FDI in Indian Defence: Implications of Raise in the Cap

14 Jul, 2014    ·   4558

Radhakrishna Rao analyses the potential implications of FDI in the Indian defence sector, and suggests ways forward

The May 2014 change in the Indian leadership where the National Democratic Alliance (NDA) government led by Prime Minister Narendra Modi took charge signalled a vastly stepped-up commitment to India’s crisis prone defence sector with particular reference to attaining self reliance in the defence manufacturing. In fact, the Bharatiya Janata Party’s (BJP) election manifesto had made a strong and specific commitment to end

India’s dependence imported arms and ammunition by boosting domestic production of high performance fighting equipment. Foreign Direct Investment (FDI) is already considered one of the ‘game changers’ for boosting India’s home-grown capability in the production of state-of-the art combat systems. In fact, the 26% FDI cap on defence sector that former Prime Minister Manmohan Singh-led United Progressive Alliance (UPA) government had failed to upwardly revise was considered far from an attractive proposition for the global defence and aerospace conglomerates to invest in India’s defence production sector. But then whether hiking the FDI cap to 49% by the NDA government in its maiden budget presented in the Indian parliament on 10 July would prod foreign investors to pass on their latest genre technologies to Indian partners is not an easy guess at this moment. 

Far from being a magic wand to help India build a home-grown defence industry based on indigenous expertise, an increased FDI could be considered no more than a catalyst for the Indian defence producers to face the challenges of designing and developing high-end, complex fighting equipment with domestic resources. In this context, Rahul Gangal, Principal, Roland Berger Strategy Consultants says, “I think this is a positive step though it may not be as much of a move forward as everyone was hoping. The treatment of the balance 51% will be critical .The earlier policy at 26% FDI required 51% to be held by one resident Indian entity. It would be interesting to note what the change in that is, if any.”

Indian Finance Minister and Defence Minister Arun Jaitley, while presenting the budget for 2014-15, did admit to the ignominious distinction India has achieved as the ‘largest importer’ of arms and fighting systems. That a country which has sent probes to Moon and Mars continues to meet 2/3rd of its defence requirements via imports stands out as a far from edifying testimony to its “poor state of  defence industrial infrastructure,” said Jaitely. “We are buying a substantial portion of our defence requirements directly from foreign players. Companies controlled by foreign governments and foreign private sectors are supplying our defence requirements to us at a considerable outflow of foreign exchange,” he added.

Significantly, it has also been decided to continue with the policy of permitting higher FDI cap beyond the stipulated 49% in the event of a foreign investor willing to part with the latest genre technologies at his command. This, however, would be subject to approval by the Cabinet Committee on Security on a case-to-case basis. For quite some time now, industry and trade bodies in India have been lobbying for facilitating an increased FDI inflow in the defence production sector. It was in 2001 that India opened its defence production sector to private participation. However, the view of the Indian industrial sector active in defence production is that it would be naïve to expect high technology to flow into Indian industry simply because foreign firms can invest more and repatriate profits. One would therefore need to wait and watch.

India should go about building a military-industrial complex based on its long term strategic needs. At present, much of the defence production activities in India are centred on the facilities of the Defence Public Sector Undertakings and Ordnance Factories Board (OFB). Lack of direction and motivation as well as interference meant that they could come out with very few new and innovative products featuring state of the art technologies. Conversely, private sector companies, that have made a modest foray into the defence production sector, are not enthusiastic about investing in research and development to build high-end fighting systems. As such, the private sector in India’s defence manufacturing would need to be encouraged and incentivised to invest in research and development through a slew of proactive measures.

There is a need for in depth evaluation of the possible long term political, geostrategic and security fallouts of an increased FDI cap in the defence production sector.

Specifically, the trade sanction and technological embargo emanating from the US and its western allies could deal a paralysing blow to a joint venture involving a partnership of a US-based defence company. Sufficient strategic safeguards should need to be built into joint ventures involving foreign participation. Otherwise the entire exercise of enhancing FDI cap in India’s defence production sector could prove counterproductive, with serious consequences for the combat-readiness of the Indian defence forces. Self reliance in defence production should revolve round a long-term vision of the security threat perception faced by the country.