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WILL EXTERNAL COMMERCIAL BORROWING FIX THE WOES OF DEFENCE SHIPBUILDING INDUSTRY?

To revive the stressed defence shipyards and boost the shipbuilding industry, External Commercial borrowing is being examined. The author analyses the issue in perspective—

According to a report by Nayanima Basuin the Hindu Business Line on 21 August 2017 ('To stay afloat, defence shipyards may be allowed to borrow abroad') an Inter Ministerial Group (IMG) has pointed out that the Indian shipbuilding industry has been hurt by the high cost of domestic capital and restrictions on the External Commercial borrowing. The report goes on to suggest that with a view to revive the deeply stressed defence shipyards and boost the shipbuilding industry, the Centre may soon allow them to bring External Commercial Borrowing funds under the automatic route to meet their working capital requirements.

            The External Commercial Borrowing (ECB) is a form of commercial loan raised by the 'resident entities from recognised non-resident entities'. Governed by the Reserve Bank of India (RBI), these borrowings must conform to the parameters set by the bank as regards the minimum maturity, permitted and non-permitted end-use, maximum all-in-cost ceiling, etc.

            The resident entities can borrow from non-resident entities in the form of loans including bank loans, securitised instruments, buyer's or supplier's credit, Foreign Currency Convertible Bonds (FCCBs), financial lease, and Foreign Currency Exchange Bonds (FCEBs), etc., through the automatic route or the RBI-approval route.

            Companies in the manufacturing and software development sector can raise ECBs for several end-uses, which include, but are not limited to, import of capital goods and related payment towards import of services, technical know-how and license fee, local sourcing of capital goods, new projects and modernisation/expansion of the existing units. The manufacturing companies can borrow up to USD 750 million in every financial year on the automatic route.

            The RBI circular permits use of the borrowings for all purposes except on the real estate activities other than development of integrated township/affordable housing projects; investing in the capital market and using the proceeds for equity investment domestically; activities prohibited as per the Foreign Direct Investment (FDI) guidelines; lending to other entities for any of these aforesaid purposes; and, purchase of land.

            The ECB facility should be useful to every resident entity that is in need of capital and not just the shipbuilding industry. Since the IMG report is not in the public domain, it is a bit unclear how it came to conclusion that the shipbuilding industry has been adversely affected by the high cost of domestic capital and in what way the existing RBI guidelines restrict ECB for this sector.

            It is not quite clear why it should require a specific notification to extend the ECB framework to the defence shipyards for carrying out activities that do not fall in any of these proscribed end-use categories. Shipbuilding is certainly not one of the prescribed end-uses. Even the FDI guidelines do not mention defence shipbuilding as a prohibited activity.

            If anything, the existing policy permits FDI even up to 100 per cent in the defence manufacturing sector, albeit through the government approval route and subject to the condition that FDI beyond 49 per cent should result in access to modern technology. The government can permit is even for any other reason as deemed. This applies to defence shipbuilding industry as it is very much a part of the broader category of defence manufacturing.

            Be that as it may, if for whatever reason it is necessary to formally extend the ECB framework to the defence shipbuilding or changes need to be made in the limit up to which funds can be borrowed on the automatic route, there should be no procrastination. There can be no justification for keeping the shipbuilding industry deprived of the ECB framework or relaxation as regards the automatic for borrowing capital for meeting its needs.

            The question, however, is whether the cost of capital is the main handicap faced by the defence shipbuilding industry and whether extension of the ECB framework will provide it the much needed leg-up? It is not clear whether the IMG has addressed this issue in its report but one cannot help making the point that there are several other more debilitating factors that may be holding back the shipbuilding industry.

            To start the process of rejuvenating the defence shipbuilding industry by first addressing the issue of the cost of capital is tantamount to starting from the wrong end of the spectrum of the multi-faceted problems faced by the industry.

            The need for ECBs will arise if the domestic shipyards have plenty of orders in hand but are finding it difficult to execute them for want of affordable capital. Is that actually the case? Does not seem like it as the private shipyards have actually been complaining for a long time of no big ticket manufacturing contracts coming their way.

            Going by the value of production and the profit after tax, even the public sector shipyards, with the possible exception of the Mazagaon Dockyards Limited (MDL), have been barely breaking even. In fact, as per the annual report of the Ministry of Defence (MoD) for 2016-17, the Hindustan Shipyard Limited (HSL)  one of the four defence public sector shipyards  just about managed to come out of the red in 2015-16 with a meagre profit of Rs 19 crore.

            While it may not be correct to generalise about the performance of the defence shipyards, it would be incorrect to say that their performance has been sterling. Had that been the case, there would have been no need for the government to rope in the private sector through the strategic partnership model for construction of submarines in the first instance and probably many other platforms later on.

If with all the hand holding by the government in every manner possible, including making sure that they are no starved of orders at any point of time, the defence shipyards, with the exception of MDL, have been facing problems, the real reason for that lies somewhere else.

            The situation the defence shipyards also points to the fact that extension of ECB framework to the private shipbuilding industry will have only a limited impact. As a standalone measure, it will only help in rescuing the shipyards that may be facing difficulty in executing whatever contracts they have in hand. It is hard to believe that this is the reason why the IMG has recommended extension of the ECB framework to defence shipbuilding.

            Given the present state of the defence shipbuilding industry, it has to be made sure that there is enough work for all the public and private sector shipyards. This is not to suggest that there all of them cannot co-exist with enough work for all of them. Indeed, with 7,516 kms of coastline and 1,382 islands, India is primarily a maritime nation, with insatiable requirement for maritime vessels, especially destroyers, frigates, corvettes, amphibious crafts, mine countermeasure vessels, torpedo recovery vehicles, patrol boats, support ships, tugs, etc., not forgetting aircraft carriers and submarines.

            According to a March 2017 report of the Standing Committee on Defence, in 2012 the Defence Acquisition Council (DAC) had approved the force level of 198 ships and submarines to be raised by 2027, against which the presently held force level  is 123 ships and 15 submarines. Thus, there is a requirement of at least 60 ships and submarines in the next 13 to 15 years for the Indian Navy alone. The domestic public sector and private sector shipyards will have their hands full if all the requirement of the Indian Navy and the Coast Guard is met in a compressed time frame. This will also give a leg up to the demand for facilities for repair and refit of the ships and other vessels.

            One only has to add to this that the never ending requirement for cargo ships, luxury liners and other smaller crafts for the merchant navy and the tourism industry to get a good idea of the promise that the naval design and manufacturing sector holds for not just the shipyards but also the ancillary industry.

            So the problem is not because there is no potential for expansion of the shipbuilding industry or for the private and public sector shipyards to co-exist. The potential domestic demand itself should be good enough to sustain both, with added potential of entering the global market. But this demand has to be triggered. There is no gainsaying that this initiative has to come from the MoD because of its substantial public spending on defence procurements.

            The problem, however is that the money available for the purpose is not substantial enough to unleash the potential of the shipbuilding industry and to keep all the shipyards  both in the public and the private sector - busy in the long run. The question is whether the MoD can trigger this demand.

            The aforesaid report of the Standing Committee shows that for the year 2017-18, a paltry sum of Rs 4,000 crore is available with the Indian Navy for new schemes, or the new acquisition programmes. Considering that only the advance payment of 15 per cent of the contract value is payable in the year in which a contract is signed, contracts for new vessels and other capital items worth only Rs 27,000 crore can be signed by the Indian Navy during the current financial year.

            This is obviously not good enough. There is need for more money but successive governments have found it difficult to raise the defence budget in any substantial measure, not because of indifference to the needs of the armed forces, including the Indian Navy whose share in the defence budget has gone down over the years, but on account of the inability to raise sufficient revenue to be able to allocate more for defence while also meeting the competing demands from other sectors such as health, education, infrastructure development and internal security.

            In these circumstances, a very judicious call will have to be taken about financial viability of the multifarious efforts being made simultaneously for acquisition of equipment, weapon systems and other platforms for the armed forces and a financially viable plan will have to be put out in the public domain for the industry to make a realistic assessment of what kind of business opportunities lie ahead. It makes little sense to lead the industry in general, including the shipbuilding industry, down the garden path only to disappoint.

            Acceptance of 65 Shekatkar Committee recommendations by the government in the last week of August is welcome but it is not sure whether it will have any significant impact on availability of funds for defence procurement. It is time other means of raising funds, such as floating of Defence Bonds, is considered seriously, though even that route has serious limitations.

            The bottom line is that unless more funds are available and MoD improves its dismal record of decision-making in regard to procurement matters, standalone measure like extending the ECB framework to defence shipbuilding industry will have limited impact.

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