The Gorshkov Deal: Beyond Economic Considerations

It has been reported that Russia has demanded US $3.5 billion from India for the aircraft carrier, Gorshkov, which is currently undergoing repairs. This is the second time that Russia has sought a price increase from the original contracted amount of $1.5 billion. Given the hike in its price and the further delay in the date of delivery, the deal has naturally attracted comment, with some people even questioning the very wisdom of having gone for the ship.

The contract for Gorshkov was concluded on January 20, 2004 at a total cost of 1.5 billion US dollar (approximately Rs. 6000 crores at that time). The price break up was: $974 million for repair and upgrade of the ship; and the remainder of $526 million for 16 embarked (12 single seat + 4 double seat) MIG-29 jet fighters and six Kamov Ka-27 and Ka-31 Helix helicopters. The agreed scheduled delivery was August 2008. India paid an advance of $500 million, which was one third of the total contracted amount. Late in 2007, it was reported that Russia has demanded an additional amount of $1.2 billion and that completion and delivery would be delayed till 2012. This caused a lot of public concern. The Indian Navy Chief was quoted as taking a firm stand of “no further re-negotiation on the price of the aircraft carrier since advance payment was already made”. The latest media reports say that Russia is now demanding a total of $3.5 billion, which is a further increase of $0.8 billion or Rs. 3920 crores at current exchange rates over the increase demanded last year. A Russian Defence Ministry official was quoted as having told news agencies that the aircraft would join the Russian Navy in case India does not agree to pay the revised price. This observation could particularly hurt the Indian Establishment much more than the hike in the price since the ship has already been re-christened as the ‘INS Vikramaditya’.

The details of the contractual provisions are not available in the public domain. However, one can make the general assumption that such deals are likely to be within the broad contours of normal contracts. The vendor would agree to bear all expenses to make the vessel sea worthy to the satisfaction of the buyer. Then the seller would quote the price. The buyer would agree to bear all additional expenditure relating to upgrades of various systems and sub-systems. In case of delay beyond the agreed upon delivery schedule, the seller would agree to bear the cost of delay in the form of a penalty. But there is always a catch in these kinds of deals.

As pointed out, the Gorshkov deal has two components in terms of financial cost. One part is for repair and upgrade of the ship, which was determined at $974 million. The second part is the cost of weaponisation of the ship, which amounted to $526 million. The current debate and controversy over the price could not have originated from the second segment of the deal at this stage. It must have been from the first element. If one removes the cost element of the second portion from the latest revised demand made by Russia ($3500 million minus $526 million = 2974 million), the percentage of increase is 305 per cent. Two questions arise in this regard. One, is such a hike in prices fair? And secondly, how is it that in spite of detailed negotiations, such an unfavourable contractual outcome could not be foreseen or prevented?

There are two possible situations where even the most detailed negotiations cannot take care of the buyer’s interest, and which the seller can always exploit to its own advantage. In plain language the seller could say: “This material or system is good enough and its performance is guaranteed. But if I put this other material or system, the performance would be much higher.” The natural tendency in such a circumstance would be to choose the second option. But the reasonableness of the cost can never be assessed correctly. Hence, there is increase in cost without violating the contractual provisions. The reported need for cabling work of 2400 kilometres in length against the originally estimated 700 kilometres could be a case in point here.

The second situation would arise with respect to maintenance cost. Russia reportedly claims that 60 to 70 per cent of the increased cost is due to ongoing maintenance and upgrade of the ship. It is not known whether the maintenance cost and upgrade cost have been worked out and shown separately. Even if this had been done, there would still be room for manipulation of the cost by the seller. In any event, the seller should logically bear the maintenance cost for the period beyond the original delivery schedule of August 2008. However, if the items had not been shown separately, there would be considerable scope for manipulation by the seller of the maintenance cost along with the upgradation cost. Upgradation cost would logically be borne by the buyer, since this is a matter of its own choice.

It is reported that a new aircraft carrier of roughly comparable capability would be available between $3 and 4 billion. If one were to go for a direct purchase, assuming that an aircraft carrier is available for purchasing, it should be relatively newer than this abandoned ship. But then one has to add the cost of the embedded ordnance system to the new ship. This will in any case add up to about $3.6 billion plus. Then weaponisation of the ship and the associated training period may take another year and a half. The benefit, however, would be that the country could have acquired an aircraft carrier well before the ‘INS Viraat’ is retired and the indigenous carrier project catches up by 2015. The benefit would have been not in financial terms but in the earlier availability of another aircraft carrier.

The two greatest concerns for India are: Will the Gorshkov be delivered at all even at the extended schedule of 2012 or in 2013 after 18 months of sea trials? Secondly, will it continue to burn a hole in the exchequer’s pockets even after the ship is finally handed over to India? These apprehensions are not without any basis. The Gorshkov is expected to serve another 30 years, though it was decommissioned by Russia in 1996 after only nine years of service. The original commissioning was reportedly delayed due to software bugs in the command and control system. Moreover, a boiler explosion led to it being docked for a year for repairs. If this history were to continue after the ship is commissioned into the Indian Navy, instead of being a prestige toy of India it will become an unstoppable economic drain because of the simple reason that major repairs and maintenance works would obviously be beyond the current technological capability within India.

How should India go about the deal then? Should it honour the contract by meeting the extra demands made by Russia, or should it abandon the deal forfeiting whatever financial advances it has paid and discharge other consequential contractual obligations? Whichever option is taken, the voice of the critics is bound to grow louder. It appears that India has to contend with two broad categories of vendors: those who are reluctant to part with technology and equipment and place a lot of conditionalities; and those who are willing to supply almost everything but place a lot of hurdles and irritants midway. In fact, it is well known to insiders that Russia’s demand for increase in the price paid for the Gorshkov is not a unique case. Delays and demand for midway upward revisions of cost are fairly widespread when it comes to executing contracts and projects with Russia.

Neither India nor Russia can afford to disown the contract. Considering the longstanding ties between the two countries in the defence sphere, the cost of this carrier is much less than the value of their relationship and the prospects for future co-operation. It is reported that existing joint projects and upcoming ones between the two countries are worth more than $10 billion. The Gorshkov deal is symbolic of the defence co-operation between the two countries. Can they transform this deal into a positive symbol of their long term political and defence cooperation into the 21st century?