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15 June, 2014

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Home > News > Defence Industry > FDI in Defence: Dispelling the Myths

Defence Industry

FDI in Defence: Dispelling the Myths

37 votes cast

By Maj Gen Mrinal Suman

Issue Vol. 28.3 Jul-Sep 2013 | Date : 30 May , 2014

India should adopt a flexible FDI policy to import much needed technologies which cannot be mastered

through indigenous efforts in the acceptable time frame. Unfortunately, every time the issue of increasing

FDI limit comes up, the opponents resort to their time-tested subterfuge of raising the bogey of security

concerns and threat to indigenous industry, thereby hiding their selfish reasons. In any case, India can

incorporate necessary security clauses in the initial license to ensure that an unscrupulous entrepreneur

does not play truant in crisis situations. India should reserve the right to take over a facility if required in

an operational emergency.

Most prospective foreign investors consider the Indian FDI policy in the defence industry to be dissuasive in

intent and content

Indias policy on Foreign Direct Investment (FDI) in defence industry is symptomatic of bureaucratic

obduracy and perverse intransigence. Unwillingness to learn from experience has been the bane of Indiangovernance. Persistence with failed policy initiatives can never yield results. In May 2001, the defence

industry was thrown open to the private sector. The Government permitted 100 per cent equity with a

maximum of 26 per cent FDI component, both subject to licensing. Unattractiveness of the policy became

evident in a short span of time. By 2004, Defence Minister George Fernandes was forced to admit in the Lok
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Sabha that India had received no FDI proposal till then.

Observing the lack of enthusiasm amongst the prospective entrepreneurs at Aero India 2005, Defence

Minister Pranab Mukherjee considered it necessary to exhort interested foreign companies to invest in the

Indian defence industry. As per the reports appearing in the press, India has received less than US$5 million

of FDI inflow in defence manufacturing during the last decade. Most prospective foreign investors consider

the Indian FDI policy in the defence industry to be dissuasive in intent and content.

In 2010, the Commerce Ministry circulated a note recommending the raising of FDI cap to 74 per cent to

encourage established players in the defence industry to set up manufacturing facilities and integration of

systems in India. It was vehemently opposed by the interested parties, with Ministry of Defence (MoD)

insisting that the 26 per cent FDI limit should be retained. In May 2013, modifying his earlier proposal,

Commerce Minister Anand Sharma suggested that the upper cap be raised to 49 per cent as a first step. It

has also been shot down by the MoD. However, in a deft move, the MoD has suggested that higher FDI may

be considered for modern and state-of-the-art technology by the Cabinet Committee on Security on a case

to case basis.

The World Bank defines FDI as net inflows of investment to acquire a lasting management interest (ten percent or more of voting stock) in an enterprise operating in an economy other than that of the investor. FDI

comprises funds provided by the foreign direct investor to the FDI enterprise as equity capital, reinvested

earnings and intra-company loans. Attractiveness of a nation for foreign investments in any sector is judged by

its FDI Confidence Index which depends on various factors such as stable policy, favourable investment

climate, structural adjustments, economic freedom and a fair market access. India fares rather poorly on this

account.

Unwillingness to learn from experience has been the bane of Indian governance

As recounted earlier, it is an undisputed fact that the current Indian policy has been an abject failure. Whereas

an intense debate is taking place to influence the decision makers, a number of articles are being planted in the

media to sway the public opinion. Unfortunately, objectivity is conspicuous by its absence. Stakeholders have

taken stands that suit their interests.

As the debate has been highly skewed, this article endeavours to remove some common misconceptions and

put all issues in their proper perspective.

Misconception One: Indian policy is highly investor friendly and does not require any

changes

The MoD continues to insist that the Indian policy is highly investor friendly and requires no changes. It

attributes lack of response to the individual entrepreneurs decision depending on his commercial

perception.

However, a closer look at the policy reveals that virtually every provision is dissuasive in nature

management control of the company must remain in Indian hands with majority representation in the board.

The Chief Executive has to be a resident Indian; a licensee can produce only the licensed products and in the

sanctioned quantity and he can neither diversify nor enhance production without prior sanction. A foreign

investor cannot transfer his equity before the expiry of the lock-in period of three-years. Even after that, suchtransfers have to be with the approval of the Government.

Although the Government can give no purchase guarantee, the proposed quantity for acquisition and overall

requirements may be made known to the extent possible. The policy directive further stipulates that arms and


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ammunition will be primarily sold to the MoD. Their sale to other security organisations in the country and

exports will be with the prior approval of the Government. Non-lethal items may be sold to non-Government

agencies but with the concurrence of the MoD.

FDI is a need-based concept; whereas a host nation needs FDI for accelerated growth, prospective investors

are guided purely by economic considerations

Oddly, India expects a prospective foreign investor to be excited by such an asymmetrical policy wherein heis expected to invest his resources in a venture where he has no significant control, faces strict

capacity/product constraints, gets no purchase guarantee and has no open access to other markets (including

exports). It defies logic. Such a lop-sided policy can never attract FDI.

Misconception Two: Higher FDI limit is a threat to national security

When every other argument fails, the spectre of security concerns is raised by the interested elements in the

MoD to stymie any proposal to raise FDI limit. Apprehensions are often expressed that during operational

emergencies, foreign investors may shut down their factories and choke supplies to the armed forces. In his

recent letter to the Commerce Minister, Defence Minister Antony has opposed the raising of FDI cap ongrounds that the country could not afford to be dependent on foreign companies and be vulnerable to policies

of their countries of origin in the field of defence on the long-term basis.

Presently, India is procuring all critical weapon systems produced/integrated abroad. It is not understood as

to how Indias security would get threatened if the same weapon systems are produced/integrated in India.

As a matter of fact, indigenous production will insulate India from unilateral imposition of embargos on

contracted supplies by whimsical foreign governments. The degree of assurance and resulting comfort

accruing from indigenous facilities will always be significantly more than dependence on imports. Additionally,

indigenous manufacturing facilities will also ensure better life-time support including supply of spares.

As regards dependability during crisis situations, no foreign investor can risk loss of his total investment by

shutting down his production facilities. Further, 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. In such a scenario, it is not easy for the company to shut down any facility and disrupt its

worldwide production network.

If India is serious about attracting FDI in defence, it has to position itself as the most lucrative FDI

destination

Most importantly, adequate safeguards can be incorporated while issuing licenses. India can reserve the right

to take over the licensed facility under certain extraordinary circumstances of national emergencies. Most

nations include such an enabling provision. It is ridiculous that imports are considered more reliable than

production in India. Needless to say, security concerns are overhyped to perpetuate status quo by

entrenched interests by resorting to specious logic. Fears expressed are totally unfounded and highly

exaggerated.

Misconception Three: Investment decisions are taken by foreign companies and India has no

role to play

It is often claimed by the MoD that foreign investors are guided purely by economic considerations and that

they are neither influenced by the FDI limit nor by other provisions. If they wish to invest in India, the upper

cap of 26 per cent will never be an impediment.


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The above argument reflects ignorance of the dynamics of FDI flow. It is often forgotten that FDI is a need-

based concept. Whereas a host nation needs FDI for accelerated growth, prospective investors are guided

purely by economic considerations. As investible funds are limited, all countries covet them. Foreign investors

carry out an inter-se appraisal of all likely destinations to determine the one that appears most lucrative for

optimum returns. Therefore, every host country has to strive to project itself as the ideal FDI destination vis-

-vis other competing suitors.

It is prudent to understand what motivates an investor to invest his resources in another country and

undertake risks associated with it. As investment in defence production means a lasting and protracted

relationship, he seeks a stable environment with long-term, well-defined economic policies which are fair and

consistent. In addition, there are four factors which influence such decisions availability of abundant raw

material, skilled work force, low cost of production and lucrative market. It is the interplay of all these factors

which influence an investment decision.

If India is serious about attracting FDI in defence, it has to position itself as the most lucrative FDI destination

with improved FDI Confidence Index. For that, it must make structural adjustment to provide functional

freedom to joint ventures to respond to market dynamics.

FDI pre-supposes a long term commitment and lasting relationship between the foreign and local enterprise

As regards the FDI cap of 26 per cent, 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 as

regards capacity enhancement and access to markets to ensure commercial viability through economies of

scales.

Misconception Four: FDI will stymie the growth of indigenous defence industry

Defence Minister Antonys statement that building up Indias 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 indigenous capability is certainly misplaced. He expressed apprehensions that such a move would

perpetuate Indias dependence on foreign countries for modern weapons.

Further, the Defence Minister has expressed confidence in Indias capability to build-up defence industry

through indigenous efforts, especially with the help of the private sector. According to him, only immediate

requirement of weapon systems is being imported till India develops its own weapon systems.

It will not be incorrect to term the above optimism as a case of self-delusion. One has been hearing such

declarations since early 1990s when confident predictions were made that defence imports would be reduced

from 70 per cent to 30 per cent within a period of ten years. On the contrary, after two decades, imports

have now climbed to close to 75 per cent.

A look at the dismal performance of the Defence Research and Development Organisation (DRDO) and the

public sector hardly inspires any confidence in their capability to deliver. Both are equally responsible for the

current abysmal state of affairs. Although DRDO has 51 laboratories with 5,000 scientists and over 25,000

support personnel, it has not been able to develop a single system in the promised time-frame and conformingto the accepted parameters. Mediocrity thrives due to lack of accountability.

Even after spending crores of rupees, the only success it has to its credit relates to replication of some

imported products (fancifully called reverse engineering and indigenisation).


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Tweet

28 13 33

India needs defence technology desperately

Even if the DRDO is able to make some progress in a few cases, it is always done with major compromises

with respect to the stated qualitative requirements. In most cases, by the time equipment is developed and

delivered, it becomes obsolete. Thus, the services are forced to live with outdated and useless equipment.

As the performance of DRDO over the last five decades has been highly unsatisfactory belying all hopes of

development of indigenous competence, it will be unrealistic to expect DRDO to change overnight and makeIndia self-reliant. The defence public sector consists of nine defence public sector undertakings and 39

Ordnance Factories. Despite getting preferential treatment from MoD, it has singularly failed to keep pace

with technological developments. It thrives on periodic infusion of transferred technology and has developed

no indigenous competence at all.

Purchase of technologies under Buy and Make route has failed to ensure infusion of meaningful

technologies. Even Antony has admitted that India had not benefitted much from the transferred technologies.

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 with its lethargic and inefficient

manner, without bothering about the quality parameters or the time frame.

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Maj Gen Mrinal Su man

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Privacy & Terms

is Indias foremost expert in defence procurement procedures and offsets. He heads Defence Technical

Assessment and Advisory Services Group of CII.

More by the s ame auth or

India as a defence manufacturing hub

Indo-US Military Trade: A Decade of Wasted Opportunities

Private Sector in Defence ProductionWithdrawal from Siachen a manifestation of Prithviraj Chauhan syndrome!

When a Soldier Cries

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10 thoughts on FDI in Defence: Dispelling the Myths

1. d.choudhury on June 5, 2014 at 4:41 pmsaid:

For getting state of the art technology in the defense sector, if we think that by allowing FDI as

majority stake in the private sector, we shall be able to get it, then we are all living in a fools paradise.

Because foreign firms will always be under the control of the country of origin. Such firms willbacktrack at the time of need by the slightest blink of the country of their origin.

Our only way out is to drastically re- organise the DRDO to a very professional level with

accountability. We shall have to admit that our military industry is having a relatively short history unlike

other western industrial power. Military armament industries have evolved with time with lot of past

Type the text
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experience to fall back upon. I feel if we persevere with our present efforts studiously , things will

definitely look up in near future. We have already seen that in certain sectors. Projects like Kaveri

engine should under no circumstances be abandoned at halfway stage. Though it is faced with time and

cost over run, the experience of evolution of such a complex programme will come to our benefit in the

future. This is also a fact that on many a occasion even in advanced countries certain projects do face

with problems and their ultimate product does not come up to expectation. Most important thing is that

we need to have the research organisations with professional approach and missionary zeal.

Government also will have to support them without any undue interference which are seen in someother places.

Like(0) Reply Report Abuse

2. Cassano on June 3, 2014 at 9:36 amsaid:

Impressive article Sir. though im still not clear about the fifth myth, what exactly is going on

there(DoG)?


3.

ranjeev on June 3, 2014 at 1:40 amsaid:

I hope author reads these comments. If you do Major than please read this article and on your next

article please give examples as the following article shows. Thank you.

ajaishukla.blogspot.com/2014/05/defence-industry-mod-hunker-down-for.html


4.

Abhishek on June 1, 2014 at 5:01 pmsaid:

Impressive article Sir. though im still not clear about the fifth myth, what exactly is going on

there(DoG)?


5.

Mayank Nauni on May 31, 2014 at 10:26 amsaid:

Kudos Maj Gen Mrinal Suman; no one could have clarified the associated myths in a better way.

Brilliantly written article

Jai Hind

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6. Ashwin Panemangalore on May 30, 2014 at 2:31 pmsaid:

Excellent in depth insight into the issues that plague the largest single element in the countrys budget

expenditure Mindless and obdurate bureaucrats ridden with fear psychosis have stifled the growth of

the local industry,starved the Defense Services of much needed equipment, fed inefficient public sector

manufacturing and allowed a behemoth like DRDO to carry on Even with the latest decision to allow

100% FDI in Defense will not change things unless many of these rules are changed


7.

Vivek Taske on May 28, 2014 at 9:43 pmsaid:

What about the technology that will come through FDI will be of sub-standard?


8.

DR. R. B. Sharma on September 4, 2013 at 6:11 pmsaid:

The matter is not that simple. Agreed that India needs substantial FDI in the Defence Sector, but not at

all costs. The issues raised by the author have been examined at several fora during the last two

decade. The foreign conglomerations are so powerfully entrenched in the field that invitation to them to

have the decision making position calls for abundant caution. A nation must retain its sovereign

authority. Also, the defence related technologies are moving so fast that to remain on the their frontiers

as also to maintain smart inventory is no less costly in real terms than making down the table payment

for picking up systems from the shelf. I wish the author had given some available case studies of

successful stories of limitless FDI investments in developing nations to add value to his article. All the

same an invigorating write up.


Ashwin Panemangalore on May 30, 2014 at 2:42 pmsaid:

Shriman Dr Sharmaji the fears expressed by you of foreign entrenchment ( where?) and their

take over in the event of some crisis are similar to what was expressed by the neosayers when

the economy was liberalised in the early 90s The rest is history This is one of the reasons for the

paranoia and the resultant inaction First of all foreign defence manufacturers will invest in this

country if it is attractive for their shareholders which mean a fair environment ,a reasonably good

market and freedom to operate No one will come in with even 100% FDI if their hands are tied

behind their back and the rules are one sided Why should they ? Lastly, we are not a banana

republic to be taken over by these companies

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9. PKSharma on September 3, 2013 at 8:58 amsaid:

Very lucid article in simple language. All issues have been clarified. I had many doubts earlier but now I

am convinced that FDI is urgently required. Send this article to defence Minister to read and

understand. Thank you IDr.


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