Defence Industry

FDI in Defence Industry
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Issue Net Edition | Date : 01 Jan , 2007

The Government of India has been taking a number of steps to achieve the target of procuring 70 per cent of its defence requirements from indigenous sources by 2010. Despite its best efforts over the last two decades, India is nowhere near that objective as yet. We continue to depend on imports for all our major requirements while the indigenous production is limited to low-tech low-end items and a few products based on bought technology.

It will not be incorrect to surmise that India has failed to be self reliant in defence production despite decades of efforts and thousands of crores of rupees expenditure. Over-dependence on the public sector has been one of the major reasons for this failure.

With liberalisation of economy, there has been a welcome change in the thinking of the national leadership. It realised that the objective of 70 per cent indigenous production would continue to remain a pipe dream for the country unless the private sector was co-opted. The private sector, in the meanwhile, had already proved its credentials by emerging as a vibrant and dynamic force, especially in the field of information technology. Its potential could no longer be ignored. In a land mark policy change, the defence industry was thrown open to the private sector in May 2001 (Press Note 4 of 2001 Series).

The Government permitted 100 per cent equity with a maximum of 26 per cent Foreign Direct Investment (FDI) component, both subject to licencing. Subsequently, the Department of Industrial Policy and Promotion issued detailed guidelines, after consultations with the Ministry of Defence, for the issuance of licence for the production of arms and ammunition in January 2002 (Note 2 of 2002 Series).

However, things with regard to FDI have not progressed the way the Government had hoped. Despite the fact that India is expected to spend approximately 1,80,000 crore rupees on defence purchases in the next 5 years, there has been a total lack of enthusiasm on the part of foreign investors to invest in the Indian defence sector . Mr George Fernandes was quite candid in admitting in the Lok Sabha in 2004 that not a single proposal of FDI for manufacturing defence related products had been received till then. He attributed this lack of interest to ‘the individual entrepreneur’s decision depending on his commercial perception’. It is as frank an admission of failure of the policy as could be expected.

The World Bank defines FDI as ‘net inflows of investment to acquire a lasting management interest (10 percent or more of voting stock) in an enterprise operating in an economy other than that of the investor’. FDI comprises of funds provided by the foreign direct investor to the FDI enterprise as equity capital, reinvested earnings and intra-company loans.

FDI is not just a question of getting funds, but access to the latest technologies. FDI pre-supposes a long term commitment and lasting relationship between the foreign and local enterprise. FDI sets in motion a chain reaction wherein FDI upgrades local technology which, in turn, attracts more FDI with higher technology and the cycle goes on. This is of vital importance to the defence sector which is highly capital intensive and undergoes rapid obsolescence of technology.

While participating in a seminar organized by the Confederation of Indian Industry during the Defence Exhibition in 2004, the then Minister of State for Defence Mr Chaman Lal Gupta acknowledged that the basic aim of allowing FDI in defence sector was to pool capital and induct latest technology to manufacture state-of-art defence equipment for own armed forces and also to enter the export market at a significant scale.

Peculiarities of FDI in Defence

FDI in defence industry is indeed essential because most defence products involve a relatively high level of technology and this technology gets transferred only if the foreign partner has a long term stake in the company. The aim of seeking FDI by India in its defence sector may be to get both funds and technology. But given the present comfortable economic environment, it is primarily defence technology that India needs desperately. Hence, a different approach is required.

Some of the major factors that influence FDI in defence industry are –

  • Rapid obsolescence of defence technology makes it imperative that the selection of technology be carried out diligently. All official sanctions and licences must be issued without bureaucratic delays. Most importantly, production must commence in the given time frame lest technological advances make the whole project anachronistic and a waste of resources.
  • Modern defence systems are highly complex and are not available from a single source. In addition to procuring/producing various systems, sub-systems and components, a systems integrator has to be identified for optimum performance. This may entail negotiations with more than one foreign investor from more than one country. Most of the major defence equipment producers follow ‘Global Factory’ concept, wherein various functions are spread over a number of locations in different countries with a view to draw maximum benefits in terms of technological expertise, cheap labour and abundant raw material that different locations offer. Therefore, any nation that covets FDI in defence has to tailor its policies to suit this world-wide network.
  • Due to heavy initial investment, the number of defence equipment manufacturers is limited in the world. Very few possess the latest technology that is sought. Additionally, embargoes on technology export by some countries make the choice highly narrow.
  • Market for defence equipment is extremely competitive and restricted. Most of the countries give preference to their indigenous manufacturers. International arms trade does not follow the dynamics of an open and free market. Invariably, major defence procurements are an extension of a country’s foreign policy. Therefore, every prospective FDI investor wants a fair degree of assurance that the equipment produced will find buyers, more so as most of the defence equipment does not have dual-use and finds no application in non-defence sector.

Present policy and its Dissuasive Incongruities

As per the policy directive of 2002, licences for the production of arms and ammunition will be issued by the Department of Industrial Policy and Promotion (Ministry of Commerce and Industry) in consultation with Ministry of Defence, whereas all FDI cases will be considered by Foreign Investment Promotion Board as well. But it is the Ministry of Defence which will have the final say as regards procurements, sales and exports (even for non-lethal items).

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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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