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Defence Procurement Procedure – 2011

The much awaited Defence Procurement Procedure – 2011 (DPP-2011) was formally released on 13 January 2011. The new procedure aimed at ‘expanding India’s defence industrial base, encourage indigenous defence production and reduce defence imports’. Salient changes made in the procedure were as given below.

(a) Shipbuilding

The chapter on shipbuilding was split into two sections. The first section contained guidelines for placing orders on a nominated public sector shipyard for ships, submarines and other crafts. The second section allowed private sector shipyards to participate in competitive bidding to bag orders. Although it was claimed that seminal policy changes had been incorporated in the ship building procedure to provide a level-playing field to the private sector, knowledgeable observers were sceptical about it. They feared that all major proposals would be categorised under the first section and the competitive section would get activated only after the public sector shipyards got fully loaded.

Industry associations had recommended that shipbuilding be kept under a single section, providing equal opportunities to the private sector shipyards to compete for orders, thereby harnessing their potential as well. However, with a view to provide protection to public sector shipyards; the Ministry of Defence (MoD) decided to reserve the right to award shipbuilding contracts by nomination. Private sector shipyards had reasons to be highly disappointed. They knew that they would have to wait indefinitely to get overflow of a few minor contracts.

(b) Offsets

Terming it as a major change, MoD announced inclusion of civil aerospace sector, internal security sector and training within the ambit of eligible products and services for the discharge of offset obligations. A comprehensive list of all such products and services was provided in the procedure. It was claimed that the changes would provide a wider range of offset opportunities to vendors participating in defence procurements.

At the face of it, it appeared to be a progressive step. However, a close look at the newly included products and services revealed an entirely different picture. As regards the internal security sector, all products and services were the same as needed by the armed forces; and the manufacturers were already eligible to be offset partners, and interestingly, almost all were in the public sector. Similarly, inclusion of civil aviation meant little, with HAL being the only major aircraft manufacturer in the country. Therefore, expansion of offset sectors was not meant to increase offset opportunities for foreign vendors but benefit the public sector as the newly added products were in their monopoly domain.

(c) Commercial Terms

Commercial terms offered to vendors were modified to simplify and streamline the procedure. Earlier, vendors had to submit two separate financial bonds for performance of contract and warranty of equipment. Each bond had to be for 5 percent of the total contract value. Now vendors were required to submit a single consolidated Performance-cum-Warranty Bond of 5 percent of the total contract value. This change was expected to help vendors save considerable financial overheads.

To rationalise evaluation of bids by discounted cash flow method, it was mandated that borrowing rate of 9 percent would be considered instead of 9.5 percent as stipulated earlier. In an effort to ensure that Indian industry was placed at par with the public sector entities, Exchange Rate Variation (ERV) clause was made applicable to all Indian vendors when in competition with their foreign counterparts under the ‘Buy Global’ category. ERV, however, remained available in cases categorised as ‘Buy (Indian)’ except for public sector units in ab-initio single vendor cases or when nominated as the production agency.

Interestingly, Integrity Pact Bank Guarantee (IPBG) replaced earnest money/security deposit. IPBG was to be Rs 1 crore in cases where the cost as estimated by the buyer was above Rs 100 crore and Rs 3 crore if above Rs 300 crore. The validity of IPBG would be 45 days post validity of commercial offer and for the successful bidder this would be extended unto the completion of contract. As there was little change in the content, nomenclature was perhaps changed to emphasise the importance of Integrity Pact.

In case of delay in supplies under the Fast Track Procedure, liquidated damages would be levied on the vendor @ 1.5 percent per week subject to maximum of 15 percent of value of delayed stores. Earlier the upper cap was at 10 percent. The penalty of getting blacklisted for non-performance was removed. It was a step in the right direction. Blacklisting of vendors had proved counter-productive. Financial penalty would prove to be a more effective deterrent against deliberate default.

(d) Transfer of Technology for Maintenance

Earlier, MoD was required to specify a list in RFP of public or private sector firms for receipt of technology for maintenance and it was for the foreign vendor to choose any one of them. It provided adequate flexibility to him to identify the most suitable entity after carrying out an appraisal of their inter-se capability to absorb concerned technology. In a major turnaround, MoD decided to empower Department of Defence Production (DDP) to nominate the recipient and the vendor had to abide by that. The recipient could be any Indian entity incorporated under the Companies Act 1956, including DPSU or entities like Ordnance Factories/Army Base Workshops/Naval Dockyards/Base Repair Depots.

This was a retrograde step, initiated with the sole intent of aiding the public sector. As all DPSUs and ordnance factories come under DDP, no private sector company had a chance of getting nominated even if it was better equipped to absorb technology.

(e) Other Issues

MoD introduced four other small but significant changes as well. One, Service HQ (SHQ) was now required to include likely timelines for the procurement to fructify in the proposal for procurement. Two, in cases where the original Request for Proposals (RFP) was issued within the stipulated period of two years from accord of Acceptance of Necessity (AoN) and later retracted for any reason, AoN would continue to remain valid as long as the original decision and categorisation remained unchanged. However, the subsequent RFP had to be issued within one year from the date of retraction of the original RFP.

Three, an additional grace period of 30 days could now be granted by respective SHQ to vendors to field their equipment for field trials. However, equal opportunity had to be provided to all vendors while granting such grace period. Finally, in the Fast Track Procedure, vendors were now required to be given 30-45 days instead of 30 days to respond to RFP.

Major Infirmities Left Unaddressed

Every review of a policy must aim at its reformation and refinement. It is generally a three-stage process. To start with, failure of the policy to meet envisaged objectives must be accepted honestly with due focus on deficiencies. Temptation to brush failings under the carpet must be resisted.Secondly, an in-depth diagnostic study should be carried out to identify impeding provisions. Finally, bold remedial initiatives must be initiated to cure the infirmities.

Unfortunately, MoD went through the review more as a routine ritual rather than a sincere exercise to perfect the system. Major weaknesses of the policy, though well known to the officials, continued to remain unaddressed.

(a) Multitude of Categories and Resultant Confusion

Illustration: Saga of Mushrooming Categories: Confusion Compounded

Every procurement proposal received from SHQ is debated at length by the Defence Acquisition Council to determine the route to be followed for its execution and is categorised accordingly. To start with, only three categories (‘Buy’, ‘Buy and Make’ and ‘Make’) were specified in DPP-2002.

Progressively, there has been a proliferation of newer categories – nine of them in DPP-2011, thereby complicating and delaying the whole process. For example, ‘Make (High Tech)’ category, introduced in 2006 had proved to be a non-starter. Nearly four years had passed and not a single case had taken off. Similarly, ‘Buy and Make (Indian)’ category of 2009 had proved to be a damp squib. Now, DPP-2011 added two categories for ship-building – one by nomination and the other by competitive bidding. See Illustration.

It would have been prudent to revert to the erstwhile three categories. ‘Buy’ category could be restricted to Indian industry on case to case basis. All developmental activities must remain under the Defence Research and Development Organisation, as it is beyond the competence of SHQ to oversee development of high-tech systems.

(b) Lack of Equal Opportunities to the Private Sector

Despite MoD’s repeated assertions of providing equal opportunities to the private sector, it continued to be treated unfairly. DPP-2011 introduced two measures that were likely to affect the private sector adversely – placement of ship-building orders on public sector shipyards by nomination and nomination of entity by DDP to receive transfer of maintenance technology.

Both the above mentioned steps were retrograde in nature. Instead of harnessing the potential of the private sector through open competition, MoD had introduced partisan provisions.

(c) Excessive Centralisation of Decision Making Powers

The complete procurement regime is controlled by MoD. At every stage, reference has to be made to the bureaucrats and Defence Finance officials. Headquarters Integrated Defence Staff (HQ IDS) and SHQ do secretarial work and put up cases with noting sheets to the bureaucracy for directions. Decision making becomes the first casualty as the bureaucrats possess little knowledge of military systems.

Once RFP is issued, the procurement process consists of technical and commercial evaluation. Technical evaluation entails examination of technical proposals submitted by vendors, field trials and preparation of staff report identifying vendors whose equipment is considered fit for induction into the services. As technical evaluation is purely in military domain, MoD should have delegated the authority to oversee it to HQ IDS.

(d) Archaic Methodology of Formulation of Parameters

One of the main reasons for MoD to resort to single vendor contracts is the procedure’s inherent weakness of not according due importance to technology. It is mandated that parameters should be of ‘contemporary technology widely available in the world/indigenous market’. Such technology cannot be exclusive. Further, all vendors whose equipment satisfies all parameters are considered at par and contract is signed with the lowest bidder. As high end technology would invariably be more expensive than a mediocre one, services get forced to accept commonplace technology.

It had been repeatedly suggested to MoD to introduce matrix system for technical evaluation wherein due credit is given to equipment with better performance parameters (albeit within the specified range). As performance is a function of technology, such an arrangement would help get latest equipment in inter se evaluation in a competitive environment and fetch best value for money.

(e) Offset Muddle

Counter trade in the form of export of sundry low-tech items is considered to be the most wasteful way of doing offset business. Despite the fact that self-reliance is one of the stated objectives of the defence procurement procedure; India has failed to recognise potential of offsets in infusing latest technology. Consequently, India continues to incur cost penalty of millions of dollars on account of offset overheads but gets no worthwhile benefits in return.

India should have made transfer of technology to be the preferred offset route. Additionally, it should have established an empowered offset authority to oversee all facets of offset regime and lay down guidelines for approving, validating and measuring offsets.

Conclusion

MoD wasted yet another opportunity by its failure to address major infirmities afflicting the procurement regime. Eight years is a long period for any policy to prove itself and for MoD to accept the inability of the existing regime to deliver. Instead of resorting to mere window-dressing, MoD should have taken bold initiatives to put the system on track. Due to bureaucratic inertia and prevailing sense of complacency, review of DPP turned out to be a self-defeating exercise.

Regretfully, MoD had been fast losing credibility both amongst foreign vendors and the Indian private sector. Foreign vendors found the procurement regime to be ambiguous, subjective, unpredictable and highly dissuasive. Private sector companies were becoming highly sceptical of MoD’s assertions of providing equal playing field to them. They found the environment to be highly skewed in favour of the public sector. They had invested considerable resources but continued to wait on the sidelines. Their patience was running thin and despondency was setting in. It did not augur well at all.

Most critically, due to an inefficient procurement regime, modernisation of the armed forces was lagging behind by 10-15 years. The services continued to wait indefinitely for vital equipment to fill critical operational voids. The situation was alarming and MoD failed to respond to the wake-up call to put the procurement regime in order through radical reforms.