Navigating COVID-19 and beyond

Navigating COVID-19 and
beyond: Policy impetus
for the Aerospace and
Defence sector
June 2020

Navigating COVID-19 and beyond: Policy impetus for the Aerospace and Defence sector
2
Indian Defence industry 06
Foreign Direct Investment (FDI) in defence
manufacturing increased to 74 percent 08
Self-reliance in defence production 10
Other announcements 10
Indian MRO industry 12
India seeks to become a hub for Aircraft
Maintenance, Repair, and Overhaul (MRO) 13
Airport privatisation to enter Round II 15
Other announcements 15
Conclusive remarks 15
Content

3

4
Preface
Over the past 18 months, India’s
aerospace and defence sector has
seen a spurt of policy attention from
the government. Roll-out of refreshed
draft Defence Procurement Policy 2020,
draft Defence Production Policy 2018,
framework for Strategic Partnership and
Offsets etc., have emerged as significant
developments in the policy landscape
for the sector, contributing to the
overarching ”Make in India” programme.
Despite a growing policy focus on
promoting ”Make in India” and
“indigenisation” of defence imports,
large-scale foreign capital has continued
to elude defence manufacturing in India.
This is primarily due to the absence of
policies permitting foreign majority/equity
participation without the underlying
need for prior government approval.
Multiple representations were made to
the Ministry of Defence and Department
for Promotion of Industry and Internal
Trade (DPIIT) for a review of the existing
Foreign Direct Investment (FDI) guidelines
for defence manufacturing, which has
remained in its nascent stage of evolution
for a decade now. Foreign Original
Equipment Manufacturers (OEMs)
and strategic investors have viewed
the hitherto permitted 49 percent FDI
cap as a major hurdle for technology
collaboration, and transfer of know-how
to Indian joint ventures led by Defence
Public Sector Undertakings (DPSUs) and
Indian partners.
In parallel, despite 100 percent FDI
permissibility, the Management, Repair,
and Overhaul (MRO) service sector has
had untapped potential for a fairly long
time due to a variety of reasons—higher
cost of setting up MRO facilities, inverted
tax and duty structure, cumbersome land
and labour laws, and as a result and more
importantly, exodus of trained and skilled
technicians/engineers leading to service-
scope limitations.
For both these sectors, the latest policy
announcements by the finance minister
are much awaited and welcome initiatives
especially in the wake of COVID-19, where
almost every sector is reeling under
substantial stress due to the demand
breakdown in the economy, in India as
well as globally.
An increased FDI cap to 74 percent
under the automatic route for defence
manufacturing will prove a net accretive
policy support as it will help encourage
foreign OEMs to commit relatively large
investments with a long-term view while
also giving them the flexibility to support
their supply chains under the current
circumstances. Combined with a highly
competitive corporate tax regime of 15
percent headline rate for manufacturing
businesses, the increased FDI in defence
manufacturing will help India emerge
as a highly competitive investment
destination within Asia. Further, the
convergence of commercial and defence
MRO should provide a positive impetus
to the aerospace and defence sector
as a whole.
The end goal is to reduce import
dependency in a staggered manner, and
in the process enable the development
of a robust and sustainable indigenous
aerospace and defence manufacturing
supply chain that can not only serve the
domestic demand, but also emerge as
a fast-growing export segment serving
the global supply chain. These policy
decisions also serve to strengthen
India’s positioning on the regional
geopolitical stage.
With the above in context, we are pleased
to share our outlook of the government
announcement impacting the aerospace
and defence sector.

5

6
Indian Defence industry
• India is the world’s third-largest country
in terms of military expenditure, after
the US and China. India’s military
spending increased by 6.8 percent to
about US$ 70 billion in 2019 and about
INR 62.8 billion (~2.1 percent of its
estimated GDP) was allocated to the
defence budget in FY2020–21.
• In 2018, India was also the fourth-
largest importer of defence goods
and services. In FY19, defence imports
accounted for ~49 percent of the total
requirement (figure 1)1
.
• In order to reduce import dependency,
the government made changes to the
Defence Procurement Procedure to
support “Make in India” and promote
strategic partnerships with Indian
players. The draft Defence Procurement
Procedure 2020 also envisages
simplification of the procurement
procedure while reducing costs, and
seeks to incorporate leasing from both
Indian and global sources amongst
others. The draft Defence Production
Policy also sets the reduction of
dependence on imports as its key
objective.
• The government has set a target to
increase its current domestic defence
production (figure 2) to US$ 26 billion
by 2025, with an investment of US$ 10
billion in aerospace and defence goods
and services. This is also to create
an ecosystem for private and public
sectors to develop India as a major
defence manufacturing hub. India aims
to achieve US$ 5 billion from exports
by 2024.2
Figure 1: Defence procurement
Figure 2: Defence production
US$ bn
FY 2015 FY 2016 FY 2017
FY 2017
FY 2018
FY 2018
FY 2019
FY 2020
(As on Feb 2020)
FY 2019
12
10
8
6
4
2
0
60%
40%
20%
0%
Total (RHS)
Other PSUs/JVs
Ordnance Factory Board
Defence private companies
Defence Public Sector Undertakings
US$ bn % share
10.5
11.4
39.4%
9.4
12.1
37.2%
10.7
39.4%
11.2
11.6
39.9%
11.0
6.9
48.7%
Foreign vendors
Total
14
12
10
8
6
4
2
0
1
Source: PRS Research and Deloitte Analysis
2
Source: PIB Press Release dated 18 Nov 2019

7
2015
• FDI up to 49 percent
under automatic route
• Government approval
route above 49 percent
wherever access to
modern and “state-of-
art” technology likely
• To achieve this objective, participation
from the private sector and foreign
OEMs in particular is critical. Currently,
the defence production in India is
dominated by the public sector.
However, despite the government’s
efforts on “Make in India” and frequent
amendments to FDI guidelines
(figure 3), the sector has not been
able to attract foreign investment as
anticipated. As on December 2019, India
received FDI inflows of ~US$ 250 million
(INR 18.34 billion) in the A&D sector
under both, the government and the
automatic route3
.
• One major concern raised by foreign
OEMs consistently was the 49 percent
cap on FDI under the automatic route,
which restricted majority control over
their Indian joint venture and access to
proprietary technology.
3
Press Release by Ministry of Defence on March 4, 2020 (accessible at https://pib.gov.in/PressReleasePage.aspx?PRID=1605127)
2001
2020
2016
2014
• Sector opened up to
100 percent for the
Indian private sector
• FDI up to 26 percent
permitted under the
government approval
route
• FDI up to 74 percent under
automatic route
• Government approval route above
74 percent, wherever access to
modern technology likely and for
other reasons to be recorded
• FDI up to 49 percent under the
automatic route
• Government approval route above
49 percent wherever access to
modern technology likely and for
other reasons to be recorded
• FDI up to 49 percent permitted under government
approval route
• Cabinet Committee on Security approval required
above 49 percent on a case-to-case basis, wherever
access to modern and “state-of-art” technology likely
Figure 3
(to be confirmed from fine print)

8
Announcement by the finance minister
• FDI limit in defence manufacturing
under automatic route raised from 49
to 74 percent.
Potential implications
• The increased FDI cap is an opportune
policy decision to ensure the A&D
supply chain developed in India is
sustained and continues to grow,
fulfilling the larger objectives of self-
sufficiency and cost reduction.
• An increased FDI cap will unlock
the large investment potential of
indigenous defence manufacturing,
as foreign OEMs will be encouraged to
commit sizeable investments with a
long view on the sector.
• The policy shift should also allay OEMs’
apprehensions around transferring
4
Companies incorporated on or after 1 October 2019 and commencing manufacturing operations on or before 31 March 2023
Source: By Deloitte India
Foreign Direct Investment (FDI) in defence
manufacturing increased to 74 percent
proprietary know-how/technology to
joint ventures with Public Sector Units
(PSUs)/Indian partners as financial
control will offer better protection of
rights.
• Increased capital commitment and
enhanced technological collaborations
will help augment indigenous research
and development capabilities, ensuring
greater reliability on local supplies,
and in turn, will reduce dependence on
imports in a phased manner.
• India also recently overhauled its
corporate tax rate and introduced a
reduced 15 percent base rate for new
manufacturing companies4
, placing
India as a competitive investment
destination amongst its Asian and
BRICS peers (figures 4 and 5).
Figure 4: Asia Pacific Tax rate
Australia
China
HongKong
India(old)
India(new)
India(new
manufacturing)
Indonesia
Japan
Korea(ROK)
Malaysia
Mauritius
NewZealand
Philippines
Singapore
Taiwan
Thailand
Vietnam
35
30
25
20
15
10
5
0
4
Companies incorporated on or after 1 October 2019 and commencing manufacturing operations on or before 31 March 2023

9
• For the OEM/Tier-I players in India, the
enhanced FDI limit gives these players
the flexibility to protect their supply
chain and take advantage of other
policy decisions to phase out the import
of certain weapons and platforms,
indigenisation of spares, and allocation
of the domestic capital budget.
• It would, however, be imperative to
evaluate whether revised FDI limits are
linked to any associated conditions in
the fine print.
Source: By Deloitte India
Figure 5: BRICS – Base Corporate tax rates
Russia
India – Old
India - New
India - New
manufacturing
China
20
30
22
15
25
• Further, FDI beyond 74 percent (up to
100 percent) is likely to remain under
the government approval route and
subject to fulfilment of the “access
to modern technology or other
recorded reasons” condition. Due to
ambiguity on what constitutes modern
technology, such conditions have and
could continue to be a hurdle for 100
percent FDI in the defence sector.
Brazil
South Africa
34
28

10
• The government will notify a list of
weapons/platforms for an import ban
with year-wise timelines.
• Separate budget provisioning to be
undertaken for domestic capital
procurement.
• Focus to be on indigenisation of
imported spares.
• Government procurements of value of
up to INR 2 billion will be reserved for
the domestic industry.
• The government’s endeavours in recent
years have been to reduce import
dependence in a phased manner and
develop a sustainable and indigenous
defence manufacturing ecosystem
through policy support and supply-
chain growth.
• Recently announced measures are
aligned with the government’s stated
policy intent of reducing the defence
import bill and developing capabilities
for indigenous weapons/platforms.
• A time-bound defence procurement
process and faster decision making
will aid the policy goal for a more self-
reliant defence manufacturing supply
chain. The project management unit
is to be set up to support contract
management, and trial and testing
procedures are to be overhauled.
• The Ordnance Factory Board is to be
corporatised to improve autonomy,
accountability, and efficiency. This can
be a significant policy move and will
encourage more private participation
from both, foreign and domestic
defence players.
Self-reliance in defence production
Other announcements
• In tandem with what is a fairly
liberalised FDI regime and a progressive
Defence Procurement Procedure, these
proposals hold significant potential
for growth of a very competitive and
integrated defence manufacturing
supply chain that promises
considerable export potential, both
regionally and globally, besides serving
India’s indigenous needs.
• As the crosshair and target are
eventually falling in line, certain other
reforms in recent times, including
a robust framework for strategic
partnership, draft Defence Production
Policy 2018, and draft Defence
Procurement Procedure 2020, will
play a huge role in driving self-reliance
in defence production and provide
impetus to defence exports. For
instance, the aforesaid draft policies
include reforms for promotion of
indigenous raw materials and software,
introduction of higher multipliers for
incentivising investments, and setting-
up of defence corridors with state-of-
the-art-infrastructure.
• The government has proposed limiting
the number of public sector enterprises
in strategic sectors (including defence)
to four. It is likely that existing defence
public sector undertakings (>4) would
be privatised/merged/brought under
holding companies’ framework. This will
be a milestone policy shift and will bring
about more market preparedness in
the approach of some existing Defence
PSUs and also foster competitive
market behaviour in terms of timely
delivery, product quality, and price
sensitivity.

11

Indian MRO industry
• In the pre-COVID-19 world, the
global commercial MRO market was
estimated at US$ 80 billion in 2019. It
was expected to reach US$ 110 billion
by 2029. APAC was likely to outpace the
global MRO demand.5
• Aircraft maintenance accounts for 10–
15 percent of the total operating cost
for airlines, with engine overhaul being
the largest segment and generating
approximately 40 percent of the total
MRO demand.
• India’s commercial MRO sector was
around US$ 0.9 billion (around 1
percent of the global MRO market) and
was expected to grow at a CAGR of 7.7
percent in the pre-COVID environment.
Indian airlines spend ~12–15 percent
of their revenues on maintenance, the
second-argest expense after fuel, with
engine maintenance being the largest
MRO expense (figure 6).6
12
• Despite the increased domestic
demand and a healthy global MRO
market growth, both for commercial
and defence MRO, for years, India has
remained uncompetitive compared
to its Asian peers, mainly due to a
regressive tax regime, and some
uninviting policies, including land and
labour regulations.
• Indian domestic and international
airlines have been outsourcing ~90
percent of their MRO work to other
countries.
• India is also poised to become a large
defence aircraft market. As military
expenditure increases, the necessity
for military MRO capabilities will also
increase.
Figure 6: India MRO market share (% of value by activities in 2019)
Engine
maintenance
46%
Component
maintenance
21%
Line
maintenance
17%
Airframe heavy
maintenance &
modification
16%
5
Source: Industry Sources and Deloitte Analysis
6
Source: MRO Association and Deloitte Analysis

13
• Major global engine manufacturers are
likely to set up engine repair facilities in
India.
• Aircraft component repairs and
airframe maintenance targeted to
increase from INR 8 billion to INR 20
billion in three years.
• Defence and Civil MRO to converge.
• GST regime for MRO ecosystem was
recently rationalised.
• Cost for airlines to substantially reduce.
• On the back of enhanced FDI norms
in the A&D sector, where large
aerospace players are also significant
defence OEMs, and considering the
potentially fast-growing aviation and
defence sector, India has articulated its
India seeks to become a hub for Aircraft
Maintenance, Repair, and Overhaul (MRO)
aspiration and potential of emerging
as a regional and global hub for MRO
services, both for civilian as well as
military applicability.
• Earlier this year, through GST
rationalisation for MRO services, the
government sought to restore balance
by introducing a zero rating status
to MRO services rendered by Indian
MRO units to customers outside India.
Further, the supply of MRO services to
Indian customers is now subject to a
concessional rate of 5 percent (earlier
18 percent), which further supplements
the domestic MRO market. Lastly,
the continuation of applicability of
Integrated-GST on the import of
overhauled parts by Indian customers
provides a better footing to Indian
MRO players (Domestic Tariff Area) in
contrast to the ones offshore for service
provision to Indian customers (figure 7).
• GST rate on MRO services reduced from 18 percent to 5 percent.
• Place of supply changed from “place of performance” to “location of service
recipient” in case of cross-border supplies (recipient or supplier outside India)
• Wide coverage in amendments for aircrafts, aircraft engines, parts, and
components MRO
• No distinction drawn for MRO of civil and military aircrafts
GST notifications issued
effective 1 April 2020
Figure 7

14
• The latest policy move to allow
convergence across civil and defence
MRO will aid in creating a larger
market place for private MRO players
and provide economies of scale.
Currently, defence MRO in India is
dominated by the public sector and this
announcement is expected to open up
opportunities for private players in the
defence MRO market.
• Besides engine MRO, government
focus on component and airframe
maintenance will provide OEMs and
investors a long-term investment
horizon while committing large
investment plans.
• Clearly, recent announcements place
India in a pole position to capture
the multi-billion dollar aviation
services market and build high-quality
infrastructure facilities, wider and
deeper precision manufacturing
capability, and a spare-part supply
chain, alongside creating skilled
employment opportunities
• To achieve the end goals set out by the
government in recent announcements,
certain other aspects, which have
historically impeded the growth of the
Indian MRO sector, would require to be
addressed, including high set-up costs,
multiple levels of certification, skill
building, service quality and breadth of
services, and tax regime (figure 8).
• While a significant cost driver in
the form of revised tax regime has
been set, the return to normalcy for
the aviation sector post the global
lockdown will determine the Indian
MRO sector’s speed of growth. The
government has made its intentions
very clear, and every effort will be made
to ensure sustainability and growth of
this sector.
Service Quality
The services offered
by existing MROs are
limited and lack the
infrastructure and
technology of their global
counterparts, resulting
in a major part of MRO
work being outsourced
to Singapore, Sri Lanka,
UAE, Europe, and others.
Tax nuances/costs
Inverted duty structure
and lack of full credit
adds to overall costs,
customs classification
issues, and inconsistent
tax classification vis-
a-vis civil and defence
MRO
Global certification
Very few Indian
MROs provide heavy
maintenance services
as it requires approvals
from several global
OEM’s and regulators.
Airlines steer abroad
due to the availability
of globally certified
standard of quality.
High set-up costs
Establishing an MRO
facility involves
huge initial costs
(infrastructure, machines,
and equipment), along
with high operating costs.
Skill building
MRO facilities require
ancillary industries and
services. There is a large
requirement for super-
specialised training
facilities.
Figure 8

15
• Bid processes for private participation
in six airports in the second round
to commence immediately. Private
investment of around INR 130 billion is
expected in the first two rounds.
• Another six airports to be identified
and put out for development through
private participation in the third round.
• After a successful first round of bidding
for six airports, where concession
for three airports have already been
awarded, the commencement of the
second round of bidding is anticipated
by infrastructure players/investors.
With the latest announcement,
India is poised at cross-roads for
consolidation and growth in the
aerospace and defence sector.
• The Indian government has taken the
opportunity of the COVID-19 pandemic
to look at the aerospace and defence
sectors comprehensively, and to initiate
policy measures that might go a long
way in resetting the sector on a more
pronounced growth trajectory.
• It is now on the industry to reciprocate
and take advantage of the emerging
playing field in the aerospace and
defence sector in India.
Airport privatisation to enter Round II
Conclusive remarks
intending bidders will look to review the
modalities, particularly the much talked
about cap of two airports per bidder.
• Private participation is expected to help
increase efficiency of airports, augment
revenue for the government, and
provide better quality infrastructure to
the public.
• A lot has changed since the first
round where a number of players
had participated in the development
of six airports. Besides the impact of
COVID-19 on passenger traffic and the
aviation sector in general, there are
differences in the scale and nature of
business at airports that are likely to be
included in rounds 2 and 3. This would
need to be considered from a private-
sector perspective.
India gets to utilise more airspace
• Restrictions on utilisation of the Indian
airspace to be eased. Presently only
60 percent of Indian airspace is freely
available.
• The proposed relaxation will make
civilian flying more time and fuel
efficient, and facilitate optimal
utilisation of airspace.
• Overall benefit of INR 10 billion per year
is likely to be captured by the Indian
aviation sector.
Other announcements
Encouraging private participation
in space
• In order to spur private sector
participation in the space sector,
the government has now provided a
level-playing field to the private sector
with the use of ISRO facilities towards
improving capacities.
• This is an important policy step to
encourage private-sector investment in
India’s space sector development.

16

17
SMEs
Acknowledgements
Contact us
Alaric Diniz
Shivam Saigal
Tushar Aggarwal
Alaric Diniz
adiniz@deloitte.com
Sumit Singhania Peeyush Naidu

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