Utilization of the Capital Acquisition Budget

The allocation for capital acquisitions is said to be invariably inadequate, but fact of the matter is,  whatever allocation is made does not get fully utilized. The author analyses the reasons....

It is ironical that the defence budget, considered grossly inadequate by many, does not get fully utilized year after year. During the 10th Defence five-year plan period (2002-03 to 2006-07), the allocation was underutilized every single year, with total underutilization adding up to INR 21,154.44 crore.

This trend continued into the first year of the 11th Defence five-year plan (2007-08) - the underutilization that year being INR 4,082.21 crore. The following four years saw a reversal of the trend before, in a display of an atavistic quality, the year 2012-13 ended with a whopping underutilization of INR 11,631.29 crore.

The irony does not end there. Even when the expenditure actually exceeded the initial allocation at the budget estimates (BE) stage from 2008-09 to 2011-12, the capital budget was underutilized every year, with the exception of the year 2010-11. (The excess expenditure during the other three years was because of the revenue expenditure going beyond the BE allocation.)

Even this fact does not reveal the real extent of the irony. The capital acquisition budget, which is a sub-set of the capital budget, has been consistently underutilized at least since 2002-03, with the exception of the years 2004-05, when it exceeded the BE allocation by a modest INR 368.52 crore, and the year 2010-11, when the excess was to the tune of INR 1,887.56 crore. The net result has been underutilization of the capital acquisition budget over a period of 11 years since 2002-03 to the extent of INR 63,911.56 crore.

During the year 2013-14, the capital acquisition budget was reduced by INR 7,076.50 crore (approximately) at the revised estimates (RE) stage, which will effectively be the extent of underutilization, assuming that the actual expenditure will equal the revised allocation. If added to the amount underutilized in the preceding 11 years, the total underutilization since 2002-03 would work out to INR 70,988.06 crore.

The significance of this fateful underutilization lies in the fact that the modernization programme of the Indian armed forces, such as it is, is funded from the capital acquisition budget  sometimes also referred to as the modernization budget. Surely, the amount underutilized over the years could have removed the night blindness of the armed forces, improved the stocks of ammunition, shored up the air defence capabilities to some respectable level or helped in meeting at least a dozen other critical requirements.

The tendency to put the blame for this underutilization on the 'arbitrary' budgetary cuts by the Ministry of Finance (MoF) prevents the Ministry of Defence (MoD) from looking inwards and taking steps to ensure optimal utilization of budgetary allocations.

Many among the strategic community actually believe in this chicanery. For one thing, the budgetary cut, whenever imposed by the MoF  and, indeed MoF has been imposing it almost every year for the past several years  does not apply to the capital budget. Secondly, the capital budget is reduced by the MoF only at the RE stage after detailed discussion with the MoD sometime in the month of December or January of the financial year, by which time it is fairly clear as to how much money would be required by the MoD for meeting the committed liabilities and on account of the new schemes likely to go through before the end of the financial year. The assessment made at this stage is more realistic than the assessment made almost a year earlier while projecting the budgetary requirement for that financial year.

Even the empirical data does not indicate any arbitrariness in reduction of the allocation for capital acquisition at the RE stage. Arbitrary reduction in a particular year would force the MoD to push the expenditure to the next year, resulting in better utilization of the subsequent year's budgetary allocation. But that has normally not been the case.

During 2002-03, the allocation for capital acquisition was reduced by INR 6,073.43 crore. Had it resulted in the expenditure being pushed to the next year, the allocation for 2003-04 would have been under great strain but that year actually ended with underutilization of the allocation to the extent of INR 3,482.95 crore. This is not an isolated example.

More importantly, the reduction at the RE stage does not actually prevent the MoD from incurring expenditure beyond the reduced ceiling if such expenditure is inevitable. In 2009-10, the allocation was reduced at the RE stage to INR 35,146.88 crore but the actual expenditure was INR 38,427.00 crore, though even that was INR 1,940.72 crore less than the BE allocation. The very next year in 2010-11, the actual expenditure not only went beyond the RE allocation but exceeded even the initial BE allocation by INR 1,887.56 crore. This was only the second time since 2002-03 that MoD ended up spending more than the BE allocation.

As an aside, it may be mentioned that if utilization of capital acquisition budget appears far more respectable now, it is on account of three steps taken by the MoD in the past seven years or so. First, financial powers for capital procurement up to INR 150 crore have been delegated to the services, up from INR 10 crore when the powers were first delegated. Second, a large amount of expenditure, which is of a capital nature, but which was earlier being incurred from the revenue budget, is now incurred from the capital budget. This includes the expenditure on refits of the naval vessels. This also includes expenditure on replacement of vehicles, which was earlier incurred out of the revenue budget. And, third, expenditure on procurement from the ordnance factories is also now being booked to the capital budget. But for these measures, the situation might not have improved during the 11th plan period.

Be that as it may, if, therefore, the allocation for capital acquisitions is invariably inadequate, as many believe it to be, but whatever allocation is made does not get fully utilized, and it is not on account of any arbitrariness on the part of the MoF in reducing the allocation at the RE stage, what accounts for this paradox?

Broadly, three reasons seem to account for this imbroglio: unrealistic projections, slippages in committed liabilities and procrastination in processing the procurement proposals.

The requirement of funds for a particular year is assessed at the end of the third quarter or sometime in the last quarter of the preceding financial year by the services. While doing so, they look at the milestones in respect of the on-going contracts likely to be reached during the year for which the requirement is being assessed as the cash outgo is related to such milestones. They also separately assess the requirement of funds on the new schemes likely to get approved during the year in question, entailing the payment of advance or even subsequent instalments depending on when the contract is signed and the delivery schedule.

While assessment of requirement on account of the committed liabilities is fairly accurate, based, as it is, on the contractual milestones, there is a fair amount of subjectivity in assessing which new schemes are likely to go through during the year. The services naturally err on the side of optimism. The then Chief of the Air Staff, Air Chief Marshal PV Naik, had stated in February 2011 that the contract for MMRCA was likely to be signed by the month of September of that year. This contract involves an advance payment of at least INR 10,000 crore. Based on this assessment, had the Air Headquarters included the amount in the projection for 2011-12 and had the final allocation been made on this basis, the amount would have obviously remained unutilized.
This is, of course, an extreme example but it illustrates the hazards of working out the requirement of funds for a particular year based on a subjective assessment of which cases are likely to get approved during the year for which the requirement is being worked out. One cannot really blame the services for this. Such is the pace of decision-making that even the most conservative estimates appear highly ambitious, when viewed in the hindsight.
Accuracy of the assessment of funds required on this account depends not just on whether a proposal is likely to get approved during the year but also when, during the year, it is likely to be approved. Quite often it takes several months, even after the approval of a proposal by the competent financial authority, for the contract to be signed and necessary formalities to be completed, paving the way for payment of the advance against that contract. A proposal may get approved during the year, as anticipated, but if it is approved sometime in the fourth quarter, it is unlikely that the payment would get made during that very financial year because of all the formalities that need to be gone through after the approval of the proposal.

This was, in the past, resulting in funds being 'parked', especially with the Defence Public Sector Undertakings (DPSUs), to ensure utilization the budget. This does not seem to be happening any more after the MoF raised serious objections to it. But the tendency to rush the signing of contracts and completing necessary formalities in a great hurry to ensure that the first payment is made before the end of the financial year continues. There is nothing wrong with it, except that such haste could result in some unforeseen glitches in the contract document or while completing other formalities.

The second reason that potentially contributes to underutilization of the allocation is the unforeseen slippage on the part of the suppliers in reaching the contractual milestones, without which the payments related to achievement of those milestones cannot be made. It does not impact utilization of the budget if the slippage does not shift the milestone to the next year but it is not uncommon for the milestones getting shifted to the next year. The payment, related to such milestones, cannot obviously be made as planned.

This problem seems to be on account of reasons which have perhaps not received adequate attention. An unrealistic delivery schedule is bound to result in slippages. The suppliers do try to negotiate a realistic delivery schedule with the contract negotiation committee but this is possible only up to a point. The slippages also occur because of the problems arising during the pre-dispatch inspection which, in turn, could be on account of lack of clarity in the qualitative requirements (QRs) or the method of inspection. Instances of the inspection teams pointing out deficiency in the performance of the equipment by interpreting the QRs in a manner different from how it was perceived by the manufacturer are not unknown. This calls for rectification of the deficiency pointed out by the inspection team, which could take a long time. There could be many other reasons why the slippages take place. The need is to identify the problem areas and take steps to make sure that slippages do not take place because of avoidable reasons.

The third reason contributing to underutilization of the budgetary allocation is procrastination in processing the procurement proposals. This is also best exemplified by the MMRCA procurement programme. But that is, by no means, an exception.
There are numerous instances of the MOD asking the bidders to extend the validity of their offers beyond the originally stipulated last date in  submission of bids, delay in processing the field and staff evaluation reports, delay in accepting the technical oversight committee reports, delay in commencement of the contract negotiations or the contract negotiations getting prolonged inordinately.

Even after all the procedural formalities are completed there is no guarantee that the financial approval of the competent financial authority would be forthcoming immediately. And this is not peculiar to the cases which require the approval of the Finance Minister (beyond INR 500 crore) or the Cabinet Committee on Security (beyond INR 1,000 crore). In fact, financial approval in the cases that are within the financial powers delegated to the Raksha Mantri or to the services could also take an inexplicably long time.

This lassitude in the decision-making process is the biggest bane for defence acquisitions. It does not impact only the utilization of the budget. The implications are far more serious. Most of the bids are invited by the MoD on firm and fixed price basis. No bidder can hold the price indefinitely. Therefore, seeking extension of the validity of the offers is an iniquitous step. But so is retraction of a Request for Proposal (RFP), often without even assigning a reason.  Where while seeking extension of the validity of the offer, the suppliers are permitted to revise the commercial offer, the possibility of that acquisition programme costing much more than what was originally anticipated cannot be ruled out. Most significantly, it delays fulfilment of the operational requirement of the armed forces.

The problems related to decision-making are not so much on account of the procedural complexities as on account of the organizational and structural inadequacies. For improving the process of decision-making, MoD needs to implement the decision, taken in 2002 when the Capital Acquisition Wing was created, to set up a Directorate of Management Information System and a Cost Accounting Cell. There is also a need for imparting training to those involved in capital acquisitions. There is also a need to review the existing system of manning of the Wing. It is a measure of lack of government's concern that a proposal to start a Defence Acquisition Institute as a part of the Institute for Defence Studies and Analyses has been gathering dust for more than two years now.

Not that these measures alone would bring about a spectacular change in the situation. Given the present atmosphere of competitive uprightness, decision-making is considered to be a high-risk activity.  This, then, is from where the whole problem starts.  Difficult to say where the remedy lies.

(The author is former financial advisor Acquisition and Additional Secretary and Member Defence Procurement Board MoD)

Amit Cowshish

Amit Cowshish

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