Defence Industry

FDI in Defence Manufacturing-26-49-100 Percent
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Issue Vol. 34.1 Jan-Mar 2019 | Date : 06 Nov , 2020

There are times when a nation is blessed with decisive leadership, which can take bold policy initiatives that would benefit future generations. In the budget of 2014, Foreign Direct Investment (FDI) in defence production was increased from the then 26 percent to 49 percent. There was noticeable excitement amongst the various production houses in India who wished to enter this exclusive domain, yet were wary of taking the first step. Reasons were plenty, and it was but natural that the industry was wary of taking that first step, for the necessary thrust with transparent changes in the existing policies had been lacking since 2001, when defence production was opened to the private sector by the government at that time.

FDI, as defined by the World Bank, is the ‘net inflow of investment to acquire a lasting management interest (ten percent 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 a stable industrial policy, favourable investment climate, structural adjustments, economic freedom and a fair market access. India fares rather poorly on most, if not all of the above accounts!

In the immediate decades after gaining independence, India saw some significant contribution of Science and Technology towards nation building, with organisations such as Council for Scientific and Industrial Research (CSIR), Defence Research and Development Organisation (DRDO) and Indian Space Research Organisation (ISRO) being the flag-bearers. The Indian Armed Forces, however, as the major ‘consumers’ of technology, had to depend on foreign industries for military hardware and have continued to do so even as on date! After over seven decades of independence, India continues to compare very poorly with advanced nations in the field of collective Science and Technology, except for the few pockets of excellence, such as the recent successes of ISRO in its Lunar and Mars missions and the DRDO missile programme.

FDI in Defence Production – A Timeline

A debate had been generated within the country’s strategists and experts on future directions in defence production. Some believe in the achievement of full capability to design, develop and produce a weapon system, while others argue that the industry should concentrate only on certain niche areas, in collaboration with foreign expertise. India has been deprived of modern technology, reasons for which are many. Hence, Joint Ventures (JVs), Strategic Partnership (SP) and Public-Private Partnerships (PPP) seem to be the best option to access state-of-the-art technology. With a change in the political environment in 2014, some steps were initiated to encourage indigenous defence production, with an increase in FDI, but these have not yielded the desired results.

India’s policy on FDI in defence industry is indicative of adamant bureaucratic inflexibility and some headstrong narrow-mindedness, which also affects the comprehension by the political authorities and the will to take hard decisions. 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 opened to the private sector. The Government permitted 100 percent equity with a maximum of 26 percent FDI component, both subject to licensing. Unattractiveness of the policy became evident very soon. By 2004, the then Defence Minister, George Fernandes was forced to admit in Parliament that India had received no FDI proposal until then.

The Ministry of Commerce had proposed in 2010, to raise the FDI cap to 74 percent to encourage established players in the global defence industry to set up manufacturing facilities in India, with integration of systems and technology. However, the Ministry of Defence (MoD) vehemently opposed the proposal and continued insisting that the 26 percent FDI limit be retained. The MoD did not incorporate mechanisms to build trust with the private sector, although not restricted to do so by any policy. The operating levels within the MoD got in to protectionism mode to safeguard the interests of DPSUs/OFs. Progress of projects under execution by DPSUs thus continued to languish, as they remained unchallenged with no competition. The MoD, as a consequence, continued to fall back on imports rather than speeding up the pace of acquisition reforms.

In May 2013, the Commerce Minister proposed to raise FDI to 49 percent as a first step, thus modifying the earlier suggestion. This too, however, was rejected. Notwithstanding the continuing policy, in 2014, with a changed political environment in the country, the FDI was increased to 49 percent with a rider that it involve the transfer of state-of-the-art technology. This would not be an automatic process as it was for 26 percent FDI, but would require the nod of the Foreign Investment Promotion Board (FIPB). The policy was amended on November 10, 2014, to include FDI of up to 49 percent under the automatic route, with no riders. Any further higher investment would still have to be cleared by the FIPB.

It may be of interest to the reader that immediately after the announcement of the increase of FDI to 49 percent, in 2014, Ulrich Grillo, President, Federation of German Industries, during his visit to India, mentioned to the media, “German Industries would not like to invest in India since with 49 percent FDI, they would not have control over selling the products.” Many foreign investors expressed similar sentiments subsequently.

Understanding FDI

To understand the intricacies of FDI flow, it is essential to understand its dynamics. Any investor, a country or a conglomerate, would like to invest, only if it is confident of getting returns on its investment. The investment could consist of equity capital, reinvested earnings and intra-company loans. To get this money and technology, the host country must have a high ranking on the FDI Confidence Index, which India, unfortunately does not have.

FDI is a need-based concept on a two-way street. The recipient nation needs funds and technical knowledge to step up its growth, while the foreign investor is looking purely at profits. The investment sets in motion a cycle wherein the initial FDI upgrades local technology, which sequentially attracts further inflows of high-end technology and the cycle thus moves on. In addition to technology, latest managerial practices and skills also come in which consecutively upgrade the information and awareness ecosystem of the recipient nation.

There however, is a rider to the investments since available funds in world commerce especially in the defence industry, are limited. It therefore, would be but natural for an investor to evaluate all likely destinations and then assess and identify the best option for optimum returns. Any nation that is looking for large investments would, therefore, have to ‘sell’ itself to woo the prospective investor. Once again, the FDI Confidence Index comes into play.

With the large funds at stake, an investor carries considerable risk. It, therefore, is normal that the degree of control that the investor can exercise is important for him. With 100 percent ownership, there would be total and unconstrained control leading to the ability to take any decisions considered correct for the business enterprise. A 51 percent investment would allow working control for daily functions and oversight of the venture; anything less, and the partner in the JV could stall passage of special instructions. The difference between 26 or 49 percent FDI is, therefore, not much for an investor, apart from the amount of profits that can be repatriated.

Investment in defence production carries high risk but if successful, can lead to a protracted relationship. This is possible only if the recipient nation has a stable political environment which would then lead to well-defined, fair and consistent industrial and economic policies. Apart from the policies, four factors also have a role to play in attracting or deterring investors. These are availability of raw material, skilled labour, low cost of production and a lucrative market. There are four other distinct features too, which are peculiar to defence production. First – the investments in this sector are normally very high with a long gestation period and an equally rapid obsolescence. Second – where export of sensitive technology is concerned, almost all governments control the sale/sharing by private companies or safeguard it through end-user agreements. Third – the defence equipment market is extremely competitive with many buyers and hence acquisitions are generally an extension of the country’s foreign relations. Fourth – modern defence systems are highly complex and not available from a single source, but rather from a conglomerate, entailing negotiations with more than one country.

FDI – Is It the Panacea for India?

As already discussed, India does not have a reputation for being business friendly. If India is to be a focus for investors in defence production, it has to show itself as an attractive business destination, giving positive vibes to the investors. For that, it must fine-tune its policies to provide freedom of action to the JVs to respond as per market dynamics. It is therefore, prudent for the policy makers and those who have to implement those policies, to peep into the minds of investors to appreciate where their motivation lies to make large investments under the backdrop of uncertainties of business continuity with fluctuating order books. This is applicable not just to the ruling dispensation, but also to the state governments, where the necessary infrastructure to launch production would be established.

In sectors such as infrastructure, insurance and retail trade, FDI primarily means bringing in of foreign funds with some managerial expertise. High-end technology is not involved and control of the JV is not of as much importance. On the other hand, FDI in defence production involves not just infusion of funds, but includes induction of new technology which is otherwise not available in the country. Since the foreign company in the business of manufacturing arms would be expected to share its proprietary knowledge and closely guarded development technologies, it would therefore want a controlling stake in the project. The policy-makers also need to appreciate that irrespective of the FDI cap, no foreign investor is going to part with all his ‘trade secrets’. The investor, therefore, would want adequate control over the use of his funds, sufficient freedom of action to increase/decrease production capacity with access to markets to ensure commercial viability, through economies of scale.

Parliamentarians greeted the increase in the FDI limit in 2014 in the defence sector, to 49 percent with the thumping of desks. It was also announced that the control of the JVs would remain in Indian hands. In 2014-2015, 2015-2016 and 2017-2018, the sector attracted FDI worth $0.08 million, $0.10 million and $0.01 million respectively, according to data presented in Parliament in June 2019, while in 2016-2017, the industry had failed to attract any overseas investments! The FDI figures during 2018-2019 are not too bright either, with a meagre $2.18 million!

The Prime Minister is quite sure in his mind that India needs to upgrade its security preparedness, considering its not-too-friendly neighbourhood and the menacing internal security conditions. The ‘Make in India’ plan conforms to his vision and affirms his reputation of being a pro-growth leader. There is no disagreement that the manufacturing sector needs an impetus for the economy to surge ahead. There was hope after the announcements in Aero-India 2015, that the new Government’s promise of quick decisions and changed policies would focus international attention to the Indian defence sector, especially the aerospace industry. The anticipation however, soon changed to despondency with the ever-familiar impulsive announcements, systemic fog, and continuing fickle mindedness in decision-making in the MoD.

It is time MoD makes up its mind on the road it wants to follow for FDI in the defence sector. If it feels that there is no need for FDI and that India can well achieve technological excellence on its own, then the charade should end. Nonetheless, if a genuine requirement exists, then the policy implementers must join hands with the policy makers and the Indian Armed Forces, to make the country an irresistible destination for any foreign investor. Vacillation in policies or a total policy paralysis must end.

The country continues to experience the hesitancy of decision-making and refusal of clearances even for projects that have a direct impact on national security. Any new defence manufacturing project requires approvals from several departments such as excise, foreign trade department, industrial promotion, heavy engineering, green agencies and others. Inter-ministerial coordination is, hence, essential without fear of the three Cs, namely, the CBI, the CVC and the CAG. A solution to overcome this hurdle would be a single-window clearance process – easier said than done!

India had surged ahead of China as the highest ranked nation by capital investment in 2015, with $63 billion worth of FDI projects in all sectors, as per the London-based, ‘fDi Intelligence’, in its 2016 report. However, the share of defence sector is a trifling amount. If India really wishes to gain new high-end technology, then it must improve its ranking in the FDI Confidence Index through some bold structural changes to promote freedom of functionality in responses to market dynamics.

The present Government has been aggressively promoting its campaign of ‘Make in India’. For the Prime Minister, it is not mere sloganeering as he has focussed his attention on the defence-manufacturing sector spurring it to attain higher levels of achievements. It is to the credit of the Government that radical changes to increase the FDI in defence to 100 percent to provide the necessary stimulus, have been announced. In addition to the increase in FDI, new policies in manufacturing and export, a new Defence Procurement Policy (DPP) document, are initiatives in the right direction to encourage indigenous defence production. The policies now need to be executed in letter and spirit. The creation of a favourable environment, the change in the thinking, shaking off the lethargy in various government departments, DRDO, DPSUs and OFs, are some of the other processes that need to be accelerated to ease the pains of a foreign investor wanting to do business in India.

Notwithstanding the so very essential, stimulus, no major ‘Make in India’ defence project has taken off in the past six years or so, ranging from new generation stealth submarines, minesweepers, Light Utility Helicopters to infantry combat vehicles, transport and fighter aircraft. An audit of long-pending projects in October 2017, has shown that the projects are generally stuck in the bureaucratic bottlenecks of long-winded procedures, commercial or technical wrangling, coupled with lack of requisite political push, resulting in a meander through different stages without finalisation of contracts to launch production activities. Some of the demands of the Indian Armed Forces have been pending for as long as 10 to 15 years!

When the FDI cap was raised to 49 percent, the reaction of the multi-national investors was one of cautious optimism. They would have loved to see India opening up its defence sector without any strings attached, but it was not to be. The foreign investors did not see the figure as an ideal one and were looking for a minimum 51 percent stake in defence manufacturing to have control in the management of the company. Despite the earlier guarded reaction of foreign investors, the present increase has been welcomed and FDI may well prove to be the panacea. This makes one optimistic that SPs and JVs are to play a big role in ‘Make in India’ in 2020 and the country is headed the right way to achieve self-reliance in defence manufacturing.

Final Thoughts

Socio-economic growth and a credible defence capability achieved through self-reliance, are fundamental for a nation to secure a globally respectable position. In a world where a few developed countries enforce control on defence equipment and technologies, it is essential for a country like India, a growing economy with formidable capabilities, to maximise indigenisation and self-reliance in defence production. Further, with defence exports becoming an increasingly effective diplomatic tool in assuring regional peace and security, it is crucial for India to become a global defence exporter too.

India does not lack capability, it lacks the will. At the biennial Defence Expo, and the International Air Show at Yelahanka, Bangalore, it is heartening to see many Indian MSMEs display their products, amply demonstrating that despite the stifling red tape and the indifference of an obstinate bureaucracy, the private sector has the potential.

The recent amendments to the FDI limit, the DPP, the Defence Export Policy and the Offsets Policy, have provided a new thrust. Introduction of major programmes in the ‘make’ category in the DPP, allowing participation of Indian public and private industry, is a big step in the right direction towards acquiring or developing cutting-edge technology. Defence offsets and the liberalisation of FDI in the defence sector must now be leveraged judiciously and expeditiously, to enhance indigenous capabilities.

India’s key advantage over many first-world nations is its youth power. Studies have reported that by 2020, every fourth skilled worker added globally, will be an Indian. There is an urgent need for skilled workers in the defence industry, more so in the aerospace industry, which depends heavily on high-end technology. What good is the addition of skilled workers, if their employability is low? There is an immediate requirement for the active involvement of academic institutions in passing out quality product or else India will be known as a nation of low-quality, low-cost and low-return employability.

Sceptics raise many a question and doubt the capability of the nation to become a powerhouse in defence manufacturing, with the all-pervasive red tape and corruption. The answer perhaps, is still evolving. Some audacious steps have been initiated. The systemic fog and arbitrariness with the familiar unpredictability is in the process of a firm removal, through the implementation of new policies, without bureaucratic lethargy and parochial politics. The government has to restructure regulatory provisions across the board, to provide clarity for the Indian and foreign vendors to carry out their business in India.

Now that the increase in FDI to 100 percent has been announced, with new policies for partnerships/JVs, the defence industry in both the private and public sectors, has to wait. A response from foreign arms manufacturers and foreign governments would probably be forthcoming after some more bold reforms, come February 01, 2020, when the next budget would be presented!

“A silver lining on the horizon is discernible, but barely”, was mentioned in 2015 by Air Marshal Vinod Patney (Retd), the then Director General, Centre for Air Power Studies at a Seminar on “Energising Indian Aerospace Industry”. The ‘silver lining’ in now appearing to be a reality!

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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

Air Marshal Dhiraj Kukreja

former Air Officer Commanding in Chief of Training Command.

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