Should the Legacy of Capital Budget Revenue Procedure (CBRP) Be Perpetuated in Draft DPP 2020?

The much awaited draft Defence Procurement Procedure (DPP) 2020 has been hosted on the website of the Ministry of Defence. Comments/recommendations/suggestions have been invited by April 17, 2020. For the first time, the term ‘Defence Acquisition’ has been defined as follows:

Procurement of goods and services which are booked under the Capital Budget Head will follow the procedure as laid down in the DPP and will be termed as ‘Capital Acquisitions’. However, if the SHQ wishes to procure goods and services from the Capital Budget through any other procedure, specific approval of the Defence Acquisition Council (DAC) may be obtained for each such case’.1

Whilst the first part of the definition was always the unstated understanding of  what defence acquisition entailed, the focus of examination in this article is the highlighted second part of the definition, wherein the Service Headquarters are given the freedom to procure goods and services ‘through any other procedure’, after approval of the DAC. 

Background

The Public Accounts Committee (PAC) of the Lok Sabha in 1989 recommended that the government draw up comprehensive guidelines with regard to negotiations and implementation of defence contracts.2 The first comprehensive instructions in the form of the Defence Procurement Procedure (DPP) were issued in 1992. In the aftermath of the Kargil conflict, the Group of Ministers (GoM) Report, which was submitted in February 20013, noted inter alia that the existing structure for procurement had led to sub-optimal utilisation of funds and flagged the long delays in acquisition which were not conducive to the modernisation of the armed forces.

Consequent to the GoM recommendations, the MoD established a new Defence Acquisition Wing, under the Department of Defence (DoD), in October 2001. The GoM report also led to broad guidelines for the new DPP promulgated in 2002, which has been revised at regular intervals — first in 2003 (DPP-2002 [Version June 2003]) and thereafter in 2005, 2006, 2008, 2011, 2013 and 2016.

The Fiscal Responsibility and Budget Management (FRBM) Act 2003 meanwhile was notified with effect from July 5, 2004. It required a reduction in two ratios, i.e., revenue deficit and fiscal deficit as a percentage of the GDP and the target was to wipe out the revenue deficit and bring down the fiscal deficit to three per cent by 2008-09.4 One of the major objectives of the Act was to affect a shift in the composition of total expenditure, in favour of capital expenditure.5  It was a welcome change for modernisation as it nearly doubled the BE for defence capital budget compared to the RE for 2003-04.

However, the newly created Acquisition Wing, established to overcome the suboptimal utilisation of capital budget, was not able to utilise the allocated capital budget in 2003-04. The result was that the Budget Estimates (BE; allocated initially at the time of passing of the Union Budget for the year) for defence capital budget for 2003-04, which was Rs 20952.76 Crs, had to be reduced at Revised Estimates (RE; allocation revised at the time of presentation of the next financial year’s budget to reflect the picture of actual expenditure expected to be incurred for that year) to Rs 16906.32 Crs.

While the acquisition wing had a challenge on its hands, the Air Force was agile and its Plans branch (see in Table 3) was able to process acquisition projects ex HAL, thanks to an effective and transparent pricing policy. This helped absorb the doubling up of the capital budget in 2003-2007. By March 31, 2007, orders were placed for Block I to III of SU 30 MKI, LCA, Hawk, Jaguar, Dornier, limited series production and series production of HJT-36 (delivery not yet commenced) and production order for ALH for each of the three services, were also placed.6 

The capital budget (BE) for 2007-08 was Rs 41922 Crs against an actual expenditure of Rs 33958 Crs in 2006-07. The revenue budget on the other hand was consistently being fully utilised. The revenue budget (BE) for 2006-07 was only Rs 54078 Crs against an actual expenditure of Rs 51669 Crs. In the light of the report of the 6th Central Pay Commission expected in 2007-08, the MoD had a challenge on its hands for utilisation of capital budget and meeting the anticipated revenue budget requirement. 

Capital Budget Revenue Procedure (CBRP)

The MoD vide letter no GOI MoD (Fin) PC -11(I)/Bud.1/2007 dated September 25, 2007, identified items of expenditure, which until then were booked to the revenue budget, to henceforth be met by using the capital budget.7 To ensure that the elaborate capital acquisition process specified in the DPP 2006 did not delay this prescribed activity, the policy letter specified that the expenditure will be booked to capital budget heads but the procedure to be followed should be as per Defence Procurement Manual (DPM). This came to be called Capital Budget Revenue Procedure (CBRP).

The list prescribed in 2007 was modified more than once subsequently. The letter further stated that offsets would not be applicable in respect of such procurements. Items were generously added to this list, vide letters dated October 21, 2008 and November 23, 2009 and a comprehensive consolidated letter with additional items was issued vide GOI MoD (Fin) letter no 2(2) B1. /2008 dated January 13, 2011.8

The annual expenditure figures under the CBRP category are not available in the public domain. The extent of its usage can however be illustrated as shown in Table No. 2 by comparing the actual expenditure for 2006-07 (prior to the introduction of CBRP) with the BE of 2016-17 and BE of 2019-20, of one minor head for the Navy (Repair and Refits) and one sub-head under minor head ‘Stores’ for the Air Force, which is meant for repair and overhaul of Air Frame and Engines. The expenditure both as a percentage share of the revenue budget and in absolute amount has come down, even defying the inflation and the adverse exchange rate over this period.

Adverse implications of CBRP

Against basic financial principles

Article 112 of the Constitution defines government expenditure from Consolidated Fund in two categories i.e. ‘Charges Expenditure’ and ‘other expenditure ‘. Whilst what is classified as ‘Charged Expenditure’ is clearly defined in this article, we need to refer to General Financial Rules (GFR) to distinguish the ‘Revenue’ and ‘Capital’ expenditure.  Rule 98 of GFR 2017 edition provides the clarity:

Significant expenditure incurred with the object of acquiring tangible assets of a permanent nature (for use in the organisation and not for sale in the ordinary course of business) or enhancing the utility of existing assets, shall broadly be defined as Capital expenditure. Subsequent, charges on maintenance, repair, upkeep and working expenses, which are required to maintain the assets in a running order as also all other expenses incurred for the day to day running of the organisation, including establishment and administrative expenses, shall be classified as Revenue expenditure. Capital and Revenue expenditure shall be shown separately in the Accounts.9

Defence expenditure has two major components, viz., Capital and Revenue. The capital budget caters for two heads. The first relates to the modernisation of the three services and includes acquisition of new platforms, weapons systems and major mid-life upgrades of platforms. The second part of the capital budget includes the capital expenditure on land and construction works for the three services, capital expenditure of the joint staff, NCC, ECHS, Rashtriya Riffles, and capital expenditure (plant, machinery and capital works) of the Defence Research and Development Organisation (DRDO), DGQA and Ordnance Factories. Modernisation constitutes about 80 to 86 per cent of the capital expenditure. The first charge on capital budget caters for ‘committed liabilities’, i.e., milestone-related stage payment due in respect of contracts signed in the past. Only the residual amount is available for ‘New Schemes’, i.e., for making the first stage payment due on signing of contracts. The capital budget is meant for creation and enhancement of ‘defence capability’.

Defence revenue expenditure caters to what may be called as ‘operations and maintenance’ expenditure for the three defence services, NCC, ECHS, Rashtria Riffles, DRDO, OFB and DGQA. This activity in equipment intensive services (platform-based arms of the Army, the Navy and Air Force) uses expensive resources and platforms, which require regular preventive maintenance. Since each of these individual organisations is made up of a large body of personnel, the foremost charge on revenue budget is for pay and allowances, and hence, funds from the available budget are first allocated for this. The expenditure on repair, maintenance of technical building, married accommodation, water and electricity are also met from this budget. The revenue budget is meant for creation and enhancement of ‘operational preparedness’.

The above, consistent with basic financial principles enshrined in the Constitution and the GFR, was the norm till financial year 2006-07, when the MoD made changes in mid-2007 by adopting the CBRP policy.

Budget share

The Navy and the Air Force are predominantly weapon platform-based services. DPSUs which provide repair & refits (MDL/GRSE/GSL/HSL) and overhaul/repair of airframe and aero engines (HAL) were able to make extensive use of the CBRP provisions (Table 2 above refers).  2016-17 was unique for Defence Budget, capital budget BE for 2015-16 was Rs 94588 Crs, the BE for 2016-17 was reduced to Rs 86371 and the RE for 2016-17 was further reduced to Rs 79261 Crs. The corresponding figures for revenue budget were Rs 132541 Crs (BE 2015-16), Rs 143869 Crs (BE 2016-17) and Rs 149051 Crs (RE 2016-17). The defence capital budget came under stress.10 The changes in the share of capital budget before, after CBRP and post 2016-17, may be seen from Table No 3 below.

This also had an impact on the revenue budget allocation, as seen in Table No 4 below.

Compromised database

Robust databases enable proper analyses and quicken decision-making process based on authentic data. The importance of databases is greater in the MoD and the Service HQs where institutional memory limitations are the default norm because of frequent movement of personnel due to short tenures. Due to CBRP, a substantial amount of capital budget was utilised for activities whose expenditure for the last 50 plus years was met from revenue budget. This suppressed the revenue expenditure from 2007-08 onwards, compromising critical accounting databases.

The 14th Finance Commission (FC) in Para 6.35 and 6.36 of its report stated that ‘revenue expenditure on defence has grown at an annual rate of 11.21 per cent between 2001-02 and 2012-13 and at the rate of 10.1 per cent between 2008-09 and 2012-13”.11 The revenue expenditure reckoned by the FC however could not reflect the actual expenditure as items earlier booked to revenue budget (like expenditure on airframes and engines, for instance) were booked to capital budget, post-CBRP.

In their submission to the Commission, both the MoD and the Ministry of Finance (MoF) highlighted the need to increase defence outlays in order to modernise and maintain defence assets and to finance defence acquisitions. Their projections provided for an increase in defence revenue expenditure (including salaries) of 30 per cent in 2016-17, which incorporated the Pay Commission impact, with a stable growth rate of 20 per cent per annum in the remaining years.

The FC appreciated the importance of defence revenue expenditure as ‘critical for defence preparedness and maintenance’ and noted that they ‘have kept the defence revenue expenditure-GDP ratio constant during our projection period, instead of allowing growth to decelerate as was the case in the past’. This rate as per the projections in Annexures of the report was 1.04 per cent of GDP.12 The revenue budget allocation from 2016-17 to 2018-19 has been consistent with the recommendation of the 14th FC report (Table No 5 below).

Life Cycle Cost

One of the unique features of the draft DPP 2020 is that it uses the term, ‘life cycle cost’, repeatedly. However, any such good clause in the contract relating to life cycle cost should have the means in place to monitor it. This monitoring system should be robust, reliable and not create additional paper work for the MoD.

CBRP has compromised a simple but effective system that was in place in the Air Force for sure. As was the norm before CBRP, all expenditure incurred on repair/overhaul/spares/consumables (everything other than ATF & manpower) was compiled to a specific sub-head ear-marked for each aircraft fleet under the revenue budget. For each aircraft fleet acquired post-Jaguar, two separate unique sub-head no’s (one for ex HAL and one for others) under Major Head 2078-Defence Services-Air Force Minor Head 110-Stores, was allotted.13

Let us for example take the case of two different aircraft fleet for comparison i.e. Mirage-2000 and MiG-29. If a macro comparison of the life cycle cost of two of these fleets was to be carried out, we could get the data of the number of hours flown from the time of their induction. The data on number of fatal accidents could have been obtained as would the details of cycle time of their engine overhaul, airframe overhaul and major aggregates would also be available through the fleet maintenance Dtes at Air HQs. Monthly average serviceability data could also be obtained from all operating units for each of these Squadrons operating this aircraft(s). But all these details would give us clarity only if we also had the details of expenses incurred for maintenance of these fleets.

Post CBRP, the database is compromised and part of it would have gone through the capital budget route without any possibility of disaggregation. Prior to CBRP policy, this would be available faster than the other details from DSE Vol II (a restricted document). The example cited above gives details about the Air Force; however, the policy of CBRP was applicable to Army and Navy also and would have resulted in the same constraints faced by these two Services as well.

Conclusion

The policy of CBRP that started in September 2007 as brought out above is not consistent with basic financial principles (enshrined in the Constitution and amplified in the GFR). The compromised database as a result of shifting of expenditure heads from revenue to capital neither inspires confidence for macro-level decision making nor for micro-level monitoring. The extensive application of life cycle management as a norm as intended in the draft DPP will get compromised.

In the Service HQs, the ‘Acquisition’ and ‘In Service Maintenance and Management’ are responsibilities of two distinct branches — Plans and Maintenance. Expenditure using CBRP route is incurred on routine repair and maintenance and topping up aggregates to maintain a high serviceability. It is to speed up this process that nearly the full revenue budget is spent using ‘Delegated Financial Powers’ by Service HQs.

The amended definition in the draft DPP 2020 seeks to include enabling provisions for CBRP to be continued but attempts to rein its usage with DAC to decide in each case (Currently it is up to the Service HQs to manage with in the capital budget allocation). Items included in the CBRP list are meant for routine maintenance activity. Specific approval of the DAC to procure goods and services using the CBRP will delay the routine maintenance activity and create avoidable load on the DAC. Since the new financial year has just started and the formal approval and issuing of the DPP is bound to take some time, the CBRP instructions issued initially in September 2007 and amended subsequently must be revisited.

Views expressed are of the author and do not necessarily reflect the views of the Manohar Parrikar IDSA or of the Government of India.

• 1. See Draft DPP 2020, Ministry of Defence, Chapter 1, Para 3.
• 2. ‘Committee of Experts for Amendment to DPP 2013, including Formulation of Policy Framework: Report of the Experts Committee’, Ministry of Defence, Para 1.2.09.
• 3. See ‘Report of the Group of Ministers on National Security’, Para 6.32.
• 4. ‘Budget 2004-2005: Speech of P. Chidambaram, Minister of Finance’, July 8, 2004.
• 5. ‘Medium Term Fiscal Policy Statement: Union Budget 2004-05’.
• 6. See Standing Committee on Defence (2006-2007), ‘In-Depth Study and Critical Review of Hindustan Aeronautics Limited (HAL)’, Ministry Of Defence, Fourteenth Lok Sabha, pp. 53-54.
• 7. See ‘Classification of defence expenditure’, September 25, 2007, Controller General of Defence Accounts.
• 8. See ‘Classification of Expenditure’, February 3, 2011, Controller General of Defence Accounts.
• 9. General Financial Rules (GFR) 2017, https://doe.gov.in/sites/default/files/GFR2017_0.pdf
• 10. Standing Committee on Defence (2016-17), ‘Action Taken by the Government on the Observations/Recommendations contained in the Twenty Second Report (16th Lok Sabha) on “Demands for Grants of the Ministry of Defence for the year 2016-17 on Capital Outlay on Defence Services, Procurement Policy and Defence Planning (Demand No. 23)”, Ministry of Defence, 16th Lok Sabha, 27th Report, p. 43.
• 11. Finance Commission of India, ‘Report of the 14th Finance Commission’, p. 70.
• 12. Finance Commission of India, ‘Report of the 14th Finance Commission’, Annex 6.1 and Annex 6.2, pp. 435-436.
• 13.  ‘Classification Handbook Defence Services Receipts & Charges 2014’, pp. 202-210.