Tag Archives | DefenceEconomics

Thoughts on defence land

The Land Division of the Directorate General Defence Estates states that “The Defence forces require large areas of land for training, ranges, depots, airfields, quartering, camping, offices etc for military activities. Ministry of Defence, therefore, owns large tracts of land of approx 17.54 lakh acres, out of which approximately 1.57 lakh acres is situated within the 62 notified Cantonments and about 15.96 lakh acres is outside these Cantonments. The responsibility of day-to-day management of land is with the user services”

The Comptroller and Auditor General (CAG) undertook a performance audit of Defence Estate Management covering the period from 2004-05 to 2008-09, and submitted its report on March 25, 2011.  Some major findings of the CAG report were

  • delay in mutation of land in favour of MoD
  • increased encroachment
  • exploitation of defence lands for commercial purposes, and
  • the dismal state of lease management.

The standing committee made the following observations and recommendations:

  • Application of land norms: The Committee noted that MoD has faltered in applying norms for proper and judicious management of lands at its disposal.  It noted the inherent risks of holding vast tracts of unoccupied land, including hoarding.  It recommended that the entire ambit of defence land record keeping, mutation, sale and transfer, etc. should be bestowed upon the Directorate General of Defence Estates (DGDE).  Further, the whole issue of requirement of land by defence forces needs to be revisited so that land is put to optimum use.
  • Variation in records: The Committee expressed concern over discrepancy in land figures in the records of Local Military Authorities (LMAs) and Defence Estate Officers (DEOs).  In a survey, the land area in the records of LMA was 47% higher than that in the records of DEO for 9 army stations.  It recommended that the MoD make it mandatory for DEOs to periodically inspect the land records maintained by LMAs.  Further, there should be a comprehensive survey of all defence lands.
  • Mutation of defence land:  The Committee noted that a large portion of acquired land has been awaiting mutation for a long period, in some cases as long as 60 years.  It noted no serious efforts were made to expedite mutation of land to MoD.  It recommended that steps be taken for the same, and documents pertaining to non-mutated land be made available to the Committee within six months.
  • Unauthorised use of defence lands: The Committee noted that the CAG has repeatedly objected to the use of defence lands for unauthorised commercial purposes such as golf courses, but no action has been taken.  In addition, revenue generated from such activities has not been credited to government accounts.  The Committee recommended that the DGDE be supplied with all information relating to such activities and revenue generation.
  • Encroachment of defence lands: The Committee noted that non-mutation of land records, non-utilisation of land and existence of multiple authorities has resulted in encroachment of land.  It recommended that a single unified authority be created to look into management and protection of defence lands.
  • Dismal state of management of leases: The Committee observed that defence land is leased out at a very low rate compared to its market value.  In addition, no serious effort has been made to renew the leases, leading to loss of revenue to the government.  It suggested that the government bring out a policy in this regard within six months.

The defence services and the Ministry of Defence must act on the recommendations of the CAG as soon as possible(the recommendations were made 6 years ago). One must also take into account that a large portion of defence lands is in central business districts of major Indian cities and monetising these pockets will enable the forces to provide modern facilities with vastly improved living conditions for personnel and their families.

PS – My colleague Nitin Pai’s article  in Business Standard, argues for moving cantonments 20 km away from 20 cities

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DRDO exists to protect the nation and not the other way around

It is not in India’s national interest to continue to run public sector organisations like DRDO if they are inefficient and not meeting their objectives

— Varun Ramachandra and Nitin Pai

Recently, the Defence Institute of High Altitude Research — a Defence Research and Development Organisation(DRDO) laboratory — inked an agreement with Patanjali Ayurveda Limited for a non-exclusive license through transfer of technology on nutritional products.

The agreement was signed under the DRDO – FICCI Accelerated Technology Assessment & Commercialisation programme which “aims to create a commercial pathway to deliver technologies developed by DRDO for appropriate commercial markets for use in civilian products and services.” Previous deals under the programme have been with business houses like Dabur Ltd, Gujarat Fluorochemicals Ltd, Bhilai Engineering Corporation to name a few.

The DRDO is not involved in production of equipment, instead it is primarily responsible for research and development till the transfer-of-technology(ToT) stage. The move to rope in Patanjali to popularise DRDO’s  seabuckthorn based nutritional products is well within its mandate. But it must also be noted that many critical projects under DRDO that have a direct bearing on combat preparedness like the Light Combat Aircraft and Kaveri jet engine are delayed by several years.

Therefore, it is important to examine the raison d’être for DRDO in the first place. The organisation was set up in 1958 with the objective of providing the Indian armed forces with indigenous scientific and technological support. In 2015, 57 years after the formation of the DRDO, India continues to rely on imports to meet its domestic defence demands. This clearly indicates a mismatch in the said objectives and the achieved outcomes of the DRDO(and other public sector undertakings that are involved in defence).

In 2007, the government set up a committee chaired by Dr. P Rama Rao to specifically improve the operations of DRDO. The committee’s report suggested a breakdown of the organisation into smaller manageable units along with merging several of its laboratories with other institutions. The committee’s recommendations have been implemented in a half-hearted manner. The DRDO is far from reaching the operational efficiency of similar organisations from across the world and successive governments have continued to spend money, inefficiently, on DRDO.

From a financial point of view, national security is a delicate relationship between the taxpayer and the armed forces. Hence, it is incumbent upon the armed forces to equip itself with the best available technologies, be it domestic or international. In such a scenario, if Indian organisations are unable to meet the armed forces’ requirements it is natural and expected of the forces to look elsewhere to meet its primary goal of national defence.

The operational costs of running an organisation like DRDO run into several thousand crores. If such an organisation is inefficient and not meeting its objectives, it is not in India’s national interest to continue to run these organisations, especially when taxpayers money is involved. The same money can be used elsewhere to meet other national objectives.

Cloaking reforms under patriotism or indigenisation has resulted in a state where India imports large chunk of its equipment, but is reticent to allow FDI in defence manufacturing. The Indian defence establishment too has called for indigenisation to avoid being coerced by exporters in the hour of need, a problem that can be solved by developing strong economic ties with all exporting countries and/or by procuring from countries where the economic ties are already in place. It is worth reinforcing the fact that defence is a sector where anything short of excellence is a failure.

The dogmatic approach towards indigenisation since independence has yielded limited fruit. It has largely resulted in policy capture by public sector undertakings in the name of indigenisation. The net result is that the domestic industry is incapable of meeting India’s defence requirements and the political economy of reforms has ensured that many PSUs are in a rut.

Indigenisation is a lofty goal that is worth pursuing. Until the goal is reached, defence requirements continue to exist. Therefore, the path towards indigenisation need not be studded with inefficient public sector undertakings. Instead, actively allowing private players and FDI in the defence sector can inject competition and contestability. This will also allow Indian industries to acquire the necessary competence to deliver world-class results.

The government must urgently implement the recommendations of the P Rama Rao committee to restructure DRDO. The DRDO must focus on projects of importance and align its project priorities with that of the defence establishment. India can ill afford inefficient institutions for they have far reaching fiscal and social consequences. Moreover, DRDO exists to protect the nation and not the other way around.

A modified version of this piece was translated to Hindi and appeared in BBC Hindi 

Update: A translated version of this piece appeared in the Kannada daily Prajavani

Varun Ramachandra and Nitin Pai are with Takshashila Institution, a Bangalore based independent think-tank and a school of public policy. Varun tweets @_quale and Nitin tweets @acorn

Featured image credits: The Surya Kiran Aerobatic Team (SKAT) at Aero India 2011 by Ruben Alexander, licensed under creative commons

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Challenges of Defence Economics

There are several operational difficulties that one faces while analysing the economics of defence in the Indian context – Varun Ramachandra(_quale)

Keith Hartley in his book “The Economics of Defence Policy” describes defence choices as complex because they have to be made in world of uncertainty and assumptions are on the basis of likely future threats(internal, external, and/or via non-state actors). Today’s choices may not be sufficient for tomorrow’s threats or worse still, today’s choices might be irrelevant tomorrow.

In such a scenario, the defence budget cannot be viewed as a stand alone entity. The larger question of how much of our national resources be directed to defence is an important one and deserves holistic treatment(pardon the cliche).  As AK Ghosh in his book “India’s Defence Budget and Expenditure Managament in a Wider Context” suggests “to say that it(defence budget) ought to be larger or smaller, without regard to its internal components or the external components that define it, is worse than useless”.

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There are several operational difficulties that one faces while analysing the economics of defence in the Indian context(or perhaps even in a global context) and this post explores the complexities one faces while studying this area.  The challenges can be classified as

  • Semantic
  • Accounting
  • Obfuscation

Semantic – Currently, there is no clarity on what constitutes as military expenditure and what constitutes as security expenditure. For constitutional and operational reasons internal security is the mandate of Ministry on Home Affairrs whereas the external defence is the mandate of Ministry of Defence. That said, there are several grey areas. Eg., Border Roads Organisation under the MoD has a peace time mission of “Contributing to the Socio-Economic Development of the Border States”. There are several strategic reasons for such assuming such roles, primarily being development and nation-building, but an analysis on whether this constitutes as military expenditure(and if it is being accounted for) is required.

Accounting – Currently, the services follow a cash accounting model which does not capture the market value of current asset and liabilities. A cash based process is a single entry accounting process which records cash transactions but does not capture non-cash transactions. This is a major challenge because large swathes of land and precious resources like spectrum and human resource are not captured while allocating newer resources. This results in unknown spending as opportunity costs are involved. (Some thoughts on accrual accounting by experts can be accessed here)

Obfuscation – As a strategic and a security measure there is definitely a need to obfuscate certain aspects of the defence budget. But care must be taken to ensure that the defence expenditure does not come under civilian heads (if however there is a case for it, it must certainly be justified and necessarily not concealed) . This adds an extra layer of complexity while analysing the economics of defence services.

Varun Ramachandra is a policy analyst at Takshashila Institution. He tweets @_quale

photo credit: Crossed wires via photopin (license)

 

 

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Defence Offsets

My review of  ManMohan S Sodhi and Rajiv Bhargava’s edited volume “Perspectives on India’s Defence Offset Policy” appeared in The Business Standard.

This book sets out with the objective of compiling different perspectives of the primary stakeholders in this space: the Indian government, global original equipment manufacturers (OEM), and Indian industrialists.

Through these perspectives, the book aims to understand the evolution, and trace the possible future trajectories, of defence procurement and offset policies in India. The volume opens with a bird’s-eye-view of these perspectives, followed by three sections containing chapters by individual stakeholders, and concludes with a section emphasising the importance of Indian manufacturing.

The entire piece can be read here

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More thoughts on accrual accounting

This is a part of a series on Defence Economics. Previous blogs on the same topic can be found here, here, and here.

In continuation with the last piece that dealt with democratic accountability and defence economics, this post provides some more sources that have analytically written about the importance of an accrual-based accounting system.

Gur Saroop Sood  in this excellent article refers to the cash-based accounting thus:

 “Under the cash-based system, the currency transactions, pertaining to a Financial Year, are available till the closing of accounts. Once the accounts are closed, past transactions do not become readily available. In this system, committed liabilities incurred do not get recorded in the accounts at the time of their occurrence. Therefore, for commitment control, such information has necessarily to be generated through additional reports. If the committed liabilities are not available, the possibility of over or under committing resources vis-à-vis available funds in a Financial Year cannot be ruled out. The accounting system also does not generate information for the decision-makers to know whether the money is being spent on core or peripheral activities. Due to the principle of lapse, the Executive tends to spend the earmarked funds during the month of March, sometimes also referred to as ‘March rush’, in order to avoid surrender of unspent funds spend the earmarked funds during the month of March, sometimes also referred to as ‘March rush’, in order to avoid surrender of unspent funds.”

Amaresh Bagchi in his Business Standard piece says

Such a system does not provide a full picture of the government’s liabilities, because accrued liabilities such as those from unfunded pensions and commitments are not taken into account; two, it keeps no track of the assets of the government, nor do they provide information on the costs of holding and operating them or of their consumption or use”

The 12th Finance Commission’s recommendations are as follows

“Compared to the cash based system, the system of accrual accounting recognizes financial flows at the time economic value is created, transformed, exchanged, transferred or extinguished, whether or not cash is exchanged at that time. It is different from cash based system in that it records flow of resources. Expenses are recorded when the resources (labour, goods and services and capital) are consumed, and income when it is earned, i.e. when the goods are sold or the services rendered. The associated cash flows generally follow the event after some time and may or may not take place during the same accounting period. Thus, in addition to cash flow, unpaid consumptions (payables) and unrealized income (receivables) are also recorded. Resources acquired but not fully consumed during an accounting period are treated as assets (inventory and fixed assets). Payments made for acquisition of inventory are included in the operating cost for the period in which it is consumed. Payments made for acquisition of physical assets, that have future service potential, are amortized over the entire useful life of the asset by charging depreciation

The system of accrual accounting thus, inter alia, allows better cost – price calculations, records capital use properly, distinguishes between current and capital expenditures, presents a complete picture of debt and other liabilities and focuses policy attention on financial position, as shown in the whole balance sheet not just cash flows or debts thereby providing a complete measure of cost of various services and provides net worth and their changes over time

The Controller General of Defence Accounts while talking about implementation of accrual accounting in Government says the following

Accrual accounting system enables system enables a more effective assessment of the performance and provides the necessary information for linking the input costs to outputs and outcomes that is required by services.

The challenge of moving to an accrual based accounting is the time that is required for the transition. Also, the switch will place considerable demands on the accounting personnel particularly at the lower and middle levels of the accounting hierarchy.

Amaresh Bagchi’s Business Standard piece has a solution to this problem as well where he suggests

 transitioning in a phased manner and in the interim both cash and accrual accounting can run in parallel to ensure a smooth transition.

There is overwhelming evidence, and scholarly  agreement about moving towards an accrual based accounting system. It is a matter of wonder that the move has not yet happened. Perhaps, an analysis on why cash based accounting  system is still in vogue is an exercise worth undertaking.

Varun Ramachandra is a policy analyst at Takshashila Institution, he tweets @_quale

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Democratic accountability and defence economics

The previous post on defence economics described the need to study the subject. it was concluded that: development of defence economics is necessary from the perspectives of

  • democratic accountability
  • efficiency of resource allocation to ensure preparedness
  • military effectiveness to ensure the right mix of services are deployed to ensure peace
  • improvement of service conditions — that ensures state of the art quality of life for servicemen, ex-servicemen and their families

This post focusses on democratic accountability and the need to maintain it even while dealing with complex choices in defence.

Sound financial management of a country’s security sector is key to maintain an efficient and effective security force that is capable of responding to the population’s legitimate security needs. Avoiding excessive, wasteful, and corrupt military expenditures and procurement thus requires high levels of transparency and accountability in military budgeting and procurement processes.”Such processes should adhere to government-wide financial management and oversight practices, within a rigorously-observed defence policy and planning framework. This includes adherence to public expenditure management (PEM) principles of comprehensiveness, discipline, legitimacy, flexibility, predictability, contestability, honesty, information, transparency and accountability”[1].

In the Indian context, the government and citizens must know the full costs of national security and this can be achieved by making the asset value of services explicit without compromising the strategic secrecy that is the imperative of any defence service.  All the forces together own valuable land, spectrum, human resources, and equipment. Arriving at an explicit asset value creates incentives for increasing the efficiency of all these assets and creates a defence establishment that is effective, efficient, and fiscally prudent.

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The process is easier said than done. For example, a simple step that is tedious to implement is a shift towards accrual based accounting. Currently, the defence budgeting system is based on a cash accounting model which ignores all non-cash transactions. This has masked the exact net present value of all the resources that the services currently possess. Such a system “does not provide a full picture of the (government’s) liabilities, because accrued liabilities such as those from unfunded pensions and commitments are not taken into account; two, it keeps no track of the assets of the (government), nor do they provide information on the costs of holding and operating them or of their consumption or use”[2].  An accrual based accounting system enables more effective performance assessment and provides the necessary information to link the input costs to outputs, and outcomes that is required by services[3].

That said, the complexities of a process should not stifle measures that ensure democratic accountability.

Varun Ramachandra is a policy analyst at Takshashila Institution, he tweets @_quale

References:

[1] “Transparency and accountability in military spending and procurement” http://www.sipri.org/research/armaments/milex/transparency, accessed 15-July-2015

[2] Amaresh Bagchi, Accrual accounting in government, Business Standard, 5-April-2005, http://www.business-standard.com/article/opinion/amaresh-bagchi-accrual-accounting-in-government-105040501073_1.html, accessed on 15-July-2015

[3] Implementation of accrual accounting in Government, Controller General of Defence Accounts, http://cgda.nic.in/accounts/accrual.html, accessed on 15-July-2015

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Opportunity cost of delays

Recent news reports suggest that the final operational clearance for  India’s homegrown Light Combat Vehicle might be delayed. If this is indeed true, this is not good news.  There is also news about handing over the entire project to the private sector. Irrespective of whether the LCA will be delayed or not, most newspapers and reports suggest that the Indian government has spent enormous amounts of money on this project.

Although the losses are significant,merely looking at a huge rupee number does not complete the story. The concept of opportunity costs has to be factored in while analysing such delays in projects. Opportunity cost in simple terms can be defined as the loss of the next best opportunity. In case of the LCA or any other delayed projects the question that must be raised is “What is the next best thing we could have done with the money”?

In an area like defence, the opportunity costs are exacerbated because delays inevitably reduce combat preparedness. A logical question to raise therefore is to track how many such delays have affected India in the numerous conflicts that it has had to face in the past.

As this ET report suggests

Sources said discussions have taken place in the top echelons of the government on the best ways to inject urgency into the Tejas programme, possibly even with the involvement of a private sector player that would be clearly incentivised to deliver a new aircraft on time and within budget

One wonders why the government has decided to bring in private players so late in the game(Depending on how the timelines are viewed, there has been a delay of more than 10 years in the LCA project).  The idea about only state-run firms handling  strategic programmes has not been a success. It is time the defence ministry and the defence establishment views efficiency, as opposed to ownership, as the metric while choosing vendors/partners.

Better late than never. Hopefully.

Varun Ramachandra is a policy analyst at Takshashila Institution and tweets @_quale

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Need for a systematic study of defence economics

Ensuring security from external aggression is a basic public good that the governments have to provide and given that it is not possible to reveal individual preferences, this has to be financed from taxes.   The important issue confronted by the policymakers, however, is the basic economic dilemma of scarcity and choice.  The funds allocated for defence are not available for spending on physical infrastructure or human development which are necessary to improve the living conditions of people.

As stated by David Greenwood[1], “What the budgeting system should ideally do is to ensure that the ‘right’ amount is spent on defence in the light of pattern of national priorities, and the ‘right’ military capabilities developed in the light of the structure of security priorities” The answers to what the “right” amount is depends on the economic choices the government has to exercise in providing various public goods, merit goods and services, given the overall resource envelope.

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As the world’s largest democracy, with an annual gross domestic product (GDP) of almost $2 trillion it is imperative to understand what the ‘right’ amount is and to evaluate whether what we are currently spending is high, low, or indeed the ‘right’ amount. While understanding the numbers are important, it is also important to explore the following

  1. various priorities in which defence spending can happen
  2. assessing existing resources
  3. investigating the possibility of developing  normative frameworks to understand security priorities & threat perception
  4. how the defence forces can be effective and yet be fiscally prudent

The national security of a country depends on defence installations and facilities being in the right place, at the right time, with the right qualities and capacities. Spending on defence, therefore, is a resource allocation problem and the budgeting for defence has two broad functions[2]

  1. Management Function — to enable concerned personnel to spend money for various activities in an efficient and economical manner.
  2. Planning Function — Budgetary resources are to be allocated such that it enables achievements regarding operational preparedness and defence capability-building.

Defence budgeting literature indicates that budget is a three-tiered exercise in choice. First, it involves choosing how much to spend on defence, given the resource constrtaint, keeping in view other competing demands. Second, it involves choosing the basis for allocating resources among the services (army, navy and airforce). Third, it involves allocation among various programmes for capability-building, which entails what capabilities to acquire & maintain and the degree of military preparedness to aspire for[3]. Therefore, development of defence economics is necessary from the perspectives of

  • democratic accountability
  • efficiency of resource allocation to ensure preparedness
  • military effectiveness to ensure the right mix of services are deployed to ensure peace
  • improvement of service conditions — that ensures state of the art quality of life of servicemen, ex-servicemen and their families.

Varun Ramachandra is a policy analyst at Takshashila Institution and tweets @_quale

[1] David Greenwood, “Budgeting for Defence”, RUSI, 1972, p8.

[2] AK Ghosh, “ Defence budgeting and planning in India”, p.25

[3] Ibid 27

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PS- My thanks to Nitin Pai and Dr. M. Govinda Rao for their inputs and help.

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