Saab has become the first foreign company to bag 100 per cent FDI in India’s defence projects. Saab’s FDI proposal, valued under Rs 500 crore, was cleared in October. India now allows up to 74 per cent FDI in the defence sector under the automatic route, with clearances beyond that available on a case-by-case basis. However, the clearance rules were relaxed in 2015, still, no foreign firm was able to get permission for 100 per cent FDI in defence. The nod for 100 per cent FDI is a significant development, reflecting the country’s willingness to attract foreign investment and expertise to boost its defence manufacturing capabilities and technology transfer. Also, the move can potentially lead to increased collaboration and tie-ups with global defence companies, contributing to the modernisation of India’s defence industry.

The company will set up a new facility in the country to manufacture shoulder-fired rockets. A new company – Saab FFV India has been set up by Saab – to make the latest generation of the Cal-Gustaf M4 system. This will be the first time Saab will manufacture shoulder-fired rockets outside Sweden. The shoulder-fired rockets are already in extensive use by the Indian armed forces. And, they can be even exported once local production begins.

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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.

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Nirmala Sitharaman, herself a former defence minister, allocated to defence Rs 471,378 crore, an increase of Rs 22,558 crore over the current year’s revised estimate of Rs 448,820 crore. This includes the outlay for revenue and capital expenditure, as well as military pensions. It works out to be 15.4 per cent of the country’s entire budget. If pensions are excluded, the defence budget was increased to Rs 3,37,553 crore, up from Rs 3,18,931 crore for the present fiscal ending March 31, 2020. This is a meagre 5.8 per cent hike.

Indian Army, Air Force and Navy which are facing a combined challenge from Pakistan and China, got just Rs 10,300 crore hike in funds to buy new arms and ammunition in the Union budget which could adversely impact their modernisation plans.

The salaries of the three Services and the civilians concerned work out to be Rs 1,34,989 crore, which now form 39.99 per cent of the budget. In other words, salaries and pensions take up more money than what is allocated for modernisation.

The forces have been demanding an increase in funds allocation to buy new weapons.  The Union budget has kept Rs 10,532 crore for defence research &development.

Army

The army has got the largest hike in capital spending, but this 8 per cent rise of Rs 2,669 crore will be insufficient to pay for the artillery guns, tanks and air defence systems the army badly requires.

Indian Army was also forced to cut some expenditures to ensure that it has ammunition for at least 10 days war.

The budget has allocated Rs 32,392 crore to the Indian army for its modernisation plans against Rs 29,666 crore given in the revised budget last year.

Navy

There is disappointment for the navy. Indian Navy has been given just Rs 26,688 crore in 2020-21 budget for modernisation against Rs 26,156 crore in the revised budget last year, despite public statements from senior admirals, including navy chief Admiral Karambir Singh, seeking a larger share of the defence budget.

Without that, the navy says it will be in no position to process important procurements – such as the production of six advanced submarines under Project 75I and the building of a second indigenous aircraft carrier to follow INS Vikrant, which Cochin Shipyard Ltd is likely to deliver next year.

A shortage in funds is forcing Indian Navy to curtail its plan to be a 200 ships fleet by 2027 as per maritime capability perspective plan. It has already cut some of the acquisition including Mine Counter Measure Vessels and P8i maritime reconnaissance aircraft.

Air Force

The Indian Air Force (IAF) has again been allocated the lion’s share of the capital budget – Rs 43,282 crore, much of which will go towards instalments on earlier procurements, such as the 36 Rafale fighters that will begin delivery this year. However, this is lower than the IAF’s allocation of Rs 44,869 crore in the current year’s revised estimates.

IAF, which is in the process of buying new Rafale aircraft and also needs more fighter jets to replace its ageing aircraft, has actually seen a slight decrease in its  capital outlay for modernisation.

Capital Expenditure

The capital allocation used for purchase of new weapons, aircraft, warships and other military hardware like guns and new UAVs is Rs 1,13,626 crore. This means modernisation gets an increase of Rs 10,316 crore over this year’s allocation of Rs 1,03,310 crore.

Despite the large number of weapons systems due for procurement, the capital allocation has been raised only marginally in 2020-21. That rise of less than three per cent is insufficient to even cover inflation and forex exchange rate slippages. The military will, therefore, have less buying power next year.

The government has allocated Rs 32,392.38 crore ($4.5 billion) for meeting the Indian Army’s capital expenses, of which Rs 4,000 crore ($560 million) has been earmarked for buying military aviation assets for the land forces.

The Indian Navy has got Rs 26688.28 crore ($3.73 billion) for new purchases, of which it is expected to spend Rs 12,746 crore ($1.78 billion) for building its naval fleet.

The IAF has got lesser capital allocation for the next fiscal at Rs 43,281.91 crore ($6 billion), which is already Rs 1,587.23 crore ($222 million) less than the current fiscal’s revised estimates. A major chunk, Rs 26,909.88 crore (3.76 billion), will go towards aircraft and aeroengine purchases in 2020-21.

Revenue Expenditure

The rest of Rs 209,319 crore (over $29.3 billion) will go towards revenue expenses, which is usually for meeting recurring expenses such as on maintenance of infrastructure, replenishment of existing weapons and equipment, and for capacity building. In the 2020 fiscal, under revised estimates.

Major Purchases

The Indian Army is already in the process of acquiring six Boeing Apache gunships and is negotiating the purchase with the global vendor under a follow-on order for the 22 Apaches bought by the Indian Air Force.

The Modi government had in 2016 ordered 36 Rafale combat jets from France and the deliveries of the aircraft began last October. The budget for the aircraft will go towards committed liabilities such as the Rafale purchase.

Pensions

The budget for pensions has been hiked by Rs 21,742 crore and is now pegged at Rs 1,33,819 crore. This year, a sum of Rs 1,12,077 crore is earmarked for pensions.

Worryingly, the only appreciable rise in spending is in defence pensions, for which the allocation has risen by almost 14 per cent to Rs 133,825 crore for 2020-21. This raise comes on the back of a an even larger 16 per cent raise this year, over the 2018-19 pension allocation.

Since the grant of “one rank, one pension” in 2015-16, the military pension budget has more than doubled from the level of Rs 60,000 crore in 2015-16.

To put this in perspective, India spends more on its defence pensioners than Pakistan’s defence budget (Rs 1 lakh crore this year). India has approximately 26 lakh defence pensioners and each year it adds 55 lakh pensioners to this total. Five-yearly revisions in pension – the One Rank One Pension (OROP) – granted by the government in 2015 – means that the pension burden is only set to increase.

Comments

The MoD is looking at “right-sizing” the forces and also at cutting costs within. The Army has already started the restructuring process.

The defence budget amounts to 15.5 per cent of the government’s total spending of Rs 3,042,230 crore next year. That share of government spending is significantly lower than this year’s share of 16.6 per cent, the 17.4 per cent share in 2018-19 and the 17.7 per cent in 2017-18.

With this, the plans of the armed forces for modernising their weapons and equipment with new acquisitions can take a backseat for the next fiscal at least.

In a tell-tale sign of how this defence budget is perceived, defence minister Rajnath Singh had not a single word to say about the allocation for the armed forces in his eight-paragraph statement on the annual budget itself. The statement came in the form of a text message to the media from the ministry’s official spokesperson.

The three Services have been pressing for higher allocations to carry forward their long-pending modernisation plans and go for big ticket acquisitions in view of fast changing security matrix in the region including China further boosting its military might.

The expectations for higher allocation rose after last year’s Balakot strikes. Military experts said though the allocation was inadequate in view of the demands of the three forces, the outlay was satisfactory considering the state of the country’s economy.

The military was hoping for healthy increase in defence funding as several modernization programmes have to be implemented – ranging from artillery guns and helicopters to fighters and submarines. The armed forces will have to prioritise their purchases given that the available resources are inadequate.

A parliamentary panel has asked the defence ministry to “strongly press” for additional funds from the finance ministry to enable the military to buy new equipment and also pay for weapons and systems it has already contracted to purchase, at a time when the armed forces projected a combined requirement of almost Rs 1 lakh crore more under the capital head for 2019-20.

The Army accounts for a lion’s share of the budget – over 56%. This year’s defence budget saw an increase of Rs 2,500 crore in the Army’s capital budget (when compared to revised estimates of last year’s defence budget). The IAF, in sharp contrast, saw capital budget slashed by Rs 1,200 crore.

For a nation that allocates 15.49 per cent of federal government’s total annual expenditure, India’s bid to strengthen its defence exports is rather an expectation than innovation. It only serves the country well to foresee itself excel in defence exports, especially when our net exports stands at a negative trade balance of $184 billion in 2018-19.

Taking pride in its defence capabilities, India can aspire for a larger role in defence export on the global front. Developing artillery guns, aircraft carriers, light-combat aircraft, submarines and combat helicopters will make India a manufacturing hub in defence on the global scale. The prime minister spoke of expanding the export of defence equipment to Rs 35,000 crore, at Defexpo show in February, mentioning how it had risen from Rs 2,000 crore in 2014 to Rs 17,000 in the last two years.

Boosting the Make in India sentiment for defence equipment not only decreases India’s imports in defence but also pushes its exports – which will help reduce the negative export balance. A call for defence investors is also a plus for India in the current economic outlook. Defence remains a lucrative sector and investor sentiment will be favourable despite dull economic growth that has played a pivotal role in shooing away investors and further adding to the misery of the investment-starved economy. A conducive business environment, efficient supply-chain and logistics supported by state-of-the-art infrastructure is perhaps the package which will put India in a position of advantage. Defence, then, can become a trump card. Expanding its defence exports will be a major plus for India. It will help reduce the net exports negative balance.

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Defence, Aerospace Got Rs 1,800 cr FDI in 5 Years

Defence and aerospace sectors, the corner stones of the government’s ambitious Make in India programme, garnered relatively miniscule foreign direct investment (FDI) in the last five years.

While the country attracted FDI valued around $286 billion in the past five years across sectors, defence and aerospace, which were projected as high potential sectors under ‘Make in India’, could grab only a measly Rs 1,834 crore, according to government data released on 10 February.

The government had also announced two defence corridors – in Tamil Nadu and Uttar Pradesh. While launching the Tamil Nadu Aerospace and Defence Industrial Policy at the Global Investors Meet in Chennai in January 2019, the then defence minister Nirmala Sitharaman had said: “…by announcing the corridor, we have invited quite a lot of manufacturers from abroad to come, choose the location where they want to establish their unit and start producing defence equipment”. But the investments are still nothing worth writing home about.

As per the data furnished by 79 companies operating in Defence and Aerospace sector, so far, FDI inflows of over Rs 1,834 crore have been reported after 2014 under both government and automatic route.In May 2001, the defence sector, until then reserved for the public sector, was opened up for 100 per cent Indian private sector participation and foreign direct investment up to 26 per cent.

Further, the government later allowed FDI up to 49 per cent under the automatic route and above 49 per cent through the government route wherever it is likely to result in access to modern technology or for other reasons to be recorded.

The government had envisaged that by allowing higher FDI in the defence sector, the global companies having high-end technologies can be encouraged to set up their manufacturing base in India in collaboration with Indian companies, thereby, resulting in creation of employment opportunities, saving foreign exchange and increasing indigenisation.

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