Defence Industry

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

Indian bureaucratic straitjacket is such that it can dissuade even the die-hard optimists. The applicant company has to be either an Indian company or a partnership firm. Management control must remain in Indian hands with majority representation in the board. The Chief Executive has to be a resident Indian. In other words, a foreign investor is expected to invest his resources without participating in decision making. The licencing authority can also verify the antecedents of the foreign collaborators and domestic promoters including their financial standing and credentials in the world market.

Though FDI limit is capped at 26 per cent, there would be no minimum capitalisation for the FDI. The Government would assess the adequacy of the net worth of a foreign investor with respect to the category of weapons and equipment to be manufactured. A foreign investor cannot transfer his equity before the expiry of the lock-in period of three-years. Even after that, such transfers would be with the approval of the Government.

The licence will contain capacity norms for production, which will be fixed after considering existing capacities of similar and allied products. This provision appears to be meant to protect the interests of the public sector by ruling out any competition to their existing monopoly. A licensee can produce only the licensed products and in the sanctioned quantity. He can neither diversify nor enhance production to cater for the market dynamics. The Government will verify all safety and security procedures once the production commences.

As regards the sale of the products, the Government can give no purchase guarantee but the proposed quantity for acquisition and overall requirements may be made known to the extent possible. Purchase preference and price preference may be given to public sector producers as per the policy.

According to the directive issued by the Government of India (Department of Public Enterprises) on 26 October, 2004, all Central Public Sector Enterprises will be given purchase preference if the price quoted by any of them is within 10 per cent of the lowest bid. This provision is applicable to all tenders where the value is Rs 5 crores or more. Additionally, Defence Procurement Manual 2005 stipulates that small scale industries can be given price preference of up to 15 per cent in comparison to large industries. These are highly inequitable stipulations, which militate against the basic canons of free market norms of fair play.

The policy directive further stipulates that arms and ammunition will be primarily sold to the Ministry of Defence. 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 Ministry of Defence.

The applicant company has to provide the standards and testing procedures for equipment to be produced to the nominated quality assurance agency. Further, the Government retains powers to inspect the finished product and conduct audit of quality assurance procedures.

Original investment as also the returns on investment are fully repatriable. Payment of fee and royalty to foreign technology provider is permitted including that by a wholly owned subsidiary to its off-shore parent company.

Thus, India expects a foreign investor to invest his resources in a venture where he has no significant control, strict capacity/product constraints, no purchase guarantee, no open access to other markets (including exports) and an unfair advantage to the local public sector. Such an expectation defies logic. No wonder that not a single application for FDI has been received by the Government so far. Many feel that such a lop-sided policy was destined to be a non-starter.

The way ahead

It is prudent to understand as to 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.

Primarily, 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. As per a study carried out under the aegis of United Nations Industrial Development Organisation, influx of FDI in any sector is dependent on a number of determinants like stable policy, favourable investment climate, structural adjustments, economic freedom and a fair market access.

Attractiveness of a nation for foreign investments in any sector is judged by its ‘FDI Confidence Index’. For FDI in defence, India scores very poorly due to the inequitable Government policy which is highly loaded in favour of the local public sector enterprises.

During informal discussions, many foreign entrepreneurs have complained that Indian policy seems to have been drafted more to perpetuate the monopoly of the public sector rather than invite FDI. A number of them have also expressed apprehensions that after they invest their resources, any public sector enterprise could import similar technology from another source and invoke the provision of price/purchase preference for securing Government orders.

According to them, almost all provisions of the policy convey the impression that India is really not too keen for FDI in defence. Even the language of the directive reflects an apathetic and lackadaisical attitude. They recall the statement of Defence Minister Mr Pranab Mukherjee at Aero India 2005 where he had said, “The defence sector has been opened up for private investment and it is not that we are dying for investment. It is for the interested companies to make necessary investment.” They aver that the tone and the tenor of the statement could dampen the enthusiasm of prospective investors.

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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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