It may be in India’s interest to cross the two per cent barrier and allow up to 51 per cent stake sooner than later

Increase in the limit of foreign direct investment (FDI) limit from 26 to 49 per cent for the defence sector is a step in the right direction and welcome. This step broadens the envelope for India’s vibrant private industry to tie-up with international original equipment manufacturers (OEMs) for opportunities where controlling stake is not central to the business case, especially in light of ‘Buy & Make (Indian)’ focus on defence procurement.

Just changing the cap from 26 to 49 per cent does not alter the control in the venture. Therefore, cases where the controlling stake is essential for the business case such as where cost of developing technology is not sufficiently liquidated or where control of intellectual property rights (IPR) is crucial, this change may not be sufficient to unleash a new wave of FDI. As the defence manufacturing industry is complex and requires significant investment in research and development, quality systems and manufacturing technologies, many OEMs may not risk loss of control in a venture by holding less than 51 per cent. Indeed, given the above, one school of thought is if 26 per cent cap has not yielded much investment, 49 per cent won’t either.

Also, a non-controlling stake would not necessarily encourage investments that are primarily meant for export-oriented manufacturing where OEMs like to set-up fully owned units to capture productivity and competitive benefits India offers without having to relinquish control on sensitive IPR.

Boeing has so far taken a non-equity route to partnership with the Indian industry. Over the years it has spent well over a hundred million dollars in supplier development, training, tooling and quality systems at Indian suppliers without taking an equity stake. Joint ventures (JVs) bring the complexity of governance, so to the extent possible, Boeing has attempted to maintain a straight supplier relationship while continuing to invest in their development. While Boeing’s investment in the Indian supply-chain may not count as FDI as it is not in the form of equity, it has been a significant contributor towards developing world-class capabilities in aerospace manufacturing at companies such as Tata Automation Limited (TAL), Dynamatic Technologies, Rossell Techsys, Hindustan Aeronautics Limited (HAL) and Tata Advanced Materials Limited (TAML).

India’s decision to liberalise FDI in defence to 49 per cent is a welcome step. We understand that on a case-to-case basis, the government may allow higher stake if that is in India’s interest – for cutting-edge technologies, manufacturing know-how and employment generation. Given the byzantine approval process for exceptions, it may be in India’s interest to cross the two per cent barrier and allow up to 51 per cent stake sooner than later.