As per a KPMG study, while six of the world’s top ten defence spenders are reducing budgets, India is among the few doing otherwise with 70 per cent of defence equipment being imported. India will spend over $300 billion ( Rs. 16,50,000 crore) till 2020 on defence equipment. It is time to get the act right to reduce the massive outflow of foreign exchange.

Is FDI the way forward?

Neelu Khatri, Head of Defence Advisory Services at KPMG, said, “India is a lucrative low-cost manufacturing and engineering service base. The market presents significant opportunities to both domestic and international players. Till domestic supply chain, infrastructure and technology support are developed, we will continue to be dependent on the global integrators.” She hoped though that the new Defence Procurement Procedure (DPP) does not turn out to be a licence raj all over again.

Ashok Saxena, Director UK Advanced Engineering, says that the recent changes to DPP have brought the private sector nearly on par with defence public sector undertakings (DPSUs), but they need the money to compete. “If the private sector does not come forward, offset obligations will be difficult to implement. This is a chance of a lifetime and India cannot afford to miss it,” he adds. R. Sundaram, former Member, Ordnance Factories Board, stated in a leading Indian newspaper, “We started off well in the initial years setting up massive DPSUs that made aircraft, frigates and tanks; but somewhere on the way our spirit of ‘we can do’ ebbed. Seed for conflict is that the military wants the best and the civilian establishment wants it to accept what can be produced. It is debatable if the new DPP will reverse the ratio of imports to local manufacture, which is static since 1998 at 70/30. Recommendations of the Rama Rao Committee to privatise sections of Defence Research and Development Organisation (DRDO) and the Kelkar Committee to corporatise ordnance factories need action. Only 29 per cent of DRDO products have entered service in the past 17 years.

The US Deputy Secretary of State, William J. Burns, while intercating with the media on May 10, 2013, said, “After our historic Civil Nuclear Agreement in 2008, our bilateral trade is likely to exceed $100 billion in 2013. The US defence sales to India already total some $8 billion. There’s a strong commitment to taking defence cooperation to the next level and that means moving ahead in co-production and co-development. Certainly, we think it’s very much in India’s own self-interest to look at ways to raise FDI cap to allow for greater investment.”

Defence analyst and former Vice Chief of the Air Staff, Air Marshal Vinod Patney said in a recent seminar, “The so-called ‘tried and tested’ course has not allowed us to progress in the past and is unlikely to be successful in the future. We have a vast pool of engineers and a genius for adaptability. Our manufacturing costs are low. Many Fortune 500 companies and major aerospace players have set up shop in India using Indian IT and engineering services. To my mind, we have no option but to increase FDI limits and enter into more joint ventures (JVs).”

FDI Contenders

Little-known companies in Bengaluru and Hyderabad are producing technologies that are used by foreign armed forces. Tonbo Imaging, founded by Arvind Lakhsmi Kumar, shifted to Singapore, as Kumar felt inhibited to enter the world market from here. Other than Tonbo Imaging for unmanned aerial vehicles (UAVs), some Indian companies that are engaged in cutting-edge work in defence include: Data Patterns for BrahMos, Captronic Systems for space programme, Maini group making components for Eurofighter and Airbus and Dynamatics Technologies manufacturing aircraft parts for Airbus. All could be great partners for foreign investors. “The best of our minds are utilised by other countries for their progress,” says A. Sivathanu Pillai, a scientist and CEO, BrahMos Aerospace.

Robert Metzger, an expert on Indo-US defence ties, says that the current 26 per cent cap is hardly a lure for foreign firms to set up shop and transfer high-end technologies. Protection of their Intellectual Property Rights (IPR) is another area of concern. Increase of FDI limit to 49 per cent will give foreign investors the confidence to manage business risks and set up industry in India to achieve the ‘Buy Indian’ goal in the long run. The Department of Industrial Policy and Promotion has suggested the FDI limit to be raised to 74 per cent and the proposal is under consideration by the government.

American Defence Strategist Edward Luttwak says, “China more freely imports military hardware while it continues to build local industry. Privatisation of the Hindustan Aeronautics Ltd. (HAL) should be India’s top priority.” A senior defence company official is reported to have said that in negotiating the bottlenecks in India, several companies have developed ‘India fatigue’.

However, in anticipation, some companies have already formed JVs: Mahindra Defence Systems with BAE Systems and Seabird Aviation; L&T with EADS, Raytheon, Boeing, RAC MiG, Saab Gripen; Tata Advanced Systems with Sikorsky Aircraft Corporation, Boeing, Israel Aerospace Industries; HCL with Boeing and Circor Aerospace.

Government Choices

According to the Ministry of Defence (MoD), around 75 private companies have till date received 135 industrial licences for production of a variety of defence systems and subsystems. These pertain to some high technology items, including armoured and combat vehicles, radars, electronic warfare equipment, warships, submarine, avionics, military aircraft, safety and ballistic products, armaments and ammunition among others. As per the “Ten Year Plan for Self-Reliance in Defence Systems”, which was formulated in the early 1990s, the import content of defence procurement were to be brought down to 30 per cent by 2005. As per the Defence Standing Committee Report to the Parliament, the self-reliance index is still hovering around 30 per cent. Indian Ministry of Science and Technology figures peg India’s overall research and development (R&D) expenditure at 0.88 per cent of the GDP. This is rather low compared with more than two per cent of GDP in most developed countries.

FDI caps are pegged broadly at five levels—26, 49, 51, 74 and 100 per cent. D.S. Rawat, Secretary General, the Associated Chambers of Commerce and Industry of India (ASSOCHAM), finds no reason why India cannot allow 100 per cent FDI in defence sector. Other industry chambers, the Confederation of Indian Industry (CII) and the Federation of Indian Chambers and of Commerce and Industry (FICCI), have supported a smaller hike up to 49 per cent in order to safeguard Indian interests. The Naresh Chandra Committee report on the ‘National Security Apparatus’, had also recommended increase in FDI to attract better technologies. Recently, the US Deputy Defense Secretary, Ashton Carter, had also suggested that if India increases FDI ceiling, it would increase commercial incentives for global firms planning to invest. The record high current account deficit, which is expected to touch around five per cent of GDP in the current financial year, has accentuated the need for the steady inflow of capital. In a letter to Defence Minister A.K. Antony, Commerce and Industry Minister Anand Sharma requested reconsideration of the proposal by the Department of Industrial Policy and Promotion to raise the FDI cap in defence sector to at least 49 per cent. With reports in the Indian media that the country plans to liberalise FDI norms, Russian business houses are looking at new windows of opportunity. This could be a big boost for companies like Sistema in expanding cooperation in the defence sector.

India’s first special economic zone (SEZ) for aerospace in Belgaum, Karnataka, was inaugurated in November 2009. The government is considering the establishment of dedicated SEZs on similar lines, catering specifically to the defence sector, providing a suitable tax-friendly environment and also aid in promoting export of products and services.

On May 17, at the Defence Expo, Suraksha 2013, in Kerala, the then DRDO Chief V.K. Saraswat gave a strong dissent and said that raising FDI cap would lead to foreign control over indigenous capability. This was well countered and a question was raised, “Where is the indigenous capability?” The Wall Street Journal mentioned about the report submitted by R.K. Mathur, the then Secretary Defence Production, to the Parliament on April 29, that stated, “The stand of the Defence Ministry has always been that beyond 26 per cent FDI at this stage, would be a compromise on the security of the country. Whether it is 49 or 74 per cent, we believe that there would not be full transfer of technology (ToT).” Mathur is right that implementation of ToT has been poor.

Will the government be able to push through FDI in a sensitive sector such as defence in the pre-election year? We need to wait and watch.