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Impact Analysis: Foreign Investment in Defence

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The recent move to permit FDI beyond 49% through government approval route, including manufacturing of Small Arms and Ammunitions covered under Arms Act 1959, would open up larger participation and will allow most leading defence companies to come in unhindered. An analysis…

India's defence industry, held under leash for long because of a conservative approach and protective regime. To develop a viable relevant, sustainable and globally competitive defence manufacturing industry has to be through orders, investments and technology.  While we have enough in house market, but the other two main factors investment and technology need to be boosted. The government willingness to rationalise policies perspective in tackling these issues logically has displayed a very clear focus and a mindset that is beyond the traditional, to remove the bottle neck of investment and technology.

Till recently the FDI regime permitted 49% FDI participation in the equity of a company under automatic route. FDI above 49% is permitted through Government approval on case to case basis, wherever it is likely to result in access to modern and 'state-of-art' technology in the country. The foreign OEMs were reluctant to bring technology unless they have the controlling share in management. We have hardly seen any substantial inward remission of FDI while it was increased from 26% to 49%. As per DIPP the amount of FDI Inflows (April 2000  Mar 2016) has been:

Although number of JVs have been reported to be formed in the recent past for Technology Sharing and investment, most of them with Public sector such as HAL, BEL and a few with Private sector. The exact outcome of technology transfer is yet to be visible; however some specific cases are indicative of Technology absorption by Private sector (who were considered novice in defence technology):

  • TASL is in global supply chain of Aero-subsystem through partnership with OEM such as Sikorsky and Lockheed Martin, Nova etc.
  • Upgrade of Armament Platform such as AD Guns, Integration of 155 mm Arty Guns by Tata Power SED, Bharat Forge and L&T.
  • Technology absorption and development by SME such as Samtel, Zen Technology, Astra Microwaves, Alpha Design technology etc.

The New Provisions

Under the earlier policy, an OEM or manufacturer looking to set up a wholly owned subsidiary required approval from the Cabinet Committee on Security. This entailed getting a clearance from various ministries and proving that the technology/product sought to be manufactured was modern and state of the art. The following changes have inter-alia been brought in the FDI policy in this sector in June 2016:

  • Foreign investment beyond 49% has now been permitted through government approval route, in cases resulting in access to modern technology in the country or for other reasons to be recorded. The condition of access to 'state-of-art' technology in the country has been done away with.
  • FDI limit for defence sector has also been made applicable to Manufacturing of Small Arms and Ammunitions covered under Arms Act 1959.

There may be several genuine reasons for the government to allow more than 49% stake to the foreign OEMs in a joint venture with an Indian company and they want to take advantage of these for the benefit of the indigenous industry. By including "modern technology" as a criterion for allowing 100 percent FDI, would open up larger participation. However the investors will need clarity about the terms like modern, 'state-of-the-art' and Govt route which are subjective. Most foreign companies were wary of using this provision to ask for higher FDI; however, easy terms like 'modern technology' and 'other reasons' will allow most leading defence companies to come in unhindered. All defence technologies are modern by their very nature. Although the new rules provide flexibility in examining proposals and giving approvals quickly and it will also allow the government to look at proposals at more proactive basis.

This decision to allow 49% FDI in manufacturing of small arms and ammunition under the automatic route is expected to attract major Small Arms manufacturing firms to India, which has a huge requirement of firearms for the Armed Forces, Paramilitary as well as Police forces. It is likely to usher in a major boost to the small arms manufacturing sector. The private sector has been striving to share the workload of the OFB (Ordnance Factories Board) for small arms and ammunition manufacture, but the ambiguity in policy prevented it from doing so.

Change in the norms will increase the level of comfort of foreign companies whose Intellectual Property Rights (IPR)-related concerns were holding them back. This would save the foreign OEMs time spent on lengthy negotiations with Indian companies. OEMs are aware that they need to tie up with Indian companies and the latest FDI relaxations will ensure a level playing field.

An added benefit of the new initiative will be encouraging defence exports. Removing the provision that required OEMs to prove that their products are modern and state of the art, will allow these companies to relocate production of slightly older and off-the-shelf products to India, which was not possible earlier.

Hopefully with increase in FDI to 100% the inflow of funds and technology will get a boost. However, it must be borne in mind the investment does not enter a country on its own just because its government has made an enabling declaration. The foreign defence manufacturer will take time to take such decisions. There are several other issues involved. For example, there are sector specific matters more so in defence production. Setting up the plant and starting production can take many years, adding to the risk faced by an OEM as manufacturing a piece of defence hardware is a costly affair. These manufacturers are not about to start manufacturing anytime soon. The case of investing in Indian defence companies has just started and don't have infrastructure and existing orders.

The Ministry should encourage development of sub-systems and equipment by Indian firms within the shortest possible time and make the procedure for procurement easier. The recent changes in Defence Procurement Procedure 2016 are expected to unleash the talent of committed Indian R&D firms into the defence space. Even companies that have been doing outsourcing work for defence will find it worthwhile to start developing products for the Indian market where the margins will be healthier and purchase process much improved.

Other Perspective

The industry has viewed this fresh move with caution as 100 percent FDI was already allowed in the defence sector with a rider that it would consider cases that brought in "state-of-the-art technology" to the country. There is clamor that increase in FDI limit in the defence sector may not be in the long-term national interest and surely will be a disaster for the country's attempt to build self-reliance.

Admittedly there are some areas in defence where companies have developed capabilities in cutting edge technologies and have competed with the world's best and won orders. Allowing higher FDI than 49% will kill Indian R&D especially as the foreign OEMs will target such budding capabilities. Indian industry needs support at this crucial juncture and keeping FDI below controlling limits would be one of the ways to support it.

This decision could force Indian companies to re-look at their plans as it reduces the dependence of original equipment manufacturers (OEMs) on domestic manufacturers and could mean that Indian companies that were rushing to tie up with OEMs in expectation of future business may find that their partners choose to enter the market on their own.

This could also mean greater competition for domestic firms. Under the previous rules, foreign OEMs were required to form joint ventures with domestic firms if they wanted to establish a manufacturing base in India. With the amendment, an OEM can independently plan and implement operations in India. The 2016 iteration of the Defence Procurement Procedures (DPP) has defined an Indian company to include within its scope wholly owned subsidiaries. With the amendment, foreign OEMs and manufacturers can compete in the Indian defence procurement space similar to Indian companies.

However, some feel that there's no material change in the policy, it's just the semantics they have replaced 'state of-the-art-technology' with 'modern technology' and is unlikely to make any visible change in the flow of technology or investments as it fails to address the 'missing link' with regard to a procurement policy. It has no enabling factor which assures the investors that the government will source from them.

Sum Up

India is moving in the right direction on liberalising its foreign investment regime. This is an ongoing process in which governments have moved in an incremental fashion. Few of Indian firms are of the opinion that a 100% FDI in defence will create a win-win situation for the country's defence forces, local industries and international OEMs and it will ensure availability of cutting edge technologies for the defence forces, boost local manufacturing in India and provide assured returns for international OEMs. Indian firms may not take too much of a hit from the new policy, which clarifies that FDI will be allowed only for technologies that are not available in India. Defence Minister Manohar Parrikar has gone on record to state that the government would not mind giving 100% FDI in a venture that would make manufacture fighter planes in India.

This policy is expected to give fillip to India self reliance efforts through robust traction to Make in India. Past experiences shows it is an arduous path with many institutional deficiencies, institutional integrity and multi-ministry competence. Need to have rigorous introspection about existing inadequacies and govt based Departments in Defence, R&D and Production units. These needs to be dis-aggregated and re-casted, including the creation of accountable defence procurement cadre, on the lines of successful models that exist in other countries. This is all the more important as the defence budgets likely to shrink in real terms in years to come.

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