INDIA'S DEFENSE BUDGET RISES MODERATELY, BUT PROCUREMENT

UNCLAS NEW DELHI 000734 SIPDIS STATE FOR SCA/INS JASHWORTH AND SCA/RA MURENA USDOC FOR 4530/ITA/MAC/OSA/LDROKER/ASTERN DEPT PASS TO USTR FOR SOUTH ASIA - CLILIENFELD/AADLER DEPT PASS TO TREASURY FOR OFFICE OF SOUTH ASIA - MNUGENT TREASURY PASS TO FRB SAN FRANCISCO/TERESA CURRAN USDA PASS TO TERPSTRA AND FAS/CARVER/RADLER/RIKER SENSITIVE E.O. 12958: N/A TAGS: ECON EFIN EINV ETRD EAGR PREL MARR IN SUBJECT: INDIA'S DEFENSE BUDGET RISES MODERATELY, BUT PROCUREMENT REMAINS A PROBLEM ¶1. (SBU) Summary: The UPA government in its 2008-09 budget presented on February 29 increased its defense spending by 10% to Rs 1056 billion ($ 26.4 billion) from a budgeted Rs 960 billion ($24 billion) for FY 2007-08 and 14% compared to the actual spending for FY 2007-08. The budget seeks to establish India's defense spending at 14.1% of total government expenditures for 2008-2009, roughly the same as last year. The defense ministry returned $1.1 billion to the general treasury this fiscal year due to the cancellation of some big ticket tenders - for helicopters and missiles - due to procurement delays. The government has allocated Rs 480 billion ($12 billion) for the acquisition of modernized military hardware, including a $10 billion deal to buy 126 fighter jets. U.S. Defense Secretary Robert Gates was in India February 26-27 to push the SIPDIS American bids for the deal. Although for the first time in the last ten years India's defense expenditure in the coming fiscal year will fall below 2% of GDP, the defense budget is seen overall as consistent with India's modernization trend. End Summary. MODEST DEFENSE SPENDING INCREASES -------------- ¶2. (SBU) Finance Minister Chidambaram delivered the government's defense spending plans on February 29, as part of the overall budget. The defense budget repeats modest increases from last year, targeting spending this year at Rs 1056 billion ($26.4 billion),an increase of about 14% from last year's revised estimates of Rs 925 billion ($23 billion) and 10% against the budgeted Rs 960 billion ($24 billion). Adjusting for inflation of about 5%, the budgeted increase is about 5%, slightly more in percentage terms than last year. India's defense spending as a percentage of total expenditures for the last ten years is as follows: 2008-09 (Budgeted) 14.1 2007-08 (Revised) 13.0 2007-08 (Budgeted) 14.1 2006-07 14.8 2005-06 15.9 2004-05 15.2 2003-04 12.7 2002-03 13.5 
2001-02 15.0 2000-01 15.2 1999-00 15.8 PROCUREMENT PIPELINE STILL WEAK -------------- ¶3. (SBU) The government has earmarked Rs 480 billion ($12 billion) in FY 2008-09 for the purchase of equipment and modernization of the armed forces. This is a 27% increase over last year's actual arms acquisition spending of Rs 377 billion ($9.4 billion),with capital outlay funding now constituting roughly 45.5% of the total defense budget. However, the Defense Ministry in recent years has not been able to finalize purchases before the end of the fiscal year, and has had to surrender the unspent allocation to the national treasury. This year, the Defense Ministry failed to spend Rs 42 billion ($1.1 billion),as two major contracts of the army for purchase of helicopters and 155MM artillery guns did not materialize. ¶4. (SBU) Analysts estimate that India plans to spend at least $30 billion through 2012 to modernize its military. This year the Defense Ministry is planning one of its biggest ever weapons purchases, ncluding a $10 billion deal to buy 126 fighter jets for the Indian Air force. U.S. Defense Secretary Robert Gates was in India February 26-27 and pushed the American bids for this deal. US companies Lockheed Martin and Boeing are competing with Russian and European rivals for the contract. Media reports that the US share in the Indian defense market is likely to grow substantially in the next decade as that market grows to $50 billion - to match that of Russia, France, Israel and the UK. ¶5. (SBU) The US has recently been awarded one contract - a $962 million deal to supply six-C-130J Hercules aircraft. Negotiations on a $2.2 billion deal to supply eight P-8I Poseidon long range maritime patrol aircraft for the Indian Navy are expected to be concluded soon. To date, the bulk of U.S. agreements with the GOI are not Government-to-Government technology sharing protocols, but commercial deals with business corporations. India is also buying 347 additional T-90S main-battle tanks from Russia valued at $1.2 billion. The Indian government plans to remain selective on the choice of target countries for export of arms and is very cautious about signing arms deals. Records show that at least 38 court cases relating to arms agreements are still pending against military officers. Defense Minister A.K. Antony has made probity in the procurement system a top priority during his term. MILITARY SERVICES -------------- ¶6. (SBU) The main components of the defense budget 2008-09 are as follows: Expenditure (Rs billion) (USD billion) Army 363 9.0 Air Force 109 2.7 Navy 71 1.8 Capital outlay 480 12.0 DRDO 34 0.85 --India's army with its strength of 1.3 million men continues to be the biggest recipient of the defense budget with an allocation of Rs 363 billion ($9 billion) - about 6 percent higher than the Rs 342 billion ($8.5 billion) it spent in FY 2007-08. The Army accounts for 34 percent of total defense spending. India for the first time has set aside $125 million to be spent on the "urgent needs of development of border areas" such as for Arunachal Pradesh state, which is being claimed in full by China. --The Indian Air Force (IAF) is slated to receive Rs 109 billion ($2.71 billion),a 4.8 percent increase over the spending in FY 2007-08. IAF will receive the highest capital outlay funds of over $4.8 billion for buying major equipment, including the Medium Multi-Role Combat Aircraft (MMRCA). The IAF urgently needs new aircraft to replace its ageing Soviet-MiG series of fighters. The US Boeing F/A-18 Super Hornet, the Lockheed Martin F-16, the Russian MiG-35, the Swedish Gripen, the French Rafale, and the Eurofighter Typhoon manufactured by a consortium of German, British, Spanish and Italian companies are the six aircrafts vying for the MMRCA order. --The Navy outlay for 2008-09 has been increased to Rs 74 billion ($1.8 billion) from the spending of Rs 70 billion ($1.8 billion) for FY 2007-08. The Navy is shopping for six submarines in addition to the six it bought last year from Armaris and European defense firm MBDA for $3 billion. Advanced negotiations are going on to buy eight long-range reconnaissance planes from either Boeing or the European consortium EADS for $2 billion, besides building a nuclear-powered submarine. --The capital outlay for modernization of the defense services will allocate Rs 480 billion ($12 billion) for FY 2008-09, almost 27% higher than it spent in FY 2007-08. --The Defense Research and Development Organization (DRDO) gets a hike of 6 percent to Rs 34 billion ($848 million) in FY 2008-09 from Rs 32 billion ($800 million) in FY 2007-08. The ordinance factories would spend the money for deploying India's guided and ballistic missiles that can carry nuclear warheads. MORE FDI IN DEFENSE NEEDED -------------- ¶7. (SBU) Ernst & Young recently released a report on "Indian Defense Industry: Reaching New Frontiers," which indicates that Israel will overtake Russia in the immediate future as the largest arms supplier to India. In recent years, Russia's sales to India have been averaging approximately $2 billion every year; Israel has closed the gap in recent years and has gone over a billion dollars worth of defense purchases from India annually. Big weapon companies forecast that India will end up ordering almost $100 billion worth of defense items over the next five to 10 years. In this context, FDI in the defense sector needs to be raised to 49% from the current 26% limit to facilitate the flow of investment and latest technological know-how which will reduce India's dependence on imports. The government plans to announce a new offset policy in April 2008, which may include some changes in bidding by foreign manufacturers for Indian defense contracts, such as credit banking, and how they will fulfill their minimum 30% offset obligations on major contracts. COMMENT -------------- ¶8. (SBU) This year's defense budget mirrors last year's in its generally flat spending. In both years, the modest hike was concentrated on procurement allocations, which continues to be underspent. Much of the challenge may be a still ongoing process of reducing the left-over, dysfunctional defense relationship with Russia. The Government of India has the money to spend more on capital expenditures, if the Ministry of Defense and the military branches improve their bidding and contract skills. However, this slow bureaucratic process could delay modernization of India's military. While some have noted that the Government of India has allowed defense spending to fall below 2% of GDP, even as China and Pakistan continue to spend above that on their militaries, the most important trend line to follow is that the GOI continues to put its money where its proverbial mouth is in terms of pouring money into military modernization. MULFORD NNNN End Cable Text