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A case for Increasing FDI CAP up to 100 per cent in India's Defence Industry

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  • December 30, 2010
    Fellows' Seminar

    Chairperson: Shri V K Misra
    Discussants: Shri Amit Kumar Singh and Shri Rahul Gangal

    This paper revolved around two key questions: Why does India need higher FDI in defence industry? And how much the FDI limit should be increased? Highlighting the present FDI policy of India, Mr Behera said that India has allowed FDI up to 26 per cent in its defence industry since 2001. However, the policy has so far not succeeded in attracting any major financial or technological inflows into the country, primarily because of the lack of incentivisation of the policy to the foreign investors. He argued in favour of increasing FDI cap up to 100 per cent and pointed out that keeping in view India’s underdeveloped R&D and production base, and various defence industry-related policies and provisions that are contingent upon liberal flow of FDI, an increase in foreign investment cap up to 100 per cent would be logical, instead of adopting a fixed cap-based method, which may be constrained in allowing some desirable inflows.

    Mr Behera argued that the absence of any meaningful FDI inflows into India - both, financial as well as technological - has led to a strong debate in the country. In response to the Ministry of Commence and Industry’s (MoC&I’s) Discussion Paper of July 2010 which argued in favour of increasing FDI cap up to 74 per cent, a cross section of industrial stakeholders ranging from industrial associations, labour union, law firms, foreign company and consultancy firm have come out with their own views. He said that the views of these stakeholders are divided along three major lines; i) FDI limit be retained at 26 per cent; ii) FDI could be allowed to a maximum of 49 per cent subject to certain conditions such as minimum financial inflows is US $100 million and compulsory inflow of technology; and iii) FDI should be increased to 74 per cent. He pointed out that the majority of the industry as represented by their big associations, such as the ASSOCHAM, CII, and FICCI, has not favoured an increase of FDI beyond 49 per cent. Moreover, the conditions they have proposed for 49 per cent FDI is stringent and highly discouraging for any foreign company to opt for this route to enter the Indian defence industry.

    The author was of the view that in a globalised world, FDI has been an important vehicle for external source of finance. However, the volume and growth of inflows notwithstanding, FDI inflows are often fraught on political grounds, as inflow of resources are invariably linked with controlling of assets, which the receiving countries are often reluctant to shed for variety of reasons, national security being the critical one. He noted that although many counties have devised detailed mechanism to filter foreign investment into strategic sector, a very few countries have a blanket ban on inflows after a certain level. Among them, India and UAE have a blanket ban on FDI after a certain threshold. While India does not allow more than 26 per cent FDI in defence industry, UAE restricts all foreign investment to 49 per cent, unless the investment falls in its Free Trade Zones.

    In response to the question why India needs higher FDI in defence industry, Mr Behera said that foreign investment in defence industry is a part of India’s broader FDI policy, intended to “bring attendant advantages of technology transfer, marketing expertise, introduction of modern managerial techniques and new possibilities for promotion of exports.” However, even after nine years of its being existence, the defence FDI policy in its present form has not been able to accrue the intended advantages in a meaningful way. Considering India’s poor R&D and production base, and the country’s desire to enhance domestic defence production, Mr Behera suggested that an increase in FDI cap beyond the present limit would be desirable for technology transfer and for meaningful ties between Indian and foreign companies. In addition, an increase in FDI cap would also likely facilitate effective functioning of the offset policy and “Buy and Make (Indian)” procurement provision. He, however, argued that given the sensitivity attached to defence industry and national security, all defence-related FDI could be subject to wider review by the empowered Foreign Investment Promotion Board (FIPB).

    At the end, he said that although a higher FDI cap up to 100 per cent would create an enabling environment for technology transfer, and setting up joint venture companies, the indigenous industry, given its size and base, would continue to play major role in India’s defence industry. He, therefore, concluded by emphasising that there is a greater need for energising the indigenous industry, both private and public sector, so as to enable them to play a more pro-active role.

    Shri Rahul Gangal: Increasing FDI limit in defence industry is not the only issue. There are other policy dichotomies which also need to be considered while discussing about increasing the FDI limit in defence industry. He focused on some key aspects such as: the foreign investors want ownership in the JVs while making investments in vital sectors. Second, the present FDI policy is also not generating more interest and motivation among outside investors. Third, they also want to have insurance of their investments. Fourth, the investors are interested only investing in those sectors where their interests are protected. They are not interested to create other new JVs if that will not yield interest. Five, the investors also want to have their position or control over key policy decisions. In addition, he pointed out the question of what will happen if these JVs start marketing the products to gain profit. He emphasised that these important issues need to be focused while thinking about increasing the FDI limit.

    Shri Ashok Kanodia: There is a need to define the national objectives while talking about increasing FDI limit. What actually India wants to achieve by increasing FDI limit in defence industry? The US and other western countries are more concerned about creating jobs. How many jobs and skills have been created in India by FDI? The present FDI policy of India started in 2001 and nine years is a long period to assess the policy. What are the policy initiatives created for the JVs? On purchasing of technologies, he said that one does not buy defence technologies from a single vendor. He agreed with Mr Behera that many of the policies that he recommended in his paper have already been made to the government case-by-case basis. He pointed out that protecting the Intellectual Property Rights (IPR) and seriousness of the JVs are the two important things which are essential for creating new JVs. Finally, he said that what nation wants to achieve by increasing FDI limit, for this, we need to take a holistic approach while arguing for increasing the FDI limit and for creating new JVs.

    Dr G Balachandran: This is a very current and relevant topic. However, the presenter needs to be very clear and careful while using some concepts and facts. He pointed out that defence technology is very different from other technologies. So the scholar needs to be clear which kind of technology that he is referring to whether it is high technology, critical technology, defence technology or any other technologies and what kind of technologies that India would acquire by increasing the FDI limit since there are different license procedures required for each of these technologies. In addition, by increasing FDI cap up to 49, 74 or 100 per cent India will not be able to obtain these technologies from foreign companies, unless the foreign companies’ government approve them. He pointed out that defence technologies are subject to strict regulations as well as international export control laws. So far as defence trade is concerned, it’s a government to government cooperation. Moreover, homogenous items or products can be obtained from many countries, but critical components cannot be obtained because these are subject to stringent export control laws. And one cannot start industry for each item or product. He suggested that first and foremost, there is need to understand technologies and then which kind of technologies that India wants to obtain by increasing FDI cap and without knowing this one cannot give 100 per cent FDI.


    • In JVs, government investment means government control. So, how to maintain the balance between government investment and control?
    • Since last two decades, China is rapidly modernising its defence system. How this will affect India? And, how China is able to bring more FDI into its country?
    • So far as the Committee on Foreign Investment in the United States (CFIUS) is concerned, how does it would work with India?
    • How does India’s offset policy affect the FDI inflow? How it works in technology imports in terms of defence technology?
    • India also needs to work on other important issues such as labour laws, centre-state coordination, better SEZ schemes and proper institutional mechanisms to attract more FDI in future.
    • FDI which is vital to India’s growth has lacked a proper policy document and has been administered primarily through a series of press notes over many years.
    • India is lagging behind China by 20 years in terms of infrastructure development. As India’s economy is rising and able to sustain its economic growth rate despite the global economic crisis, it needs to pay greater attention to infrastructure development. Otherwise in long term basis, it cannot compete with other major powers.
    • While foreign equity participation has increased in most sectors, there are still sectors where there is huge potential for FDI inflows. Further increases in FDI ceilings in sectors such as banking, telecom, power generation, civil aviation, food retailing, insurance, investing companies and the real estate sector will be required to achieve this potential.
    • Do political parties have any stake in FDI?

    Chairperson’s Remarks: Shri V.K. Mishra said that India’s defence industry has not attained critical mass in R&D and manufacture sectors. Joint venture, thus, is an important route to develop India’s R&D and production base as well as critical infrastructures. There are massive deficiencies in these sectors. So far as the FDI limit in defence industry is concerned, unless we increase the present limit, we cannot compete with other countries. India’s JVs in defence sector has been lost so far. However, there is no dearth of opportunities. He cited that India’s joint venture with Russia in Brahmos missile programme is very successful. He hoped that such JVs will open in many other sectors with other countries. Shri Mishra concluded by observing that India’s defence industry is lagging far behind, and that’s why new JVs need to be created in this sector by following a liberal FDI policy. But he noted that there is need of greater transparency in defence department to make it more effective.

    Report prepared by Dr Saroj Bishoyi, Research Assistant, IDSA