FDI in Defence India

It was in 2001 that foreign participation in Defence sector was allowed with a cap of 26%. Before that, production was carried on a limited scale by only eight Defence public sector undertakings. Despite the liberalization of the sector country did not receive any significant amount of FDI. One reason cited for this is limited returns on investment to the foreign companies and lack of control over the intellectual property rights related to technology. Consequently, today India is a largest importer of military hardware with no substantial improvement in capabilities of domestic industry. Even the public sectors enterprises are in severe state of crisis.

The present government has further liberalized the sector by raising the cap to 49%. These reforms are introduced to boost domestic industry. But the question remains is FDI –a solution to the Defence crisis India is facing.

Changes In The FDI Policy-2015

Earlier, the foreign investment up to 49 per cent was permitted under government approval route. But now the government relaxed the FDI in defence sector by allowing 49% under automatic route and beyond that through the approval of FIPB (Foreign Investment Promotion Board). Also, there is no requirement of approval from the cabinet committee on security beyond 49%.

Also Portfolio investment and investment by FVCIs will also be allowed up to permitted automatic route level of 49 per cent. Earlier it was restricted to 24 per cent only.

Dissenting Views

There are divergent views on liberalizing the defence sector. The views in favour of liberalizing Defence FDI are as follows:

Firstly, Indian armed forces are working with obsolete military equipments and the domestic industries are not able to match the standards and requirements of the armed forces. The three armed forces put together require more than $100 billion, which currently cannot be managed domestically. FDI will help in bringing the required capital to modernize the sector. Secondly, if domestic production increases by increased FDI in the Defence procurement, India’s dependence on imports will decrease, thus helping in not only lessening the burgeoning fiscal burden of the country but will also ensure the security of the country. Thirdly, the foreign companies will bring new technology with themselves which will help the domestic industry to boost its production. Fourthly, to strengthen the India’s security vis-à-vis nations like china and Pakistan, FDI is inevitable. According to 2013 figures, China’s annual defence budget is $188 compared to India’s defence budget of $47.4 billion. Lastly, foreign companies have big pockets to invest in research & development which is key to indigenization of defence sector. Besides above benefits; job creation and other multiplier effects leading to growth of economy are obvious.

However the opponents of FDI refute all the above benefits by citing that self reliance should be priority and FDI would not make India self reliant. The arguments are as follows:

Firstly, there are no established trends wherein increase in FDI cap ensures inflow of money in the country. This is based on the fact that since 2001, there has been a  meager inflow of only $4.8 billion in Defence sector, in an overall FDI inflow of around $334 billion. The situation will likely to remain same unless the foreign investors are allowed to hold a major stake in the government. Secondly, the over simplistic assumption that FDI will automatically bring technology is flawed. Although India has a defence offset policy but it has not been able to prove very effective due to lack of willingness of foreign companies to share technology with the Indian companies. For instance, the delay in Rafael deal with France is due to the dispute over dilution of offset clause. Also, there are number of informal agreements regarding technology transfer like MTCR etc. which put sanctions and various conditions before the transfer of technology to a country. And as per the rules of International Traffic in Arms Regulations (ITAR) the percentage of ownership as well as the fact that whether transfer of technology are to Indian Armed Forces, DPSU (Defence Public Sector Undertakings) or an Indian company does not make any difference. So just the liberalization of FDI will not bring technology by itself as the final decision will remain with the parent country controlling technology. Thirdly, Defence is a strategic area, more than mere commerce. Concerns like, shutting down of factory by the foreign company in case of any crisis thus choking the supply, are not misplaced. A country cannot afford to be dependent on foreign country and be guided by its policies.

The Way Forward

There is no doubt that today armed forces are in dire need of modernization but the indigenous industries neither has the capacity nor the finance to meet the requirements. So, at present there is a need of flexible FDI policy to gain much needed technologies which cannot be mastered through indigenous efforts in the acceptable time frame. For this we need to exploit FDI in a manner which strengthens our domestic production by learning from their technologies.

On the issue that FDI might compromise our national security we need to adopt a cautious policy with the primary focus on national interest. Today, India has become one of the largest importer of military equipments. So, we need to understand that allowing foreign companies to manufacture in India is nothing worse than being dependent on imports. In fact in India suitable legislations can be imposed on the manufacturers thus giving more safeguards.

Moreover with 49% cap in FDI the management of the company will remain in the hands of Indian manufacturers. This will act as a shield against any activity of the foreign companies.

Ultimately the success of FDI will depend upon the efficient FDI policy. All FDI must be towards greater indigenization, sharing of technology and involvement of domestic companies in design and development.

But at the same time we should realize that FDI is not a magic wand which can solve all the problems of the defence sector. So Increase in the FDI Cap should be complemented by other defence sector reforms such as ensuring enabling environment for investment, solving land acquisition issues etc.

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