India has a fledgling Military-Industrial Complex (MIC) composed of Public Sector Undertakings (PSUs) and Private Sector entities of all sizes and shapes. Much has been written about it. Notwithstanding former Defence Minister Manohar Parrikar’s attempts at growing the MIC and weaning the services off imports, the period after his death has seen what some fear is a reversion to old ways. The current crisis with China and the emergency imports reinforce those fears, to an extent.
I’ve attempted to quantify the potential benefits that would accrue from investing in domestic products as compared to ordering from OEMs in other countries.
—This, but unironically.
Assumptions
The Armed Forces (AF) need Anti-Tank Guided Missiles (ATGM). A tonne of them. But, like everything else in life, fiscal constraints dictate that there are only $10 million available in year one. For each subsequent year, the amount will organically increase by 8%.
The ATGM supplied by the foreign OEM – let’s call the ATGM ‘Barb’ – costs $210,000 / unit in year one. Each year the cost will increase by 4% because the OEM is genuinely benevolent (hah!).
The ATGM supplied by the domestic OEM will be called Ophiophagus – ‘Ophi’ – because, well, why not? Ophi costs 80% more than Barb in year one because a good 50% of its components are sourced from foreign OEMs. Also, the per unit cost for Ophi increases by 8% unless indigenous content increases. Expensive proposition. I can already see veterans shaking their sage heads.
—An ATGM like Ophi.
To summarise:
Barb costs $210,000 per unit & increases at 4% per year
Ophi costs $378,000 per unit & increases at 8% per year, except if indigenous content increases.
We assume zero offsets because frankly I don’t understand how to factor those in without turning this into a full-time project for six months.
I’ve taken assumptions about Cost of Goods Sold as % of Revenue, Salaries as % of Revenue, etc. from Bharat Electronics for the domestic OEM. The GST rate is assumed to be 18%, and the effective Income Tax Rate for employees of the domestic OEM is assumed to be 15%. The full set of assumptions can be seen in the image below.
Begin Procurement
Here I’ll indulge many a Bharat Rakshak fantasy and assume MOD’s procurement is instantaneous.
Year One
Now in year one, $10 million buys 48 units of Barb but just 27 units of Ophi. Bad news for Ophi, right? But here’s the thing, Ophi’s OEM sources half its components & raw materials from domestic suppliers. We’ll assume there are only 3 levels of suppliers.
So of the $10 million that flow to Ophi’s OEM, $2.35 million flow to the L1 supplier. Out of that amount $552,000 flow to the L2 supplier, and out of that $129,000 flow to L3 supplier. At each stage, GST is paid, Corporate Tax is paid, and employees pay Income Tax.
Total taxes paid = $1.53 million.
Year Two
Here we’ll do something that every mandarin in the Ministry of Finance will despise: we will redirect these taxes back to the ATGM budget for year two, subtracting 5% for R&D (which also flows to Ophi’s OEM, but for boosting indigenous content).
So year two ATGM budget for Barb is $10.8 million (8% increase), but that for Ophi is $12.25 million (after taxes flow back into it). Also, the 5% R&D results in indigenous content rising to 53% (because it’s a small enough and arbitrary enough number).
Since indigenous content goes up, per unit cost of Ophi goes down in proportion to the increase in indigenous content and the difference in price levels between India and Barb’s OEM’s home country.
Ophi’s per unit cost increases by 8% per year. But it can also decline. 50% of its components are procured from foreign entities. We assume all procurement happens from Barb’s OEM to keep things simple. Costs are higher there as compared to India. So if we manufacture a component in India, it should be cheaper than importing it from Barb’s country.
How much cheaper?
Since this is a quick & lazy analysis, we use Purchasing Power Parity of both countries to arrive at a figure of 4.15.
In year two, the diverging budgets afford 50 Barbs or 34 Ophis.
Cumulative count: 98 Barbs OR 61 Ophis.
Year Three
Let’s plough taxes back into the Ophi & R&D budgets for year three.
Ophi’s budget for year three is now $15 million whereas Barb’s budget is $11.6 million. Ophi’s indigenous content has increased to 56%.
Ten Years
What happens if we continue this for ten years?
At the end of ten years:
1. 573 Barbs have been procured OR 1,145 Ophis have been procured.
2. If Ophis are procured, domestic OEM & its suppliers (L1 to L3) have:
a. Earned $472 million in revenues
b. Paid $62 million in taxes (GST, Income Tax, Corporate Income Tax)
c. Consumed $3.12 million for Research & Development
d. Grown indigenous content to 77% of Ophi by value
3. Over 10 years, with increasing indigenisation of components, the per unit cost of the Ophi declines by 33% and it becomes more than competitive with respect to Barb even if you ignore other economic benefits (let’s not even mention the strategic advantages of controlling the supply chain for weapons systems we use).
But wait, there’s more.
Going by BEL’s numbers, it appears that earning $1 in revenue requires $0.2539 in Capex. Assuming that Capex depreciates over 5 years, a very simplistic calculation tells us that Ophi’s OEM and suppliers need $24 million in Capex from year one to year ten.
The National Institute of Public Finance & Policy estimates a cumulative fiscal multiplier of 4.8 for Capex. Basically, $1 in Capex yield $4.8 in economic activity in the long run. I know it might not fit directly here, but this is a short article not a bloody research paper, so it will have to do.
For $24 million in Capex, the economic activity would be $115 million.
So, for $148 million spent organically by GOI on procuring Ophis (i.e. excluding taxes that flow back), $115 million in economic activity gets generated, the AF get 99.83% more ATGMs, and domestic OEMs earn $472 million in revenues.
These are all, of course, first order effects (except for the Economic Value Injected on account of Capex). When you factor in second and third order effects like:
In addition to paying taxes, employees consume goods and services, boosting economic activity,
Indigenous components developed (taking indigenous value from 50% to 77%) get used in other products like, for example, Hand Held Thermal Imagers or Day/Night sights for a tank or APC,
et cetera, the benefits of procuring Ophis instead of Barb become a no brainer.
In the next part we will examine what happens if Ophi’s per unit cost does not decrease with an increase in indigenisation. Subscribe to stay tuned.
Shaunak Agarkhedkar writes spy novels. His first two - Let Bhutto Eat Grass & Let Bhutto Eat Grass: Part 2 - deal with nuclear weapons espionage in 1970s India, Pakistan, and Europe.
Sir could you do this for Artillery system purchase...How much money would the govt. Get back after ordering this amount.
2000 ATAGS
2000 self Propelled Howitzers
500 ULH
500 K9
500 Dhanush
1000 Garuda 105
SImilar agreeement could be made for LCH vs Apache but it won't be considered a peer-peer comparison by some. ATGM is perfect here, I mean for the sake of making a case to begin with.