Defence executives cautiously welcome foreign investment liberalisation in defence

By Ajai Shukla

Business Standard, 13th Nov 15

On Tuesday, two days after the Bharatiya Janata Party’s (BJP’s) electoral drubbing in Bihar, and two days before Prime Minister Narendra Modi left on an official visit to the United Kingdom, the government announced foreign direct investment (FDI) reforms in 15 major sectors of the economy.

In the defence sector, foreign investment had been raised by the National Democratic Alliance in its first budget, in July 2014, from 26 per cent (prevailing since 2001) to 49 per cent, with the approval of the Foreign Investment Promotion Board (FIPB), on a case-by-case basis. Now 49 per cent FDI will be permitted automatically.

Foreign investment above 49 per cent thus far required sanction from the Cabinet Committee on Security (CCS). Now sanction can be accorded by the FIPB.

The other change concerns permissible levels of portfolio investment and investment by foreign venture capital investors (FVCIs). Previously restricted to 24 per cent, FII and FVCI investment will now be permitted, under the automatic route, to 49 per cent.

So far, the FDI policy had mandated that proposals involving a total foreign equity inflow up to Rs 3,000 crore could be considered by the FIPB, while proposals above Rs 3,000 crore would require consideration by the Cabinet Committee on Economic Affairs (CCEA). Now, “to achieve faster approvals on most of the proposals”, the FIPB will consider proposals up to Rs 5,000 crore.

Broadly, FDI liberalisation measures have been welcomed by industry. Ficci chief, Jyotsna Suri, said “Simplification of procedures for foreign investments, putting more sectors on the automatic route, introducing fungibility between FDI and FII and having a single reference document for all FDI related guidelines are steps that would boost investor confidence further.”

Yet, most large Indian defence companies that Business Standard contacted dismiss these changes as largely cosmetic. Top CEOs point out that FDI has so far been restricted to a mere Rs 30-40 crore (with Rs 500 crore in the clearance pipeline) less because of FDI caps, than because of an unviable business model created by the defence ministry’s Department of Defence Production (DDP).

Potential overseas investors, especially those with offset obligations, are provided little assurance of continuing orders from India’s military. For example, Company X, which must produce Rs 300 crore worth of aero parts in India as offsets in a Rs 1,000 crore purchase of transport aircraft by the Indian Air Force (IAF) would look for assured long-term orders before sinking FDI into a production unit in India.

“Since the DDP provides no assurances, overseas vendors prefer to discharge their offset obligations through manufacturing in Indian facilities, without investing in production units. A more attractive business case is essential for attracting FDI,” says Jayant Patil, Larsen & Toubro’s defence business chief.

“Furthermore, defence is a strategic field that is not governed by the rules of normal commerce. Raising FDI caps is no guarantee that foreign investment will flow in. Overseas vendors might want to ‘Make in India’, but their governments may not give sanction, since most governments control defence technology”, points out Patil.

Global vendors, however, have long argued for a “strategic stake”, i.e. at least 51 per cent in FDI, to obtain management leverage over the joint venture company.

Rajinder Bhatia, defence vertical chief of the Kalyani Group, cautions against giving FIIs too much space in the Indian defence industry, since they are inherently short-term and speculative, unlike FDI, which is a longer and more strategic investment.

Bhatia agrees a favourable business climate will be the main driver of FDI. “Unless business flows due to its own commercial logic, the new liberalisation measures are mere catalysts. You must create business constituents to truly boost FDI”, he says.

Rahul Chaudhry, of Tata Power (Strategic Engineering Division) who heads Ficci’s defence committee, cautions about the need to carefully watch FII investments, which are inherently opaque. With 49 per cent FDI/ FII investments permitted under the automatic route, there will be no examination of FDI proposals unless it is above 49 per cent.

“It is good that the government is attempting to liberalise FDI. But it must be done while carefully protecting indigenous defence capabilities”, says Chaudhary.

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What industry says:

Ficci chief, Jyotsna Suri

“Simplification of procedures for foreign investments, putting more sectors on the automatic route, introducing fungibility between FDI and FII and having a single reference document for all FDI related guidelines are steps that would boost investor confidence further.”

Jayant Patil, Larsen & Toubro defence chief

“Defence is a strategic field that is not governed by the rules of normal commerce. Raising FDI caps is no guarantee that foreign investment will flow in. Overseas vendors might want to ‘Make in India’, but their governments may not give sanction, since most governments control defence technology”.

Rajinder Bhatia, defence chief of Kalyani Group

“Unless business flows due to its own commercial logic, the new liberalisation measures are mere catalysts. You must create business constituents to truly boost FDI”.

Rahul Chaudhary, Chairman, Ficci Defence Committee

“It is good that the government is attempting to liberalise FDI. But it must be done while carefully protecting indigenous defence capabilities”.