Hold the Champagne: India’s Fighter Deal with France Portends Trouble for Western Defense Companies

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India’s recently announced blockbuster $8.7 billion Rafale buy could be seen as a dogged, hard-fought victory for Dassault Aviation SA and France’s defense sector. But the deal is less deserving of celebration than it might appear. The challenges that Dassault and other leading aerospace companies faced in the nine-year saga leading up to the sale will become a fixture in the 21^st century defense marketplace.

Export deals matter more than ever to Western defense contractors, whose sales at home have come under sustained budgetary pressure going on a decade. But the emergence of non-Western industrial rivals and the proliferation of countries desperate to boost their domestic defense industry have stiffened the competition on doing business abroad. They have also made nearly every international competition a certain occasion for colossal headaches and heartbreak. From Israel to South Korea, and even such countries as Saudi Arabia which has historically been a reliable customer of Western defense firms, more governments are stepping up their efforts to spawn, incubate, and promote indigenous defense production.

Nowhere is this truer than in India, whose defense budget recorded double-digit per annum growth between 2010 and 2015 and will reach $40 billion next year. What should not be lost on foreign executives and defense officials from Friday’s Rafale deal is that it still leaves India with an outstanding requirement for over 100 fourth-generation fighter aircraft that will only likely be realized with foreign assistance. Dassault and other Western suppliers will be tempted to pursue this and other opportunities that address the profound needs of the Indian armed forces. Yet these firms and their supporting governments are certain to encounter an unwillingness to fulfill those requirements without first securing stringent offset conditions from foreign suppliers. In a determined effort to reduce what it views as a dangerous over-dependence on defense imports, India will seek to wring as much as it can from foreign firms agreements on the transfer of technology, license production, and even the re-locations of entire production lines.

Behind the Rafale saga is a complicated but important history that Western defense officials need to understand if they are to succeed in the international marketplace. In 2007, India first released a competitive tender for 126 medium-range air-superiority aircraft as part of the Medium Multi-Role Combat Aircraft (M-MRCA) program. A full five years later, on January 31, 2012, New Delhi selected Dassault’s Rafale C/B fighter aircraft as the winner of the competition. The twin-engine Rafale is a nuclear-weapon capable fighter suited for aerial combat and patrol missions. The decision represented a significant coup for Dassault, having defeated rival bids from Lockheed Martin Corp., Boeing Co., Eurofighter GmbH, Saab AB, and Russian-based RSK MiG, as well as the French company’s first successful export of the platform.

However, contract negotiations between the Indian Air Force and Dassault quickly stalled because of disagreements over total cost, offset requirements, and work-share responsibility. Initial reports suggested that Dassault would produce 18 of the 126 units in Merignac, France and deliver them to the IAF off-the-shelf. The remaining 108 units would be produced by India’s national aerospace sector champion, state-owned Hindustan Aeronautics Ltd. (HAL), in Bangalore, under Dassault’s close supervision. HAL’s historic inability to deliver previous production orders on time, coupled with a significant backlog of existing orders and issues with quality, caused Dassault initial hesitation. Consistent meddling from Indian politicians and (critically) New Delhi’s insistence on making Dassault fully responsible for the production of the 108 units in the case of delays and other problems, represented a step too far for the French arms manufacturer.

In April 2015, in an attempt to break the three-year deadlock, India’s Prime Minister Narendra Modi announced during a state visit to France that his country would purchase 36 fighters in “flyaway” condition in a separate government-to-government deal. This highly public intervention from the two countries’ most senior political figures raised significant concerns about India’s ability to conduct defense deals directly with private defense suppliers. Shortly afterward, on July 30, 2015, the Indian Ministry of Defense formally cancelled the M-MRCA program, citing irreconcilable differences in price and responsibility share and dealing an embarrassing blow to both parties. Negotiations for the 36 government-to-government sales continued distinctly from the fall-out of the M-MRCA, though those, too, encountered numerous delays. The two parties finally appear to have come to a resolution on the deal last week, in which Dassault will deliver the aircraft within 36 months and invest 50 percent of the value of the deal in offsets.

So long as HAL remains uninvolved in the acquisition process, the specified timeline will likely be observed, although it will be a case of too little, too late for the Indian Air Force. Even with last week’s deal, the Indian Air Force retains an unfulfilled requirement for at least 100 medium-range air-superiority aircraft. To effectively fight in a two-front conflict with Pakistan and China, as official Indian military doctrine stipulates, India requires up to 45 squadrons of approximately 18 to 21 combat aircraft each. The current-serving fleet of approximately 30 squadrons includes 20 squadrons of vintage Mig-21, MiG-25, MiG-27, Jaguar, and Mirage 2000 fighter aircraft, which have been in service as early as 1967 and, despite having undergone numerous service life extension programs, are well past their recommended flying age. They will likely be forcibly retired over the next five years. Without immediate replacements, India will watch its fleet size dwindle even further.

The conundrum that India and other nations with aspirations to boost indigenous industrial expertise face involves reconciling those aspirations with the (often critical) operational needs of their armed forces. The other half of Friday’s Rafale deal entails a hefty offset clause, where Dassault is responsible for reinvesting at least 50 percent of the $8.7 billion it receives from the Indian Ministry of Defense back in India. While Dassault repeats its enthusiasm to comply with the requirement, the doomed M-MRCA ordeal (involving these exact two parties) faltered and ultimately collapsed on the nature and extent of these kickbacks. The contract negotiations revealed all too clearly India’s near-obsessive preference for promoting its domestic aerospace industry over all other objectives, including fleet readiness. And this trend will likely only intensify going forward. India (or at least significant elements of its defense policy-making base) appears to accept that fleet readiness may (temporarily) fall while the country reduces its dependence on imports. But it becomes a small price to pay if a national champion like HAL can propel itself to the fore of the global defense industry in the process.

The possibility that the M-MRCA competition (or at least a smaller portion of the outstanding requirement) will be up for bidding by the five losing bidders from 2007 certainly exists. The Indian Air Force appears set to suffer most from the aforementioned trend, which extends beyond fighter aircraft to trainer aircraft and rotorcraft, and are understandably unhappy. The force’s leaders will likely push for an international competition to stem the high level of attrition its combat aircraft fleet will face. And, of course from the suppliers’ perspectives, the Eurofighter Typhoon (the runner-up), F/A-18 Hornet, JAS-39 Gripen, F-16 Fighting Falcon, and MiG-35 have significant stakes in a possible order of this magnitude. Lockheed Martin, Boeing, and Saab have all even reportedly offered to move production lines for the Fighting Falcon, Hornet, and Gripen, respectively, to India in a bid to prolong those programs by several more years. But doing business in India will become even more contingent on a willingness on the part of foreign suppliers to engage in increasingly costly offset agreements. The likelihood is that India will double down on its commitment to indigenous industry and demand foreign suppliers either transfer critical technologies or enter into joint ventures with local partner firms.

While Dassault may have beaten out the largest defense companies in the world who were vying to be the preferred airpower provider to the world’s biggest democracy, the deal’s circuitous path portends how future transactions will likely go in India and elsewhere. Long gone are the days of the simple defense export, where a customer country conducts an “off-the-shelf” purchase of a required capability from a foreign supplier without any strings attached. More countries will now require their suppliers to guarantee some degree of kickbacks to sweeten the deal. Those companies and supporting governments that seek to succeed in this new international defense market environment will need to adopt a different, more flexible, and increasingly proactive set of tactics than in the past. For starters, Western defense firms will need to develop a more diverse (i.e., global) supply chain, as well as encourage more creativity in structuring future bids. Success will also require a profound understanding of local industrial contexts, particularly where host governments may demand the formation of joint ventures with domestic firms. Finally, foreign defense suppliers will require a healthy dose of patience and persistence, as procurement processes around the world are likely to be even more delayed by this trend.

All this is another way of saying that for Western defense suppliers eyeing deals with such industrially ambitious nations as India, don’t be too quick to put the champagne on ice.

Daniel Yoon is a Senior Market Analyst with Avascent Analytics. The trends mentioned in this analysis of India are further explored in an extensive study of emerging non-Western defense suppliers authored by Yoon and Managing Director of Avascent Analytics, Doug Berenson.

Image: Rafale – RIAT 2009, CC