defence expenditure

Funds Available for Operational Defence Expenditure Are Up, but Little for Modernisation

The ball is now in the armed forces’ court, to determine how effectively – or not – they utilise the resources made available to them.

The Rs 5,83,538 crore budget outlay for defence, representing a 13.2% hike for financial year 2023-24 (FY23-24) over the previous year’s budget estimates (BE), is somewhat misleading.

The allocation has dipped from 2.04% to 1.97% of the gross domestic product (GDP), which is well short of the 3% demanded by military planners, service veterans and defence analysts. Additionally, the share of defence expenditure in the overall budget for the forthcoming FY too has declined, albeit marginally, from 13.31% to 13.18%.

Statistics apart, this increase is unlikely to satiate the armed forces’ aspirations, who like the proverbial Dickensian orphan Oliver Twist, are always in the need for more.

This perennial debate notwithstanding, the entire defence outlay is not available to the armed forces for modernisation and operational tasks, as it includes Rs 1,38,205 crore for defence pensions and Rs 22,613 crore for organisations like the Border Roads and the Indian Coast Guard (ICG).

The balance Rs 4,32,720 crore is for the military, of which Rs 2,70,120 crore has been earmarked for revenue expenditure and Rs 1,62,000 crore as the capital outlay, representing year-on-year hikes of 15.93% and 6.71% respectively. The former includes salaries and the armed forces’ running costs like transportation, stores, while the latter is meant for procuring new equipment, upgrading existing kit, acquiring land and developing infrastructure.

But even this amount in not available to the armed forces in its entirety, as it also incorporates the outlay for the Defence Research and Development Organisation (DRDO), Ex-servicemen Contributory Health Scheme (ECHS), National Cadet Corps (NCC), Director General of Quality Audit (DGQA) and other sundry departments. The DRDO, for instance, accounts for Rs 10,414 crore of the overall revenue budget and Rs 12,850 crore of the capital outlay, equalling a total of Rs 23,264 crore.

What further constricts the budget is that a significant proportion of the revenue expenditure is consumed by salaries, while that of the capital budget is pegged to ‘committed liabilities’, or payments due in the coming year on account of previously acquired materiel. It is not known how much of the capital budget will go towards discharging these liabilities, but past trends indicate that it could be as high as 80-90% in all three services, leaving limited funds for new acquisitions.

This has been an enduring handicap in modernising the armed forces and a cross-section of military planners and defence analysts agree that it is unlikely to change in the coming financial year. Hence, the chimera of upgrading military capability persists, seemingly without cure.

Furthermore, although the capital outlay has increased by 6.71% to Rs 1,62,000 crore over the current year’s BE, or 8.4% over the revised estimates (RE), even then it is far less than the 16% hike anticipated by the Ministry of Defence (MoD), as reflected in the 2020 report of the Fifteenth Finance Commission, which at the time had also suggested the establishment of a non-lapsable Defence Modernisation Fund. More than two years later, this remains a work-in-progress.

As for the revenue budget, salaries of the service personnel and the defence civilians have traditionally been a major and steadily increasing component of the outlay. But, remarkably, the share of salaries in the total net revenue budget has come down from 64.12% in the current year’s BE to 57.18% in next year’s budget due to all three services magically restricting their expenditure in this regard.

The Indian Army (IA), for its part, has brought down its salary share from 70.78% in the current year to 65.09% in FY 2023-24, while the other services have done even better; the Indian Navy (IN) has reduced its salary bill from 49.82% to 39.57% and the Indian Air Force (IAF) has cut it from 60.95% to 51.40%. What accounts for this dip is not presently clear, as there has not been any significant reduction either in the manpower or emoluments, but the puzzle is expected to resolve itself as the year progresses.

Be that as it may, a consequential outcome of this salary decrease has been that the moneys available for operational expenditure have increased almost five percentage points, up from 27.87% to 32.39% of the total net revenue allocation. For the IAF, this has jumped from 39.69% to 48.70%, for the IN from 40.56% to 48.75%, and from 25.22% to 27.47% for the IA.

These calculations are based on the premise that the operational expenditure comprises mainly the outlay for procurement of ordnance and other stores, execution of civil works related to maintenance of infrastructure, transportation of personnel and equipment, repairs and refit of naval vessels, and some other miscellaneous operational expenditure.

The outlay for Joint Staff, which caters for tri-services organisations like the Defence Cyber and Space Agencies, Strategic Forces Command, and Andaman and Nicobar Command, has been increased from Rs 3,195 crore to Rs 4,222 crore, signifying the increasing focus on operational jointness, especially in the Indo-Pacific. It also signifies a commitment to ‘jointness’ which all three services have been striving towards for years, but not achieving.

The defence R&D budget too has increased marginally from Rs 21,331 crore to Rs 23,264 crore. This includes a hike in the revenue budget from Rs 9,349 crore to Rs 10,414 crore and the capital outlay from Rs 11,982 crore to Rs 12,850 crore. This seems grossly insufficient keeping in mind the imperatives of atmanirbharta or self-reliance in defence production and a reduction in imports.

Also, there is no indication that 25% of the R&D budget has been set aside to finance private industry, start-ups and academia for taking up the design and development of military platforms and equipment, singly and in collaboration with the DRDO as announced by finance minister Nirmala Sitharaman in her budget speech last year.

The capital allocation for the ICG, on the other hand, had jumped from Rs 5,245 crore in 2021-22 to Rs 7,310.29 crore in the current FY, but has been reduced to Rs 7,198 crore for the FY23-24. Concomitantly, there has been a sharp decline in the ICGs capital allocation from Rs 4,246 crore to Rs 3,526 crore, whereas its revenue or operational allocation has increased from Rs 3,064 crore to Rs 3,661 crore, which is an indication of the importance the government places on coastal defence. But the fall in capital allocation could adversely impact the ICG’s expansion and acquiring platforms like patrol boats, helicopters and even fixed wing aircraft.

Amid all this, the allocation for the Border Roads Development Board has been increased from Rs 4,555 crore to Rs 6,005 crore, no doubt with an eye on infrastructure development along the disputed Line of Actual Control with an irredentist China.

To sum up, the major highlight of the defence budget is the increase in funds available for operational expenditure under the revenue segment of the budget but with little primacy to modernisation. Given the need for fiscal consolidation, increased capex for rapid economic growth, and containing the common man’s tax burden, this is possibly the best the finance minister could do to strike a balance between the competing requirements.

The ball is now in the armed forces’ court, to determine how effectively – or not – they utilise the resources made available to them.

Amit Cowshish is a former financial advisor (acquisitions), Ministry of Defence.

Defence Offset Policy Yielding Diminishing Returns Despite Various Amendments

In DAP 2020, the scope for offsets is now confined only to contracts involving outright purchase of materiel from foreign vendors through competitive bidding.

The modified defence offset policy in the recently released Defence Acquisition Procedure (DAP) 2020 reflects the vacillation that has dogged its evolution since 2005, when it was adopted by the Ministry of Defence (MoD) amid fanfare to achieve objectives that were, however, delineated only seven years later in July 2012.

The policy was aimed at binding foreign vendors to plough back a certain percentage of the overall contract value into the buyer country on terms and conditions stipulated by the latter. Till the advent of DAP 2020 offsets could be discharged by investing in cash or kind in India’s domestic defence manufacturing and services sector, civil aerospace, internal and coastal security, and defence research and development.

Initially, all outright capital procurements exceeding Rs 300 crore from overseas vendors, or their licensed production through a production agency designated by the MoD, entailed an offset obligation of at least 30%, with the latter reserving the right to alter it. An almost sevenfold rise in this basic threshold to Rs 2,000 crore in 2016 led to a significant reduction in the number of contracts necessitating offsets.

Also read: Will the Defence Acquisition Procedure 2020 Make India Self-Reliant in Defence Production?

Scope of offset policy restricted

In DAP 2020, the scope for offsets has shrunk further. It is now confined only to contracts involving outright purchase of materiel from foreign vendors through competitive bidding. Conversely, all contracts based on ab initio negotiations with a single vendor are now exempt under the new procedure from discharging offsets.

The MoD’s somewhat disingenuous justification for terminating offsets is that vendors ‘load’ extra costs onto the final contract value and doing away with them can reduce purchase costs. This, however, was known even in 2005, but the MoD took a conscious decision to bear this additional cost in order to strengthen India’s fledgling defence industry through integration with the global supply chain and infusion of technology.

The offset-exempt categories in DAP 2020 include acquisitions through inter-governmental agreements or IGAs, for instance, the 2016 procurement of 36 French Rafale medium multi-role aircraft and other assorted equipment acquired via the US foreign military sales (FMS) programme. The import of Apache attack and Chinook heavy-lift helicopters are India’s most recent FMS buy. This exemption is significant as a large proportion of India’s recent military acquisitions have been via these government-to-government routes.

Five Rafale combat aircraft from France arrive at the Air Force Station in Ambala on July 29, 2020. Photo: IAF via PTI

What could be the possible consequences?

Consequently, it is only a matter of time before private overseas materiel vendors begin pressing their governments into duplicating IGA or FMS-type schemes to bypass India’s offset policy. Such a move would automatically terminate the offset policy altogether, much to the foreign vendors’, and possibly, even the MoD’s relief.

If this policy were indeed discontinued eventually, the MoD would be relieved, as it would then not need to ‘police’ offset contracts that are difficult, if not impossible, to monitor. The vendors, for their part, would be appreciative as navigating the MoD’s complex and inchoate offset regulations and timelines to discharge them is nothing short of a nightmare, further exacerbated by the threat of the MoD penalising them for defaulting on offsets, instead of removing the bottlenecks to facilitate performance of the offset contracts.

The case for terminating offsets is reinforced by the Comptroller and Auditor General of India (CAG) that stated in a report tabled in the parliament on September 23, that they had not yielded the ‘desired results’ despite being repeatedly tweaked over the past 15 years to render it industry-friendly and result-oriented.

From the onset, offsets were stymied by unnecessary MoD controls. Offset guidelines elaborately specified ways for vendors to discharge this obligation, but concurrently robbed them of the freedom to do so by stipulating that its prior approval was mandatory. Even changing an Indian offset partner (IOP) or either re-phasing or restructuring the offset implementation schedule necessitated MoD’s prior approval. This not only hindered offset execution, but also severely tried the vendors’ patience to an extreme.

The regulatory control exercised by the MoD could perhaps be justified had it helped in achieving its policy objectives but, unfortunately, that is not the case. The CAG pointed out in its September 2020 report that in many cases the vendors made various offset commitments to qualify for the principal contract without being earnest about fulfilling them.

Also read: Defence 101: Atmanirbhar Bharat Will Need More Than Another Official Declaration

An instance of this facetiousness stated in the report is the prevarication on the part of Dassault Aviation in confirming technical assistance to the Defence Research and Development Organisation (DRDO) for indigenous development of the Kaveri engine for the Light Combat aircraft as part of its Rs 59,000 crore deal for 36 Rafale fighters.

The reality is that the control exercised by the MoD in ministering its offsets through the medium of technical evaluation often ‘persuades’ the vendor – otherwise free to choose the avenues for discharging the offset obligation – into agreeing to unworkable demands and implementation schedules, defeating the basic rationale of the policy, if ever there was any. In fact, the policy could have perhaps worked better in the absence of these controls and greater clarity about what the MoD wanted.

In short, after 15 years, the MoD’s offset policy is terminally floundering, partly due to the way it was structured, but more because of the means incorporated to enforce it which have not been untangled in the latest round of revision. Hence, its quiet burial remains the only sensible way forward to try and untangle the complex and, at times, incomprehensible DAP 2020.

This brings to mind a song by Urdu poet and song writer Sahir Ludhianvi in the 1963 Bollywood blockbuster Gumrah: Woh afsana jise anjam tak lana na ho mumkin, use ik khubsoorat mod de ke chhodna achha (It is better to abandon the story that cannot be brought to its logical end, giving it a beautiful twist.)

India’s defence offset policy that is struggling to deliver the intended outcome can certainly benefit from Sahir’s romantic, but unassailable, advice.

Amit Cowshish is former financial advisor (acquisitions), Ministry of Defence.

A Challenge to the 15th Finance Commission’s Credibility

The Additional Terms of Reference were issued at the fag end, when the commission had presumably completed all required processes.

On July 29, the president of India issued an order extending the date of submission of the report of the 15th Finance Commission (FC) to November 30, 2019. The same order also includes one additional term of reference (AToR). The commission is required “to examine whether a separate mechanism for funding of defence and internal security ought to be set up and if so, how such a mechanism could be operationalised”.

Incidentally, consultative process and close examination of finances of both the levels of government provide the foundation of a finance commission’s recommendations. This is what has contributed to its high credibility and its image as an independent and non-partisan institution. The AToR is issued at the fag end when the commission has presumably completed all the above processes.

The ToR of an FC is constitutionally defined under Article 280: Distribution of the net proceeds of the sharable taxes between the union and the states and allocation among the states; the principles that should govern grants in aid of revenues of the states out of the Consolidated Fund of India and later the 73rd and 74the amendment of the Constitution added the measures needed to augment the consolidated fund of a state to supplement the resources of the panchayats and municipalities on the basis of the recommendations of state FCs. However, under 280 (d) the President may refer any other matter in the interests of sound finance.

Beginning from the first FC, additional issues were in fact referred to successive FCs. These reflected one or the other concerns relating to sound budget and fiscal management. The AToR which relates to protecting defence and internal security expenditures of the Union government does not fit in the framework of the constitutional provision, Article 280 (d).

Similarly, defence is in the Union list and therefore the responsibility of the Union government while internal security is largely the states’. Even when states requisition para military forces, they bear the expenses. It is not, therefore, an issue that should legitimately come under the domain of the FC.

Also read: The 15th Finance Commission May Split Open Demographic Fault Lines Between South and North India

In any case, the original ToR itself incorporates a consideration to have regards to, “The demand on the resources of the central government particularly on account of defence, internal security, infrastructure, railways, climate change, commitments towards administration of UTs without legislature and other committed expenditure and liabilities.”

There could be two reasons why this AToR is added at this stage. One, the defence expenditure declined from 2% of GDP in 2014-15 to 1.48% in 2018-19 and even lower at 1.45 % in 2019 -20 budget. Similarly, defence expenditure as a percentage of the government’s expenditure declined from 14.3% in 14-15 to 11% in 20i9-20. The other is that with the slowdown of the economy, it would be a challenge to even ensure this low level of allocation provided in the budget for 2019-20 while maintaining the fiscal deficit at 3.3%. Hence, the attempt to ring-fence the defence expenditure.

Having been referred to, what could the 15th FC do?

As noted earlier, the FC is already required to, under the original terms of reference, take into consideration the defence and internal security needs. While assessing the requirements of the Union government, the 15th FC should explicitly take into consideration the fact of the declining defence expenditure as a percentage of its total expenditure and make appropriate provisions in its expenditure projection.

The 15th FC could also recommend that the Union government reallocate expenditures wherever possible and eliminate wasteful expenditure. Further, it could suggest that the government mobilise more resources from sources such as the following: first, it should take measures to raise the tax-GDP ratio which has slumped to 11.7% in 2019-20 (Budget Estimates) as compared to 11.9% in the Revised Estimates to augment its resources to meet its expenditure requirements.

Second, it could minimise undisputed tax arrears which stood at around nine lakh crore at the end of 2017-18 and non-tax arrears of about 2 lakh crore in the same year. Similarly, the government could rationalise the tax incentives given to the corporate and non-corporate sectors – for the corporate sector alone, it was estimated at 1.39 lakh crore in 2018-19, which perhaps would decline following the recent policy decision if the corporate sector avails the lower rate of corporation tax, by giving up the incentives and exemptions they have been enjoying. Third, the Union government could monetise the huge chunk of government land under the ministry of defence, the railways etc., which the thirteenth commission, indeed, had recommended.

Also read: On Finance Commission Allocations, Modi Is So Far off the Mark, It Isn’t Even Funny

What should the 15th FC not be doing?

Over the years, the FC has established itself as a non-partisan institution of fairness and neutrality in which states repose a great deal of trust. It should not do anything that has an adverse impact on the divisible pool. In any case, the divisible pool is under significant stress. First, the 15th FC may not be able to increase states’ share beyond 42% that the 14th FC recommended.

Second, with a slowdown of the economy, the divisible pool would be adversely impacted. Third, with seven state taxes being subsumed in the GST, the states’ ability to mobilise resources from their own sources has been constrained. Fourth, the GST has yet to emerge as a buoyant tax.

On the contrary, CAG (Report no. 11 of 2019) noted that its yields declined by Rs one lakh crore in the revised budget of 2018-19 as compared to the original budget for 2018-19. It might further decline until the slowdown of the economy is reversed. States’ GST revenue with 14 % growth would be protected till 2022-13 but not for the entire award period of the 15th FC.

Fifth, cess and surcharges that are outside the divisible pool have increasingly become important instruments of revenue mobilisation. Just to illustrate, while the total transfer to states and UTs were Rs 4.1 lakh crore in 2017-18, revenue mobilisation by the central government through cess and surcharge stood at 3 lakh crore or 15.7 % of Centre’s gross tax revenue.

This went up to 5.12 lakh crore in 2019-20 (BE) accounting for 21.03% of the Centre’s gross revenue as against the total transfer to states and UTs to only 5.2 lakh crore in 2019-20 (BE). Last but not the least, even after rationalisation and restructuring of the centrally sponsored schemes, there remain 28 core schemes in which the general category states are required to contribute in 40% for their costs and three optional schemes requiring states to contribute 50%. Increasing states’ contribution to Core and optional schemes has clearly led to reducing states’ fiscal space and autonomy.

Also read: Debate: The Fifteenth Finance Commission is Vital for Economic Equality Within the Indian Union

For all these reasons, the 15th FC should deal with the AToR in a way that would have no adverse impact on the divisible pool which is already under great stress.

Atul Sarma is the chairman of the OKD Institute for Social Change and Development and was a member of the 13th Finance Commission.

Defence Experts Question Trump’s Military Spending Proposal

There were no cost estimates in the proposal and Trump proposed revenue-raising steps that budget experts called insufficient.

Republican presidential nominee Donald Trump speaks at the Cleveland Arts and Social Sciences Academy in Cleveland, Ohio, US, September 8, 2016. Credit: Reuters/Mike Segar

Washington: Republican presidential nominee Donald Trump’s US military buildup plan would cost hundreds of billions of dollars – but with no apparent strategy, defence experts from across the political spectrum said on Thursday.

“I haven’t seen any kind of strategy,” said William Hartung, director of the Arms and Security Project at the Center for International Policy. “He (Trump) says nobody is going to challenge us because we will be so strong. But that’s not a strategy. It’s just a kind of wish-fulfillment.”

US senator Jeff Sessions, a top Trump backer who sits on the Senate armed services committee, said the proposal was based on recommendations from groups such as the National Defense Panel and served as a statement of Trump‘s commitment to build the military.

“I believe this lays out a framework for rebuilding the military, and it represents a commitment by Donald Trump to make this a priority,” Sessions said in an interview. “If you don’t have presidential leadership really defending the need for a robust national defense, you’re not going to maintain the defense budget.”

Trump‘s proposal, unveiled in a speech on Wednesday, did not spell out how he would accommodate the additional manpower and hardware as the US shutters military bases or where and for what purposes the larger forces would be employed. There were no cost estimates and Trump proposed revenue-raising steps that budget experts called insufficient.

“He just called for higher defense spending without giving us a number and without telling us how he is going to pay for it,” said Lawrence Korb, a former Reagan administration Pentagon official and senior fellow at the Center for American Progress, a think tank aligned with the Barack Obama administration.

Trump’s Democratic opponent in the November 8 election, Hillary Clinton, advocates tough defence and foreign policies, but has yet to take a stand on the size of the Pentagon budget.

Stephen Miller, a Trump policy adviser, said Trump‘s proposal came in contrast to Clinton, who he said has “no military plan.”

Trump pledged to expand the army to 540,000 active-duty troops from its current 480,000, increase the Marine Corps from 23 to 36 battalions – or as many as 10,000 more Marines – boost the Navy from 276 to 350 ships and submarines, and raise Air Force tactical aircraft from 1,100 to 1,200.

Trump said those numbers were based on assessments by the conservative Heritage Foundation and other groups. Heritage said in a report that it looked at the capacity needed to handle two major wars to determine its force-size recommendations.

Trump said he would bolster the development of missile defenses and cyber capabilities. He made no mention of US nuclear forces already in the midst of a modernisation effort that will cost an estimated $1 trillion over 30 years.

To pay for the buildup, Trump said he would ask Congress to lift a Pentagon budget cap and “fully offset” the increased costs by collecting unpaid taxes, cutting appropriations for federal programmes operating without congressional reauthorization, cracking down on social welfare fraud and other fraud, and collecting additional taxes and fees from increased energy production.

‘Soft pedalling’ the cost

Writing in The Weekly Standard, a conservative magazine, Tom Donnelly, a defence scholar at the American Enterprise Institute think tank who opposes Trump’s election, praised Trump for embracing a buildup that many mainstream Republicans advocate.

“However, Trump undercut the power of his proposals by soft-pedaling the cost of such a buildup,” he wrote.

Independent cost estimates for Trump‘s plan range from $150 billion in additional spending over 10 years, according to the bipartisan Committee for a Responsible Federal Budget, to as much as $900 billion over the same period, as assessed by Todd Harrison, a defense budget analyst at the Center for Strategic and International Studies think tank.

Harrison said that increase could be achieved only by raising the federal budget deficit, raising taxes, or cutting other spending, such as benefits programs for seniors and the poor. “None of those things are politically popular,” he said.

The Committee for a Responsible Federal Budget estimated that lifting the cap would cost $450 billion over 10 years. The revenue-generating steps proposed by Trump would leave $150 billion of that amount uncovered, it said.

Another flaw in Trump‘s plan is the assumption that Republican members of the House of Representatives who belong to the deficit-fighting tea party movement would agree to end the budget cap.

In April, army chief of staff General Mark Milley told a Senate committee that adding more soldiers without a sufficient budget would be disastrous for the country and the army. Bases would close and programs that support troops and their families would have to be curtailed to make up the shortfall, he said.

The navy already has launched a shipbuilding program to raise the number of vessels to more than 300 by 2021. Trump‘s plan fails to account for the country’s limited shipbuilding capacity and the cost of manning, maintaining and basing the additional warships he proposes to build.

“The whole thing is unrealistic,” said Dov Zakheim, the Pentagon’s top financial official under former President George W. Bush. Zakheim, who opposes a Trump presidency, estimates that Trump’s plan would boost defense spending by roughly $300 billion over five years. “It’s a soundbite,” he said.

(Reuters)