By Aashna Jain, National Law University, Jodhpur.

SEGMENT 1

FDI in Defence- Recent Development

It was December 2014 and the debate on the topic of FDI in Defence got heated up.

“The biggest and the most immediate fallout from Prime Minister Narendra Modi’s visit to the United States should be this: India allows 100 per cent FDI in defence. This is the crying need of the Indian armed forces, neglected for decades, if the national security issues have to be redressed hundred per cent.”[1]

RBI has a say on the Issue:

The Reserve Bank of India (RBI) on Monday notified the government’s decision to increase foreign investment ceiling in defence. After assuming power, the NDA government has reviewed foreign direct investment (FDI) policy for defence. In the defence sector, foreign investment (FDI, FIIs, RFPIs, NRIs, FVCIs and QFIs) up to 49 per cent have been permitted under government route (FIPB) in the defence sector.[2]

As per the revised policy for defence sector, portfolio investment (RFPI/FII/NRI/QFI) and FVCI investment will not exceed 24 per cent of the total equity of the investee company. Portfolio investment will be under the automatic route.[3]

Political Comments:

In a bid to encourage foreign firms to transfer state-of-the-art technology in defence production, the government may increase the FDI cap for the sector to 74% from 49% at present.

Several opposition parties and even some affiliates of the ruling BJP, such as the Swadeshi Jagran Manch, are opposed to opening defence to foreign investment. “Keeping the FDI cap at 49% was a political call,” the official said.

“The next big sector for foreign investments is defence. To attract serious players, the government has to ease the policy. Once the political climate cools down we will move a cabinet note to increase the cap to 74%,” a senior government official said on the condition of anonymity. This may take up to two years.[4]

The Backdrop of FDI in Defence:

The production of defence equipment was, until relatively recently, entirely a government function. The Industrial Policy Resolution, 1948, restricted the entry of the private sector into this industry. The defence industry in India was thrown open to the private sector in May 2001[5] when the government permitted 100 percent equity with a maximum of 26 percent FDI component, both subject to licensing.[6]

Under the UPA government, the defence sector had been opened up to FDI up to 26% in all cases, up to 49% where transfer of technology was involved with a provision of allowing even 100% FDI in special cases where state-of-art technologies were being brought in to India. The proposal was to allow up to 49% FDI as a general rule, that is, without prior approval, 74% where transfer of technology is involved, and 100% in special cases as earlier.[7]

The policy draft proposing to open up the Indian defence industry to FDI up to and including 100% was advanced within two days of taking office by the new Minister for Commerce, Ms.Nirmala Sitharaman.[8]

In actual fact, the policy initiative is not new at all, but only further liberalizes a policy first adopted by the NDA government under Prime Minister Vajpayee in 2001 and taken to the next step by the UPA government. The proposed new policy is a rehashed version of a policy framework proposed by the Department for Industrial Policy and Promotion (DIPP) during UPA-2, underscoring the fact that many of the Modi Government’s “new” policies are merely dressed up variants of earlier, especially UPA, policies.[9]

Is there a need for 51% FDI investment?

Amber Dubey, Partner and India head of aerospace and defence at global consultancy firm KPMG said, “49 per cent in defence FDI is disappointing. Makes no difference from 26 per cent technically. The hike to 49 per cent may create the same issues of sleeping partners and ‘effective control’ as we have seen in the case of the airline sector.”[10]

49% FDI in Defence is ineffectual in getting technological enhancement because foreign firms shy away from a business deal where there is transfer of technology without ownership and management control over the Indian Venture.

There are substantive economic advantages of resorting to FDI in Defence.

Reduction in Imports: –

According to Nirmala Sitaraman, Commerce and Industry Minister FDI in Defence will reduce imports; improve country’s capacity to produce defense equipment locally and save foreign money.[11] Raising foreign direct investment cap to at least 51 per cent in the defence sector will help India become a major manufacturing and export hub, reducing dependency on imported equipment.[12] The FM added that the Narendra Modi Government wanted to promote FDI ‘selectively’. For some time now, the Government has been keen to develop the indigenous defence industry and reducing dependence on import.[13]

Employment Opportunities: –

The FDI in Defence will definitely create abundant employment opportunities for the local population. It also means that taxes and other revenues will flow back to the local economy. It may lead to technological sophistication, higher employment, might help in building the local expertise and improving the reach and effectiveness of the services.

Apart from these two major advantages other ancillary benefits could be transfer of advanced sensitive technology, making India a Home Market (major domestic sales market and global manufacturing hub), benefit to private defence manufacturers in funding as well as technology, etc.

Why Not?

One pertinent reason for this sentiment is that many developing countries, or at least countries with a history of colonialism, fear that foreign direct investment (in defence – the subject matter of this article) may result in a form of modern day economic colonialism, exposing host countries and leaving them and their resources vulnerable to the exploitations of the foreign company.[14]

Case for National Security:

The case against increasing the cap for FDI, as argued by the MoD, is founded primarily in Indian sovereignty, security of supply issues and promoting organic industry development. It believes that allowing greater levels of FDI, even below 49 percent level, would increase the amount of control exercised by foreign partners and consequently reduce the actual level of indigenization and maintain the reliance on foreign suppliers.

MoD has also argued FDI levels of more than 50 percent would imply that the management control would be with foreign investors. Therefore due to the strategic nature of the defence industry, there is an apprehension that such ventures would fail at critical times given the possibilities of withdrawal because of embargoes, sanctions and pressures imposed by foreign governments or international agencies.[15]

Passing off the Equipment designs- A reason to worry?

There can be concerns about passing of the equipment, designs or source code to enemy countries. Such a possibility exists even in the case of imported equipment. In fact, in the case of indigenous equipment, we can control the production mechanism in a much better manner. The government could also reserve the right to inspect or control the production and dispatches in these facilities through deployment of necessary security agencies. Export to enemy countries could be banned through a negative list.

What is the moral of story?

India’s cap on FDI is stunting the process of modernization of the armed forces. It is a cap that India cannot afford. The case for raising the cap primarily rests on increasing the transfer of foreign technologies, which will kick-start the development of Indian Defence sector. The objections relating to sovereignty, security of supply issues and promoting the organic industry development can be overcome by strong government regulation.

The goal is to sow the seeds in India.

This is the first article in the series of articles we will be publishing, covering FDI in India.

References:

[1] 100%FDI in defence: How Modi can strengthen India against china, Pakistan, Firstpost, Rajeev Sharma, October 13, 2014,

[2] This cap was at 26 per cent earlier.

[3] RBI Notifies New FDI Policy for Defence, Railways Infrastructure, NDTVPROFIT, December 8, 2014

[4] Govt. may hike foreign direct investment in defence units to 74%, Arnab Mitra and Timsy Jaipuria, Hindustan Times, New Delhi, December 3, 2014

[5] Press Note 4 of 2001 Series

[6] “FOREIGN DIRECT INVESTENT IN INDIA’S DEFENCE SECTOR-GO BEYOND 51%”, Takshashila Institution, Discussion Document, Sushant K Singh, p. 2, April 14, 2010

[7] 100% FDI in Indian defence Industries: Nationalists Ditch Self Reliance? D.Raghunandan, June 19, 2014, Delhi Science forum, June 20, 2014

[8] Supra note 7

[9] Supra note 7

[10] FDI hike in defence sector to reduce imports, boost local manufacture, The Hindu, Business Line, Mumbai, July 10

[11] FDI and its Possible Consequences on Defence, Nila R Rijesh, June 27, 2014, CAclub India. Available at <http://www.caclubindia.com/articles/fdi-and-its-possible-consequences-on-defence-20886.asp>

[12] 51% FDI in Defence will be a game changer for India, Economic Times, June 26, 2014

[13] Supra note 10

[14] Disadvantages of Foreign Direct Investment, Economy Watch, June 29, 2010

[15] 33rd Report of the Parliamentary Standing Committee on Defence, December 2008, Page 67, paragraph 3.4