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Potential Shifts in Pakistan’s Defence Industry

In July 2020, the Pakistan Ministry of Defence Production (MoDP) published its “Two Years Performance Report” to outline the activities of the country’s various state-owned defence industry organizations.[1]

One of the MoDP’s notable disclosures in the report was the creation of a draft offset policy document, which, according to the MoDP, “is being circulated to all concerned for input.”[2] The offset document may be an effort to revive or utilize the Directorate General Defence Purchase’s (DGDP) current offset policy.[3]

In addition, the MoDP said it was working on a number of reforms that would encourage greater oversight of its activities, deepen engagement with Pakistan’s private sector businesses and academic institutions, and drive more transfer-of-technology (ToT) arrangements in big-ticket contracts.[4]

The MoDP likely set these goals in response to longer-standing calls for more defence exports and, at least within the Pakistan Navy (PN) and Pakistan Air Force (PAF), support for indigenization efforts. Controlling the cost of defence procurement is a significant contributor to both the offset and indigenization efforts.

However, Pakistan is also at the crossroad of deciding whether it wants to continue investing in its defence industry, at least in regards to specific state-owned organizations.

These organizations – such as (among others) Pakistan Ordnance Factories (POF), Heavy Industries Taxila (HIT), Pakistan Aeronautical Complex (PAC), and Karachi Shipyards & Engineering Works KSEW) – form the bulk of the country’s defence industry. In effect, the state is Pakistan’s main domestic defence vendor.

Pakistan formed these organizations to locally support the armed forces’ equipment through overhauling, repair, and other major maintenance tasks. Since 2000, these organizations started manufacturing some major equipment, but with support from original equipment manufacturers (OEM) in China and Europe.

Unfortunately, the armed forces have yet to fully rely on these organizations for these requirements. The Pakistan Army (PA), for example, recently ordered the NORINCO VT4 main battle tank (MBT) from China, even though it already has a domestic MBT program in the form of the al-Khalid series. Given the fact that HIT was not manufacturing at full capacity, the purchase of a solely imported design is curious.

The issue with importing the VT4 (when HIT is not at full capacity) is not solely a question of whether HIT is able to deliver on the PA’s requirements, but if General Headquarters (GHQ) should continue spending money on supporting HIT. Because HIT et. al are state-owned organizations, the overhead cost of running these facilities is borne by the armed forces. In its simplest sense, funding that goes to support an HIT that is not functioning as intended is money going away from new hardware from another source.

Indeed, overhead costs are among the biggest drawbacks of maintaining a publicly run defence industry ecosystem. The armed forces must foot the bill for payroll, infrastructure support, facility upgrades, and a plethora of other commitments such as health care and housing schemes, among others. In crude terms, if an investment of this scale is ‘not working,’ then what is the point of continuing it?

Well, the fundamental advantage of a state-owned industry – no matter in its inefficiencies – is that it can stay for as long as the state funds it. Outside of a drastic policy change, there is no risk of dissolution, nor the consequences of such a collapse, namely the loss of talent, intellectual property (IP), and other inputs. If the state can continue supporting the industry, it will largely retain its benefits, even with a lack of use.

On the other hand, a private sector company would bear the cost of investing and maintaining its facilities, labour, and IP generation. If viewed in Pakistan’s context, the PA would not have to spend on an HIT-like organization in order to rely on it for future MBTs. However, if the PA does not order from that company, that company may dissolve and, in turn, lose its assets.

Of course, a private sector company has mechanisms to prevent its own collapse. If efficient, it can offset the loss of domestic orders with exports and/or solutions for the local private sector. However, to achieve this level of efficiency, the company would need favourable (or at least non-antagonistic) policies. It will not be able to export hardware if there are regulations restricting it from doing so, for example.

The state could intervene to save a private company (i.e., ‘bailouts’), especially if it is matter of national security. Interestingly, that risk of having to absorb defunct companies can incentivize the state to ensure its private sector can operate efficiently and churn profits. However, bailouts are an effective contingency.

That said, these are the general points. Pakistan, however, also has its unique characteristics that may not fit such a mold, at least neatly. For Pakistan, the defence industry issue is not solely economic, but also a means to overcome supply-side restrictions over certain weapons and technologies. These same restrictions would stop Pakistani private sector firms from leveraging the same types of partnerships and collaborative efforts companies in other countries could take for granted.

Thus, it is no coincidence that the entity that is catching investment in in-house research and development (R&D) is PAC. The PAF is generally not able to acquire certain weapon systems from overseas, especially offensive, or cutting-edge technologies that can alter the balance within South Asia. For the PAF, Project Azm may be the only realistic way to acquire such capabilities.

However, at the other end, the PA is not short of any options for new tanks and other armoured vehicles, be it from China or the West. Yes, the latter is a costlier option. However, the former provides increasingly strong quality and economies-of-scale, giving the PA both advanced and cost-effective options. Moreover, NORINCO’s pace of advancement is also faster than that of HIT. It would cost the PA to re-tool the latter for manufacturing a next-generation machine, on top of the cost of procuring units.

In this respect, the PA’s incentive of keeping HIT is declining. It has evidently kept direct imports a realistic option and, if there is a need to localize production, defer the work to the private sector. If there is enough inventive, the latter can maintain and upgrade the production facilities.

The government can generate that incentive through a robust offset policy. Basically, if the Army ordered $1 billion US in armoured vehicles, it would stipulate that the OEM spend percentage of the contract value in Pakistan. The OEM can spend that money by contracting some of the production work to the Pakistani private sector. Ideally, the government would follow-up those contracts with efforts to deepen the OEM’s reliance on the Pakistani private sector so that contracts continue outside of the offset agreement.

However, both the PA and PAF are some distance away from channeling offsets from big contracts to the private sector. Currently, both organizations are deeply reliant on in-house production. Interestingly, the Pakistan Navy (PN) may be best set-up to start experimenting with offset-driven private growth.

Though the PN maintains KSEW, it does not have the same level of vertical integration or control over the supply chain as the PA and PAF do in their respective areas. There is also a policy-level willingness to invite the private sector to support the PN’s needs.[5] Finally, there had been discussions between the PN and the American shipbuilder Swiftships to collaborate on commercial naval production.

Pakistan’s naval industry growth can occur through offset-driven private sector growth. For example, the PN can draw on Damen Shipyards’ general interest or willingness to deliver offsets. It can encourage the Dutch shipbuilder to co-invest in Gwadar Shipyards in-exchange for a follow-on offshore patrol vessel or corvette contract. Likewise, it can work with its integrator for the next-generation anti-submarine warfare (ASW) aircraft to set-up the conversion and configuration expertise in Pakistan via a private sector firm.

[1] “Two Years Performance Report.” Ministry of Defence Production. Government of Pakistan. 08 July 2020. URL: http://modp.gov.pk/Publications

[2] Ibid.

[3] “Defence Offset Policy.” Directorate General Defence Purchase (DGDP) Pakistan. Accessed: 03 December 2017. URL: http://www.dgdp.gov.pk/documents/defoffsetpolicy.pdf

[4] “Two Years Performance Report.”

[5] “‘Construction of shipyard in Gwadar approved to support ship building industry.’” Pakistan Today. 28 December 2017. URL: https://www.pakistantoday.com.pk/2017/12/28/construction-of-shipyard-in-gwadar-approved-to-support-ship-building-industry/

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