Increase FDI in defence, says CII survey

By Ajai Shukla

Business Standard, 10th May 2010

With the government evaluating a decision on enhancing the current 26% Foreign Direct Investment (FDI) cap in defence production, a CII survey released today suggests that the Indian defence industry supports enhanced FDI levels, while opposing 100% FDI in the sector.

A majority of Indian companies (57%) favours an increase in the FDI cap to 49% or higher; a minority of just 17% of Indian companies want to retain the status quo; while 26% say “maybe”.

The debate on raising FDI in defence has divided not just Indian defence companies, but also the government of India. While the Ministry of Commerce and Industry (MoC) has signalled its willingness to support 100% FDI in defence, the Ministry of Defence (MoD) has opposed any enhancement of the 26% FDI cap. 

Two applications for setting up JVs with 49% foreign holding --- the first between the Mahindra Group and UK-headquartered BAE Systems; and the second between L&T and European conglomerate, EADS --- have already been turned down by the MoD.

India’s MoC had allowed private industry into defence production in 2001, subject to government licensing and a 26% FDI cap. In the Defence Procurement Procedure of 2008 (DPP-2008), the MoD had permitted 49% FDI on a case-by-case basis. Last year’s Economic Survey had also suggested that 49% FDI would be allowed. And, since early this year, the MoCI’s Department of Industrial Policy and Promotion (DIPP) has been talking up allowing 100% FDI in defence in order to attract foreign technology and to position India as a global hub for defence production.

The CII survey suggests that the current 26% FDI levels have failed to attract global defence investment, pointing out that a mere Rs 70 lakhs have been invested as FDI in Indian defence production between April 2000 and February 2010.

But the survey also notes significant opposition to the argument for developing India as a “home market” for global defence giants. Reflecting the opinion of Indian corporates that have invested heavily into defence R&D and production, a viewpoint that the MoD highlights and supports, the survey notes the belief of these companies that permitting increased foreign control would hamstring the organic growth of the Indian defence industry.

Describing this viewpoint, the report says that, “…allowing greater levels of FDI, even below 49% levels, would increase the amount of control exercised by foreign partners and this in turn would reduce the actual level of indigenization and maintain the reliance on foreign suppliers. 

This notwithstanding, the majority belief in the Indian defence industry remains that the current 26% FDI cap must be increased, provided that the JVs being set up “should be engaged in R&D and the IPR should rest with JV” (sic), and that the foreign partner must bring in high technology that is not easily available, and it must ensure that the JV can access the global market. 

This compromise does not address the key issue of foreign reluctance to bring in high technology without a controlling interest in the company.

The survey, however, highlights the ongoing debate over whether the proposed FDI cap raise from 26% to 49% would be sufficient to attract foreign investment, since increasing the FDI cap from 26% to 49% does not provide any additional control over the company. The issue in question is whether the FDI cap should remain at 26% or be increased to 51% or higher.

Some of the recommendations for the way ahead, cited in the CII survey, are:

• Targeting key technologies by allowing enhanced FDI in specific spheres.

• Fiscal incentives like tax holidays to attract key technologies.

• While purchase guarantees by the government are difficult, a level playing field should be provided to all players. Public sector companies should not be granted preferential terms.

• Allowing FDI through technology transfer under the offsets route.