Hike in FDI in Defence Cap: a Hollow Initiative

Hike in FDI in Defence Cap: a Hollow Initiative

(Indian Express 29 Aug 21014)  

Major General Mrinal Suman

The much trumpeted move of the government to hike foreign direct investment (FDI) limit in the defence sector from 26 percent to 49 percent can be aptly termed as a cosmetic reform. It means little and will serve no purpose whatsoever. Without adequate control over the joint-venture, no foreign investor is likely to be enthused to share his proprietary technology. Except for a proportionate increase in repatriable profits, there is no difference between 26 and 49 percent holdings.  

Realising the futility of continuing with the current dispensation, the Commerce Ministry has been suggesting a relook at the policy. Unfortunately, every time the issue of increasing FDI limit comes up, stiff opposition is put up by the self-seeking entities, i.e. the powerful public sector lobby and the influential business associations. Both consider the entry of foreign manufacturers to be a threat to their business interests. The public sector prefers that the technology be made available to it under the ‘Buy and Make’ route, as hitherto fore.

Ingeniously, the time tested subterfuge of raising the bogey of security concerns and threat to the indigenous industry is raised to create apprehensions in the minds of the decision makers. Selfish interests are thus cunningly camouflaged as national concerns.  

India’s prowess in defence technologies is simply pedestrian. For example, while the world has moved to the fourth generation of night-vision devices, India is still struggling to master the second generation technology. Even after 67 years of Independence, India cannot produce a reliable small arm for the soldiers and has to resort to imports.

At times one gets the impression that the leaders and the functionaries are very comfortable with the current state of affairs. They appear to be proud of the fact that India is the largest importer of conventional weapons in the world. How else can one explain haughtiness and swagger in their demeanour while visiting foreign pavilions in every Defexpo? Instead of feeling ashamed of India’s inability to produce even basic equipment, they flaunt huge shopping lists and bask in the attention showered on them by the foreign vendors.

In defence technologies, India is lagging behind by up to 20 years. There are only two ways of covering the yawning technology gap – either through indigenous research and development or through the infusion of imported technologies.

As regards indigenous research and development, the track record of the Defence Research and Development Organisation (DRDO) has been dismal. It has been thriving on patronage, exaggerated claims, tall promises, unexplained delays and sub-optimal products.

It is a matter of record that DRDO has never produced a defence system in the promised time-frame and conforming to the required parameters. The only success it has to its credit relates to the replication of some imported products (under the misleading taxonomy of ‘reverse engineering’ and ‘indigenisation’). It is an irrefutable fact that DRDO does not possess the required competence to usher in a technological revolution and make India self-reliant.

The claims that India has the capability to design and develop weapon systems through indigenous efforts are bereft of any reality. Knowledgeable observers consider such confidence to be totally misplaced, terming it to be a preposterous assumption and a case of self-delusion.

Opponents of FDI hike claim that the entry of foreign companies would stymie the growth of the indigenous industry and demand protection for it. It is the most ridiculous logic. They conveniently forget that despite enjoying total protection for the last six decades, the Indian industry has achieved little and is in an abysmal state. Assembly of imported sub-assemblies and components is no defence production.

Thus, the only option available to India to kick-start indigenous defence effort is through the import of foreign technologies. For that, joint ventures offer the best route. Equity participation by foreign partners 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.

While opening the defence industry to the private sector in May 2001, the Government allowed 26 percent FDI, hoping that foreign investors would rush in with their bags of money. However, all hopes have been belied and the policy has been acknowledged as a total failure. India has received less than 5 million USD of investments in the defence sector during the last 12 years.

Prospective foreign investors find the cap of 26 percent to be highly dissuasive. In addition, many provisions are felt to be too restrictive – a foreign investor is expected to invest his resources in a venture where he has no significant control, is bound by strict capacity/product constraints, gets no purchase guarantee and is denied open access to other markets (including exports).

Unfortunately, when every other argument fails, the specter of security concerns is raised by the self-seeking entities to oppose raising of FDI limit. They demand that the ownership of core strategic industries like defence should remain under Indian control. Apprehensions are expressed that foreign investors may close production and deny supplies to the armed forces during warlike emergencies. It is one of the most ludicrous excuses.

One of the objectives of inviting FDI is to persuade foreign companies to manufacture within India those systems which are otherwise being imported in fully built up form. It is not understood as to how India’s security concerns would get threatened if the same weapon systems are produced/integrated in India. Production in India through joint ventures is infinitely more reassuring. Whereas supplies can be easily cut-off unilaterally by the foreign suppliers, factories in India cannot be shut and shifted. In any case, all governments reserve the right to take over critical industries during national emergencies.

Most of the major defence equipment producers follow ‘Global Factory’ concept, wherein various functions are spread over a number of locations in different countries. As every facility is intrinsically integrated in the total production cycle, it is not easy for a foreign manufacturer to shut down any facility and disrupt his worldwide production chain/network. Additionally, local manufacture of a product ensures better life-time support and regular supply of spares.

Therefore, fears expressed on account of security concerns are totally unfounded and highly exaggerated. As a matter of fact, indigenous production will insulate India from unilateral imposition of embargos on supply of essential spares by whimsical foreign governments. 

  

A word about the importance of the FDI limit will be in order here. A partner holding 100 percent stake can exercise total and unhindered control over the enterprise. He can pass both ordinary resolutions (passing of accounts, approving dividend levels and appointing directors) and special resolutions (buy back of shares, diversification and merger/amalgamation).

Whereas 51 percent holding implies working control of the joint venture, 26 percent holding empowers the holder to stall passage of special resolutions. Thus, control-wise, there is no difference between FDI limits of 26 percent and 49 percent. The control remains with the indigenous company while the foreign participant can prevent passage of special resolutions. Similarly, there is little to choose between 51 percent and 74 percent FDI caps.

In sectors like insurance, FDI is sought solely for the inflow of funds while the defence sector needs both technology and funds. In fact, infusion of technology is of primary concern to India. Therefore, India should have a technology centric FDI policy. The policy must have inherent flexibility and financial irresistibility to attract needed technology.

Defence industry covers too vast a range of products, from bullet proof jackets to aero-engines. It is patently incorrect to apply a single yard-stick to all joint venture proposals. They should be assessed and categorised on the basis of nature, level, depth and exclusivity of technology being infused for the fixation of FDI cap.

Whereas proposals with commonplace low technologies can continue to be governed by   26 percent cap, the limit for proposals with stabilised technologies that are available from multiple sources can be raised to 49 percent wherein majority shareholding still remains in Indian hands. Similarly, proposals that involve latest high technologies or exclusive technologies can be allowed 51 and even 74 percent FDI component.

In rare cases, when infusion of frontier and cutting edge technologies is promised, even 100 percent FDI may be permitted. Such a methodology will provide an excellent safeguard to ensure that indigenous growth does not get ‘stymied’, as feared by many. Proposals that threaten indigenously developed technologies can be easily blocked.

As the Union Cabinet has decided to keep FDI limit unchanged at 49 percent, India cannot expect major foreign investments. The current limit is considered unattractive and dissuasive. The much-hyped provision of allowing higher FDI caps for cases involving state-of-the-art technologies by the Cabinet Committee for Security is a sham as the authority to initiate such cases lies with the Defence Ministry. Incidentally, the said proviso has been in existence since 2006 but not a single case has ever been processed.   

Regrettably, an issue that has immense potential to propel India’s quest for self reliance in defence production is being viewed and debated from narrow narcissistic perspective by the self-serving stake holders. Decisions taken as a matter of political and populist expediency can prove disastrous for the nation in the long run.

Indian policy on FDI in defence industry is symptomatic of perverse intransigence and an unwillingness to learn from the past experience. Persistence with failed policy initiatives can never yield results.

Finally, infusion of foreign technologies is absolutely indispensable if India wants to develop a vibrant and dynamic defence industry. For that, India must evolve an investor–friendly policy and simplify procedures. It must project itself as an irresistible FDI destination for the defence industry.*****