MoD starts process to further liberalise FDI in defence

By Ajai Shukla

Business Standard, 30th April 16

Just five months after the government liberalised foreign direct investment (FDI) in defence, by permitting global vendors 49 per cent stake in Indian joint ventures (JVs) without the need for further permissions (i.e. “under the automatic route”), the doors for foreign vendors are being opened wider.

So far, incremental liberalisation has failed to attract significant foreign investment. On Friday, Defence Minister Manohar Parrikar told parliament: “From August 2014 to February 2016, a total amount of Rs 112.35 lakhs has come into the country as FDI in defence sector.”

In a fresh bid to create a more liberal FDI environment, the ministry of defence (MoD) last week invited defence industry representatives to discuss a briefing note it had prepared on liberalisation.  Business Standard has reviewed the note.

The current FDI policy, promulgated in November 2015, permits 49 per cent foreign investment through the automatic route. For FDI above 49 per cent, up to 100 per cent, the Foreign Investment Promotion Board (FIPB) must grant permission on a “case-to-case basis”.  However, lack of clarity on what conditions apply has created uncertainty.

Now, to bring in clarity on what “case-to-case” actually means, and thereby facilitate decision-making on the grant of higher FDI, the MoD note stipulates four conditions.

First, it mandates that proposals for FDI above 49 per cent must be examined “on case-to-case basis by a Standing Committee headed by Secretary (Defence Production), with all stakeholders as members.”

Second, the foreign original equipment manufacturer (OEM) is required to “ensure a minimum level of indigenous content as its value addition in India.” This is intended to ensure that the joint venture (JV) does not serve as a front for simply importing foreign-built equipment.

Third, the MoD regulations for licensed defence industries, i.e. appointing resident Indian citizens as chief security officer (CSO) and cyber information security officer (CISO) “may also be put in for the proposals beyond 49% FDI from national security imperatives (sic).”

Finally, the new guidelines stipulate that the foreign OEM’s home country regulations, which may continue to operate even for its units in India, do not prevent the sale of its output in India. It says “to avoid such possibility, a clause of usage of products manufactured by them in India by Indian Industry/Organisation (sic) may also be retained.”

Foreign OEMs, most recently Airbus Industries, have been demanding higher FDI limits that would give them greater control over joint ventures that they establish in India. They remain uncomfortable with the minority position that is imposed by a 49 per cent cap.

Parrikar has viewed foreign OEMs’ demands sympathetically. At the India Today Conclave in New Delhi on March 13, he said: “If there is a company that has the technology and wants to make, for example, fighter planes in India without any obligation on the part of the government, I am willing to give them approval for 100 per cent investment in the venture.”

Business Standard learns from three persons who attended the discussion in the MoD that Indian private industry had reservations, but eventually came around to agree on the benefits of more liberal FDI clearances.

However, there were exceptions. Innovative Indian defence companies that develop new systems have always opposed increasing FDI limits. In an op-ed article last month, Ashok Atluri, who heads simulator design company, Zen Technologies, argues that FDI limits need not be raised since the Indian defence market is anyway too large for foreign vendors to ignore. He fears foreign OEMs will use higher FDI limits to enter the market and then “kill” Indian competitors by underpricing products until they establish a monopoly.

“The MoD officials did not specifically say FDI limits would be raised to 74 per cent, or to 100 per cent. But it seemed quite clear that more liberal conditions will soon be announced”, said a defence industry chief executive.

The government of India has traditionally been cautious on FDI in defence. In May 2001, FDI up to 26 per cent was first allowed, subject to licensing. In August 2014, that was raised to 49 per cent, subject to government clearance, with cabinet clearance needed for FDI above 49 per cent, on a case-to-case basis. This also permitted foreign portfolio investment up to 24 per cent.

The policy imposed conditions on the JV. First, its management had to remain in Indian hands, with an Indian chief executive and CSO. The company had to be self-sufficient in product design and development, and be able to support the defence equipment it manufactured all through its service life.

Business Standard learns that several large investments are currently waiting for FDI liberalisation. French warship and submarine builder, DCNS, is reportedly keen to set up a fully owned venture to which high-end submarine technologies could be transferred.

Separately, Israeli company, Rafael, is reportedly keen on a joint venture with Pune-based Kalyani Group. But Rafael wants 74 per cent holding in the JV.