America. The US consumes approximately one-fifth of the global chemical consumption whereas Europe is
the largest consumer with approx. half the consumption. The US is the largest consumer of commodity chemicals
whereas Asia Pacific is the largest consumer of agrochemicals and fertilizers.

                        (Last updated on 03.03.2008)

Indian Chemical Industry Scenario

Chemical Industry is one of the oldest industries in India, which contributes significantly
towards industrial and economic growth of the nation. It is highly science based and
provides valuable chemicals for various end products such as textiles, paper, paints and
varnishes, leather etc., which are required in almost all walks of life. The Indian
Chemical Industry forms the backbone of the industrial and agricultural development of
India and provides building blocks for downstream industries.

Chemical Industry is an important constituent of the Indian economy. Its size is

estimated at around US$ 35 billion approx., which is equivalent to about 3% of India's
GDP. The total investment in Indian Chemical Sector is approx. US$ 60 billion and total
employment generated is about 1 million. The Indian Chemical sector accounts for 13-
14% of total exports and 8-9% of total imports of the country. In terms of volume, it is
12th largest in the world and 3rd largest in Asia. Currently, per capita consumption of
products of chemical industry in India is about 1/10th of the world average. Over the last
decade, the Indian Chemical industry has evolved from being a basic chemical producer
to becoming an innovative industry. With investments in R&D, the industry is registering
significant growth in the knowledge sector comprising of specialty chemicals, fine
chemicals and pharmaceuticals. The Indian Chemical Market Segment wise is as under: -

Segment Market Value (billion US$)

Basic Chemicals 20
Specialty Chemicals 9
High End / Knowledge Segment 6
Total 35

The Indian Chemicals Industry comprises both small and large-scale units. The fiscal
concessions granted to small sector in mid-eighties led to establishment of large number
of units in the Small Scale Industries (SSI) sector. Currently, the Indian Chemical
industry is in the midst of a major restructuring and consolidation phase. With the shift
in emphasis on product innovation, branch building and environmental friendliness, this
industry is increasingly moving towards greater customer orientation. Even though India
enjoys an abundant supply of basic raw materials, it will have to build upon technical
services and marketing capabilities to face global competition and increase its share of
exports.
As the Indian economy was a protected economy till the early nineties, very little large-
scale R&D was undertaken by the Chemical industry to create intellectual property. The
Industry would, therefore, have to make large investments in R&D to successfully
counter competition from the international chemicals industry. India has a number of
scientific institutions and the country’s strength lies in its large pool of highly trained
scientific manpower.

India also produces a large number of fine and specialty chemicals, which have very
specific uses and are essential for increasing industrial production. These find wide usage
as food additives and pigments, polymer additives, anti-oxidants in the rubber industry,
etc.

Food Processing In India - Industry Report 06

The Indian food processing industry was valued at Rs. 5060 billion in 2005, a growth of
10% over the previous year. The Food Processing industry consists of segments like processed
fruits and vegetables, cereal based products, dairy products, meat, poultry and fishery products,
beverages and confectionery. In addition, the Indian food processing industry is becoming an
attractive FDI destination; it attracted around INR45.19 billion FDI during 1991-2005 which is
3.3% of total FDI inflow in India. This report on Food processing in India gives an overview of the
food processing industry and its segments in terms of size and growth over the last five years. The
Food processing report examines the detailed information on products, exports, imports and
outlook for the segment. The report examines the recent trends, developments, Issues &
Challenges in the food processing industry in India. The report ends with the outlook for the food
processing industry for coming years. The report on Food processing in India will be useful to the
government food processing departments and agencies working in the field to get an insight of the
Food processing industry.

Beneficial for
- The report will be useful to the food processing companies (Indian and overseas) in
understanding the Indian food processing industry in a better way.
- It will also be useful to the government food processing departments and agencies working in the
field to get an insight of the industry.
- The educational institutes may also use this information for their academic purpose to have in-
depth industry knowledge.
- Other research bodies, industry experts, associations & consortia of the industry and consulting
organizations may also

GEMS & JEWELLERY INDUSTRY:

IN THE FOREFRONT OF GLOBALISATION:
In the gems and jewellery industry, the cottage-based diamonds processing and jewellery making
units compete with modern factories using state-of-the-art machinery and computerized operations.
Modernisation and technology absorption through capital goods imports have given a cutting edge to
both diamond processing and jewellery manufacture in India. As a step in operational integration,
more and more diamond manufacturers have set up jewellery manufacturing units as well, creating an
invaluable synergy in the gems and jewellery industry.

The Indian gems and jewellery units have set up a worldwide network of offices in Antwerp, New
York, London, Tokyo, Hong Kong, Singapore, etc. One can find the offices of Indian gems and
jewellery units in every hotspot on the diamond industry map of Europe, Japan, USA, Israel, South
East Asia and the Middle East.

The phenomenal growth in gems and jewellery exports is a record for among the large Indian export
sectors. In fact, the gems and jewellery industry presents itself as a perfect case study for discussing
how to build competitiveness of Indian industries. The diamantaires and jewellery makers and their
devoted and skilled artisans have shown that even an unorganized industry can achieve international
competitiveness. The Indian gems and jewellery industry was the first one to absorb and assimilate
the true spirit of globalization by integrating itself with the world gems and jewellery industry.

GEOGRAPHIC SPREAD OF GEMS & JEWELLERY INDUSTRY

Gold jewellery making is spread throughout the country with every village having a family of
goldsmiths. The diamond processing industry has spread from the State of Gujarat, which accounts for
almost 80% of the diamonds processed in India, to other States. Surat, Ahemedabad and Bhavnagar
are the diamond centres in Gujarat. Many diamond processing units have been set up in Mumbai in
Maharashtra. There are also diamond processing units in Trichur in Kerala, Coimbatore in Tamil Nadu,
Jaipur in Rajasthan and also in Goa. Mumbai continues to be the main trading centre for diamond
exports. Ninety-three per cent of diamond exports are dispatched through Mumbai airport (see Table -
2).

Engineering and machine tools

The Indian machine and machine tool manufacturers and exporters with their pursuance of a systematic
approach to quality control and product standardization coupled with a long history of engineering
excellence have hence carved a niche market position for themselves in the international arena.

More than 2500 firms from the engineering sector have acquired ISO 9000 accreditation in areas of
casting and forging, automobile parts, machine tools, electrical machinery, primary iron and steel
products, industrial machinery, IC engines, pumps, textile machinery, etc. The Indian machine tool
industry manufactures almost the complete range of metal-cutting and metal-forming machine tools.

There has been a perceptible change in the image of the ‘Made in India ’ brand in overseas markets –
particularly true for Indian-built machine tools. Enhanced features, competitive price and marketing
focus have increased demand for Indian-made machine tools in overseas markets. Indian-made machine
tools are currently exported to over 50 countries, including United States, Italy, Brazil, Germany, and the
Enhancing Manufacturing Capability for Efficient Offsets
Middle East.
Absorption

Mukesh Bhargava and J.D. Patil

January 2009

Volume: 

Issue: 

Defence Offsets

Since Independence, as a policy, Defence R&D in India had been reserved for the state
sector with the DRDO having been established with the mandate to conduct research
into Defence areas. Defence Public Sector Undertaking units (DPSUs) and Ordnance
Factories (OFs) were set up with the twin objectives of:
 Productionisation of systems developed by DRDO;
Produce defence goods under Transfer of Technology (ToT) from foreign suppliers
and assimilate the technology.

This policy, when formulated, factored in the then state of private sector and also the
fact that basic R&D in all nations need to be funded by the state. This resulted in
investments, over the past decades, in infrastructure and facilities in Defence R&D and
Defence Public Sector Undertakings, with the onus to work on technology and product
development from the abstract stage to the productizing and hand holding at the
production stage. DRDO did invite and involve a large number of industry partners within
the limitations of prevalent procurement policies and did create few major success
stories.

This model has served the nation to some extent. It can also be seen that little ToT
actually happened from foreign technology sources in the cutting edge technology areas
to the OFs and the DPSUs. These organizations did master the production skill sets, the
ToT model for production denied development of upgrades and new systems. For a
nation of one billion plus with arguably the best knowledge driven industry better than
the best in the world, we ought to have done better. Need for the self reliance we seek
cannot be emphasised more than the back of envelop calculation of the multiplier effect
it will produce for the national economy through manufacturing growth rates and job
creation. The only way ahead over next 10 to 15 years is to build focused product
strategy with commensurate investments in Defence Industry across segments including
private sector so that in the long term, the country meets its defence requirements as
much as possible from within the country. This will only be possible by allowing the
private sector to a play rightful role in product design, development, manufacturing and
integration capabilities available in the private sector to augment the capacities built in
the Public sector through Public–Private–Partnerships (PPP). The same, however, could
not be harnessed proactively for the Defence Sector owing to the limitations of prevalent
defence policy.

During the pre-liberalisation era, industrial activity was allowed only under license, and
imports were controlled by the Director General Technology Development (DGTD) and a
cap was put on the production capabilities. Government policies placed barriers on free
trade and insulated the country from rapid technological advances. This resulted in
stifling the economic and technological growth across sectors. The post liberalisation era,
saw the removal of import restrictions, thus bringing in competition from the global
players. Indian industry developed competitiveness despite the policy tilt in favour of
imports of finished goods. Over the past decade and a half R&D in private sector came of
age, Indian industry evolved and poised to become a global player in ICT, engineering
and manufacturing. This was realized by the other strategic sectors (nuclear power and
aerospace). They collaborated and synergised with private sector R&D for its nimbleness
to achieve almost total self reliance in their needs thereby insulated the nation from all
kind of sanctions. In the defence sector, however, the production remained reserved for
the DPSUs / OFs. The ToT from OEMs was limited to manufacturing technologies. The
result was that the nation remained a net importer of its security.

Even in the post liberalisation era, 1991 onwards, local sourcing was limited to
component supplies, limited thrust was given to the private industry and “imports were
not discouraged”. Realising the vast potential of the industry, the process of integrating
the private sector in the defence industry was initiated by the Government in 2001. The
policy decisions announced in May 2001 permitted 26 per cent FDI in the Defence
industry and allowed the Indian private sector to participate in Defence production by
obtaining a license. The Defence Procurement Procedure 2002 (DPP 2002) turned out to
be the watershed for the Defence industry as it allowed the participation of the private
industry in defence production in-principle. Kelkar Committee was constituted in 2004, to
review private sector participation in defence production. Some of the recommendations
made by the Committee have also been implemented through the Defence Procurement
Procedures. These include constitution of selection committee for Raksha Udyog Ratnas
(RUR), which are potential system integrators from the private sector, the very
important offset policy common to both the public and the private sectors, and the Make
Procedure. The aim was to enhance competitiveness of the industry with an aim to make
them efficient, and achieve global benchmarks essential to compete in the global defence
market. The subsequent DPP 2005, DPP 2006 and 2008 have incrementally over come
some of those shortcomings and bridged the gaps in the promulgated policy. However,
the policy intent is yet to be implemented fully as the nomination of the DPSUs / OFs still
continues.

The Direct Offset policy applicable to all “Buy Global” RFPs valued at Rs 300 crores and
above stipulated a minimum of 30 per cent of the cost of acquisition to be sourced from
Indian defence industry. This policy aimed not only at ensuring the induction of advance
technology in the industry but also bring in capital investment for the economic growth
of the country.

Further, introduction of Offset Banking, announced in DPP-08, will not only facilitate the
implementation of offsets with sunrise and sunset stipulations to enable foreign OEMs to
demonstrate their intent for a long term engagement with the Indian Industry.

The foundation for the induction of technology, development of infrastructure and

making investments attractive for the foreign OEMs is thus, in place.

Indian Industry: Capability

Indian industry has developed a strong industrial base with a successful track record of
implementing technology intensive projects including bulk production within stipulated
time frames at reasonable cost and world class quality. It has strengths in design,
engineering, finance and marketing. It has a reservoir of management, scientific and
technological skills. The growth in the manufacturing sector has been phenomenal and
global standards have been reached in ICT, engineering and manufacturing. India is fast
turning into a manufacturing hub for the world. Major MNCs have established their R&D
and product development centres in India.

Even in defence sector there are large and small industry houses that have, over the
years, built capabilities and capacities, through partnership with development agencies
like DRDO, indigenisation cells in the services and DGQA. Many large industry houses
have either built new capacities or carved out capacities within their own design and
manufacturing capacities for defence sector.

Today private industry has the capability and the capacity to take up R&D / system
integration projects under the following categories:

Missile, rocket and torpedo launchers and fire control systems, both land mobile,
and naval;
Naval combat systems and platform management system;
 Naval engineering systems steering gears, stabilisers, landing grids, hanger
shutters, traversing mechanism, boat davits;
Platform specific machinery for ships, submarines, battle tanks;
Ship design centre;
Tank and gun upgrades;
Other weapon systems and upgrades;
Radar and towed Sonar;
Rugged computers for ground and mobile applications;
Air Defence command centres;
Avionics and airborne systems;
C4I2RS areas;
Defence electronics;

Domain specific software development such as EW, Air Defence, RDP, MST, Fire Control /
Ballistic Computer applications, etc.

Offset Policy and Offset Banking

The Offset Policy announced by the Government leverages bargaining power to get
benefits to the country in the form of offsets to build its Defence Industry. This as per
the current policy is direct and demands 30 per cent offsets on all Defence procurement
above Rs.300 crores. The benefits are economic gains, skills development, technology
gains, employment generation etc.

While looking at offsets, government seem to have stopped at making Indian Industry a
part of global supply chain of defence majors and missed out at on the system domain.
The consideration seems to be limiting to Transfer of Technology / Knowledge (Low
Level). This is evident from the current taxes and duties treatment of offsets limiting
offsets to supply of “parts and subsystems” sold by Indian industry through physical
exports (being part of global supply chain) thus misses out on systems and system of
systems integration within the country. Following needs to be looked into to make the
offset policy more efficacious for the country:

Offsets could also be supply of indigenous systems supplied as part of system of

systems being sold by the foreign OEM and may directly be supplied to Indian
services (not getting physically exported).
It is also possible that offsets could be delivered by the foreign OEM in the form
of system integration especially where large systems need to be fully integrated
and tested in India. This involves passing on the system level know-how that is
vital for building industry capability in doing so in India.
Tax and Duty (T&D) implications in either of these cases add up to approximately
40 per cent of price accounting for the T&D on inputs as well as at point of sale.
This effectively reduces offsets from 30 per cent to 21 per cent if delivered in
India.
To avoid this and facilitating indigenous capability building MoD may treat such
system offsets at par with indigenous supplies to MoD or treat offsets either as
“Import Substitution” or as “Deemed Exports” with use of corporate bonds and
not involving physical payment of T&D upfront and get it reimbursed.

Capability to Absorb Offsets

The myth regarding capability of the Indian industry to absorb the huge quantum of
defence offsets need to be looked at from the consideration of capability and non-
capacity and track record. Let us examine if the offset volume is really large for the
Indian industry? The capital defence purchases for this year are estimated at $10 billion
and expected to reach $20 billion / year by end of 11th plan. Assuming that 50 per cent
of this purchase would be from imports, and 60 per cent of that would qualify for offsets
(less than Rs 300 crores), Offsets obligation at 30 per cent would mean volume of just
about 9 per cent of the capital budget i.e. approximately $1- $2 billion per year.

Indian manufacturing industry has come of age and is growing steadily at the rate of 25
per cent year-on-year since 2001. The manufacturing sector has shown enormous
potential for growth. There is a healthy FDI flowing in to further bolster this growth.
Thus absorbing approximately $2 billion per year of offset volume is not an issue at all
for the Indian industry.

Manufacturing Strength
India is undergoing structural transformation with manufacturing increasing its role in
the Indian economy. Manufacturing now accounts for about a 27 per cent of India’s GDP
and contributes 53 per cent of total exports, 79 per cent of FDI and employs 11 per cent
of the workforce. India’s competitive advantages offer huge opportunities for exports
especially in areas like automotives and electronics.

According to a study by the Boston Consulting Group, India's vast domestic market and
relatively low-cost workers with advanced technical skills will make it a manufacturing
powerhouse within the next 5-10 years. Accordingly, multinationals have already started
setting up operations in India to operate in skill-intensive industry segments requiring
advanced technical expertise, areas in which India is becoming a primary sourcing and
manufacturing base. In fact, high skill sectors account for almost 40 per cent of the
manufacturing output of India.

The strong manufacturing base coupled with the well-established IT industry would be
able to comfortably absorb offset related investments in their respective sectors. Given
below is some further information on the manufacturing sector which indicates the ability
of the local industry to absorb substantial amount of offsets. India is the second largest
small car market in the world; it is one of the three countries that make their own super-
computers and has the second largest mobile phone market.

The Export Story

India’s export target for the year 2008-09 is $200 billion. India has had a sustained
year-on-year growth of approximately 25 per cent year-o-year for the past four years.

Source: Ministry of Commerce, Government of India.

India has not yet begun to tap its manufacturing export potential fully, ‘Made in India’
could become the next big manufacturing export story with its “Frugal” engineering
capability.
According to Mckinsey Report, if India were to take advantage of global low cost country
manufacturing trend, manufactured goods exports from India could increase from $40
billion in 2002** to approximately $300 billion by 2015, leading to a share of
approximately 3.5 per cent of the world trade in manufactured projects. This is likely to
create 25-30 million new jobs in manufacturing and add 1 per cent to India’s annual GDP
growth rate.

Attractiveness of India as a manufacturing destination

Figure 2
Manufacturing sector in India
Following sectors contribute 60-70 per cent to export:

Auto industry: The Indian auto industry is a $44 billion industry (Automotives is a
$34 billion industry and Auto components are $10 billion).
Chemicals: The size of the chemical industry in India (petrochemicals to paints) is
$30 billion.
Electronics: The electronics industry is a $11 billion (consumer electronics to
electronic components) industry.
Engineering: A $22 billion industry including heavy and light engineering.
Machine Tools: Industry size is $225 million.
Textiles: Industry size is $38 billion.

The balance 30-40 per cent exports are from sectors like automotive, cement, food
processing, drugs and pharmaceuticals, telecom equipment, IT hardware, electronics,
paper, minerals and metals

Indian manufacturing is forecasted to grow at 12-14 per cent over the next decade and
sectors like automotive, electronics etc. are expected to be growth drivers.

Manufacturing – A Perspective
Joint Ventures: The Indian defence industry lags far behind the global defence industry.
The capability of Private sector that was introduced to defence sector only after opening
up of the defence sector, is in a nascent stage (with some exceptions). The offset policy
introduced in the year 2006 can transform the threshold level of Indian defence industry.
Perspective joint ventures precisely help do that task when used as a tool to support the
offsets.

The joint ventures partnerships between industries envisage cooperation and co-working
by sharing each other’s expertise, experience and resources leading to development and
further selling of a product globally. Such partnerships can be cross border, across
sectors, range, and based on a win–win model to evolve new products, improve existing
products, raise the technology threshold, improve skills as well as cater to in service-life
support.

Joint Ventures for Indian Defence Industry

The joint ventures and co-production are one of the very effective ways to improve the
capabilities of Indian defence industry. The performance of Indian defence industry
primarily meant to support the Indian defence forces under the “protective environment”
has been sub optimal as is evident from the statistics below.

Breakdown of the revenue of OFs and DPSUs and their share in defence capital
expenditure:

Year Ofs DPSUs Total % of capex

2003-04 6,523.87 9,892.73 16,416.60 78

2004-05 6,186.65 11,248.59 17,435.14 52

2005-06 6,891.68 13,025.07 19,916.74 58

Note: Figures in INR crores;

Source: Ministry of Defence, GOI.

India’s defence industry in private sector is in a transition stage, where the effects of the
policy changes are yet to materialize. There is thus a need to boost the local defence
industry involving both public and private sector through the route of joint ventures
facilitated by the Offset Policy through appropriate incentives. This will not only help get
the technology and work ethics, but also expose the local industry to the global supply
chains and bring in domain knowledge in system integration.

Potential Areas for Joint Ventures in Indian Defence Industry

Defence industry is not restricted to a particular sector, and spreads across complete
range of goods and products involving land systems, aviation, marine, arms and
ammunition, IT and communication, missile, general stores, to name a few. There will be
need to define the priority areas and match them with the existing and potential
capability of Indian Defence industry for achieving optimum benefits by Joint Ventures.

Methodology
While Joint Ventures need to be discussed on case to case basis, the following are
recommended:

 Define the objective of Joint Venture i.e. upgrade the Indian defence industry.
 Joint Ventures and Long term partnerships are preferred over project to project
relationship and other options in offsets.
 All projects for Joint Ventures should be pre approved by DOFA.
 Need to insist on Joint Ventures with production facilities in India and involving
domain expertise.
 Monitoring of projects is done by DOFA and credits be banked on yearly basis –
based on the progress.
 Rule of 26 per cent FDI cap should be dovetailed with country’s need and level of
domain expertise brought in.
 Both private and public sector should be allowed – the foreign partner should
have the liberty to pick up the partner as per current offset policy.
 Government should monitor the Joint Ventures and benefits that accrue out of
them.

Joint Ventures are a means to upgrade the local industry. They should be given priority
in offsets for the benefit of Indian defence industry.

Offsets Implementation: Taxes and Duties

 Customs Duty on imports:

Currently the Offset Partner needs to pay applicable customs duty (CD) and countervailing
duty (CVD equivalent to excise duty) on the imports that are needed by Offset Partner. At
present, for the Defence related contracts placed directly on Indian suppliers, Indian
suppliers are provided with customs duty (including CVD) exemption certificate for their
imports.

Further, the Customs duty (as also CVD) is exempted for Defence supplies from Foreign
OEM when ordered directly by MOD. A similar treatment need to be given to Indian Offset
Partners of foreign OEMs.

 Excise Duty:

Deliverables by Offset Partner needs to pay prevalent excise duty (14.42 per cent at
present) on their deliverables as well as local input materials. This is at variance with the
rest of the specified category Defence systems (for deliverables), when excise duty
exemption is granted for the deliverables by Indian supplier to MOD/DRDO etc. Equivalent
 excise duty (CVD) is also not applied on the deliverables by foreign supplier, directly to
MOD, as CVD is also exempted along with the CD.

There is a case for treating “Indigenous value additions” for indigenous sales either in the
form of system integration or systems as part of system of systems supplied by foreign
OEMs as “Import Substitution” and treated on par with imports.

 Sales tax / VAT:

Contract for offset is going to be placed by foreign supplier on Indian Offset Partner.
Therefore, deliverables are sold from Offset Partner to Foreign supplier. Hence sales
tax / VAT (12.5 per cent) becomes payable on deliverables by Offset Partner.

There is a case for treating “Indigenous value additions” for Indigenous sales either in
the form of system integration or systems as part of system of systems supplied by
foreign OEMs as “Import Substitution” and treated on par with imports.

Both the above scenarios would not be the intentions of the "Offset Policy" and are
certainly not favourable to Offset Partners looking at large value addition.