FDI For Our Defence

Times of India

6th June 2013

The chorus for increasing the foreign direct investment (FDI) limit in the defence sector is growing louder by the day. The parliamentary standing committee on defence has also now urged the government to raise the limit to mitigate the 'steadily expanding deficiency in defence modernisation'. Yet, there is a danger that the issue will be relegated to the back burner as in the past.

The recurring and dominant theme of those who oppose the increase is that the defence sector must be the monopoly of the defence public sector undertakings. The putative reason for not relaxing the ceiling is that it would make the Indian defence sector hostage to foreign companies, jeopardising our national security. This is a rather tenuous argument.

Unfortunately, when it comes to policy changes in the defence sector, we resist change, are slow learners and only yield when crisis is upon us. The delay in the decision to share the Long Term Integrated Perspective Plan (LTIPP) with private industry announced last month is an illustrative instance.

A strong case for both increasing the FDI and sharing the LTIPP was made in a seminar at the Institute for Defence Studies and Analyses five years ago. But it took a defence scandal to engender a change in policy.

Are there so many negatives in relaxing our FDI policy? A careful analysis would reveal that there is much to be gained in taking a more liberal approach.

First, among the nations with comparable or large military budgets, or even the Brics, none are so dependent on imports as India is. Russia and China are in a completely different league, though the latter has only recently built its capacity through a slew of measures ranging from clandestine procurement of technology to reverse engineering.

Around 70% of India`s defence equipment is imported and if the total value of the foreign components in the equipment/platforms assembled/manufactured in India is computed, the dependency would be higher. As a result, of the estimated $80-100 billion capital acquisition over the next five years, defence wares worth upwards of $63 billion would have to be imported. This will hurt our security more than higher foreign equity of some defence companies may. A nation that would have to face several challenges as it strives to become a greater economic power, cannot afford to be so dependent on imported weapons.

To reduce dependence on imports, the creation of an ecosystem that allows foreign companies to establish industries in the country is imperative. We could, perhaps, take some lessons from the Brazilian experience of bolstering its military-industrial complex, harnessing foreign technology through a liberal policy.

Brazil amended its restrictive 1988 federal constitution that prohibited foreign investment in certain sectors, including defence, in 1995, allowing even 100% investment by foreign companies in the defence sector. The policy has helped expand the country`s domestic production capability and enhanced its defence export prospects. For instance, Helibras of Brazil, which manufactures/assembles advanced helicopters for the three forces, is 85% owned by Eurocopter, the European aviation giant.

Secondly, India`s domestic defence industry requires foreign technology to build production capacity to supply sophisticated weapons to our armed forces. It has to be sourced from companies/nations that safeguard their defence technologies jealously by encouraging them through a compensatory mechanism.

Thirdly, 26% FDI is too small to attract major players. According to Indian company law, 26% equity holding only enables the shareholder to prevent special resolutions. It does not give them the freedom to appoint directors or determine their remunerations. It also limits the profit of such companies. Why then should a company transfer technology and create competition for the parent companies?

Third, link FDI with offsets. Allow higher percentage of ownership to incentivise a company that wins a defence contract to establish production facilities that would fill domestic technology gaps. As an adjunct strategy, allow a combination of higher ownership with the use of multipliers (giving higher credit value) in discharging offset obligations when specialised equipment is manufactured in India.

Fourth, where higher equity is allowed, impose export obligations on the entity. This would encourage the parent company to outsource from India.

Fifth, allow some sort of price preference for defence companies in India that do not have more than 49% foreign ownership. It would encourage foreign firms to progressively reduce their holdings while at the same time retaining their interest in Indian entities.

It is time that we took some bold steps to strengthen our own military-industrial complex. The seemingly sacrosanct figure of the present 26% ceiling on foreign investment in defence appears to have attained the inviolability that crossing the Rubicon had for the returning Roman legions. This has to change and change now.