The Indian industry does not have the wherewithal and the foreign companies know that the largest importer of arms hardly has the required technological or manufacturing base. Both have thus come together to pressurise for increase in FDI.

Opening up of the defence industry to the Indian private sector in 2001 with 100 per cent equity and 26 per cent foreign direct investment (FDI) has not achieved any results of significance even after a decade. India’s defence industry in the private sector is still at a nascent stage. It requires heavy investments and infusion of high technologies to produce relatively small numbers. Despite repeated industry-friendly improvements to the Defence Procurement Procedure (DPP) and Production Policies, the momentum is lacking. Foreign defence industry majors intending to make investments have been seeking increase in FDI to 74 per cent to gain control. Currently, the government is considering revision of FDI limit only to 49 per cent. The potential in the defence industry is significant as India is likely to spend over $100 billion ( Rs. 5,50,000 crore) in the next five years on acquisition of military hardware.

The Indian industry does not have the wherewithal and the foreign companies know that the largest importer of arms hardly has the required technological or manufacturing base. Both have thus come together to pressurise for increase in FDI. ‘Reliable’ foreign companies may soon invest in Mahindra Aerospace, Larsen and Toubro (L&T), Tatas and Reliance. The Prime Minister himself has raised hopes in the Confederation of Indian Industry (CII) national conference. The Commerce and Industry Minister Anand Sharma also supports the proposal. Finance Minister P. Chidambaram backs increase in FDI as a means to finance the yawning current account deficit. CII President S. Gopalakrishnan has sought a long-term FDI policy for the defence sector to encourage multinational firms to set up shop here.

International Practices

Nations permitting FDI in defence have always retained the ‘ultimate’ veto share. BAE has a restriction of 15 per cent FDI stipulated by the British Government. The French Government is opposed to foreign investment above 10 per cent in Thales. The Italian Government is required to clear foreign investment above three per cent in its defence industry. Finland, Lithuania and Slovenia prohibit FDI from outside the NATO or the European Union. In Austria, Spain and Sweden, foreign investment requires government approval on case-bycase basis. In UK and Germany, foreign acquisitions in defence-related industries require government approval. The US Government monitors closely all defence firms irrespective of domestic or foreign equity and restricts FDI if it threatens national interest.

Arguments for FDI

Defence technologies developed after years of investment in research and development (R&D) are the preserve of the few and not to be parted with easily. Foreign investors welcome the thrust on higher indigenous content. As it is cheaper to manufacture in India and also as Asia offers huge market potential, India could actually be developed as an export hub. Maintenance, repair and overhaul (MRO) is another area attractive for investment. India needs investments and the West requires markets, a win-win situation for both.

Arguments against FDI beyond 49 per cent

High levels of FDI could have implications for national security. Foreign control could throttle defence supplies, retard local development through infusion of only low-end technologies or restrict technologies of critical components. There may be uncertainty about assured supplies during operations. The recent UN Arms Trade Treaty could also put restrictions on foreign companies to transfer certain technologies to developing countries. Experience shows that that high percentage of offset obligations is a better route to secure joint manufacturing and co-development than FDI.

Way Forward

Notwithstanding the apprehensions, it is not easy for a foreign investor to antagonise the local government which can easily put export restrictions and cancel local orders. The important consideration is that the indigenous industry must have a better than level playing field. Unlike foreign institutional investments, FDI cannot be pulled out. The Indian Government must retain oversight rights even if it means a golden ‘veto’ share, monitoring equity transfers closely and specifying restrictions. The government must have its representatives as members on the board and can veto critical appointments. As the subject is complex, a firm-footed approach is the need of the hour. For the way ahead, read Forum.