HAL disinvestment: thin end of the wedge

In a move with far reaching consequences, the Defence Acquisition Council of the Ministry of Defence (MoD) last week gave in-principle approval to divestment of 10 percent stake in Hindustan Aeronautics Limited (HAL), currently a 100-percent state-owned defence public sector undertaking (PSU). HAL will be the third out of nine defence PSUs in which the state has off-loaded shares. The state has already divested 25 percent stake in Bharat Electronics Limited (BEL) and 34 percent in Bharat Earth Movers Limited (BEML).

For several reasons, the HAL disinvestment has greater significance. HAL with annual sales of over Rs.130 billion or Rs.13,000 crores ($3 billion) is much larger than either BEL or BEML. BEL makes radars, other defence-related avionics and instruments, while BEML manufactures a range of four-wheeled vehicles, transporters including mobile missile carriers, railway coaches and earth-moving machines, but neither is the sole manufacturer of such items even within India. HAL is India’s only defence aircraft manufacturer and arguably Asia’s largest. Indeed, MoD has in the past even resisted proposals to separate the Kanpur Division of HAL which makes mainly civilian aircraft, despite government’s keenness to have HAL focus only on defence aviation, because of the strategic importance of HAL in the Indian aviation industry. India’s national security and its hard-won self-reliance in high technology areas, especially in the crucial defence sector, are thus interwoven with HAL and its capabilities and role.

Proposals for disinvestment of HAL have been doing the rounds for a long time, having first been mooted as far back as the ‘80s, but were always and quickly shelved precisely because of the sensitivity of such divestment in the defence aviation PSU. But clearly there has been greater readiness to embrace the idea in the new climate of privatization especially under UPA-II. Disinvestment of profit-making PSUs is now virtually mandatory. Government divestment policies have also been tweaked to permit PSUs to retain substantial proportion of divestment proceeds for reinvestment in infrastructure, capacity enhancement and technology upgradation, rather than handing over the proceeds to the treasury for meeting social sector expenditures. Whatever be one’s views about disinvestment of PSUs in general, surely defence PSUs require to be regarded differently, and other strategic considerations must come into play.

Rationale Given the strategic importance of HAL and therefore the significance of the move to off-load some government stake, the rationale behind this decision has not been made clear at any level.

Several government spokespersons have cited “lessening of the government burden” for HAL’s ambitious yet essential modernization programme as the prime motivator. HAL expects to invest about Rs.200 billion or Rs.20,000 crore over the next decade in upgrading its facilities. These modernization plans are necessitated, not only by the obsolescence of much of HAL’s several decades-old facilities, but especially by the upcoming license-manufacturing or sub-contract tasks in connection with the many new military aircraft that India has ordered or will soon be ordering.

In years gone by, HAL could only have approached government for these funds. But this is no longer the case. Navratnas including HAL now have greater autonomy. HAL has huge cash reserves, reportedly over Rs.9 billion or Rs.900 crores, and excellent credit rating. With the new and forthcoming acquisitions, HAL’s order books have swollen and in 2010 are Rs.85 billion (Rs.8500 crores) more that last year! HAL is already manufacturing the Sukhoi Su-30 MkIs and Hawk Advanced Jet Trainers, and will soon start work on the over $10 billion (Rs.45,000 crores) Medium Multi-Role Combat Aircraft (MMRCA) and later on the Russo-Indian Fifth Generation Fighter Aircraft (FGFA) expected to be worth over $30 billion (Rs.135,000 crores) in all. HAL will start serial production of the “indigenous” Tejas Light Combat Aircraft in a few years. HAL will also be undertaking offset work for several other smaller but financially significant recent or forthcoming acquisitions, such as the Boeing P8i reconnaissance aircraft, Eurocopter and the carrier-based MiG 29s expected to come with the Admiral Gorshkov, and will also participate in upgrade contracts for the Jaguar, Mirage 2000 and so on. HAL will remain one of the most profitable PSUs, having registered a profit of around Rs.20 billion or 2,000 crores in 2009-10, because of its privileged cost-plus pricing structure. With all this going for it, HAL can easily raise the funds it needs from financial institutions.

So why should HAL go in for divestment? Some commentators have opined that “going public” would help improve corporate governance. This is hardly credible. The modalities of divestment are not yet decided upon, and there is considerable doubt if it will take the form of an IPO for retail investors. Past experience also shows that 10 percent stock here or there makes no difference to how a company is run.

If improving HAL performance were really a goal, there are many measures government or the Department of Defence Production (DoDP) could take. Greater autonomy for HAL, professionalization of its management and proper oversight has long been required but never seriously addressed. Government, MoD, DoDP and HAL, have always hidden behind the “secret” veneer of defence and other strategic establishments, and a cloistered cost-plus pricing policy reaping profits without accountability. Greater functional autonomy for the different divisions of HAL has also long been called for. And, contrary to government’s apparent desire to reserve HAL for military aviation, increasing the civilian aviation component in HAL’s portfolio would increase efficiency, capabilities and culture of user-responsiveness.

Of course all this can be discussed, but rationale for divestment of HAL appears not to lie in these considerations but in an ideology of privatization and, perhaps more important, in the on-going efforts by vested interests to pry open India’s defence manufacturing sector and gradually hand it over to corporate houses both Indian and foreign.

Privatization of Defence Production Strenuous and determined efforts are being made to open up defence production in India to the private sector and to foreign direct investment (FDI). First the defence industry was opened up in 2001 to 100 percent private participation including upto 26 percent FDI. Then the Defence Procurement Policy as modified various times till 2010 introduced a compulsory offsets policy under which foreign suppliers would sub-contract work to Indian partners upto some percentage which, combined with the huge spurt in defence acquisitions earlier opening up of defence manufacturing to the private sector, encouraged large corporations to enter the defence sector in a big way. Finally, a new Defence Production Policy was announced which explicitly promoted private participation in defence manufacturing and in fact invited the Indian corporate sector to participate in the much-anticipated bonanza of Indian acquisitions of an estimated $50 billion over the next few decades (see https://www.delhiscienceforum.net/peace-and-disarmament/432-defence-production-policy-.html).

As if all this were not enough, the Department of Industrial Policy and Promotion (DIPP) put out a formal Discussion Paper in May 2010 http://dipp.nic.in/DiscussionPapers/ DiscussionPapers_17May2010.pdf calling for raising the ceiling of FDI from 26 percent up to 74 to 100 percent! The ostensible rationale was that if foreign manufacturers were to be compelled to transfer technology through the offsets provision, they would not part with state-of-art technology and risk its leakage unless they had greater control. In other words, if for instance Boeing were to sell F18s to India and part with related technologies, they would do so only if they were permitted to open a dominantly Boeing-owned entity in India which would then undertake the offset manufacturing. DIPP further argues that this would also promote export of military hardware from India. The DIPP’s great concern for the interests of the foreign vendors, or even its focus on the commercial aspects, do not unfortunately extend to a similar concern for building indigenous technological capability which obviously would not happen if the technology was simply going to be transferred from Boeing USA to Boeing India!

We have already seen that HAL is likely to be a major beneficiary over the next few decades through license manufacturing or offsets contracts, since a considerable proportion of big-ticket Indian defence acquisitions are likely to be in the aviation sector. It may therefore well be that the divestment of HAL is a first step, but a very important one at that, the thin end of the wedge if you like, to prize open Indian defence aviation industry to the Indian and foreign corporate sectors.

Straws in the wind here are already several significant pointers to this. The trend of Indian corporate majors such as Tatas, Mahindras, L&T and so on setting up substantial infrastructure for military hardware production is by now well known. Pipavav is set to emerge as a major partner of the state-sector Mazagon Shipyards, if not overtake it, as regards warship and even submarine production.

Former Chairmen, other retired senior HAL executives and numerous defence and industry commentators have started raising a chorus of calls for stepping up the privatization of the Indian defence aviation sector. It is argued that 10 percent divestment in HAL is too small, and that bringing in retail investors will not serve the purpose, so efforts should be made to attract corporate investors including foreign companies. Indeed that may already be the government thinking, as revealed by a source off-the-record to some business dailies. The Society of Indian Aerospace Technologies and Industries (SIATI), with over 300 corporate members, has called for converting HAL into a public limited company with private partners. Even otherwise well-meaning Air Force spokesmen, while bemoaning that the Indian private sector has a poor record in R&D and has unknown capabilities when it comes to defence hardware, argue that India’s defence PSUs including HAL are over-burdened and stretched to the limit, and that private sector involvement could help. But defence PSUs sub-contracting work to private sector players is a very different proposition to having major private defence manufacturers in India, or even foreign defence majors with Indian subsidiaries. And the latter is what many powerful voices are pushing for. In an Editorial on 14 September, the Financial Express called the HAL divestment “inadequate” and argued that, just as handing Suzuki a dominant stake and role in Maruti promoted the Indian automobile sector, what HAL needs is a strategic stake sale! So if Maruti-Suzuki, why not HAL-Boeing?

The saving grace is that the HAL divestment is not a done deal yet. It now needs to get clearances from the Finance Ministry, Cabinet Committee of Economic Affairs and go through different levels of government. Can this dangerous move be stopped?