FDI POLICY: DEFENCE PRODUCTION

Higher FDI for Stronger Defence

Higher FDI in India’s Defence sector will not only bring Higher Revenue and State-of-The-Art Technology, It will also Pave way for Self-Sufficiency in The Crucial Sector of defence Production.

Issue Date - 17/02/2011

For a country such as ours which spends billions of dollars every year to import nearly 70% of its total military equipment, the government seems to be stuck with the country’s defence establishment still reluctant to lift the 26% cap on foreign direct investment (FDI) in the “sensitive” sector of defence production. Despite India being one of the biggest users of conventional defence equipment and the cumulative defence budget growing at the rate of over 13% annually since 2006-07, we continue to depend heavily on imports for all our major requirements, with domestic production limited to low technology items and some based on bought technology.

In a discussion paper floated last year seeking stakeholders’ views, the Department of Industrial Policy and Promotion (DIPP), under the Ministry of Commerce, had favoured 100 per cent FDI in defence in order to attract foreign technology. It further called for an urgent need to ‘enhance the deterrent and the operational capabilities of the armed forces’. The paper also stated that almost 50% of India’s defence equipment was suffering from obsolescence while merely 15% could be called state-of-the-art.

The government, however, now seems to be keen on allowing greater participation of the private sector and expert players in the defence sector to invite higher technology in the sector. With strong backing from both the Finance and Home ministries, the Ministry of Commerce and Industry is learnt to be preparing to move a Cabinet note on increasing the cap on FDI in the defence sector to 49%.

The case for a firm government stand on increasing the FDI cap is backed by the fact that it is of vital importance to the defence sector which is highly capital intensive and where technology requires frequent upgrading. FDI is not just a subject of getting funds, it also facilitates access to the latest technologies and provides for a long term commitment between the foreign and local enterprise. It creates a sort of a cycle where the foreign investment upgrades local technology which, in turn, attracts more FDI with higher technology.

Despite the presence of such alluring factors, the Union minister for Defence A K Antony has registered his firm disagreement with the said proposal on the ground that the Indian defence sector was not matured enough to absorb higher FDI. He did however mention at a conference last year that higher FDI in the long run could not be ruled out and said that the ministry could consider permitting it on a case-by-case basis. The reluctance of the defence establishment, sources say, is also based on the rather conventional belief that defence is a sensitive sector and that opening doors to foreign players could lead to security concerns.

The defence sector in India, which was initially subject to 100% monopoly of the public sector, saw the government open doors to private participation and allow 26% FDI following a policy change over the last decade. However, the policy move did not really help as it failed to amuse both the domestic private sector and the foreign direct investors. Over-dependence on the public sector has been cited as one of the major reasons for this failure. Also, the complete lack of enthusiasm by investors, both Indian and offshore, failed to achieve the basic aim of allowing FDI in the defence sector, which was to pool capital and foster technology partnerships in order to manufacture defence equipment for the armed forces and also register its presence in the export market on a significant scale.

On a global front, India’s defence exports have ranged between 1.5% to 2.4 % of the total production, with an import-export ratio of 194:1, as compared to 1.3:1 in the case of Israel, 8.8:1 in the case of South Korea and 19.7:1 in the case of Singapore. It is disappointing to note that ever since the introduction of FDI in defence in 2001, the grand total of investments in defence through the FDI route have been a meagre $15 million.

Budget allocations to the defence sector have gained special prominence after the onslaught of recent terror attacks and the rising concerns of internal security. As per the Budget Estimates (BE) for the year 2010-11, the defence sector has been allocated Rs.1.47 trillion, a marginal increase of 3.98% over the BE of 2009-10. The outlay for defence comprises of Rs.873.4 billion for revenue expenditure and Rs.600 billion for capital expenditure. Keeping in view the requirement of modernisation of forces, the capital budget has been given an increase of 9.44% over the BE of 2008-09. The revenue allocation has increased only by 0.5%. However, there is a net reduction in allocation of Rs.10.96 billion in revenue budget in comparison to the revised estimates of 2009-10. In the Interim Budget 2009-10, the allocation for Defence was increased to Rs.1.42 trillion crore, almost a 35% increase in current prices from the previous year’s revised estimates. The total revised expenditure for 2008-09 was Rs.1.14 trillion crore. The planned expenditure of Rs.868.79 billion against Rs.736 billion will include Rs.548.24 billion for capital expenditure as against Rs.410 billion in the revised estimates for 2008-09. The expected defence spending over the next five years is $50bn.

Another case for strong legislation in favour of the proposed hike is based on concerns that our vast dependence on imports can be stifled in times of crisis, leaving India defencseless. Considering that India currently needs to import even basic stuff like bullet-proof jackets, ballistic helmets, assault rifles, shells etc., FDI can be kept out of areas which are really sensitive. In fact, the DIPP discussion paper on allowing foreign companies to bring in 100 per cent equity to set up their own manufacturing and integration centres in India, had allayed concerns that fully foreign-owned companies based in India may not be in the county’s security interests, arguing that the concerns remained even in case of direct imports and hence could not be cited for opposing higher FDI.

With India emerging as a major economic destination for several sectors, the efficient management of funds allocated in the defence budget will be of vital importance keeping in view its target of reducing dependence on imports. What India needs today is a dedicated and technology specific policy which is flexible enough to attract frontier technology within the broad regulatory policy framework. It is vital that in the case of cutting edge technology, FDI limit be increased to 51% in order to instil a sense of confidence in the foreign entrepreneur that he would continue to own the enterprise by holding majority stake. An FDI cap of 49% may prove totally unfruitful and even pose as a major hurdle towards attracting high-end investments. Supporters of higher FDI in the defence sector say foreign investors will set up units in India that should lead to cheaper prices of defence equipment, secure supplies and also bring steady jobs for Indians.

For India to sustain its steady economic growth and support it with a robust defence base, we need to offer opportunities which are more striking than our other FDI competitors. In order to have a strong defence industry base in India, it is vital to recognise the peculiarities of the defence sector. Investor facilities in line with prevailing international standards is needed, backed by proper policy support which override the dissuasive incongruities present in the sensitive sector of defence production.

“No question of compromise in security”

The government, for a change, is pressing hard to push through a policy change to attract foreign investments and also bring on board state-of-the-art technology in the sensitive sector of defence production. Even though defence Minister A. K. Antony says India is not ready for higher FDI yet, renowned defence analyst Maroof Raza tells B&E why higher FDI is the right step forward.

B&E: What is your opinion about the current level of FDI allowed in defence sector?
Maroof Raza (MR): One thing is very clear that the defence sector needs huge investments and anyone doing so will not be looking for 26% of stake. If we really want path breaking technologies to come to India, we will have to raise the stake of Foreign Direct Investments up to 74%. Once the foreign companies have control over the projects, they will bring all the investment, high-end technology and would also like to make India as their exporting base.

B&E: Will it in any way threaten to compromise the interests of national security?
MR: The bulk of our arms come from foreign destinations. Whether it is the 126 Medium Multi-Role Combat Aircraft or the Artillery Guns, we are procuring them from outside. Once the companies set up their base in India it will be beneficial for the country. There is no question of security getting compromised.

B&E: What may be the reason for India’s under performance in defence production despite having the DRDO, a dedicated organisation for defence specific technology and production?
MR: We have an intellectual baggage, a Nehruvian idea of self sufficiency, which, to an extent, is okay. But once you look closely at DRDO, you will find that it is adversely affecting the defence preparedness of the country. Most of the important DRDO projects are either incomplete or are thrust on the forces. This is true for Light Combat Aircraft, Tejas and Main Battle tank, Arjun. The point here is not to run down DRDO, but it is also foolish to keep investing in re-inventing the wheel. Thumb rule is to get cheap and efficient.

B&E: What remedy do you propose?
MR: We should focus on cutting edge, high-end technologies and then task the DRDO with projects along with a time-line. For example, when a Sukhoi can be roughly equivalent to three MIGs, then we do not require investing in MiGs. The case is the same with other arms. It is very important that we should look for the best, whether it is from the market or is self produced.

Inputs from Mayank Singh