Predictable patterns in calls for raising FDI in defence

By Ajai Shukla

Business Standard, 19th June 14

A day after this newspaper reported that the Confederation of Indian Industry (CII) and Federation of Indian Chambers of Commerce and Industry (Ficci) had divergent positions on over the government’s proposal to liberalise foreign direct investment (FDI) in defence (“CII & Ficci disagree on raising FDI in defence”, June 12, 2014) a traditionally protectionist Ficci attempted to paper over its divergence with a CII that has whole-heartedly endorsed higher FDI.

On June 13, Ficci said in a press release that it “welcomes the proposal put forth by the Ministry of Commerce and Industry to enhance FDI levels in defence beyond 26% to higher levels up to 49%, 74% or even 100% in exceptional cases”. Yet Ficci threw in a demand for “safeguards” that recognised “the strategic nature of the defence sector.”

It is evident that there are divergent views on the advisability of raising FDI in defence. An assortment of players in the defence economy each seeks an FDI regime that best serves its interests.

Business Standard has mapped the following seven major interest groups, each of which lobby for their preferred FDI level depending upon where they are located on the industry canvas.

The first category of FDI lobbyists consists of professional managers and chief executives of defence companies. These are basically employees, who do not hold a significant share of the defence company they run. Many are accomplished and competent professionals who enjoy credibility within the defence industry, including industry bodies, as also with the defence ministry. They argue for raising the FDI cap to 49 per cent, with the proviso that “control of the company should remain in Indian hands.” Their motivation is self-interest: allowing more foreign capital and management practices would raise their emoluments, while the jobs would remain protected by the proviso that Indian nationals must run the defence companies.

A second category of FDI inputs comes from professional managers of companies like L&T, who are also part owners through shareholding accumulated over time. These managers want foreign investment and technological expertise to galvanise growth in their defence units, but without disrupting their control. They argue, as L&T boss AM Naik has done in a recent media interview, that, “We should agree to 49 per cent, subject to genuine transfer of technology. But nowhere in the world, even in the most advanced nations like the United States, which has a high-tech defence sector, do they allow foreign companies to own a majority stake.” Ficci directly echoes this viewpoint.

A third category includes companies with some valuable defence and engineering capabilities, who would harness international partners to expand their opportunities. For example, Bharat Forge knows that the Indian market for artillery guns --- a prime area of expertise --- would be limited to about Rs 25-30,000 crore. Expanding into related fields like opto-electronics and networking systems would expand the market manifold. Without in-house capability in these technology domains, these companies need foreign partnerships. The foreign OEM gains access through the Indian company; which, in turn, benefits from high technology. Thus the CII’s welcome of even a “foreign investor having majority equity.”

The fourth category includes established corporates like the Tatas, who see big profits in defence but remain uncomfortable with the unpredictability and murk of defence contracting. Seeking a hedge in higher foreign ownership, some of these companies have already made profits in the past through strategically divesting their share to a foreign partner --- e.g. Tatas to Lucent in telecom, and to Honeywell in process management and control solutions; and the BK Modi group to Alcatel. This kind of divestment takes place most profitably in a gradually liberalising FDI regime that permits incremental equity dilution. For the present, this group would back 49 per cent dilution with control remaining in Indian hands and would incrementally back greater FDI and looser control.

The fifth category of FDI lobbyists follows what could be called the “Ranbaxy model”. These include small-to-medium, family-owned businesses that have established themselves painstakingly in a hostile, anti-private-sector policy environment. The owners, some facing internal boardroom battles, would be relieved to encash their hard-won success by selling their entire holding to foreign buyers. Having fought the establishment for years, these entrepreneurs feel they deserve a good retirement. This group is prominent in arguing for 100 per cent FDI.

A sixth group that also wants full FDI liberalisation comprises of several relatively new defence companies that were set up after defence production was opened to the private sector in 2001. While masquerading as technology developers, these companies are actually “build-to-print” manufacturers of foreign --- especially Israeli --- defence equipment.

A seventh category, which wants no liberalisation to the current 26 per cent FDI cap, comprises genuine, home-grown entrepreneurs that have created high-technology products through in-house research & development. This includes many micro, small and medium enterprises (MSMEs), and several larger companies like Zen Technologies, Data Patterns and Astra Microwave. These companies want maximum protection from foreign competition in order to grow and increase their valuations manifold. The slogan of one such CEO: “The future is bright; the colour is saffron.”

Interest groups pitching for various FDI levels
1	Defence companies run by professional managers, CEOs, who want better emoluments, but control in Indian hands	FDI up to 49%
2	Companies like L&T with managers holding equity, want foreign funds, technology, but while retaining control (Ficci position)	FDI up to 49%
3	Companies like Bharat Forge, with strong capabilities in single field, but wanting foreign technology in order to expand capabilities and repertoire (CII position)	FDI above 51%, up to 74%
4	Companies like Tatas, uncomfortable in defence field, would like to shelter behind foreigner, have previous experience of divesting for huge profits	Incremental rise in FDI up to 100%
5	Established small-to-medium defence companies, now looking to encash position by selling out to foreign OEM	FDI to 100%
6	Defence companies set up after 2001, who are mostly “build-to-print” manufacturers of foreign defence equipment	FDI to 100%
7	Home-grown, successful, committed companies who plan to stay in business and would like to protect their own markets. entrepreneurs	FDI restricted to 26%