Raising the Foreign Direct Investment cap to 49% in Indian private companies in defence

by Ajai Shukla

Business Standard: 30th April 08

In 2001, the Ministry of Defence (MoD) opened the doors for the private sector in defence production, but the welcome has been less than whole-hearted. Press Note No 4 of 2001 laid down a 26% cap on Foreign Direct Investment (FDI) into defence manufacture, private companies must still pay for R&D in defence products and the MoD has not yet delivered on its promise to nominate selected private companies as Raksha Utpadan Ratnas (RuRs, or Champions of Industry), which would be treated on par with the defence public sector undertakings (DPSUs).

In the first five years after that initial opening, the 26% cap on FDI was never an issue; neither the private sector, nor foreign majors actually set up any facilities. But in the last two years, as India’s defence market has boomed and the Defence Procurement Policy of 2006 (DPP-2006) offered a clearer idea of the business landscape, foreign wariness has given way to a growing appetite for joint ventures (JVs) with Indian private companies for setting up development and manufacturing facilities. This change has also been accelerated by India’s defence offsets policy, which obliges every foreign company winning a defence contract to produce in India defence goods and services of the value of 30% of the contract.

If global defence majors now have the incentive to partner Indian companies, the Indian private sector has its own compulsions for establishing foreign tie-ups. The most important of them is the need to mitigate commercial risks in that most fraught of development environments: defence products. Military systems, which are usually at the cutting edge of technology, require enormous capital to develop and there are never any guarantees of actual orders. The Indian MoD had signalled its intention to subsidise private industry to the extent of 80% of the cost of developing high-tech systems; DPP-2006 contains an entire “make” section, with the procedure for funding an Indian company to “make” a defence product. But that procedure has never been used and private Indian defence manufacturers have little choice but to look abroad for partnership, funding and technology. 

But no foreign major is comfortable with transferring proprietary technology to a company in which it owns barely a quarter share. Advanced technologies cost billions of dollars to develop; a 26% share of the profits, say these companies, is small recompense. Their demand, in most cases, is a 49% share, since the foreign majors believe that the Government of India will insist on Indian control over the company.

Ultimately, the foreign majors’ bargaining power will be determined by the level of cutting edge military technology that they bring to the table. Moscow successfully demanded a 50% share in the Brahmos JV, since Russia contributed the technology for propulsion systems, which India was far from developing. Similarly Russian companies will get a 50% share in the JV that develops the Multi-Role Transport Aircraft (MRTA), purely because of the technologies that they supply.

If South Block is uncomfortable with crucial technologies being developed by JVs in which there are substantial foreign holdings, the MoD will have to create an environment in which Indian entities (DPSUs, private companies, and the Defence R&D Organisation or DRDO) can produce entirely Indian systems. That means urgently nominating the private sector RuRs, generously subsidising their R&D, and assuring a minimum order that can subsidise their input costs.