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Defence investments under attack

A proposal of the department of industrial policy and promotion (DIPP) to increase the FDI cap in defence came under immediate attack. The ministry of defence believes that our defence sector is not mature enough to handle increased foreign investments.

The DIPP for its part, through a discussion paper recently issued, was hoping for an informed debate on the increase, and acknowledged that defence being a sensitive sector, the views of the ministry are essential. But no one expected such immediate rebuke, especially since India is one of the largest global military spenders and nearly 70% of our defence requirements are met through imports.

Currently, under the consolidated FDI policy (Policy), foreign investments up to 26% are permitted in the defence industry with government approval. Such investments are subject to the defence procurement policy (including the offset requirements therein), obtaining an industrial licence and certain conditions contained within the Policy.

The applicant must be an Indian company/partnership and the management of the applicant company/partnership should be in Indian hands with majority representation on the board, as well as the CEO of such applicant, should be a resident Indian.

To check fly-by-night operators the conditions stipulate that antecedents of the foreign collaborators be thoroughly reviewed, including a review of the adequacy of the net worth of the foreign investor and preference would be given to original equipment manufacturers.

And while the defence ministry does not give any purchase guarantees, the conditions do specify that the arms and ammunition produced by private manufacturers will be sold primarily to the ministry or other government entities.

The Confederation of Indian Industry (CII) has for long advocated an increase in defence sector FDI. It recently conducted a survey which favoured increasing the cap to 49% as the industry itself did not want 100% foreign investments. The survey suggested that increase in FDI caps should be subject to the proposed joint venture (JV) engaging in joint R&D and any resultant intellectual property vesting with the JV company.

It also suggested that subject to regulations, the foreign partner should ensure that the JV has access to global markets for the domestically produced goods and the foreign partner should bring in specialised technology not available locally to manufacturers.

The CII survey also noted concerns of foreign companies: not having control of any proposed venture, where their technology is licensed, coupled with the current 26% investment cap made investments in this key sector commercially unattractive.

To address these concerns, the DIPP discussion paper analyses the domestic defence production and notes that it mostly takes place either through ordnance factories (OF) or defence public sector undertakings (DPSUs).

There is acknowledgement that most equipment manufactured by them is obsolete and there is urgent need for modernisation by acquiring state-of-the-art technology.

Therefore, either our dependency on imports can rise or we accept the realities and allow private players to enter by making it a viable business option for them.

Is resistance to greater private sector participation in defence out of concern for these DPSUs and OF or ideological? As the discussion paper notes, if imports continue at their current level, these government-controlled entities would get marginalised.

Arguably, if greater investment in the sector were permitted, then the foreign companies would most likely collaborate with the DPSUs and OF who better understand the nuances of doing business in India.

Does the concern for any reason stem out of protecting India’s sovereign status? The reality is that in contrast to imports, having domestic manufacturing facilities located in India and subject to domestic Indian laws is perhaps most desirable.

Self-reliance in defence is largely a function of indigenisation of defence production. And this could potentially be achieved by domestic businesses wanting to play a larger role in the sector, coupled with foreign companies willing to make the investments required.

Therefore, the real debate is not whether to increase FDI, but on the incremental advantages between raising the cap to 49%, as proposed by CII, or increasing it to 51% or beyond where proprietary information of foreign companies is within their control.

Legitimate apprehensions about majority ownership of sensitive defence companies being in the hands of foreign players and exports to enemy countries can both be addressed by more stringent licensing and export control regulations.

The European Union and US, both of which allow 100% FDI in their defence, have had success with such stringencies.

Eventually, just as India’s defence sector craves for state-of-the-art technology, it’s also time to embrace modern-day investment practices by considering the business case for greater FDI in defence.

First Published in the Economic Times on June 07, 2010

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