Proposal to Raise FDI Cap in Defence Faces Selfish Opposition
(FORCE Jul 14)
Major
General Mrinal Suman
The Indian policy regime
is infamous for subordinating national concerns to the interests of some
self-seeking pressure groups. Worse, a number of self-proclaimed experts
readily join hands with egocentric lobbies to spread disinformation. Invariably,
truth becomes the first casualty. False examples, taken out of context, are
cited in support of their flawed contentions. The case of Foreign Direct
Investment (FDI) in defence is symptomatic of the detrimental malaise that
afflicts the Indian polity and the intelligentsia.
Every time a proposal is
mooted to raise FDI limit in defence sector, a highly motivated and vicious
media campaign is unleashed by the selfish entities who feel threatened. Most
unfortunately, efforts are made to frighten the policy makers through
well-planned subterfuge of spreading falsehood. FDI is portrayed as an evil
that threatens national security and has the potential to cripple the
indigenous industry to make India captive to foreign companies. Attempts are
made to make their opposition appear credible by quoting select examples,
albeit in a highly inventive manner. Full facts are never revealed.
In a recent article, it
was claimed that Germany had lately reduced FDI cap in defence from 26 percent
to 25 percent; thereby suggesting that India should draw lesson from Germany
and not consider enhancement of FDI limit. Oddly, India (with its abysmal
defence industry) was ingeniously compared with the world leader Germany and
the underlying reason for the German step was intentionally passed over.
The fact is that Germany
wanted to prevent leakage of its exclusive defence technologies by reducing the
clout of the foreign investors. Thus, the example of Germany was just a red
herring to mislead people and has no relevance to the ongoing Indian debate. It
needs to be highlighted here that as per a report released by the UN Conference
on Trade and Development, Germany is one of the three most attractive and
investor friendly countries. It received Euro 23.4 billion in FDI in 2013.
Most shockingly, whereas
the whole world strives to attract maximum FDI, our bought-out experts trash the
very validity of the concept of FDI. They go to the ridiculous extent of
claiming that no country has ever benefited from FDI. They forget that the
entry of Suzuki ushered in a revolution in the India automotive industry.
Unraveling the FDI Conundrum
The World Bank defines
FDI as ‘net inflows of investment to acquire a lasting management interest (10
percent or more of voting stock) in an enterprise operating in an economy other
than that of the investor’. FDI comprises of funds provided by the foreign
direct investor to the FDI enterprise as equity capital, reinvested earnings
and intra-company loans.
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. Any country that covets FDI has to convince the prospective
investors of the advantages accruing to them as compared to competing suitors.
FDI pre-supposes a long
term commitment and lasting relationship between the foreign and the local
enterprise. 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.
FDI limits are generally
discussed in terms of three primary considerations – one, quantum of profit
that a foreign investor can repatriate; two, degree of control that he can
exercise over the joint venture; and three, liberty to pass resolutions, both
ordinary (passing of accounts, approving dividend levels and appointing
directors) and special (buy back of shares, diversification and merger/amalgamation).
100 percent ownership gives
total and unhindered control to the holder. He can take any decision that he
considers prudent for the venture. In other words, he can pass both special and
ordinary resolutions, provided they are in consonance with the host country’s
policies and laws. On the other hand, 51 percent holding implies working control
and day-to-day functional oversight of the joint venture. 26 percent holding empowers
the holder to stall passage of special resolutions.
From the above, it is
apparent that leaving aside a proportionate increase in the repatriable
profits, there is very little difference between FDI limit 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.
The Current Policy – a
Flop Show
To achieve the often stated objective of procuring 70 percent of
defence requirements from indigenous sources by 2010, the Government allowed 26
percent FDI in the defence sector in May 2001. Detailed guidelines for the
production of arms and ammunition were issued by the Department of Industrial
Policy and Promotion (DIPP) of the Ministry of Commerce and Industry, after
consultations with the Ministry of Defence (MoD), in January 2002.
As per the current policy, the
applicant company has to be either an Indian company or a partnership firm with
management control in Indian hands. The Chief Executive has to be a resident
Indian. A licensee can produce only the licensed products and in the sanctioned
quantity – he can neither diversify nor enhance production. The policy directive further stipulates that arms and ammunition
will be primarily sold to MoD and their sale to other security organisations in
the country will be with the prior approval of the Government. Similarly, their
export will also need prior sanction. Non-lethal items may be sold to non-Government
agencies but with the concurrence of MoD.
The current policy has
been an utter failure as India has received paltry USD 5 million of FDI inflow
in defence manufacturing during the last decade. Analysing reasons for the
same, the Department of Industrial Promotion
and Policy (DIPP) opined, “FDI cap of 26 percent discourages original equipment
manufacturers from bringing in proprietary technology, as they may be reluctant
to license their proprietary technology to a company in which their equity is
restricted to a minority of 26 percent. This has resulted in India not being
able to access the latest high-end technologies available.”
Interestingly, as per an official declaration of 2006, even 100 per cent
FDI in defence is allowed on a ‘case-by-case’ basis. However, it is purely a theoretical
proposition and means little – no guidelines have been issued and no
rules have been framed. Despite repeated requests, Mahindra’s proposal for a
joint venture with BAE Systems holding 49 percent equity was rejected without
assigning any reasons, making it obvious to all that the government is dead set against granting permission to proposals entailing
more than 26 percent FDI. Therefore, to say that no foreign investor has come forward with
a proposal of 100 percent holding is simple baloney.
A discussion paper was initiated by DIPP in May 2010 advocating
raising of the FDI limit in the defence sector to 74 percent. The policy makers
were reminded that it was unrealistic to expect domestic manufacturing to make
state-of-the-art equipment without sourcing high-end technologies from abroad by
encouraging foreign defence manufacturers to establish manufacturing bases in
India to help catalyse the growth of the indigenous industry.
DIPP sought views of all
involved parties. Whereas the services backed the proposal, both MoD and the
industry could not rise above petty selfish considerations. To protect the
grossly inefficient public sector, MoD wanted status quo to continue wherein
defence public sector undertakings import sub-assemblies under the garb
of transfer of technology through ‘Buy
and Make’ route, put their own label on the assembled products and sell them to
the services at a huge profit.
The response of the Indian industry was equally self-seeking. Major
players did not want FDI above 49 percent as entry of powerful foreign
manufactures was viewed as a threat to their business interests. They wanted
joint ventures but with controlling stake. Accordingly, all the three major
industry associations/chambers opposed raising the limit beyond 49 percent.
In May 2013, the
Commerce Minister initiated a fresh proposal. In order to mollify MoD, he
advocated that the limit be raised to 49 percent initially, instead of 74
percent recommended by him earlier. It was a conciliatory move as he felt
strongly that the cap of 26 percent was too low to attract foreign investments.
Once again, terming the
proposal to be a ‘retrograde step’, MoD decided to stick to its earlier stand
of keeping the limit at 26 percent. Defence Minister Antony felt that allowing
foreign companies to set up manufacturing/assembly facilities in India would
stymie the growth of indigenous design and development.
After the recent change of guard at Delhi, the Commerce Ministry has once
again raised the issue of increasing FDI cap. The cabinet note spells out three
options – raising caps to 49 percent, 74 percent and 100 percent. True to the
past precedence, an aggressive media campaign has been initiated by the
interested parties to oppose the move.
FDI versus Indigenous Industry
Defence Minister Antony’s statement that ‘building up India’s
own indigenous capabilities for designing and developing weapon systems is
vital’ cannot be disputed at all. However, his assertion that allowing foreign
companies to set up manufacturing/assembly facilities in India would be a
retrograde step and stymie the growth of the indigenous capability is totally
erroneous.
Statements like ‘every weapon system that is imported
leaves one less for indigenous industry to develop’ are hollow and misleading.
What has the indigenous industry achieved during the last six decades to demand
protection? Has it been able to develop a single major system so far? Assembly
of imported sub-assemblies and components is not development of defence
systems.
The confidence expressed
by MoD in India’s capability to build-up defence industry through indigenous
efforts is a case of self-delusion. One has been hearing such confident
predictions since the early 1990s that defence imports would be reduced from 70
percent to 30 percent within a period of ten years. Despite repeated
protestations, imports have climbed to close to 75 percent now.
Leaving aside the limited progress made in the field of
missiles, the Defence Research and Development Organisation (DRDO) has not been
able to develop a single system in the promised time-frame and conforming to
the accepted parameters. The only success it has to its credit relates to
replication of some imported products (fancifully called ‘reverse engineering’
and ‘indigenisation’). It will be unrealistic to expect DRDO to change
overnight and make India self-reliant.
The defence public sector
consists of defence public sector undertakings and the Ordnance Factories Board. Most unfortunately, the Indian
military is a captive customer of the Indian public sector and is forced to buy
what it produces. With assured orders in hand, the public sector carries on
inefficiently, without bothering about the quality parameters or the time
frame.
It is also suggested by some observers that need for technology can be
met by indigenous development under the ‘Make’ procedure, even with imported
sub-assemblies and components. It is conveniently forgotten that the ‘Make’
procedure was introduced in 2006 and has failed to deliver so far. Currently,
two projects are being progressed under the ‘Make’ procedure – Futuristic
Infantry Combat Vehicle and Tactical Communication System. Both have failed to
take off and stay mired in bureaucratic muddle. Interestingly, even the much
touted ‘Buy and Make (India)’ has not made a start as yet.
Security Threat Posed by
FDI
When every other
argument fails, specter of security concerns is raised by the self-seeking
entities to stymie any proposal to raise FDI limit. 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 ridiculous
excuses.
The fact that it is infinitely more reassuring to indigenously
produce (through joint ventures) those systems which are otherwise being
imported in fully built up form is conveniently overlooked. Whereas supplies can
be easily cut-off unilaterally by foreign suppliers, factories in India cannot
be shut and shifted. Additionally, indigenous manufacturing facilities also ensure
better life-time support including supply of spares.
Equally
importantly, all major defence equipment producers follow ‘Global Factory’
concept, wherein various manufacturing functions are spread over a number of
locations in different countries. When a major defence company invests in any
country, it makes it an integral part of its overall production chain. For example, European Aeronautic Defence and Space Company has
more than 70 production sites and Safran carries out industrial, design and
commercial operations in more than 30 countries. In such a scenario, it
is not easy for a company to shut down any facility and risk disruption of its
worldwide production network.
As
pointed out by Commerce Minister Anand Sharma, most nations in the world
(including the United States and the European Union) allow 100 per cent
FDI in defence with security issues being addressed through verification/clearance
procedures’. India should also incorporate adequate safeguards while issuing
licence. It can reserve the right to take over the licenced facility under
certain extraordinary circumstances of national emergencies. Most nations
include such an enabling provision.
Surprisingly, in some of the recent writings in the media, it has been claimed that no
country in the world allows majority stake with the foreigners. It is expediently
forgotten that our own Mahindra Group has acquired majority stake in two Australian defence
companies, Aerostaff Australia and Gippsland Aeronautics. Both the companies
are niche players with well-developed technologies and products.
Infusion of Technology and
FDI Cap
Advocates of higher FDI
cap argue that an increase in stake will provide incentive to foreign
manufacturers to share their technological expertise, thereby promoting
self-reliance in defence production. However, the opponents have conjured up a
novel hypothesis. According to them, exporting country would not allow sharing of
its proprietary technologies with India,
even if the FDI cap is raised to irresistible levels. It is a hollow argument.
In the present day
geo-political environment, economic considerations rule supreme. For attractive
economic benefits, all countries grant waivers. There may be an odd exception. It
is a well known fact that major defence contractors enjoy immense clout to
pressurise their governments. Irresistible financial gains will make countries
allow export of technologies which they may not be ready to share in normal
business deals. Thus, higher FDI cap will act as a forceful magnet to attract
FDI.
As stated earlier, the
current revolution in the Indian automotive industry started with the arrival Suzuki.
As it possibly could not bring all components from Japan, it urged its Tier-II
and Tier-III sub-contractors to have collaborations with Indian companies to
manufacture components in India. Resultantly, development of a vast network of
ancillary industry got a big boost.
Recommendations
Defence industry covers
too vast a range to be branded as a single entity as regards infusion of
technology for the formulation of FDI policy. The range varies from cryogenic
engines, aero engines, gun-stabilisation system of tanks and terminal guidance
system for missiles to small arms for the infantry. Therefore, it is patently
incorrect to apply a single yard-stick to the complete defence industry. A more
prudent option would be to categorise defence industry on the basis of
technology being infused and the FDI upper-cap fixed accordingly.
In other words, India should adopt a flexible and technology-specific policy. See
Illustration.
|
|
Illustration: Technology-Centric FDI Policy
All joint venture
proposals should be assessed on the basis of nature, level and depth of
technology involved and categorised accordingly for the fixation of FDI cap, as
follows:-
·
Tier 1: Proposals that
entail infusion of frontier and cutting edge technologies – up to 100 percent.
· Tier 2: Proposals that promise transfer of exclusive
technologies not commonly available – up to 74 percent.
·
Tier 3: Proposals
involving latest high technologies – up to 51 percent.
· Tier 4: Proposals with stabilised technologies that are
available from multiple sources.
·
Tier 5: Proposals with commonplace low technologies – up to 26
percent.
To start with, approval
for Tier 5 proposals should be through the automatic route. In areas where adequate indigenous capability exists, FDI cap can be
retained at the current dissuasive level of 26 percent. Similarly, to encourage
indigenous R&D, it should be ensured that only those proposals are
sanctioned that entail import of technologies which India is struggling to
master.
FDI
is an effective mechanism for persuading foreign companies to manufacture
within India those systems which are otherwise imported in fully built up form.
Degree of assurance and resulting comfort accruing from indigenous facilities
will always be more than the imports. However, necessary safeguards should be included in the licence
to address security concerns.
FDI could either be in a
Greenfield project or through merger/acquisition. Normally, developing
countries attract Greenfield projects, whereas acquisitions/mergers are more
prevalent in the developed nations. India today stands at a threshold where
both the options can be exercised.
As economies of scale
are essential to ensure commercial viability of a project, capacity constraints and restrictions on exports should be
relaxed, albeit keeping national interests in mind. Import of dual use
technology should also be encouraged as it benefits other segments of the
economy as well.
As more companies
establish defence industries in India, significant reduction would accrue in
the outflow of foreign exchange. Ancillary industry will grow and local employment opportunities
will increase multifold. India’s export potential would get a boost. More importantly, a
raise in FDI is essential to facilitate fulfillment of offset obligations which
are expected to be over USD 12 billion in the next ten years.
Finally
Opponents of the proposed hike in FDI
cap have adopted contradictory stands. On one hand, they cite the example of
telecommunication sector to question the very purpose of seeking FDI. On the other hand, they are ready to welcome
FDI in defence as long as the control stays with the Indian partners. It is a strange logic that FDI is beneficial to India only if does not
exceed 49 percent. It reveals the true intent of the opponents – they dread
competition from foreign manufacturers and seek protection by portraying FDI as
an evil.
If India feels that FDI
is not required in defence, it can continue to stick to the current failed
policy. In any case, self-serving stake holders have already joined hands to
oppose any change. However, if the government wants foreign companies to invest
in India, it has to change its approach and revisit the policy. The much-hyped
provision of sanctioning higher FDI caps for cases involving state-of-the-art
technologies is a sham.
What is really surprising is the fact
that the opponents of FDI express confidence in the capability of DRDO to usher
in technological advancement. It is a preposterous proposition. Optimism is
justified only when based on the past track record.
Given its favourable
geo-political position and technical man-power, India must strive to be a hub
for global outsourcing and partner co-production of defence products as a part
of multi-nation consortiums. For that, India has to put its act together by evolving
an investor-friendly policy, streamlining procedures and projecting India as an
ideal FDI destination for the defence industry.
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