Challenge to 26% FDI cap in defence: Mahindra-BAE Systems apply to set up 51-49% Joint Venture

(Photo: A truck mounted 105 mm Indian Field Gun. The integration was done by the Tata Group, which hopes to foray into manufacturing artillery)

by Ajai Shukla

Business Standard, 28th April 08

India’s impending multi-billion dollar purchase of 155 millimetre artillery guns has sparked a significant challenge to the cap of 26% on foreign direct investment (FDI) in Indian private defence industry, which was legislated by the Ministry of Commerce (MoC) in 2001.

On 21st April, Mahindra Defence Systems (MDS) and BAE Systems, the world’s fourth biggest arms company, applied jointly to the Foreign Investment Promotion Board (FIPB) for permission to set up a Joint Venture (JV) in which BAE Systems would hold 49% of the equity. The balance of 51%, and control of the company, would remain with MDS.

Sources in MDS and BAE Systems confirm plans to manufacture important components of the BAE Systems 155mm guns at a new facility near Faridabad. BAE Systems is submitting bids for supplying ultra-light 155 mm howitzers, and a new-generation version of the FH-77B Bofors gun of Kargil renown, which is now made by BAE Systems. If the company wins the contract, it will meet its offsets liability of 30% of the contract value, by producing defence material in the new JV.

But the JV, both companies emphasise, is not about offsets, but for creating a manufacturing hub in India as a part of the UK giant’s global supply chain. BAE Systems sources say that their participation in the JV hinges on being allowed 49% of the equity.

The 26% cap was imposed through Press Note No 4 of 2001, in which the Department of Industrial Policy and Promotion (DIPP) first opened defence manufacture to private industry. Since then, foreign companies have campaigned strenuously for increasing the FDI cap to 49%, allowing them a larger share of the risks and profits and the confidence to transfer sensitive technology to a JV in India.

The MoD, which plays a major role in granting such waivers, has publicly stated on several occasions that it is willing to waive the FDI cap if that would bring significant technology into India. The MoD is encouraged by the Brahmos success story, in which an Indo-Russian 50-50 JV built the world’s most technologically advanced cruise missile. On Wednesday, Defence Minister AK Antony told parliament that the government was processing another 50-50 JV with Russia to co-develop the Multi-Role Transport Aircraft. And yet another 50-50 JV is on the cards, with an Israeli company, for jointly developing the next generation Barak missile.

But there is significant opposition to enhancing FDI limits from private Indian companies with existing capabilities in defence manufacture. These companies, which include large and influential players like L&T and Kirloskars, are lobbying within industry bodies like the CII, and in the MoD to discourage grant of waivers. They apprehend that Indian newcomers to defence could piggyback on foreign technology to bypass their own painstakingly built capabilities. So far, the CII has refused to take a position on this.

Interestingly, in the one instance in which the FDI cap has been waived for a private sector JV --- a Rs 5 crore private sector JV between Rolta Ltd and French company, Thales, in January 2008 --- the possibility of high technology barely seemed to influence the grant of the waiver. In the ministry notings, which Business Standard has reviewed, the MoD barely examined whether India would gain any technological benefit from the JV. The MDS-BAE JV application, nevertheless, rests its case on the transfer of sensitive technology, such as robotics and rapid prototyping.