CHINA’S READJUSTMENT STRATEGY

Five Year Plan

 

China

China

Picture3

 

 

 

 

 

The Great Recession of 2008 as a consequence of the subprime mortgage and euro zone crisis adversely impacted the external demand upon which China had long relied. The timing of the economic crisis coincided with the internal drafting of the 12th Five Year Plan (2010-15)  – which by this time had moved up to the National Development Reforms Commission (NDRC) for due consideration. The planners perceived that the crisis brewing-up was likely to have long lasting aftershocks in the developed world which in-turn could have far reaching implications on the Chinese economy. Many countries adversely affected by recession were also major markets for China’s exports accounting for more than 30% share of its GDP[1]. Therefore the leadership effectively readjusted policy directives in the 12 Five Year Plan (FYP) to steer the economy clear of the emerging global crisis.

Development plans are considered key indicators of the direction and changes of country’s development strategy. Convergence of policy directives in the 12th plan were targeted towards correcting the prevailing unsustainable levels of economic growth. Hence China had to rethink on some of its core values by compromising on the external demand and shifting focus towards internal demand. The National People’s Congress (NPC) ratified the 12th five year plan (2011-15) in midst of the prevailing global crisis by following due diligence at every stage in the consultative process (Table 1).

Guidelines for Drafting Five Year Plan (Table 1)

NATIONAL PEOPLE’S CONGRESS Ratifies National level FYP
STATE COUNCIL Provides guidance for key themes within National FYPs
NATIONAL DEVELOPMENT REFORMS COMMISSION (NDRC) Constructs and oversees National FYPs
MINISTRIES Constructs industry and issue specific FYPs
LOCAL GOVERNMENT Constructs local and regional FYPs

Source: China’s 12th FYP, APCO Worldwide December10, 2010

 

Great Leap into Modernisation

The Chinese economy in the first three decades after the civil war was autarkic centered on Mao’s preposterous belief that any kind of contact with foreigners would not only corrupt the political structure but also pollute its cultural ethos. As a result, during the early years government prohibited foreign investment and restricted foreign trade. However in the post-Mao era, the Chinese government realizing that it was economically lagging behind much of the rest of the world began to rethink on its future economic posture. Deng in 1978 visited Matsushita’s television division in Ibaraki, Osaka prefecture and told Konosuke Matsushita (founder of Panasonic) “they say you are the God of management, could you help with China’s modernization”? On May 22, 1987, Matsushita and China signed an agreement to establish a joint venture to set up a TV cathode-ray tube plant at a time when the rest of the world was hesitant to enter into any type of a contract with China[2]!

China’s tryst with liberalization began in 1979 when it enacted the law on joint ventures and in 1980 set up Special Economic Zones (SEZs) in Shenzhen, Zhuhai, Shantou and Xiamen. In 1984, it opened up fourteen cities to trade, in 1986 passed a law on foreign capital enterprise, ended the preferential tax treatment in 1995 and announced tariff reduction on 5000 items. China was gradually preparing itself to being accepted in the WTO by amending its legal code to conform with the WTO stipulations on issues ranging from trade to rules governing tariffs and antidumping regulations[3]. Hence the carefully crafted economic policy scripted by Deng followed a step by step process of liberalization which got them gradual entry into the world of foreign trade and investment by intrinsically becoming an active strand in the global supply chain.

The economic model formulated by Deng was unique because on the one hand the economy was being driven by free market principles, on the other hand one party continued to maintain absolute monopoly and political authority. China was following a model unparalleled in history but based on the principle of regional decentralization which provided flexibility and space to the regions to experiment upfront with economic reforms. The strategy of empowering regions and prefectures in decision making could well have been the inflection point in propelling the economic transformation to an unprecedented scale never before witnessed by the world. The process was engineered with a strong underlying caveat that China was not prepared to tamper with the political process and therefore averse to the idea of political liberalization[4].

The incentives to invest in China were compelling. 1980s started to witness swarms of foreign companies waiting to invest in South Asia because of the latent market potential and availability of scarce resources. China was a huge reservoir for the factors of production. With the onset of economic liberalization in China and the economic slowdown of 1980s in the West; China by default became a preferred destination for businesses which wanted to persist with their only aim of profit maximization. The investments ranged from manufacturing to export processing and license agreements both in military and civil. By the turn of the decade in this century, direct investments surged and foreign investments consisting of more than 600,000 joint ventures valued in excess of $1 trillion had become the mainstay of China’s economic turnaround. China along with US accounted for almost two third of total global growth. Rapid economic growth further propelled the purchasing power and to put the argument in correct perspective; what the West achieved in five decades during the period of industrialization, China achieved the same level of development in less than a decade. In its calibrated development plan, China was building infrastructure by investing trillions of dollars on highways, seaports, airports, dams, power plants, communication networks, high speed railways and infrastructure for both strategic as well as other industries[5].

Engineering a New Economic Revolution

China was attempting to restructure the economy through its 12th plan by boosting domestic consumption, developing service sector, shifting to a higher value added manufacturing and by finally setting the tone for carrying out deep rooted reforms. In its evolutionary industrial strategy there was a conscious effort to shift away from imitation to innovation by either embracing technology through fair means and if required even through subterfuge. In its stratagem transfer of technology was not used as a tool to enhance production but to move up in the innovation ladder.

Hence the provisions in the last two plans were clearly directed at promoting development by increasing allocation on R&D, ameliorate quality of manufactured goods which would ultimately enhance their competiveness in the global arena. China targeted increased spending on R&D from the current level of 1.75 percent to 2.2 percent by the end of this plan and further hike it to 2.5% by 2017; comparable with any OECD country[6]. The larger strategy for the first two decades of this century has been to promote scientific and technological development in carefully selected fields which would ultimately enhance their innovation capabilities. The new revolution in the 21st century was expected to flow out from the prescriptions of the 12th FYP and not necessarily from the barrel of the gun – as China embarks to the next level as world’s leading economic and military power.

The previous revolution initiated by Deng spread over three decades, culminating in China moving up from a low income to a middle income economy but at a much faster pace compared to a similar transition by the west and America during the period of industrial revolution. The transition witnessed a shift to large scale privatization in some non-critical sectors. The ongoing revolution however is expected to energise the national innovation system by setting goals for development of science and technology which would automatically act as a stimulus for China’s development strategy in the coming years. Enhancing R&D intensity, increasing number of researchers, publications, patents and R&D laboratories would be the simple methodology followed to achieve the set goals. In the ongoing plan for economic development, while on the one hand the earlier manufacturing model which promoted exports was being replaced by the service sector model to enhance domestic consumption, on the other hand the government was trying to incentivize and retain the high tech manufacturing which would help promote Chinese companies to compete globally.

While opportunities and challenges in the coming decade are expected to be distinct and therefore, future too will demand a development strategy – separate from the past. In a fast growing economy, strategies need to not only be adaptive but also flexible to enable governments to carry out mid course correction in accordance with the changing dynamics. China was aware that if it did not shift away from policies directed towards unsustainable high growth rate, then it could well be sitting on a potential socio-economic time bomb. Therefore a shift towards economic rebalancing and moving to a more balanced growth structure was not only inevitable but also the most likely course for China to follow in the coming decade. The likely policy prescriptions include lower growth rate at 7%, minimal government intervention, larger role for the private sector to set up upgraded and high technology industries and an improvement in the overall indigenous innovation capability by both private enterprises and the state.

China is carrying out calibrated reforms in the 12th plan by focusing on equitable income distribution, enhancing overall social well being through better education opportunities and health care so that large number of domestic citizens also benefit from economic growth. They are enhancing domestic consumption by using technology to raise agriculture productivity; amending tax policies that would increase rural purchasing power; building infrastructure including roads, railway lines, ports and airports; constructing apartments for the weaker section of the society; and targeting to increase the rate of urbanisation beyond 50% by revising the ‘hukou’ system (residency permits). In its policy initiatives, there is a deliberate shift away from ‘growth at any cost’ towards a more balanced and sustainable pattern, controlling inflation and keeping the economy in synch with the reality of the existing global economic environment.

Social Quotient

It is fascinating to see the emergence of groups of people in a typically authoritarian state who are able to freely network through blogs on social networking sites. While micro blogs (Weibo) were becoming vibrant medium of freedom of expression for large number of thinkers and activists otherwise not available to the citizens in a controlled system; Renrou search engine too had become a medium for netizens to vent their views. Renrou was emerging as the most fearsome and potent non-state controlled artillery being used not only to gather information but also to expose influential individuals to the glare of public scrutiny. China, particularly after the ‘Jasmine Revolution’ had become extremely wary and cautious of the consequences of social instability which in its opinion could adversely impact party’s control. Therefore China was left with little choice other than carrying out adequate course corrections in its future development strategy by deliberately adapting to more egalitarian policy measures aimed to arrest social unrest which otherwise had the potential to snowball into people’s revolution – not the best result expected in an authoritarian state where instability was most feared. The policy makers gradually started abolishing agricultural taxes, subsidized health care, and implemented measures to make basic education more accessible – send a loud signal of government’s intent to reduce disparity by following a more balanced growth structure where the common man could benefit as much from the country’s ongoing economic prosperity.

 

Readjustment Strategy

Since the dawn of the new millennium, reforms have been critical for China’s success. While the experiments with reforms started in 1980s, however they appear to have taken shape with China’s ability to diverge from the laid down path and execute policy readjustments since the 11th plan. The 12th FYP actually picked up from where the previous plan (11th FYP) left off in terms of broad policy guidelines. The emphasis, however had shifted from what used to be ‘hard production’ to now ‘quality production’ with greater role envisioned for private sector and foreign investments. Initiatives were also undertaken to reduce bureaucratic regulations and state intervention which largely pointed towards maturing of the state administrative machinery.

In the 12th plan, China revisited its three decade old economic strategy – but this time signaling a shift away from its traditional export-led model (exports in China consist of 30% of GDP) to one that would now be driven by the consumers themselves. The government was forced to infuse $640 billion stimulus package for development of domestic market since the western markets had dried up resulting in the lay-off of millions of workers in China’s manufacturing sector.[7] The 12th plan largely promoted two key aspects one – government’s focus on inclusive and balanced growth and second, enhancing indigenous innovation capability through large public and private investment in research and development which would enable China take a great leap forward from “Made in China” to “Created in China” – expected by the end of this decade.

In its transition from a simple manufacturing and export driven economy to a nation hoping to rely on high-end technology manufacturing and service sector; China was open to adopting measures which would encourage not only the flow of foreign investments but also foreign technology, vital for scientific development. It was ready to make readjustments in policies to attract foreign investments by easing regulations and lowering taxes. The policy formulations initiated in the 12th plan resulted in China becoming the world’s largest recipient of Foreign Direct Investment (FDI) according to the half yearly estimates of Global Investment Trends Monitor. In the first six months of 2012, China attracted FDI amounting to $59.1billion, while FDI flow into the US amounted to $57.4 billion[8]. The amount by the year end had swelled to over $100 billion despite the slowing down of the economy and many favourable factors of production now becoming unfavourable.

In the past, large global trade and foreign exchange imbalances have irked many countries. China has been blamed for blatantly manipulating the Renminbi (RMB) thus leading to tensions between China and its major trading partner – America. The American anxiety of the relative standing of the US and Chinese economies was also reflected in the heated rhetoric over China as a currency manipulator in the 2012 US Presidential debate. The anxiety is not limited to China deliberately undervaluing the RMB but extends largely to dollar losing space to RMB as a potential reserve currency in the future. While international use of RMB has not yet expanded to transactions beyond those with China, however China has started allowing companies to settle payments for imports and exports outside mainland China in RMB since 2009. China has 18 bilateral currency swap agreements with countries including India, Japan, Russia, Brazil and Chile which permits the central banks of these countries to access RMB outside China. Public Bank of China (PBOC) allowed almost 60,000 firms worldwide to transact in RMB and almost 7% of merchandise trade in 2011 was settled in RMB, a rise from 2% in 2010[9]. RMB’s international use and credibility has grown manifolds and since June 2012, all mainland firms were being permitted to invoice and settle their foreign trade transactions in RMB. FDI transactions by Chinese firms abroad and by foreign firms in China are increasingly being carried out in RMB and such transactions effectively reduce the need for a currency to hedge against dollar volatility –implying broadly that dollar was losing space in favour of another currency[10].

As China steps up in the international pecking order by measure of its Comprehensive National Strength, it would be natural for China to promote RMB as a global reserve currency. RMB moved into the trading band in 2005 enjoying swaps with over a dozen countries. Further internationalization would mean that RMB would not only become one of the top global trading currency but also an investment currency to supplant US dollar as the dominant currency in the foreign exchange market. China expects to excessively benefit from RMB’s hegemony in the world financial systems anticipating other countries to orbit around it. While correcting the abysmal proportion of consumption to GDP would be one of the many drivers for shifting to a consumption model and hedging to internalize its future development strategy. A shift away from the export model would further reduce China’s requirement to carry out excessive currency manipulation against sharp dollar depreciation. It is therefore anticipated that China will only gradually like strengthen the RMB rather than deliberately weaken RMB –which has appreciated by almost 3-5% in 2012[11].

China’s fifth generation leadership appears flexible to policy readjustments and consumers could well become protagonists in China’s future development strategy. There are also possibilities that circumstances could guide Beijing into accepting the orthodox market based system starkly different from the socialist market economic system proposed by Deng. Tax breaks, subsidized electricity and land, financing targeted industries for development of future civil and military technologies, and encourage investments will eventually become the future drivers for growth and economic development. The central, state and private sectors together are expected to invest in excess of $2 trillion to achieve the set goals[12].

By 2015, China is expected to invest 8% of GDP in development of key Strategic Emerging Industries (SEI) which include sectors like new materials, aerospace, displays, high end software and clean and alternate energy (Table2).

Strategic Emerging Industries (Table 2)

NEW MATERIALS
  • High performance composites
  • Advanced Structural Materials
  • New Function Materials
  • Generic base Materials
HIGH END EQUIPMENT MANUFACTURING
  • Aerospace and Space Industries
  • Rail and Transportation
  • Ocean Engineering
  • Smart Assembly
BIOTECHNOLOGY
  • Innovative Pharmaceuticals
NEXT GENERATION INFORMATION TECHNOLOGY
  • New Displays
  • Integrated circuits
  • High end software and servers
  • Digitisation of creative industries
  • Next-generation core equipment
  • Smart Devices
  • Next-generation mobile communication
  • Convergence of telecom/ cable TV/ Internet network
ALTERNATIVE ENERGY
  • Nuclear power
  • Solar power
  • Wind Power
  • Smart Power Grids
  • Biomass power
GREEN ENERGY VEHICLES
  • Electric Hybrid cars
  • Pure electric cars
  • Fuel cell cars
CLEAN ENERGY TECHNOLOGY  

Source: Backgrounder China’s 12th FYP

The 12th plan points to a shift in priorities favouring consumption by increasing investments in the service sector and rate of urbanization. China has lifted millions of citizens out of poverty and, inclusive growth along with solving issues of widening income disparity will continue as focus areas in the 12th plan. The transition from an economy dependent on hard manufacturing to consumption and higher quality growth model is expected to be gradual. Enhancing R&D to 2.2% as proportion of GDP by the end of this plan will be another key priority (Table 3).

Economic Indicators of 11TH AND 12TH FYP (Table 3)

TARGET

11TH FYP (TARGET)

11th FYP           (ACTUAL)

12TH FYP           (BY 2015)

Average GDP growth

7.5%

11.2%

7%

Service Sector as percentage of GDP

43.3%

43%

47%

Urbanisation

47%

47.5%

51.5%

R&D as percentage of GDP

2%

1.75%

2.2%

Strategic Industry as percentage of GDP

8%

Source: Backgrounder China’s 12th FYP

In the previous three decades, China successfully created an integrated global production system unprecedented in scale and complexity. However future directions must not only deal with challenges unfolding in the struggling developed countries but also in China as a result of increasing production and labour cost. Transition from “Made in China” to “Created in China” would require increase in allocation on R&D. Remarkable achievements made in the area of science and technology in 2011 has been adequately highlighted by the Chinese Academy of Sciences (CAS) and Chinese Academy of Engineering (CAE). Successful rendezvous of Tiangong 1 and Shenzhou 8; invention of high speed laser equipment; integration of China’s breeder reactor with the grid; launching the first manned deep sea submersible to a depth in excess of 5000 metres; construction of first deep water drilling platform; increasing yield of China’s super rice through advancements in agriculture technology; and development in missile and aviation technology are examples of few advancements made in science and technology in recent years.

Disruptive Military Modernisation

Beijing is on the cusp of becoming the world’s largest collector of military arsenal. Its order of battle consists of modern jets, frigates, submarines, range of missile systems, radar network and space based systems. It also boasts of a robust infrastructure consisting of road and railway network across the Tibetan plateau, high altitude airfields and over 11 million kms of optic fiber cables to strengthen its command and control system. Rapid pace of military modernization has extensively benefitted from globalization of arms industry and China’s deliberate strategy of becoming an intrinsic part of the global chain of suppliers and buyers. Beijing is not embarrassed to acquire military hardware surreptitiously if it is not available through legal means. While China enjoys official military ties with more than 150 countries, some of which are sources of defence technology; it is also in alliance with other countries not publicized because of political sensitivities, but are sources of defence technology as well. One such country with which China continues to maintain a formal cooperative and a sacred relationship is the state of Israel which has been a vital source of defence technology guiding China’s military modernization. Though China and Israel established official diplomatic relations in 1992 but they have enjoyed a symbiotic relationship rooted in informal alliance spanning almost four decades. The bilateral trade grew from $54 million in 1992 to in excess of $8 billion by the end of 2011. China is an Israeli target export country in the field of telecommunications, agro-technology, security, environment and infrastructure and Israel is opening ‘Einstein Centres’ in many Chinese cities to showcase its companies.[13]

The foundation of China-Israel nexus was rooted in a win-win business model. While Israel was looking for a potential market to maximize profits for its civil and military industries; China was in search of a partner with expertise in Russian and American advanced weapon systems – in that context China could not have found a better partner than Israel! China was aware that Israel over the years had not only gathered experience in countering the Soviet weapon systems but also developed capabilities to integrate these weapons into its own arsenal. It is an open secret that Israel provided China enough technology to drive China’s military modernization through the 1990s. Some of these capabilities include in the field of communication, radar, electronic warfare systems, optical instruments (night vision instruments), missiles (Patriot anti-missile technology, Gabriel sea skimming anti ship missiles and Raphael Python-3 AAM), laser guided armour piercing warheads, anti-tank missiles, fighter aircraft technology (J-10 considered to be a derivative of Lavi) and Unmanned Aerial vehicles (UAVs)(Harpy anti-radar drones). It is also believed that Israeli technician helped the Chinese improve the guidance system of DF-3A, which were later sold to Saudi Arabia. If the aborted Phalcon deal fructified, it would have signaled a high point in the Sino-Israeli military cooperation. Israel pledging closure on future weapon sales to China only made the Israel-China nexus less transparent, however the volumes of Israel arms sales to China continue to surge, only to be surpassed by Russia.[14]

Today, a battle zone is not limited to a region but extends across regions and further into space. Hence a conventional battlefield is transforming into a seamless global battle zone. The arms industry too are being driven by globalization where like all the other industries, defence industries too are in search of favourable factors of production for profit maximization. China in that context has evolved as a preferable destination for major primes because of cheap labour, good infrastructure and latent market potential due to the increasing pace of military modernisation. The irresistible market potential is complementing Beijing’s drive to achieve rapid industrial development and military modernization. China is openly embracing western methodology, blatantly absorbing technology from any country willing to share and if not, even ready to adopt illicit methods to bring technology home. China’s surreptitious acquisition of technology has been the cornerstone of its development strategy. It has become a collector of export restricted defence systems and sensitive commercial technology used to step-up its capabilities to match the Russian weapon systems and also play catch-up with the American weapon technology. In this effort, China’s Military Intelligence Department (MID) under the PLA has played a pivotal role in assisting Beijing acquire technology in the denial regime. In MID, one arm is actively involved in collection and analysis of data from open source and the second arm is engaged in carrying out industrial cyber espionage.

As a result, China over the years has been able to successfully design nuclear missiles, send taikonauts into space, manufacture aerial platforms; however despite many years of R&D, they are yet to design and develop a low by-pass turbo fan jet engine for their home grown fighters. China’s long term priority is to develop a high performance power plant for the J-10, J-11, J-20 and J-31; however in the interim they are also utilising their resources to design engines for the ARJ 21 and C919 single aisle passenger aircraft. The demand for these engines is expected to rise and could be worth $100 billion over the next two decades. In the mean time Beijing is contemplating increasing investments on research to $50 billion for the underfunded low by pass turbo fan engines[15]. Eventually increase in allocation on R&D to 2.5% as proportion of GDP and flow of technology from China’s expanding range of commercial aviation joint ventures will boost the development of the aero engine programme. The development programme for WS-10 (Taihang) which commenced in 1986 has significantly benefitted from increased investment on R&D and when complete will replace the Russian AL31F. The timeline for China’s WS-10 and WS 15 is shown in Figure 1.

Development and production time line of WS-10 & WS-15 (Fig 1)

 Source: Global Times

China in Post Mao-Era

China is on the cusp of disruptive transformation in the 21st century markedly distinct from its earlier avatar in 1990s. China is readjusting its development strategy by reducing state ownership and controlled prices in favour of market forces; realigning infrastructure to emphasise on quality than mass production; encouraging foreign private investment by lowering trade barriers; focusing on enhancing domestic consumption instead of exports and, developing China’s less developed western regions to improve lives of Chinese citizens across an extended spectrum. China’s economy is showing signs of recovery. Recent survey of Chinese manufacturing activity points to recovery as a result of improved global trade and stimulus provided by the government in 2012. The performance managers index (PMI) published by HSBC has recorded fifth consecutive improvement.[16] The PMI in January rose to 51.9 from 51.5 in December 2012, highest level in two years, a good start for China in 2013. Qu Hongbin, Chief China Economist for HSBC said that while export growth is likely to remain tepid, infrastructure construction is regaining momentum and companies have started to step up hiring and manufacturing. The reading underlined a pattern as also envisioned in the 12th plan that years of double digit growth is history and the Chinese economy is slowly coming to terms with modest pace of expansion of its economy. The mid January data in 2013 reveals 7.8% growth of the Chinese economy as compared to 9.3% in 2011 and 10.4% in 2010[17].

China in the 21st century has turned out to be far less pervasive that what was perceived by Mao. Liberalisation of cross border trade, development of services and infrastructure supporting international trade, changing international political dynamics, expansion of cross national cooperation and increase in and expansion of technology have been the prime drivers for globalization in China. While at one time, it was incomprehensible for China to even contemplate carrying out any kind of trade with Taiwan; however, today trade between the two countries are governed by provisions laid under the Economic Cooperation Framework Agreement (ECFA) on 273 items. China has become Taiwan’s largest trading partner with bilateral trade worth $110 billion.[18] Trade between China and Taiwan since December 2008, when the two sides opened trade links has grown to an astounding figure of $554 billion in October 2012. Chinese mainland imports from Taiwan totaled $439 billion and its export to Taiwan reached $116 billion (Fig2).[19]

Fig 2

Source: Taiwan Bureau of Foreign Trade (* 2013 forecast figures based on 2009 figures)

Globalisation in the 21st century has increased at an accelerated pace. Almost quarter of world production (includes military) is sold outside the country as compared to barely 7% in 1950. Restrictions in imports are decreasing, foreign ownership of assets as a percentage of world production has been increasing and the world is transforming into a global playground. While 1960s and 1970s were a lost decade for China, 1980s and 1990s were periods of experimentation, consolidation and realignment. China grabbed opportunities, witnessed a double digit expansion of its economy thereby helping Beijing to leverage far greater influence than it ever expected. The first decade of this century beyond doubt been a period of rationalization, evident from the 11th and 12th five year plans and China of 2013 has settled for a more modest and sustainable pace of growth under the prevailing global economic turmoil.

India’s Consternation

Decoding both India’s defence spending and investor sentiments and carrying out ballpark comparison with China since 1990s  reveals that while on the one hand India has been far too conservative in defence spending, on the other hand the overall institutional investments too have depleted over the years. Surprisingly the share of India’s defence spending in GDP declined steadily after liberalization whilst China has been increasing its allocation on defence by 17% every year. The foreign funds too have poured more generously into emerging markets such as China, South Korea, Brazil and Taiwan when compared with India. There are also a new group of emerging countries like Mexico, Indonesia, Nigeria and Turkey – called the MINT, sucking substantial investments but at the cost of India. In January 2013, China recorded the highest foreign fund inflows of $5.6billion as compared to modest $1.3 billion into India in January 2013.[20] Also India’s own aspiration to evolve as an indigenous player in the defence sector appears suspect.

If India is aspiring to emerge as one of the regional power centres then it would certainly have to reverse the extremely skewed Self Reliance Index (SRI), expand its defence expenditure and immediately address other critical areas that require attention in our defence economy. India’s vision to close-in the gap with its major adversary will have to be backed with credible and perceivable actions. Joseph Nye described power as the ability to obtain the outcomes one wants[21]. Hence, India will have to effectively devise strategies to not only be perceived as a credible adversary but also possess power to hedge on critical issues related to economy and security in the region. For India to envision a role for itself as a major player in the region after the US exit from Afghanistan, it would necessarily have to be supported by substantial and meaningful increases in the defence budget to enable India leverage its position in the region – unlike our current strategy (budget 2013-14) founded on a meager increase of 5.3% in the defence outlay against an overall increase of 12% in government expenditure.

India has to take meaningful strides, carry out significant amendments in the procurement procedures by effectively reducing long gestation period which in turn would result in reducing leakages and unnecessary cost overruns – effectively making procurements cheaper. Slippages in timelines due to long gestation periods and complicated procurement process effectively results in acquisition of relatively old machine instead of acquiring modern contemporary platform. This is because procurements conceptualized in the previous generation actually fructify in a different generation due to slippages in times lines resulting in procuring older generation platforms. Also, India at this juncture cannot afford to succumb to financial pressures and surrender large chunks out of capital expenditure when the armed forces are suffering from critical deficiencies adversely affecting its military preparedness. India surrendered Rs 10,000 crore under the capital head from the 2012-13 estimates. Once again in 2013-14 budget, capital outlay has been pegged at Rs 86,740 crore, but how much of it will actually be spent on defence modernization is only a matter of speculation. Carefully tracing the pattern of capital expenditure in the defence outlay only in this decade reveals certain facts and points towards the direction of our strategic thought process. The actual expenditure in 2011-12 was Rs 67,900 crore. The RE in 2012-13 was Rs 69,578 crore against BE of Rs 79, 578 crore – modest increase of less than Rs 2000 crore against a planned budgeted increase of Rs 11678 crore. In this election year too, it will be worthwhile to look out for major social sops and its impact on the capital expenditure budgeted at Rs 86.700 crore! While the government on the one hand will be eager to keep the fiscal deficit under 5%, the military on the other hand will be sweating to modernize its arsenal – which of the two will end up being a winner will be known in February 2014! The figures at the end of this financial year will largely indicate the intentions and the strategic thinking of the government of the day at a time when India is poised at a critical juncture in geopolitics and the region is witnessing a gradual shift in the geostrategic landscape.

Unless the government considers binding to increase the defence outlay (BE) by 15% every year, peg the defence budget at 2.5% of the GDP and target R&D at also the same percentage point, India will continue to lag behind in its modernization plans and not be able to play catch up with the rest of the world. Indian strategist will need to shift focus from their obsession for acquisition to indigenization. India will have to realign LTIPP, SCAP and AAP[22]. Proposals for capital assets that flow out from the planning process should be founded on indigenization instead of acquisition which in turn would help reverse the SRI. For India to emerge as a regional power centre, it will have to indigenously develop top performance systems with cutting edge technologies for future battle fields, guard against any form of technology entrapment by strategising and cleverly lowering threshold below the denial list and crossing the threshold through indigenous R&D. The planners will have to lay emphasis on low life cycle costs for the systems being indigenously developed by attracting private players which would be the key to its defence modernization plans and, help propel India as a regional power centre if not by the end of this decade then at least by the first quarter of this century.

India at this stage cannot afford to be stuck in the mud. The Standing Committee on Defence (2010-2011) adversely commented on under utilization of R&D budget resulting in project delays and slowing down of India’s defence modernization plan.  Inability to utilize meager allocations on R&D should be considered as acts of indiscretion because technology in future will act as an elixir in defence modernization plan which will become the mainstay in addressing factors affecting India’s security dilemma. In the changing geostrategic landscape and India poised at the cusp of emerging as a credible regional power; India will have no choice other than to step-up allocation in R&D, develop network of laboratories and undergo seamless transition from the present mindset of ‘acquisition’ as panacea to India’s security challenges to laying greater focus on design, development, manufacturing and integration (including private players) of its defence economy.

Assessing the ongoing projects undertaken by DRDO and DPSUs does not reflect the strategic thinking envisioned to guarantee India’s security or ensure a smooth transition of the state into a credible regional power. Tejas project sanctioned in 1983 at an original cost of Rs 560 crore is still preparing for the second Initial Operational Clearance (IOC) in 2012, while it should have been ready for operational deployment at least two decades ago. The first phase was completed with a cost of Rs 2188 crore; the government sanctioned Rs 3301.87 crore for the second phase and additional Rs 5302.98 crore for full scale engineering development (FSED). The Intermediate Jet Trainer (IJT) project, Sitara (HJT 36) being developed by HAL (DPSU) since 1997, is yet to be put up for IOC, and the delay is causing impediment to basic training in the Indian Air Force. Time slippages in projects undertaken by DRDO and DPSUs are becoming a ritual adversely affecting operational preparedness and the modernization plans of the armed forces which are a matter of enormous concern[23].

The Standing Committee on Defence (2010-2011) also commented on the adverse impact slippages in timelines and cost overruns were having on India’s defence preparedness. The committee highlighted increase in air accidents largely attributable to human failure and problems related to the availability of a top of the line trainer aircraft. The committee highlighted that Indian Air Force was plagued with high accident rates and 44.59% of all accidents were being ascribed to human failure largely due to non availability of a basic trainer aircraft[24]. If this is true then it is a matter of grave concern and further delays will necessarily have to be attributable to criminal negligence on part of DRDO and DPSUs, who have taken upon themselves the mammoth responsibility of guaranteeing India security by developing credible weapon systems. The committee recommended that the ministry should focus on development and integration and make efforts to fully utilize allocation on R&D to push for indigenization of weapon system and modern platforms for our armed forces.  Despite directions, the vision is not backed by credible actions by the government. Share of defence budget in GDP had fallen to less than 2% and R&D was at an abysmal rate of 6.5% of the defence budget which accounts for less than 0.2% of the total GDP. The standing committee also took note that the MoD was yet to implement the recommendations of the Rama Rao Committee submitted on March 5, 2008 for restructuring the DRDO.

There is a missing link in India’s development strategy. While infrastructure continues to be a weak area, we also lack quality and trained manpower ready to toil on the shop floor to provide the necessary boost to the manufacturing sector. India also has to shift focus to import of capital goods and services, incentivise FDI and technology licensing which would help it to acquire the enormous pool of the global knowledge from beyond its borders. According to a World Bank report published in 2005, India is lagging behind its adversary since it is unable to effectively utilize the resources literally available at its disposal (Fig 3). In the present context, the performance gap between India and China has only widened. While India’s expenditure on R&D has been almost at the same level, China has substantially increased its allocation on R&D to almost 1.8% of GDP. While the number of Indian researchers in R&D has not increased substantially, the numbers in China have grown to in excess of 1200 researchers per million people. FDI into China is also increasing at brisk pace while India still appears to be taking very small strides to attract FDI. Despite weak macro-economic indicators like rising costs from higher wages, dwindling working population and currency appreciation, China has been able to attract FDI worth $111.7 billion in 2012[25].

Fig 3

Source: World Bank Knowledge Assessment Methodology

Disjointed structures, excessive reliance on imports and DPSU’s, lack of adequate impetus to indigenization and a fuzzy aerospace strategy are the few impediments slowing down the development of India’s defence economy. Long gestation periods and frequent changes in the procurement processes are inherent barriers for entry of private players who as it is appear laggard and risk averse to making a foray into this untested area for carrying out business. While the private players are wary of participating in the Indian defence economy, lack of a definite vision from the government is further drawing them away from actively participating in the defence economy. Minimal interaction and collaboration between DPSU’s and the industry coupled with lack of synergy between the DRDO, DPSUs and the end users are factors responsible for plaguing the development of a robust defence economy in India – essential to guarantee India security and ensure elevation as a credible regional power. China on the other hand is aggressively increasing spending on its defence. Once again this year (2013), the official defence expenditure has increased substantially to $119 billion, amounting to almost a quarter of US defence allocation (Fig 4). However if the unofficial estimated figure is aggregated along with spending on internal security (which is more than China’s defence expenditure), then China’s defence allocation would amount very close to US defence spending! China is doing things which to the world may appear ‘politically incorrect’ but conforms to their strategic vision and goals to aspire to elevate its status as an emerging power.

China’s Defence Expenditure in the 21st Century (Fig 4)

Source: Business Standard March 6, 2013

China has substantially reversed its dependence on imports. It was a top importer of arms in the first half of the previous decade of this century but successfully reversed its dependence as it considered technology and indigenization as a guarantor for national security. In the ranking of countries importing arms, China slipped to the fourth position. India on the other hand has been consistent in maintaining a stable SRI at 70% since the last decade of the previous century. As a rarity, India has successfully dethroned China to occupy the pivotal position as the largest importer of arms accounting for 10% of the total global arms import.

China is also not shy from declaring its long term military aspirations which it considers as a legitimate act for an emerging power – rarely a top power cedes position to the number two power peacefully[26]. But whether China is aspiring to dethrone the US as the number one power or is it just happy to be slotted as the number one regional power is a matter of a larger debate. However China spending billions of dollars on military should hardly be perceived as a conspiracy but as a justifiable act of any sovereign nation with legitimate aspirations to guarantee national security to its citizens. China’s readjustment strategy is structured on many verticals. While one vertical is looking to internalize its future development strategy, focus on controlling spiraling inflation and try to ease out from the prevailing unsustainable rates of economic growth. The other vertical is dedicated to address people centric policies aimed at arresting the increasing number of social unrests also reiterated by the country’s largest think tank (CAS). The government has abolished agricultural taxes and subsidized health care and education since the party is extremely wary of potential fallout resulting from mass protests and explosion of anti establishment sentiments spread through the electronic medium. However China’s resolve to focus on building a robust military as part of its larger strategic vision and as an ultimate guarantor of national security will continue to remain its final vertical.


[1] Aileen Wang & Nick Edwards, China 2012 FDI inflows slow, Stay on Track for $100 billion, November 19, 2012 http://www.reuters.com/article/2012/11/20/us-china-economy-fdi-idUSBRE8AJ06C20121120 accessed on March 5, 2013

[4] Yukong Huang, “In China, most politics is local”, International Herald Tribune, The Global Edition of New York Times, January 30,2013

[5] John D Daniel, Lee H Radebaugh, Daniel P Sullivan, Prashant Salwan; International Business Environment and Operations, Pearson, 12th edition,2009

[6] Joseph Casey and Katherine Koleski, US Economic and Security Review Commission, Backgrounder: China’s 12th Five Year Plan, June 24, 2011

[7] ‘Reforms Critical to China’s Decade of Success’, Xinhua October 30,2012,  http://english.peopledaily.com.cn/90785/7995964.html accessed on October 30, 2012

[8] Tom Gregor, Commentary: China’s Top Spot For Global FDI, October 25,2012,People’s Daily http://english.peopledaily.com.cn/90778/7991215.html accessed on October 31, 2012

[9] Victor Shih and Susan Shirk, To Renminbi or not to Renminbi? Why China’s Currency isn’t Taking over the World, Foreign Policy October 18,2012  http://www.foreignpolicy.com/articles/2012/10/18/to_renminbi_or_not_to_renminbi accessed on October 31, 2012

[10] ibid

[11] David Walker, Yuan to Appreciate by a modest 3% in 2012, June 13, 2012, http://www.investmenteurope.net/investment-europe/news/2184014/yuan-appreciate-modest-2012-allianz-gis-lam, accessed on Nov 6, 2012

[12] APCO Worldwide, “China’s 2011National People’s Congress (NPC): Fine-tuning the economy with an eye on social stability,” March 2011 http://www.apcoworldwide.com/content/PDFs/npc_briefing_2011.pdf

[13]Alex Pevzner, “TIP Announces Breakthrough China Program” and Cnaan Liphshiz “China marks 17 years with Israel”http://www.theisraelproject.org/site/apps/nlnet/content3.aspx?c=asIOI5NJKeK0F&b=7676985&ct=11138743#.UQoUQB2deBU and http://www.haaretz.com/china-marks-17-years-with-israel-1.7201 accessed on January 31, 2013

[14] Dallas Boyd, Advanced Technology Acquisition Strategies of The People’s Republic of China, report by ASCO, September 2010

[15] Gabe Collins and Andrew Erickson, “Jet Engine Development in China:  Indigeneous high performance turbofans are a final step toward fully independent fighter production, China SignPost, June 27, 2011

[16] PMI higher than 50 indicates growth and reading below 50 indicates contraction of the economy.

[17] Bettina Wassener, “Chinese economy shows signs of recovery from slowdown”, International Herald Tribune, The Global Edition of the New York Times, January 25,2013

[18] “China and Taiwan sign key investment protection pact”, http://www.bbc.co.uk/news/business-19204608 accesed on January 29, 2013.

[19] Trade between China and Taiwan Hits $554.26 billion http://www.chinaeconomicreview.com/trade-between-china-taiwan-hits-55426bn accesed on January 29,2013

[20] Foreign Funds pour more into China than India in Jan, Business Standard, February 8, 2013

[21] Joseph S Nye Jr, ‘Don’t Try to Contain China” , International Herald Tribune, January 28, 2013

[22]15 years Long Term Integrated Perspective Plan(LTIPP)

5 years Services capital Acquisition Plan (SCAP)

Annual Acquisition Plan (AAP)

[23] Standing Committee on Defence (2010-2011), Fifteen Lok Sabha, MoD, Ninth Report  December, 2010

[24] Standing Committee on Defence (2010-2011), Fifteen Lok Sabha, MoD, Ninth Report  December, 2010

[25] Jamil Anderlini, ‘Foreign Direct Investments in China Fall’, Financial Times, January 16, 2013 accessed from http://www.ft.com/cms/s/0/5537736c-5fc8-11e2-8d8d-00144feab49a.html#axzz2Me6JGeZ4 on March 5, 2013

[26] Kishore Mahbubani, While America Slept, Foreign Policy, February 27,2013