Industry executives relieved by restrictions in new defence FDI policy

In May, Finance Minister Nirmala Sitharaman, while announcing a Rs 20 trillion stimulus for the coronavirus-hit economy, said a decision had been taken to raise the foreign direct investment (FDI) cap in defence production from the existing 49 per cent (under the automatic route) to 74 per cent.
 

On Thursday, the Department for Promotion of Industry and Internal Trade (DPIIT) issued Press Note No. 4 (2020 series), which stated: “FDI up to 74 per cent under automatic route shall be permitted for companies seeking new industrial licenses.”

The raised FDI cap is not on offer to companies that already have government approval for 49 per cent FDI in a joint venture (JV). “Proposals for raising FDI beyond 49 per cent from such companies will require government approval”, said the note.
 

If an overseas defence vendor (referred to as a foreign original equipment manufacturer or FOEM) who already has government approval for FDI wishes to raise its stake to 49 per cent, the FOEM is only required to file a declaration with the Ministry of Defence (MoD) within 30 days of the change in equity or shareholding pattern.
 

Setting up a JV with 74 per cent FDI is contingent on the FOEM bringing in end-to-end technological capability. “Investee company should be structured to be self-sufficient in the areas of product design and development. The investee /JV company along with the manufacturing facility, should also have maintenance and life cycle support facility of the product being manufactured in India,” states the press note.
 

Business Standard learns the Swadeshi Jagran Manch (SJM) pressured the government to mandate the inflow and retention of intellectual property (IP) in defence technologies. “This will be implemented strictly, to avoid a domestic backlash,” said a source close to the SJM.
 

The government’s dual objective in permitting higher FDI in defence is to boost manufacturing and facilitate the inflow of high technology. On March 4, the MoD told Parliament: “By allowing higher FDI in the defence sector, the global companies having high-end technologies can be encouraged to set up their manufacturing base in India in collaboration with Indian companies, thereby resulting in the creation of employment opportunities, saving of foreign exchange and increasing indigenisation.”
 

Many Indian defence company executives are relieved the liberalised FDI caps come with these restrictive conditionalities.

“Allowing FOEMs 74 per cent FDI through the automatic route, and treating them as Indian companies and thus eligible to participate in the “Make in India” categories of procurement – such as “Buy – Indian Designed, Developed and Manufactured”,
“Buy (Indian)” and “Make” categories of procurement would have been disastrous for the fledgling Indian defence industry. The FOEMs have the deep pockets needed to wipe out the truly indigenous defence firms,” says Jayant Patil, Larsen & Toubro’s defence chief.
 

Other executives disagree. Rahul Chaudhry, former chief of Tata Power (Strategic Engineering Division), who now heads his consultancy, points out that the decision to liberalise FDI is in line with the General Financial Rules (GFR) changes announced in May 2017. “The new rules mandate that an indigenous product is not defined by the equity structure of the manufacturer, but by domestic value addition of at least 50 per cent.
 

Chaudhry says it is incorrect that technology will flow to Indian defence JVs by permitting foreign ownership above 51 per cent. “Defence technology flows are regulated by governments, not by companies. A foreign government would control the IP flowing to a 100 per cent-owned subsidiary in India as rigorously as it would to an Indian subsidiary in which it owns a much smaller stake,” says Chaudhry.
 

There has been only limited success in attracting foreign investment into defence since it was first permitted in 2001. In March, the MoD told Parliament that, between 2001 and the end of 2019, Rs 1,834 crore in FDI had flowed to 79 Indian aerospace and defence companies. By June this year, investment has risen to Rs 3,454 crore, the MoD told Parliament on Monday.
 

FDI in defence was first permitted in May 2001, when defence manufacture, earlier reserved for the public sector, was opened up to 100 per cent for Indian private sector participation, with FDI up to 26 per cent permitted, both subject to licensing.

In 2016, Press Note No. 5 (2016 Series) permitted FDI up to 49 per cent under the automatic route, and above 49 per cent through the government route, provided it was likely to result in access to modern technology or for other reasons to be recorded.
 

FDI in defence is also subject to licensing under the Industries (Development & Regulation) Act, 1951. The manufacture of small arms and ammunition is regulated under the Arms Act, 1959.

In addition, foreign investment in the sector is subject to security clearance by the Ministry of Home Affairs, with guidelines issued by the MoD. “Government reserves the right to review any foreign investment in the defence sector that affects or may affect national security,” says the new policy.