In 2001, as part of its effort to unshackle the Indian economy, the government opened doors to foreign direct investment (FDI) into the Indian defence industry. Since then, the limit of FDI in this sector permitted had been pegged at 26 per cent and any proposal beyond this figure would have to be considered on case-by-case basis and finally approved by the Cabinet Committee on Security, a procedure of formidable complexity that proved to be a deterrent to potential investors. This decision of the government was in conformity with the Indian Companies Act, 1956. However, as the investment was limited to just 26 per cent and the policy was bereft of any incentive for the investor, it failed to inspire any significant inflow of investment or state-of-the-art technology that was anticipated. The level of enthusiasm displayed by foreign companies for FDI into the Indian defence industry is abundantly clear from the data of the last 14 years. During this period, the total quantum of funds received as FDI under this head by the Indian defence industry was a paltry $4.94 million!

Re-evaluation of Policy on FDI

The almost complete lack of enthusiasm on the part of foreign investors about the Indian defence industry compelled the government to re-evaluate the policy on the subject. The Ministry of Finance (MoF), in its economic survey report for the period 2008-09, strongly recommended that it was time to abandon the existing cap at 26 per cent on FDI into the Indian defence industry and that it be raised ideally to 74 per cent; in any case not less than 49 per cent. The report further stated that on a case-by-case basis in strategic and high technology segments, FDI could be raised to 100 per cent to eliminate dependence on imports. The report stressed the need to encourage reputed global aerospace and defence majors to establish manufacturing and systems integration facilities in the country.

As a consequence of this review, in July 2010, the then Minister of Defence A.K. Antony informed the Lok Sabha that the Ministry of Defence had in fact been tasked to redraft the policy on FDI keeping in view the recommendation of the MoF to raise the cap on FDI in the Indian defence industry to 74 per cent. The debate over this issue in the industry that was intense and was finally settled in June this year by the Confederation of Indian Industry (CII) that recommended that FDI above 49 per cent be allowed by the government only on case-by-case basis and that too when transfer of technology was involved. The CII had earlier proposed FDI at 51 per cent and stated that 100 per cent FDI ought to be permitted in cases where the finished products are to be exported and are not diverted for internal consumption.

Revised Policy on FDI Approved

Finally on August 6, 2014, the government cleared the proposal to raise the cap on FDI in the Indian defence industry from 26 to 49 per cent. However, the requirement for all proposals to have prior approval by the Foreign Investment Promotion Board has been stipulated as a prerequisite. This policy change is also expected to be in sync with the thrust of the NDA Government to make India a global manufacturing hub. This is being projected as a philosophy of ‘Make in India’ proposed by Prime Minister Modi. The Indian defence industry has immense scope for foreign investors as for the last six decades the nation has been procuring over 70 per cent of its requirement of military hardware from abroad. The effort towards the development of indigenous manufacturing capability has unfortunately been pitifully low.

Response from Potential Investors

As per initial responses, the decision to raise the cap on FDI to 49 per cent has been welcomed by the Indian defence industry with the general belief that it will boost sentiment. Logically, higher FDI ought to benefit the industry in the areas of design, development and state-of-the-art manufacturing as well as build up a robust indigenous capability to have positive impact on the nation’s military capability.

However, the general view that is emerging is that it might not lead to significant increase in investments from abroad. As per the US-India Business Council, “The decision to increase FDI in the Indian defence sector to 49 per cent is only an ‘incremental’ step and is unlikely to bring the much needed funds in this key area”. As the cap on FDI has been fixed at 49 per cent, in effect, there is no qualitative change in the new policy. So long as the FDI limit is kept at below 51 per cent, the new policy would continue to suffer the same limitations that afflicted the system when the FDI was limited to 26 per cent. While the imperatives of national security have been advanced as the justification for not transgressing the 50 per cent barrier, the perspective of the potential global investors must also be taken into account.

With FDI in the Indian defence industry limited to 49 per cent, the foreign investor will still have no management control of the joint venture companies as it will continue to remain with the Indian partner. Perhaps the only advantage that the foreign investor will have is that with FDI at 49 per cent, he will be able to repatriate a larger share of revenue generated by the joint venture company. But a major disincentive for foreign investors of FDI cap at 49 per cent will be the issue of transfer of technology especially of the high-end variety. The Indian aerospace industry has generally been engaged in licensed production and has failed to develop any meaningful capability in this regime. Thus to be able to leapfrog into a bright technological future, transfer of high-end technology into the Indian defence industry will be an inescapable requirement. The government will have to find ways to achieve a balance between the need to inspire foreign investment and the concerns of national security. In a system that is in the grip of debilitating bureaucratic control, this may not be an easy task. Hopefully, as and when the NDA Government and especially Prime Minister Modi finds time to focus on issues related to the Indian defence industry, the situation may change for the better.

Global aerospace and defence majors have developed high-end technologies devoting years of effort and at enormous costs. It would therefore be unreasonable to expect them to transfer futuristic technologies to India over which they have no control so long as the limit of FDI is below 51 per cent.

Unless this issue is addressed with objectivity with focus on core interests of all stakeholders, development of true indigenous capability will remain a mirage!