Last month I simulated the economic benefits of investing in domestic products as opposed to purchasing products from OEMs in other countries. Today I’ll tweak the simulation and do an apples-to-apples comparison between procuring the MBT Arjun Mk.1A vs the T-90MS. The assumptions will be on the conservative side; a worst-case scenario of sorts for the Arjun. For example, the simulation does not assume any economies of scale for the Arjun, but the economies are already baked into the T-90’s per unit cost.
The simulation is made even cooler by the fact that I’ve now written it in Python.
I am assuming that all T-90MS are imported, and the value added to them domestically is negligible. I am also neglecting the knock-on effects of domestic R&D associated with procurement of the Arjun (like subsystems that get utilised for upgrading other tanks with the Indian Army, etc.).
Supplier levels
Like last time, only 3 levels of suppliers are considered, and they’re assumed to pay three kinds of taxes: corporate tax, GST (on components procured domestically), and income taxes paid on salaries of employees.
Taxes flowing back
The taxes flow into the following year’s central government budget, and are redirected to MBT procurement in proportion to the percentage of central government budget allocated to Defence. This is an additional nuance I’ve incorporated from last time. So if 24% of the central govt. budget goes to Defence, only 24% of the taxes collected from the domestic MIC involved in Arjun Mk.1A production is redirected to the following year’s Arjun procurement.
Budgetary excess
However, since we are procuring the same number of units for both tanks in any given year, and since the procurement budget grows organically as well as due to a proportion of the supply chain taxes flowing back, we end up with a situation where for each year we have an excess. This can be utilised to buttress or replace those bridges that were believed to be incapable of supporting the Arjun’s weight. Or it can be used to procure more Arjun Mk.1A tanks.
Such a scenario does not arise in case of the T-90MS tank.
Year One
Units procured: 120
T-90MS $4.5 million / unit x 120 units = $540 million
Arjun Mk.1A $7.8 million / unit x 120 units = $936 million
We begin with the per unit cost of Arjun Mk.1A being $7.8 million and that of the T-90MS being $4.5 million. Since we need 120 units, the T-90 budget for Year 1 is $540 million, while that for the Arjun is $936 million. A bad start for the Arjun by the look of things, but let’s see what happens.
47% of that money goes to procuring components, half of which are domestically produced by Level 1, Level 2, and Level 3 suppliers. At each stage GST is paid on domestically procured components, the companies involved pay corporate taxes, and their employees pay income tax.
Arjun Mk.1A - Domestic Supply Chain
Total procurement = $936 million
Cost of components = 47% of total procurement
Three levels of suppliers, each paying taxes:
Total taxes paid in India = $196 million
24% = $47 million -> Procurement budget for Year 2
05% = $10 million -> R&D budget Year 2 -> 1% increase in indigenous content
The total taxes collected from the OEM and its suppliers in case of the Arjun is $196 million, out of which $47 million flow to the next year’s budget for the Arjun, and $10 million flow to R&D for the same project. This $10 million goes towards increasing indigenous content of the tank by 1%.
No such taxes are collected in case of the T-90.
Year Two
Units procured: 121
T-90MS $4.7 million / unit x 120 units = $567 million
Arjun Mk.1A $8.0 million / unit x 120 units = $976 million
Per unit costs increase 4% per annum (organically)
For year two, the costs per unit are $8 million and $4.7 million respectively. The Arjun budget is $976 million while the T-90 budget is 567 million. 121 tanks are procured this year.
With $47 million flowing into the budget from the previous year’s taxes, and a 5% organic increase in the budget (common for both tanks), year two sees an excess of $54 million in the Arjun budget.
Arjun Mk.1A - Domestic Supply Chain
Total procurement = $976 million
Cost of components = 47% of total procurement
Total taxes paid in India = $205 million
24% = $49+ million -> Procurement budget for Year 3
05% = $10+ million -> R&D budget Year 3 -> 1% increase in indigenous content
Budgetary excess = $53.6 million (organic 5% increase + flow back from previous year less spent on procurement in current year)
$205 million in taxes are collected from the Arjun project, and $49 million flow back to it while $10.24 million flow into R&D.
This year sees a budgetary excess of $53.6 million which, as we mentioned earlier, goes to reinforcing or replacing bridges that cannot support the Arjun’s weight.
…
Jumping ahead.
…
Year Twenty
Units procured: 144
T-90MS $9.48 million / unit x 144 units = $1,364 million
Arjun Mk.1A $14.78 million / unit x 144 units = $2,128 million
Still looks bad for the Arjun, what with a higher per unit cost. But when we look at the cumulative figures, the picture changes radically.
Cumulative numbers
Arjun Mk.1A - Domestic Supply Chain
Total procurement = $29,117 million
Total taxes paid in India = $6,494 million
24% = $1,558 million -> Total flow back from project to own budget
05% = $325 million -> R&D budget
Budgetary excess = $1,595 million (organic 5% increase + flow back from previous year less spent on procurement in current year)
A cumulative investment of $325 million into R&D is 1.5 times the amount spend by DRDO in developing the Arjun tank all the way from initial designs to Mk.1A.
This allows for both incremental improvements in the Mk.1A as well as complete design & development of a successor.
Capex
Domestic suppliers of the Arjun OEM earn $11,446 million in revenues. Together with the OEM, the total revenues earned from the Arjun project stand at $40,563 million. Based on BEL’s figures, companies need $0.23 in assets to earn $1 in revenues. We’ll assume the assets depreciate over twenty years.
Based on that, the total fixed assets needed to earn $40,563 million would be $9,330 million.
Taking the same multiplier used last time (4.8), the economic activity generated by this accumulation of fixed assets would be $44,782 million.
To summarise
Arjun Mk.1A
Total = 2,633 tanks
Average unit cost = $10.9 million
Total spend = $29.1 billion
Additional spend vs T-90MS = $9.7 billion
Total taxes collected = $6.5 billion
Total budgetary excess = $1.6 billion
Supplier revenues = $11.5 billion
Supply chain investment = $9.3 billion
Economic activity generated= $44.8 billion
T-90MS
Total = 2,633 tanks
Average unit cost = $6.7 million
Total spend = $17.9 billion
Total taxes collected = $0.0
Supplier revenues = $0.0
Supply chain investment = $0.0
Economic activity generated= $0.0
Even with very conservative assumptions about cost improvements from indigenisation, as well as conservative supply chain assumptions, the economic benefits of procuring the Arjun Mk.1A would far outstrip the lower per-unit cost of the T-90MS.
The tax revenues generated by the domestic supply chain would augment the government’s budgetary resources, funding incremental procurement, R&D into incremental improvements as well as the next MBT model, and fund the improvement of border infrastructure to accommodate the greater weight of the Arjun Mk.1A. It would also generate $45 billion in economic activity from the investments in fixed assets.
Assumptions
Bharat Electronics is taken as representative of domestic OEMs.
Cost of Good Sold is 47% of Revenue, Salaries are 17%
Effective income tax rate for employees is 15%, Corporate tax rate is 25%
GST rate on domestic components is 18%, on imported components is 0%
Domestic OEM profit margin (for tax calculations) is 20%
24% of the central govt. budget goes to Defence, 5% goes to R&D
Price level difference between Russia and India is taken from the Big Mac Index. This applies fully to salaries, but only 50% to components (as measured by COGS)
As per the Big Mac Index, Russia is 43% more expensive than India. Consequently salaries are 43% more expensive, but components are only 21.5% more expensive in Russia than in India.
The Arjun MBT starts at 50% indigenous by value. 5% of the taxes generated as a consequence of domestic production of the Arjun are ploughed back into R&D for the same programme.
This R&D results in an incremental 1% indigenisation each year, in addition to capability improvements.
Per unit cost for both products goes up by 4% per year, but incremental indigenisation reduces the impact.
The total number of units purchased each year is the same for both the Arjun Mk.1A & the T-90MS.
Shaunak Agarkhedkar writes spy novels. His first two - Let Bhutto Eat Grass & Let Bhutto Eat Grass: Part 2 - deal with nuclear weapons espionage in 1970s India, Pakistan, and Europe.
Shaunak, use Arena, not python