FDI in Defence: Time to Revisit the Policy

FDI in Defence: Time to Revisit the Policy

(Communique May 2010)

Major General Mrinal Suman, AVSM, VSM, PhD

In a land mark policy change, the defence industry was thrown open to the private sector in May 2001 (Note 4 of 2001 Series). The Government permitted 100 per cent equity with a maximum of 26 per cent Foreign Direct Investment (FDI) component, both subject to licencing. Subsequently, the Department of Industrial Policy and Promotion issued detailed guidelines, after consultations with the Ministry of Defence, for the issuance of licence for the production of arms and ammunition in January 2002 (Note 2 of 2002 Series). 

However, things with regard to FDI have not progressed the way the Government had hoped. There has been a total lack of enthusiasm on the part of foreign investors. As is well known, the upper cap of 26 percent dissuades prospective investors as they get no significant control of the enterprise. Additionally, foreign investors are bound by strict capacity/product constraints. Worse, they are provided no purchase guarantee and have no open access to other markets (including exports). 

FDI is not just a question of getting funds, but access the latest technologies. FDI pre-supposes a long term commitment and lasting relationship between the foreign and local industries. FDI sets in motion a chain reaction wherein FDI upgrades local technology which, in turn, attracts more FDI with higher technology and the cycle goes on. This is of vital importance to the defence sector which is highly capital intensive and undergoes rapid obsolescence of technology. 

Attractiveness of a nation for foreign investments in any sector is judged by its ‘FDI Confidence Index’. Any nation that covets FDI in defence has to project itself as a lucrative and safe destination for investment. For that, adequate freedom must be provided to a foreign investor to cater to market dynamics, albeit within the broad regulatory policy framework. Restrictions on capacity should be relaxed so as to promote economies of scale, thereby reducing India’s procurement price as well. Exports should be encouraged to ensure economic viability of an enterprise as also to offset outflow of foreign exchange through repatriation by foreign investors. 

Most importantly, FDI cap should be raised to 100 percent, opposition on the grounds of security notwithstanding. This single step will address all apprehensions of prospective investors and convince them that their genuine commercial interests would remain safe. Security concerns have been overhyped to perpetuate status quo by entrenched interests. Presently, India is procuring weapon systems produced/ integrated abroad. It is not understood as to how India’s security would get threatened if the same weapon systems are produced/integrated in India. As regards dependability during crisis situations, no foreign investor can risk loss of his total investment by shutting down his production facilities. As a matter of fact, indigenous production will insulate India from unilateral imposition of embargos on supply of essential spares by whimsical foreign governments.   

  

FDI is a need based concept. The host nation needs funds and technology for its accelerated growth while a foreign investor is guided purely by economic considerations. It has to be appreciated that no foreign investor is going to part with his closely guarded technology unless he has adequate control over the enterprise and is assured of sufficient autonomy. Raising the cap to 100 percent will make India an irresistible and ideal FDI destination. Therefore, it is time India revisits the policy to rationalise its incongruent provisions.