This article is written by Vineet Kumar, a student of Dip. DEABL of LawSikho, Presently working as ‘Dy Head of Representative Office, Hanoi, Vietnam’ for Bharat Electronics Ltd India, a Navaratna Public Sector under Ministry of Defence, Govt of India.

Introduction

Historical perspective

No nation can delink its Defence and securities policies from its foreign policies. India being biggest arms importer of the world, Defence Procurement, Defence Production, FDI in defence, Defence Technology Development, Make-in-India in Defence, MSMEs for Defence are closely interlinked, strategic policies for the government under the shadow of its foreign policy environment.

The post-independence, production of Defence items was in the Reserve List mandatory for production by public sector and technology development by DRDO. India thus established as of now nine Defence Public Sector Undertakings (DPSUs), 39 + Ordnance Factories (OFs) with 50 odds DRDO labs.

The major evolution in Indian Defence starting from 1992 by establishing Defence Procurement Procedure, which was later revised in 2001 post Kargil war based on the Group of Minister’s recommendation on reforming the National Security System. For the first time in 2001, Defence Sector was opened to 100% Indian private sector participation, with Foreign Direct Investment (FDI) up to 26%, both subject to licensing. Reforms in the Indian Defence sector and the procurement policy have been one continuous process since then, beginning with the formulation of DPP 2002 and its successive revisions (the last version DPP 2016), formulation of the Defence Production Policy, issuance of Joint Venture guidelines and Strategic partnership in Defence (As part of DPP2016).

Evolution of FDI Policy In India 

In consolidated FDI Policy issued in 2014 by the Department of Industrial Policy and Promotion (DIPP)/MoC&I, again FDI in Defence is limited to 26% initially through the Government route and above 26% with the approval of Cabinet Committee on Security (CCS) on a case-to-case basis. Later with discussions and feedback from all industry stakeholders, DIPP/MoC&I revised the FDI cap in Defence Sector up to 49% through Government (Foreign Investment Promotion Board or FIPB) route and above 49% through CCS, on case-to-case basis with provision up to 100% (Foreign ownership – for modern technologies) in Aug -2014. The same was reiterated again in Consolidated FDI policy of May-2015, with portfolio investment up to 24% in JV companies in Defence.

Subsequently ‘Committee of experts for Amendment to DPP-2013 including formulation of policy framework’ headed by Shri Dhirendra Singh, Former Secretary to the Govt of India had concern over the policy for foreign investment beyond 49%. They observed that in current FDI policy, 100% FDI in the Defence sector, for products not requiring a license, is permitted by default. Committee raised the question whether a 100% owned subsidiary of foreign vendor or for that matter a Joint Venture where the foreign vendor has more than 51% (controlling) stakes, which may be registered under the Companies Act 2013, would qualify as “Indian vendor” for participation in various categories of Defence procurement not requiring license. Hence, the committee proposed the definition of ‘Indian Vendor’ for the purpose of defence acquisition for next version of DPP. Committee also recommended for safeguarding Indian companies involved in design and manufacture of critical defence products from takeover by foreign entities.

Even with an enhanced limit of 49% and beyond, foreign investors were not turned up for Investment in India. Since most of the critical defence products required Industrial license, mere 49% stake by foreign companies perceived as less control of their Intellectual Property (IP) which is developed with great effort after many years of research.  Once again, a lot of discussions and feedback took place in the defence industry to further improve the FDI in defence and therefore the Government revised and liberalized more the FDI policy in the current version.

Present FDI Policy For Defence Sector

As per ‘Consolidated FDI Policy’ of Jun 2016 (Press Note 5), the policy allows FDI in Defence Industry subject to Industrial license under the Industries (Development & Regulation) Act,1951; and Manufacturing of small arms and ammunition under the Arms Act, 1959 up to 100% Equity / FDI Cap. Presently FDI is through Automatic route up to 49% and Government route beyond 49% wherever it is likely to result in access to modern technology or for other reasons to be recorded. The other conditions governing FDI Policy in Defence manufacturing sector as notified in the Press Note 5 of 2016 Series dated 24/06/2016 are as under:

1. a) Infusion of fresh foreign investment within the permitted automatic route level, in a company not seeking an industrial license, resulting in the change in the ownership pattern or transfer of stake by an existing investor to new foreign investor, will require Government approval.
2. b) License applications will be considered, and licenses given by the Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, in consultation with the Ministry of Defence and Ministry of External Affairs.
3. c) Foreign investment in the sector is subject to security clearance and guidelines of the Ministry of Defence.
4. d) Investee company should be structured to be self-sufficient in areas of product design and development. The investee/joint venture company along with the manufacturing facility should also have maintenance and life cycle support facility of the product being manufactured in India.

Further, the Foreign Investment Promotion Board (FIPB) is abolished and the work of granting approval for foreign investment under the extant FDI Policy has been entrusted to the concerned Administrative Ministries/Departments. The Department of Industrial Policy & Promotion, Ministry of Commerce & Industry has been given the responsibility of overseeing the applications filed on the Foreign Investment Promotion Portal (FIFP) and to forward the same to the concerned Administrative Ministry. DIPP has finalized a Standard Operating Procedure (SOP) for examination of foreign investment proposals by Administrative Ministries and placed on their website. The CSS approval process is not required anymore as per the revised policy. The requirement of a single largest Indian ownership of 51% of equity has been removed and a lock-in period of three years on equity transfer has been done away with. This is considered as major reform and milestone in Indian Defence industry.

What Does DATA Say?

The Indian government has approved a total of 50 Joint venture proposals since April 2000 in Defence Sector for the manufacturing of Defence Equipment, both with Indian Public and Private Companies.  However total cumulative FDI in Defence from April 2000 to Dec 2018 is Rs. 41.19 crores ($ 7.26 million) as per latest FDI data of DIPP. DIPP statistics reveals that after FDI reform in June 2016, there is an inflow of Rs. 15.7 crores.in two years itself, balance inflow of Rs 25.49 Crs is for the period of 2000 to 2016. This can be seen a significant impact of policy change, however, the concern is ‘why FDI is not flowing despite many JVs in Defence sector in India’. The cause of low FDI through JVs can be seen in investment pattern. JV’s partners are forming a company, but not initially, investing much in infrastructure and production capability building in want of domestic or offset /export orders. Despite so many reforms, DPP could not improve the slow decision making and long acquisition cycle time in any case of procurement category.

As per DPP 2016 companies with exposure to FDI beyond 49% or JVs with more than 49% ownership will not be considered for projects in the ‘Make’ category.  Further, such companies /entities would not be considered as Strategic Partners by the Government for high-value projects as per ‘Strategic Partnership Model’ of DPP-2016.

Factors Supporting FDI Reforms In Defence Sector

The new FDI policy, along with the revamped DPP – 2016, allows the Indian industry to work closely in collaboration with global companies with immense technological capabilities. The Indian companies would be solely responsible for negotiating and concluding procurement contracts, which would also include mandatory indigenous content as per various procurement categories of DPP 2016. Moreover, new offset guideline allows foreign OEMs one avenue to discharge of offset obligation by FDI in India, which will ensure smooth functioning of the offset policy. It is treated as best to way to attract foreign original equipment manufacturers to strategically collaborate with Indian companies, in order to take advantage of the current trend in Indian Defence.

Few initiatives which will further support FDI in Defence sector are:

•    Governments continuous reform for ease of doing business
•    India’s increasing Defence capital expenditure i.e. increasing domestic demand for     Defence and Home Land Security market
•    Ease facilitation of Defence exports through institutional mechanisms and         streamlining the process of issuing NOC/ clearance for export of military stores
•    Through a series of reforms, the government has now confined the requirement of licenses to a notified list of Defence equipment, which it released in the public domain. The validity of an Industrial License for Defence production has been raised from 3 to 15 years, extendable up to 18 years considering the long gestation period of Defence contracts. The application process has been automated and simplified.
•    The government has created Level playing Field among Private and Public sectors and has done various policy reforms, for not to favour and provide equal opportunity.
•    In the last 2 years, India has signed Defence cooperation agreements and MoUs with over 20 countries such as Japan, Singapore, UAE, Oman, Canada, Kenya etc. to encourage Defence exports under Act East Policy, entered the Missile Technology Control Regime, and strengthened bilateral relationships with major suppliers. For instance, India signed a military logistics agreement with the United States and was recognized as a ‘Major Defence Partner,’ which will enable license-free access to a wide range of dual-use technologies. India strengthened its strategic partnerships with USA, Russia and EU nations to facilitate the transfer of technology for cutting-edge Defence equipment. India has also extended Defence line of credit to few countries.
•    India and its various states are developing Special Economic Zones, Defence corridors and National Investment and Manufacturing Zones (NIMZ).  Such zones are to promote rapid economic growth by using tax and business incentives to attract foreign investment and technology. Few Indian states have already announced their policies for Aerospace and Defence sector.

Areas Of Concern For FDI In Defence

Although a lot of reforms initiated by the government for making the industry more lucrative and attractive for investors throughout the world, some areas of concerns are yet to be resolved. Such as –

•    Defence production and R&D involves highly skilled engineers and technicians. Availability of highly skilled workforce is required to meet the industry demand.
•    India to make a balance between its own motive of self-reliance in Defence and FDI through foreign technology and foreign ownership.
•    Major Defence companies are system integrator and highly depend on the supply chain, therefore the development of Defence cluster for tier 1, tier 2 and tier 3 suppliers are also required for the success of the industry. Otherwise, companies will import major subsystems, parts and components, which will lead to higher production cost and equals to almost near to the direct import cost of equipment.
•    To stop tier 2 and tier 3 supplier to import basic material and components, investment in indigenous R&D and commercialization of the same is required.

Conclusion

Liberalized FDI in Defence slowly but surely will lead to a lot of investment in Defence sector in India. The growth-oriented policies of the government have created a favorable business sense and combined with the demand for modernization of the world’s third largest armed forces, may prove a catalyst for India’s defense sector. Armed with more defence budget, better and quick procedures focused on acquiring and making the best of class equipment, the Indian defense industry has placed itself on the path of growth and challenge-driven production.

The sector reforms are well appreciated for employment generation, investment, ease of doing business and public-private sector intersection. Like every industry, the success of the defense industry will greatly depend on its continued efforts to maintain a strong framework and conducive ecosystem for all stakeholders. The government’s stated goal of self-reliance and indigenization in Defence can be fulfilled in the near future when public and private industry both, make adequate investments in defense design, development, and production. The liberalized FDI in defense will encourage the induction of modern technology, promote competition, bring value for money and boost trade for domestic ancillary Defence and Non-Defence Companies.

Students of Lawsikho courses regularly produce writing assignments and work on practical exercises as a part of their coursework and develop themselves in real-life practical skills.