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India: Capital Acquisition Budget: Factors Affecting Its Utilization – Analysis

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By Amit Cowshish

As the year draws to a close, the familiar spectre of underutilization of the capital acquisition budget has started raising its head. At the end of November 2012, the compiled expenditure on capital acquisition was INR 33,379.11 crore against the allocated budget of INR 66,032.24 crore, which works out to 50.55 per cent of the allocation at an average of 6.32 per cent every month. Going by this average, the expenditure at the end of the FY 2013 would be around 76 per cent, resulting in underutilization to the extent of approximately 16,850 crore. This could be highly embarrassing for the Ministry of Defence (MoD). Fortunately, the expenditure does not get incurred at an even pace throughout the year and there is substantial bunching of expenditure towards the end of the year, despite the MoD cautioning the ministries and departments against such bunching. The underutilization will, therefore, be much less than what the extrapolation based on the averages suggests. In fact, the Ministry of Finance would, in all probability, reduce the allocation to a level that would be closer to what the MoD is likely to spend by the end of the financial year. The actual expenditure would thus appear to be quite satisfactory with reference to the revised estimates. This is a perennial phenomenon. But why does it happen year after year? It is almost customary to blame it on defective planning, apathy of the civilian bureaucracy and procedural complexities. This view, however, does not take into account many factors that have a bearing on utilization of the fund allotted for capital acquisition.

India
India

The capital acquisition budget, which is a sub-set of the capital outlay for defence, normally comprises of two notional categories: the funds set aside for meeting the committed liabilities on account of the contracts signed in the previous years and the funds meant for making payment in respect of new acquisitions for which the contracts are signed during the current year. Since in most cases the delivery schedule of capital assets spans several years, only an advance payment (normally 15 per cent of the contract value) is made in the year in which the contract is signed and the payment of the remaining amount is linked with pre-defined milestones or stages. If, however, the delivery is scheduled to be completed during the year in which the contract is signed, the full amount is paid out of the notional allocation for new schemes. These categories are notional in that these are not separate budgetary heads and it is always possible to alter the allocation under these categories without any parliamentary approval.

From the current year (FY 2012-13), the requirement of funds for meeting the expenditure on supply of capital items by the Director General of Ordnance Factories (DGOF), who controls the ordnance factories, is also included in the capital acquisition budget. Thus, there are three categories now: committed liabilities, new schemes and DGOF supplies. The allocation under these categories for the current financial year is INR 54,839.91 crore, 5,520.82 crore and INR 5,671.51 crore, respectively. This works out to 83.05 per cent, 8.36 per cent and 8.59 per cent, respectively. The past trend has not been substantially different.

Considering that the committed liabilities account for the bulk of the expenditure on capital acquisition, utilization of the budget depends to a very large extent on payment on account of the committed liabilities. These payments are related to pre-defined stages in design and manufacturing contracts or delivery of the contracted equipment in supply contracts. It implies that the payment cannot be released unless the pre-defined stage or milestone is reached. The MoD does not have much control over this. Most of the slippages in this regard are because of the inability on the part of the vendor/manufacturer/supplier to reach the pre-defined stage or achieve the pre-defined milestone as per the contract. Consequently, the payment related to that stage or milestone cannot be released. Any such slippage could make a difference of hundreds of crore if it is in the context of a major acquisition programme. Sometimes, however, the vendor/supplier is persuaded to put in extra efforts to achieve a milestone or make the delivery earlier than the stipulated date so that the payment related to that stage or milestone could be released earlier than planned to minimize the underutilization of allocated funds.

Another manifestation of this problem is the occasional, but not infrequent, inability of the Defence Public Sector Undertakings (DPSUs) and shipyards to adhere to the plan for withdrawal of funds in respect of on-going contracts, some of which are cost plus contracts. This plan is taken into account by the Services while preparing their budgetary forecasts. Therefore, the cash outgo is adversely affected if the withdrawal plan gets disturbed. For their part, the DPSUs are unable to adhere to the plan because of a variety of reasons. For example, if withdrawal of a certain amount is contingent upon the DPSU placing orders on their sub-vendors/suppliers for a pre-determined amount but the DPSU is unable to do so as planned, it may not be able to claim the payment as per the contract.

If the MoD is dependent on external factors for utilization of the allocation earmarked for discharging the committed liabilities, it is dependent to a large extent on another set of external factors, viz., the Ministry of Finance (MoF) and the Cabinet Committee on Security (CCS) for utilization of the allocation under the category of new schemes. As per the existing delegation of powers, schemes costing INR 500 crore to INR 1,000 crore are approved by the Finance Minister and schemes beyond that limit are sanctioned by the CCS. The contract is signed only after the scheme has been approved and normally the cash outgo is limited to 15 per cent of the contracted value in the year in which the contract is signed. The allocation under this segment during the current year is INR 5,520.82. Assuming that this entire amount is to be paid by way of advance of 15 per cent, contracts for INR 36,805 would need to be signed during the current year to be able to utilize this money. Considering the high value of defence contracts, this does not appear to be a difficult task. In practice, however, it becomes quite difficult to do so unless a couple of big contracts get signed.

The Services work on the basis of an Annual Acquisition Plan (AAP). These plans are, in fact, two-year roll-on plans containing the list of new schemes to be processed during a particular year. Not all schemes included in this plan can be processed during the course of a single year. But depending on the inter-se priority of the listed schemes, as many schemes used to be processed for approval as the budgetary allocation under the new schemes segment would permit. This created a problem as delay in approval of one or more schemes used to result in underutilization of the funds earmarked for those schemes. Consequently, it was decided some time in 2007 or 2008 that the number of schemes to be processed for approval would be decided in such a manner that, after making allowance for likely slippage in obtaining approval in respect of some of them, the remaining approved schemes would be sufficient to consume the budget earmarked for new schemes. It has had the desired effect to some extent, with the possible exception in the case of the Army.

It would be legitimate to ask why it becomes difficult to conclude new contracts as planned. A detailed study is required to discover the real reasons, which may differ from one Service to the other. Whatever be the other reasons, the delay is not likely to be because of defective planning, bureaucratic apathy and procedural complexities. In 2007-08, the Army, Air Force and Navy spent 70.10 per cent, 86.31 per cent, 39.50 per cent, respectively, of the funds earmarked for new schemes. In 2010-11, the utilization of funds earmarked for new schemes increased to 72.23 per cent, 112.90 per cent and 201.10 per cent, respectively. Thus, while the Army just about managed to maintain its record of utilization under the new schemes (going up to 72.23 per cent from 70.10 per cent), the Air Force improved its record from 86.31 per cent to 112.90 per cent and the Navy galloped from 39.49 per cent to a whopping 201.10 per cent. These figures, culled from the 15th report of the Standing Committee on Defence (15th Lok Sabha), indicate a trend that cannot be explained by invoking the usual demons of defective planning, bureaucratic apathy and procedural complexities.

The third category of the capital acquisition budget comprises of the allocation earmarked for the supplies made by the DGOF. The Services do not release payment on account of these supplies as in the case of other contractual payments. The value of supplies is credited to the DGOF budget as receipt by way of book adjustment by the Defence Accounts Department (DAD). The Services (mainly the Army) have to make a provision in their budget for an amount equal to the value of the supplies to be made by the DGOF during a particular year. Therefore, this segment of the capital acquisition budget gets blocked for the Services. But they have no control over production and supply by the DGOF and the book adjustments tend to gather pace only towards the second half of the year. In fact, adjustments keep getting made even after the month of March as the accounts for a particular year remain open generally till the month of June of the next financial year for book adjustments. Any shortfall in the target set by the DGOF for supply of capital assets to the Services thus results in underutilization of the amount earmarked for the DGOF in the budget of the Services. Even if the DGOF reduces its targets at the revised estimate stage, thereby reducing the requirement of budgetary support from the Services, it is too late for the Services to utilize that money on other schemes.

The MoD monitors the pace of expenditure regularly at various levels up to the level of the Defence Minister. But a segment of the capital acquisition budget is not susceptible to detailed review at the higher echelons. Presently, expenditure is booked to the capital acquisition budget through four streams. The bulk of the expenditure is, of course, booked on account of schemes that are processed by the capital acquisition wing of the MoD. The second stream of booking is related to the schemes that are sanctioned by the Vice Chiefs of the Army and Naval Staff and the Deputy Chief of the Air Staff under the financial powers delegated to them (presently up to INR 50 crore). The third stream through which expenditure is incurred from the capital acquisition budget is related to procurements made as per the decision made by the ministry in 2007 – that expenditure on items which are capital in nature but were being procured from the revenue budget would be debited to the capital budget. The expenditure under this category is sanctioned by various authorities as was being done when these were purchased from the revenue budget and the procurement is made following the procedure for revenue procurements. The fourth stream, added this year, is related to supplies made by the DGOF. Although the accounting system provides for the expenditure incurred through these four streams to be identified separately, the efforts made in the past to earmark separate budgetary allocations for the first three streams has not had the desired effect. (The allocation for the fourth stream is already being made separately.) This makes the task of monitoring very complex and unmanageable.

If the problem of underutilization of capital acquisition budget has to be overcome, these factors that have a bearing on its utilization have to be reckoned with. The most critical of these factors is the slippage in sanctioning of new schemes, which has a direct bearing on the modernization plan of the armed forces. Therefore, it merits immediate attention. Since every case that is beyond the financial powers delegated to the MoD has to be referred to the MoF, whether for sanction by the Finance Minister or as a pre-requisite for bringing the proposal before the CCS, it might perhaps help in reducing the time normally taken to complete this step if an inter-ministerial forum were to be set up to process all such proposals rather than their being processed through to and fro movement of files between the Ministries of Defence and Finance.

Amit Cowshish is Former Financial Advisor (Acquisition) & Additional Secretary and Member Defence Procurement Board.

Originally published by Institute for Defence Studies and Analyses (www.idsa.in) at http://www.idsa.in/idsacomments/CapitalAcquisitionBudget_acowshish_261212



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The Institute for Defence Studies and Analyses (IDSA) is a non-partisan, autonomous body dedicated to objective research and policy relevant studies on all aspects of defence and security. Its mission is to promote national and international security through the generation and dissemination of knowledge on defence and security-related issues. IDSA has been consistently ranked over the last few years as one of the top think tanks in Asia.

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