FDI In Defence : Boon or Bane

Issues Details: 
Vol 10 Issue-3 Jul - Aug 2016
Page No.: 
Sub Title: 
A detailed analysis of the latest Defence Procurement Policies and opportunities that have emerged due to increase in FDI and related policies
Col KV Kuber (Retd)
Saturday, July 23, 2016

On 20th of June 2016, the Government of India announced a series of FDI measures, all of them relaxations with a view to attract FDI into the country reflecting a 360o view on the defence sector, its needs and the manufacturing and trade opportunities it offers.
Holistic view
The Government of India (GOI) has taken a holistic view of the Defence Sector and approached reforms in a methodical and integrated manner. While on the one hand the GoI has addressed regulatory aspects from the DIPP side, on the other the MoD has taken concrete steps to enhance ease of doing Business in Defence Sector. Some of the major reforms that affect the Defence Sector are summarised below :-
• Industrial Licensing. In one go, the GoI has eased out the requirement of licensing by removing more than 60% of the products/sub-systems/components and accessories from the compulsory list of licensing. Presently, in the context of Defence Sector, only following items under the ITC HS classification are under compulsory licensing. Items not included in the list would not require IL for defence purposes. It has also been clarified by the MoD that Dual Use Items, having military as well as civilian applications, other than specifically mentioned in the list, would not require IL. This is a great boon for the domestic industry that has been hither-to-fore has been harassed for obtaining IL in the sector. The specific list requiring IL are as under (these are various sections under the ITC HS Code):-
- ITC HS 87.10 : Tanks and other AFV
- ITC HS 88 : Defence Aircrafts, space craft and parts there of : from 8801 to 8805 : the complete chapter
- ITC HS 8906.10 : Warships all kinds
- ITC HS 93 : Arms and Ammunition and allied items of defence equipment; parts and accessories thereof :: 93.01 to 93.07
- Reference : Press Note 3 (2104 Series)
• Exports. A multitude of radical changes have been made to enable exports of defence products from the country. Following are the major policy initiatives in the regards (these are also elucidated in the update, separately):-
- A Strategy for Defence Exports.
- SOP for Exports
- Notification No 115 (RE-2013)/2009-2014 dated 13 march 2015. This is regarding export of Military stores and the restrictions associated with each of these. Thus the list of military stores that require NOC from DDP have been notified.
- Obtaining NOC online
• Reduction of Imports. The GoI, has taken a giant initiative in mandating the OFB and DPSUs to increase their outsourcing from domestic industry, with the present meagre 2 to 3% outsourcing being flagged with concern. Websites of OFB and DPSUs now carry impressively long lists of items for indigenisation.
• Registration by DGQA. MoD has come out with regulations and procedure for registration by DGQA, which was suspended a decade ago. This allows for a single point registration and enables expeditious procurement.
• Revised DPP 2016. The DPP 2016 is a landmark DPP with many innovative and industry friendly provisions to align the defence procurement with the Make in India initiative.
• Revised DPM. This is work in progress and at an advanced stage of completion.
• Strategic Partnership. Also work in progress and to be announced after extensive consultations with all stake holders.
• Review of FDI In Defence : Vide PN 7 (2014 Series) the GoI has undertaken a complete review of the FDI policy in 2014, thus easing out the decades old restrictive FDI policy in the sector. The Defence Industry was till then subjected to a IL under the IDR Act 1951 and subjected to a 26% FDI cap under the government route and above 26% on a case to case basis the CCS was to be approached wherever it was likely to result in access to Modern and State of Art technology in the country, besides other conditions. Vide the above PN, in 2014, the GoI enhanced the FDI limit to 49% under the government route and beyond that ipso facto under the CCS.
• Radical Changes in the FDI Policy regime: On 20 June 2016 The Union Government has radically liberalised the FDI regime with the objective of providing major impetus to employment and job creation in India. This is the second major reform after the previous one in Nov 2015 and opens up the Defence Sector under the Automatic route upto an investment of 49% and beyond 49% under the government approval route. While the consolidated FDI circular was effective from June 07th 2016, on the 20th of June the FDI policy was further liberalised by dropping the need of “State-of-the-art technology” for FDI above 49% under Government approval route. Under the present policy there is no necessity for approaching the CCS, since the government approval route by itself can approve FDI proposals up to 100%. In addition the GoI has also made applicable the instant FDI limit to manufacturing of Small Arms and Ammunitions under the Arms Act 1959. This indeed is a significant step.
How does this Sync
The entire procurement procedure has thereby been reformed to redraw the boundary conditions for procurement. Concept of IDDM (Indigenously Designed, Developed and Manufactured), Industry enabled MAKE procedure with enhanced funding and revolutionary commitment to placement of orders, drifting away from the beaten track of NCNC (No cost no commitment) to NCFC (No cost Firm commitment) are other landmark provisions. While the government has opened up the limits of FDI, they have taken care to restrict the limits to established prevalent norms.
What is the Change?
Allowing FDI under the automatic route for all investments upto 49% is the first major change.
Doing away with the requirement of going to the CCS for approval and simply allowing the investments beyond 49% through government route is the second major change.
The third major change is to remove the mandated “State of the art” technology and retaining the “modern” technology for considering cases beyond 49% .
Why such a change?
Even as late as July 2013, and a year preceding that, enhancement of FDI in Defence sector amongst others was engaging the attention of the government of that time. A committee headed by the Economic Affairs Secretary, Arvind Mayaram, had recommended that FDI limit be raised in almost all sectors up to 49% through automatic route. This was also preceded by a commerce ministry note of 2010, which recommended 74% FDI cap in the defence sector. The Home Ministry at that time considered FDI beyond certain limit from countries like China, Pakistan, Bangladesh, Saudi Arabia and Indonesia in defence, space, telecom, information and broadcasting, civil aviation may allow people from these countries to dictate terms which could be contrary to India’s interests.
Foreign capital is an imperative, even as a temporary measure, if a progressive agenda for development of the defence sector is to be pursued. Foreign capital usually brings with it scare commodities such as technology infusion, business expertise and knowledge, besides providing a fillip to the skill development.
A decade ago, Indian MoD instituted an Offsets policy to repatriate a uniform 30% of the FE spend in a structured manner into the defence sector. This was a great initiative, but fell short of expectations in performance due to the restrictions imposed on the FDI investment by foreign OEMs. Even if they intended well, they were bound by home constraints in transfer of technology with a minority stake holding. They also feared IPR infringements.
Certain Myths on the FDI norms
There have been concerns raised on allowing FDI in defence and some of them are listed herein:
•             This is a sell out, technology transfer may not take place.
•             Indian private sector has got the raw end of the deal, they may not be able to compete with the global companies that would set up shop here.
•             Relaxed FDI norms would have an adverse effect on      DRDO.
•             Relaxed FDI norms is a sell out to western countries.
•             In a strategic sector like defence, relaxation could compromise national security.
FDI beyond 49% is still under the government route, which means that the applicant company will still need approval of the GoI, meaning thereby that the government has retained control where necessary. Requirement of “Modern Technology” as a pre-requisite has been retained by the government, which will mandate the applicant company to come up with technology as proposed/agreed. Also, in a situation of trust and ease of doing business, there is no reason for the applicant company to make huge FDI investments and not transfer technology, as none else will be the loser.
Indian private sector has really emerged to its present shape thanks to the reforms attempted in 2002, although much is left to be desired. There is an aspiration in the domestic industry, with more than 1 lac crores worth of business placed under the ‘Make in India’ categories by the present government. There is energy in the small industry, which has benefited from offsets besides participating as tier 2/3 vendors. The present government has also made enabling provisions for MSMEs to actively participate in defence contracts under the MAKE category. However, one single gap is in the form of technology. DRDO developed technologies were made available to the Public sector alone, this has been corrected only recently in 2015, with active interference from the political leadership, to now allow a level playing field. This crucial gap can be filled by foreign companies willing to collaborate.
Relaxed FDI norms would be helpful to DRDO to form collaborative arrangements for co-development and also in collaborative research. Taboo gone, their doors are now open and DRDO could do well to exploit this opportunity provided by the government to explore collaboration in niche fields and fill up the identified gaps in technology.
There could be an element of truth in the concern that this could be a sell out to west, but then, statistics are louder than words of accusation, after all the top ten selling countries are from the west. We need them, to propel growth. If we continue to depend on organic growth alone, we could take decades to reach where the west has and by then they would have propel faster to even widen the gaps that were existing. Therefore, an attempt at inorganic growth, as now done, is a good method. The present strategy of the MoD to adopt both the organic as well as the inorganic method of growth has a promise like never before.
National security is not so fragile that it can be compromised by a clearly defined set of procurements made from Indian companies from within the geography of our country, even though these are owned by foreign companies, either as wholly owned subsidiaries (WOS) or with a majority share in them.
In any case,  a wholly owned subsidiary puts plenty of work in the system, energises the supply chain, indigenises the production lines, improves manufacturing technology, increases manufacturing content, enhances requirement of skilled force, creates and sustains job opportunities.  The pressure that develops on the supply chain will propel growth in focus areas of MSMEs, thus diversifying manufacturing expertise.  All of this works towards, “Advantage India”.
Why should Foreign companies come to India with FDI
Is there a more promising destination in the world than India for defence manufacturing? Has the government done enough to improve ease of doing business in India?
With the slew of reforms undertaken by the government, it is natural for the global defence majors to view India as the most attractive destination for their future expansion and endeavours. The same product produced from India could be cost effective besides providing the abstract boost in terms of acceptability. Labour arbitrage is just one of the small economic benefits that can be drawn in the entire gamut of production advantages in India.
In the recent past, the Private sector has exhibited immense energy with demonstrated capability in many areas including niche ones. Small companies and start-ups of the 2005/6 era, have grown to mid-sized companies, having had first-hand experience as Indian offsets partners to foreign OEMS and having participated in some programs in the MoD in the Buy Indian category. In all cases they have won contracts in an open competition and in some DPSUs also have participated. This has opened up yet another challenge to the domination of the OFB and DPSUs to be gifted contracts on nomination basis. OEMs may like to view this as an opportunity to make right type of investments in terms of technologies and production enhancements. This would provide the Armed Forces with options to source their systems at cost effective prices and higher global quality standards.
Collaboration with DRDO in co-development of critical technologies, addressing gaps in technologies through technology transfer, addressing fundamental research and development of pure sciences is an area the OEs may like to explore. The pool of talent, abject understanding of engineering technologies, immense knowledge base and a young talented population are major attractions.
Indian companies will be preferred partners in defence procurements, OEMs have the technology and expertise specially at higher ends of the spectrum, Indian companies have the essential knowledge and skill set, all of this adds up for an intelligent collaboration.
FDI could come through Tier 2 and Tier 3 cooperation from both sides. These are the ones who hold technology and will make a difference through horizontal integration. We have already witnessed some flavour of Vertical FDI with upstream and own stream investments in the value chain. What we are likely to now experience is the Horizontal FDI and Platform FDI. That will be the game changer.
The reforms attempted by the government are path breaking and well thought through. It is time our industry takes advantage of these reforms to the benefit of our Armed Forces. Synchronising the Offsets policy with FDI, enabling Innovative funding mechanisms(as suggested by the Experts Committee), prioritise privatisation of inefficient Ordnance factories, corporatize the OFB, encourage OFB to compete for opportunities, creation of a real level playing field, effective implementation of MAKE programs, encouraging tie-ups and JVs, collaborative R&D, risk-sharing design and development in an atmosphere of encouragement and trust, will be the key to growth. Our Prime Minister’s vision will be fulfilled when every citizen feels the positivity around.

Military Affairs