Defence Industry

FDI in Defence: Dispelling the Myths
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Issue Vol. 28.3 Jul-Sep 2013 | Date : 08 Jul , 2014

India should adopt a flexible FDI policy to import much needed technologies which cannot be mastered through indigenous efforts in the acceptable time frame. Unfortunately, every time the issue of increasing FDI limit comes up, the opponents resort to their time-tested subterfuge of raising the bogey of security concerns and threat to indigenous industry, thereby hiding their selfish reasons. In any case, India can incorporate necessary security clauses in the initial license to ensure that an unscrupulous entrepreneur does not play truant in crisis situations. India should reserve the right to take over a facility if required in an operational emergency.

Most prospective foreign investors consider the Indian FDI policy in the defence industry to be dissuasive in intent and content…

India’s policy on Foreign Direct Investment (FDI) in defence industry is symptomatic of bureaucratic obduracy and perverse intransigence. Unwillingness to learn from experience has been the bane of Indian governance. Persistence with failed policy initiatives can never yield results. In May 2001, the defence industry was thrown open to the private sector. The Government permitted 100 per cent equity with a maximum of 26 per cent FDI component, both subject to licensing. Unattractiveness of the policy became evident in a short span of time. By 2004, Defence Minister George Fernandes was forced to admit in the Lok Sabha that India had received no FDI proposal till then.

Observing the lack of enthusiasm amongst the prospective entrepreneurs at Aero India 2005, Defence Minister Pranab Mukherjee considered it necessary to exhort interested foreign companies to invest in the Indian defence industry. As per the reports appearing in the press, India has received less than US$5 million of FDI inflow in defence manufacturing during the last decade. Most prospective foreign investors consider the Indian FDI policy in the defence industry to be dissuasive in intent and content.

In 2010, the Commerce Ministry circulated a note recommending the raising of FDI cap to 74 per cent to encourage ‘established players in the defence industry to set up manufacturing facilities and integration of systems in India’. It was vehemently opposed by the interested parties, with Ministry of Defence (MoD) insisting that the 26 per cent FDI limit should be retained. In May 2013, modifying his earlier proposal, Commerce Minister Anand Sharma suggested that the upper cap be raised to 49 per cent as a first step. It has also been shot down by the MoD. However, in a deft move, the MoD has suggested that higher FDI may be considered for modern and state-of-the-art technology by the Cabinet Committee on Security on a case to case basis.

The World Bank defines FDI as ‘net inflows of investment to acquire a lasting management interest (ten per cent or more of voting stock) in an enterprise operating in an economy other than that of the investor’. FDI comprises funds provided by the foreign direct investor to the FDI enterprise as equity capital, reinvested earnings and intra-company loans. Attractiveness of a nation for foreign investments in any sector is judged by its ‘FDI Confidence Index’ which depends on various factors such as stable policy, favourable investment climate, structural adjustments, economic freedom and a fair market access. India fares rather poorly on this account.

Unwillingness to learn from experience has been the bane of Indian governance…

As recounted earlier, it is an undisputed fact that the current Indian policy has been an abject failure. Whereas an intense debate is taking place to influence the decision makers, a number of articles are being planted in the media to sway the public opinion. Unfortunately, objectivity is conspicuous by its absence. Stakeholders have taken stands that suit their interests.

As the debate has been highly skewed, this article endeavours to remove some common misconceptions and put all issues in their proper perspective.

  • Misconception One: Indian policy is highly investor friendly and does not require any changes

The MoD continues to insist that the Indian policy is highly investor friendly and requires no changes. It attributes lack of response to ‘the individual entrepreneur’s decision depending on his commercial perception’.

However, a closer look at the policy reveals that virtually every provision is dissuasive in nature – management control of the company must remain in Indian hands with majority representation in the board. The Chief Executive has to be a resident Indian; a licensee can produce only the licensed products and in the sanctioned quantity and he can neither diversify nor enhance production without prior sanction. A foreign investor cannot transfer his equity before the expiry of the lock-in period of three-years. Even after that, such transfers have to be with the approval of the Government.

Although the Government can give no purchase guarantee, the proposed quantity for acquisition and overall requirements may be made known to the extent possible. The policy directive further stipulates that arms and ammunition will be primarily sold to the MoD. Their sale to other security organisations in the country and exports will be with the prior approval of the Government. Non-lethal items may be sold to non-Government agencies but with the concurrence of the MoD.

FDI is a need-based concept; whereas a host nation needs FDI for accelerated growth, prospective investors are guided purely by economic considerations…

Oddly, India expects a prospective foreign investor to be excited by such an asymmetrical policy wherein he is expected to invest his resources in a venture where he has no significant control, faces strict capacity/product constraints, gets no purchase guarantee and has no open access to other markets (including exports). It defies logic. Such a lop-sided policy can never attract FDI.

  • Misconception Two: Higher FDI limit is a threat to national security

When every other argument fails, the spectre of security concerns is raised by the interested elements in the MoD to stymie any proposal to raise FDI limit. Apprehensions are often expressed that during operational emergencies, foreign investors may shut down their factories and choke supplies to the armed forces. In his recent letter to the Commerce Minister, Defence Minister Antony has opposed the raising of FDI cap on grounds that the country could not afford to be dependent on foreign companies and be vulnerable to policies of their countries of origin in the field of defence on the long-term basis.

Presently, India is procuring all critical weapon systems produced/integrated abroad. It is not understood as to how India’s security would get threatened if the same weapon systems are produced/integrated in India. As a matter of fact, indigenous production will insulate India from unilateral imposition of embargos on contracted supplies by whimsical foreign governments. The degree of assurance and resulting comfort accruing from indigenous facilities will always be significantly more than dependence on imports. Additionally, indigenous manufacturing facilities will also ensure better life-time support including supply of spares.

As regards dependability during crisis situations, no foreign investor can risk loss of his total investment by shutting down his production facilities. Further, all major defence equipment producers follow ‘Global Factory’ concept, wherein various manufacturing functions are spread over a number of locations in different countries. When a major defence company invests in any country, it makes it an integral part of its overall production chain. In such a scenario, it is not easy for the company to shut down any facility and disrupt its worldwide production network.

If India is serious about attracting FDI in defence, it has to position itself as the most lucrative FDI destination…

Most importantly, adequate safeguards can be incorporated while issuing licenses. India can reserve the right to take over the licensed facility under certain extraordinary circumstances of national emergencies. Most nations include such an enabling provision. It is ridiculous that imports are considered more reliable than production in India. Needless to say, security concerns are overhyped to perpetuate status quo by entrenched interests by resorting to specious logic. Fears expressed are totally unfounded and highly exaggerated.

  • Misconception Three: Investment decisions are taken by foreign companies and India has no role to play

It is often claimed by the MoD that foreign investors are guided purely by economic considerations and that they are neither influenced by the FDI limit nor by other provisions. If they wish to invest in India, the upper cap of 26 per cent will never be an impediment.

The above argument reflects ignorance of the dynamics of FDI flow. It is often forgotten that FDI is a need-based concept. Whereas a host nation needs FDI for accelerated growth, prospective investors are guided purely by economic considerations. As investible funds are limited, all countries covet them. Foreign investors carry out an inter-se appraisal of all likely destinations to determine the one that appears most lucrative for optimum returns. Therefore, every host country has to strive to project itself as the ideal FDI destination vis-à-vis other competing suitors.

It is prudent to understand what motivates an investor to invest his resources in another country and undertake risks associated with it. As investment in defence production means a lasting and protracted relationship, he seeks a stable environment with long-term, well-defined economic policies which are fair and consistent. In addition, there are four factors which influence such decisions – availability of abundant raw material, skilled work force, low cost of production and lucrative market. It is the interplay of all these factors which influence an investment decision.

If India is serious about attracting FDI in defence, it has to position itself as the most lucrative FDI destination with improved ‘FDI Confidence Index’. For that, it must make structural adjustment to provide functional freedom to joint ventures to respond to market dynamics.

FDI pre-supposes a long term commitment and lasting relationship between the foreign and local enterprise…

As regards the FDI cap of 26 per cent, no foreign investor is going to part with his closely guarded technology unless he has adequate control over the enterprise and is assured of sufficient autonomy as regards capacity enhancement and access to markets to ensure commercial viability through economies of scales.

  • Misconception Four: FDI will stymie the growth of indigenous defence industry

Defence Minister Antony’s statement that building up India’s own indigenous capabilities for designing and developing weapon systems is vital cannot be disputed at all. However, his assertion that allowing foreign companies to set up manufacturing/assembly facilities in India would be a retrograde step and stymie the growth of indigenous capability is certainly misplaced. He expressed apprehensions that such a move would perpetuate India’s dependence on foreign countries for modern weapons.

Further, the Defence Minister has expressed confidence in India’s capability to build-up defence industry through indigenous efforts, especially with the help of the private sector. According to him, only immediate requirement of weapon systems is being imported till India develops its own weapon systems.

It will not be incorrect to term the above optimism as a case of self-delusion. One has been hearing such declarations since early 1990s when confident predictions were made that defence imports would be reduced from 70 per cent to 30 per cent within a period of ten years. On the contrary, after two decades, imports have now climbed to close to 75 per cent.

A look at the dismal performance of the Defence Research and Development Organisation (DRDO) and the public sector hardly inspires any confidence in their capability to deliver. Both are equally responsible for the current abysmal state of affairs. Although DRDO has 51 laboratories with 5,000 scientists and over 25,000 support personnel, it has not been able to develop a single system in the promised time-frame and conforming to the accepted parameters. Mediocrity thrives due to lack of accountability.

Even after spending crores of rupees, the only success it has to its credit relates to replication of some imported products (fancifully called ‘reverse engineering’ and ‘indigenisation’).

India needs defence technology desperately…

Even if the DRDO is able to make some progress in a few cases, it is always done with major compromises with respect to the stated qualitative requirements. In most cases, by the time equipment is developed and delivered, it becomes obsolete. Thus, the services are forced to live with outdated and useless equipment.

As the performance of DRDO over the last five decades has been highly unsatisfactory belying all hopes of development of indigenous competence, it will be unrealistic to expect DRDO to change overnight and make India self-reliant. The defence public sector consists of nine defence public sector undertakings and 39 Ordnance Factories. Despite getting preferential treatment from MoD, it has singularly failed to keep pace with technological developments. It thrives on periodic infusion of transferred technology and has developed no indigenous competence at all.

Purchase of technologies under ‘Buy and Make’ route has failed to ensure infusion of meaningful technologies. Even Antony has admitted that India had not benefitted much from the transferred technologies. Most unfortunately, the Indian military is a captive customer of the Indian public sector and is forced to buy what it produces. With assured orders in hand, the public sector carries on with its lethargic and inefficient manner, without bothering about the quality parameters or the time frame.

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The views expressed are of the author and do not necessarily represent the opinions or policies of the Indian Defence Review.

About the Author

Maj Gen Mrinal Suman

is India’s foremost expert in defence procurement procedures and offsets. He heads Defence Technical Assessment and Advisory Services Group of CII.

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21 thoughts on “FDI in Defence: Dispelling the Myths

  1. Wow…Quite a capitalistic article Sir…!! This article suggests that the pose of argument is more important to you than the actual pursuit of truth. In fact your clever answers take precedence over profound questions.

    Do you know there is a country called United States of America in this world. If you do, than I suggest you to go through the country’s real history and current economics. US is the best example of a notion called THE MILITARY-INDUSTRIAL COMPLEX. This notion does not rise or occur accidentally. It is a consequence of industrialising the Military & Defence sectors. Despite having an infinite supply of Dollars(with the federal reserve banking & petro-dollar arrangement with OPEC), the US has to constantly manufacture conflicts. This industrialisation require constant wars for survival and growth. And that is the reason why the US had to manufacture bogus false flag operations & outright provocations to engage in WW1(Provoking Germany for the sinking of Lusitania), WW2(Provoking Japan for an attack on Pearl Harbor), VIETNAM(Lying about the Gulf of Tonkin incident which never happened) & now the so called ‘WAR ON TERROR’(a self inflicted 9/11).

    Do you want largest Democracy of the world to follow in the footsteps of the Oldest Democracy of the world…?? A smart man makes a mistake, learns from it, and never makes that mistake again. But a wise man finds a smart man and learns from him how to avoid the mistake altogether.

    Allowing FDI in the National Defence is an act of treason against motherland. Do you think the foreign investors care about our national & strategic interests?

    If we cannot arm & equip our defence forces than it’s useless to have armies, because purpose of armies & defence forces is not to invite foreign investments, but to protect against foreign armies.

  2. I am shocked to read comments of Arun. Grow up man. You have not countered a singlke point of the article. Learn to debate issues rather than calling names. Every one can abuse a writer. Find logic to counter him. I could not. It is a simply superb writeup. Tell me, how is safer to import a system rather than asking OEM to build in India. What ha syour drdo done in last 60 years. Shameful approach.

  3. Sir, Thank you for the brilliant article. I wish you could get this article out to more people and the PM and the defense ministry. I hope you do manage to get this article to be read by the Govt. India seriously needs to cut down on defense imports. It needs to become a manufacturing hub. If not US or French companies, we should let Israeli companies have 74% FDI in defense. They have the technology and we have the man power, together both countries can reach great heights.

  4. BTW, Russia does not allow 100% FDI in defence. Nor does China. France makes sure its Thales, Dassault are owned by French controller ship or by politically reliable allies. Yet, India must allow 100% FDI.
    The DRDO is apparently worthless and mediocre. Yet, its codeveloped Brahmos can strike targets pinpoint in mountainous terrain (which its original Yakhont baseline cannot). Its Agnis can go 5000 km away & its Akash can hit targets 30 m above sea level.. when self appointed experts in defence procurement wear their bias so openly and shill for foreign interests whilst running down their own countrymen using dubious claims, why should anyone take them seriously? Sorry to say, but Suman’s grandiloquent posturing (India’s foremost expert) etc is not sufficient for the MOD or anyone else to make policy decisions on. I think the current admin has showed what it makes of such pomposity – the DRDO’s capital budget is up 60%, while the capex for imports for services in large platforms is capped at prior levels. India has to develop its own industry & proceed ahead, not on the whimsy of folks like Suman who will gladly run down their own people to score brownie points for dubious policy decisions.

  5. Nothing much in this article other than Suman batting for the foreign OEMs interests and doing his usual DRDO/DPSU bashing in the guise of being a neutral observer. No doubt if the FDI cap is relaxed, the good General will make his way as advisor to one of these august organizations as their Indian head of operations like many of his peers have done. While the Navy is busy equipping its ships with DRDO items, the Army is full of gentlemen like Suman, gleefully awaiting imports and unwilling to work with local industry or DPSUs whom they call names. No wonder India is in such a mess. As if any foreign OEM would anyways work with local industry private or public, if it could get 100% owned subsidiary in India. But Shri Suman is more bothered about the interests of the poor foreigners! So it goes. Lord save us from self appointed foremost experts, strategists and their policy prescriptions.

    • Agree with Arun. DRDRO has done excellent work despite low funding and more bias from both our defense forces who are more aligned with external vendors for making money thru other means. If given a full freedom, time, and resources our own organizations can do much better job than external vendors. Just trust our own DRDO, ISRO and other who have done fantastic job compared to even the US NASA which has the record of many failures…don’t lobby and write articles for the sake of making money, do it for country, you are an army men….this kind of articles don’t make sense, you know it from your heart

  6. 49 % FDI in defense is a Good warm-up towards 100 FDI!! Let’s see if patient comes out of coma, FDI 2000-2014 only $4.94 bln of the overall $322 bln. What exactly is FOREIGN of FDI? Is Laxi Mittal with Indian passport qualified to open defense facility? Sweat/research shops in India but headquartered (top brass) in say UK? How about a PIO is he eligible to run business from US/India or only born/brought-up never an NRI, is this what is ‘Indian’ who wants to have control 51% stake? At McKenzie, ,CITI, , PEPSI, Microsoft/Nokia top brass are/were India educated FOREIGNER, not too sure on their passport identity. L&T an aggressive player in defense, hydrocarbon business headquartered in Sharzah, two CEOs of its IT arm are based in US, not too sure if they still hold Indian passport. There were news paper reports/speculation of shifting L&T head-office to Dubai, of hiring an Italian to head hydrocarbon business of L&T. Mr. Naik is slogging at 72 to find successor, fighting talent crunch due to life style and global (business hub) location expectations of top Indian/global talent. Foreign of FDI needs to be established to shed Indian/Foreign mindset. Incremental 100% hike in defense budget over next five years, utilized to strengthen ‘bellwether’ all time most reliable RAKSHAKS, defense PSUs. ‘Private Sector’ Indian/foreigner can play in a level playing field of 100% FDI. Play well, enter/exit based on profits – but please don’t mix profit with patriotism/protection – Be a A business MaN.

  7. Dear General,
    Ii is a good analysis. The most important information ,mentioned in your article is that no proposal for FDI was received till 2004, a four long years after Govt allowed 26% investment and 100% equity. We have to find out the root cause behind such apathy.
    It may be appreciated that major share of foreign procurement remains within missiles ,aircraft,ships,tanks,submarine radar etc.These are high-end products ,need huge investment and strong technology base.Whatever limit is set to FDI,the foreign manufacturer will never part with the real technology or the Know-Whys. This puts the Indian investors in a precarious position ,in case the foreign partner withdraws or the competitor comes with a better product ,possibly at a cheaper cost which is quite usual in high tech products.The other important factor is the delay associated with trials , acceptance of high end products and mid course correction made in QR by the user. You may be aware of many examples where the equipment purchased from abroad fail to comply with the specifications Negotiation process in such cases are too difficult and time consuming . Whereas,for any indigenously developed item by DRDO or PSU,we have much better access to design and technology.
    The primary reasons for lack of initiative from Indian manufacturers to take up major defence items are two- firstly, existing technology and future development of it, is simply beyond the reach of Indian industries and secondly, no industry in private sector can tolerate the unavoidable delay associated with manufacturing,test and induction of any high-tech defence item. Both criteria can be met only by Govt owned organisationsHence this argument will prove that it is not possible to manufacture and supply high-tech defence products by Indian industries even with 49% FDI.
    The solutions:a) make our OFs and PSUs more efficient b) Govt.to provide impetus to the industries to improve technology base to attract FDI Regards
    AKC

  8. For getting state of the art technology in the defense sector, if we think that by allowing FDI as majority stake in the private sector, we shall be able to get it, then we are all living in a fool’s paradise.
    Because foreign firms will always be under the control of the country of origin. Such firms will backtrack at the time of need by the slightest blink of the country of their origin.
    Our only way out is to drastically re- organise the DRDO to a very professional level with accountability. We shall have to admit that our military industry is having a relatively short history unlike other western industrial power. Military armament industries have evolved with time with lot of past experience to fall back upon. I feel if we persevere with our present efforts studiously , things will definitely look up in near future. We have already seen that in certain sectors. Projects like Kaveri engine should under no circumstances be abandoned at halfway stage. Though it is faced with time and cost over run, the experience of evolution of such a complex programme will come to our benefit in the future. This is also a fact that on many a occasion even in advanced countries certain projects do face with problems and their ultimate product does not come up to expectation. Most important thing is that we need to have the research organisations with professional approach and missionary zeal. Government also will have to support them without any undue interference which are seen in some other places.

  9. I hope author reads these comments. If you do Major than please read this article and on your next article please give examples as the following article shows. Thank you. ajaishukla.blogspot.com/2014/05/defence-industry-mod-hunker-down-for.html

  10. Excellent in depth insight into the issues that plague the largest single element in the country’s budget expenditure Mindless and obdurate bureaucrats ridden with fear psychosis have stifled the growth of the local industry,starved the Defense Services of much needed equipment, fed inefficient public sector manufacturing and allowed a behemoth like DRDO to carry on Even with the latest decision to allow 100% FDI in Defense will not change things unless many of these rules are changed

  11. The matter is not that simple. Agreed that India needs substantial FDI in the Defence Sector, but not at all costs. The issues raised by the author have been examined at several fora during the last two decade. The foreign conglomerations are so powerfully entrenched in the field that invitation to them to have the decision making position calls for abundant caution. A nation must retain its sovereign authority. Also, the defence related technologies are moving so fast that to remain on the their frontiers as also to maintain smart inventory is no less costly in real terms than making down the table payment for picking up systems from the shelf. I wish the author had given some available case studies of successful stories of limitless FDI investments in developing nations to add value to his article. All the same an invigorating write up.

    • Shriman Dr Sharmaji the fears expressed by you of foreign entrenchment ( where?) and “their take over ” in the event of some crisis are similar to what was expressed by the neosayers when the economy was liberalised in the early 90s The rest is history This is one of the reasons for the paranoia and the resultant inaction First of all foreign defence manufacturers will invest in this country if it is attractive for their shareholders which mean a fair environment ,a reasonably good market and freedom to operate No one will come in with even 100% FDI if their hands are tied behind their back and the rules are one sided Why should they ? Lastly, we are not a banana republic to be taken over by these companies

  12. Very lucid article in simple language. All issues have been clarified. I had many doubts earlier but now I am convinced that FDI is urgently required. Send this article to defence Minister to read and understand. Thank you IDr.

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