Higher FDI in Defence May Bring Benefits
The Union Cabinet approved a policy for raising the cap on foreign direct investment (FDI) through automatic approval in the defence sector to 74% from 49%, on 18 September, while affixing a ‘national security’ clause to it. Foreign investments will be subject to scrutiny on grounds of national security and the government will have the right to review any investment that has a bearing on the country’s security.
Currently, 100 per cent overseas investments are permitted in the defence industry – 49 per cent is allowed under the automatic route but beyond that, government approval is required, in cases resulting in access to modern technology or for other reasons to be recorded.
While no reason for including the national security clause has been provided, it has been brought in since defence is a sensitive sector. The new condition of national security was proposed by the Ministry of Commerce and Industry. It says, “Foreign investment in the defence sector shall be subject to scrutiny on ground of national security and the government reserves the right to review any foreign investment in the defence sector that may affect national security.”
By bringing in a more liberalised policy, the government wants foreign original equipment manufacturers (OEMs) to shift operations to India. It also wants private entities to play a bigger role in defence production.
Earlier in May, finance minister Nirmala Sitharaman had announced raising the FDI cap in defence sector through the automatic route to 74%. Thereafter, a draft defence production and export promotion policy 2020 was released which spelt out the efforts made to liberalise FDI in the defence sector. It also spoke about how private investment in manufacturing facilities was being encouraged.
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The Centre is looking to ramp up manufacturing in the defence sector to Rs 1.75 lakh crore, including exports worth Rs 35,000 crore, by 2025. In the last year, production of defence equipment, such as aerospace and shipbuilding industry, stood at around Rs 80,000 crore, of which the contribution of public sector undertakings was around Rs 63,000 crore.
Fresh foreign investment of up to 49 per cent in a company not seeking a new industrial licence or which already has government approval for FDI in defence will also need to be cleared. The company has to declare to the defence ministry any change in equity or shareholding pattern or transfer of stake by the existing investor to the new foreign investor for FDI of up to 49 per cent, within 30 days of the change. These companies will need the government’s sanction for raising foreign investment beyond 49 per cent.
The government had in 2018 relaxed FDI rules in the defence sector by allowing foreign companies to invest up to 49 per cent directly. The move was aimed at boosting the domestic industry as India imports about 70 per cent of its military hardware.
Defence industries have since received FDI equity inflows of USD 9.52 million or Rs 57 crore) between April 2019 and March 2020, according to the government.
Commentary
The Indian defence industry was open to private sector way back in May 2001, allowing 100 per cent equity with a maximum of 26 per cent FDI, though subject to licensing from the government. The change in policy through resulted in some Joint Ventures (JVs) between Indian and foreign companies, but failed to attract any worthwhile FDI proposal to the government. Subsequently, the Ministry of Commerce and Industry had proposed to increase it to 74 per cent in 2010 and many other studies conducted at that time also indicated a need to increase in FDI minimum up to 51 per cent, as anything below that would not be sufficient to attract suitable companies to invest in India. However, the defence ministry at that time did not accept the proposal citing security issues.
The FDI limit was subsequently raised to 49 per cent in 2015 through automatic route and the government also undertook various other measures to make it more attractive for foreign investors, such as allowing higher FDI through government approval on a case to case basis for state of the art technologies (later amended to modern technologies), abolishing the Foreign Investment Promotion Board (FIPB), doing away with the requirement of CCS approval and requirement for single largest Indian ownership of 51 per cent, apart from doing away with the requirement of three year lock-in period for equity transfer by the foreign investor. The FDI up to 100 per cent was also offered in case of state of the art technologies, after government approval. However, in spite of all these measures the FDI in defence did not took off as envisaged, which has seriously hampered the indigenization efforts in the defence sector. The most important factor seems to be the minority shareholding of the foreign company which may not be ready to part with its technology without being able to control the decision making in the company.
Raising the FDI in defence to 74 per cent through automatic route seems to be a welcome step in the right direction. However, the success of the same will depend largely on its implementation by the government.
Implications
The reform is likely to attract many foreign companies to set up base in India, since it is seen as one of the growing economies in the world with vast scope for investment. The setting up of two ‘Defence Industrial Corridors’ in Uttar Pradesh and Tamil Nadu announced by the Government in Jul 2019 is also likely to immensely benefit from this move.
The foreign companies were averse to transfer modern technology so far without being the major shareholder, which would be feasible with the changes in FDI limit. India is lagging in development of modern technology and the only way to bring the latest technologies is through the setting up of subsidiaries by foreign vendors through JVs with Indian companies in India, which have now been facilitated through increased FDI share. The imported technologies can become the base for further development of technologies in future.
The draft Defence Procurement Procedure (DPP) – 2020 released in Mar 2020 for public comments has added a new category Buy (Global–Manufacture in India), which mandates 50 per cent indigenous content achieved in the manufacturing of either the entire equipment or spares/assemblies/sub-assemblies/Maintenance, Repair and Overhaul (MRO) facility through the Indian subsidiary. The change in FDI policy will further encourage foreign vendors to set up subsidiary in India and participate in the procurement though this route.
Setting up of foreign defence companies in India will also require a eco-system to procure spares and parts from the local manufacturers to cut down on the cost of the equipment, which is likely to facilitate defence manufacturers involved with low-end technology to provide necessary spares. This will develop a defence eco-system in the country which will come very handy in times of crisis as the spares will be available locally. This will also assist in providing a better life time support to the equipment.
As per SIPRI, India has been the second largest importer of Defence Equipments in the world. As per estimates, India spends approx$100 bn in defence contracts per year. An indigenous defence industry will not only facilitate getting a portion of this money back in Indian economy through procurement of equipment manufactured within the country but will also facilitate creation of large number of jobs and infrastructure which will also facilitate further economic growth of the nation.
Negative Impact
The biggest apprehension of MoD against raising the FDI has been the likelihood of a foreign company being controlled by a foreign government shutting down its facility in times of emergency. Though the concern is valid, it needs to be understood that a facility existing within the country will be governed by Indian laws and is always better than importing weapons and equipments from another country. Notwithstanding, the government will need to include some favourable clause with respect to dealings during national emergencies.
Adverse effect on growth of indigenous industry has been another issue of contention discouraging increase in FDI over the years. However, the issue is more applicable to countries which already have developed home grown technologies. In our case, the DRDO, DPSUs and even the private defence sector have failed to develop any worthwhile technology and in all likelihood sourcing high end technologies through increase in FDI will act as catalyst for future development of in-house technologies within India.
