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Foreign Investment in India's Defence Sector: Are We Ready?

There has been an animated debate on the need to boost Foreign Direct Investment (FDI) in India’s defence sector which has not been in a position to meet the diverse requirements of the Indian defence forces owing to the lack of financial resources, technological expertise and advanced manufacturing base. While some consider FDI to be an alluring option for giving impetus to the domestic defence sector, there is also a view that the entire issue is “sensitive and controversial” in nature. This implies that a balance must be struck between increased FDI flow and national interest. India could institute a policy framework to encourage foreign participation in terms of financial investment, technological know how, manufacturing expertise and marketing skill to not only meet the  domestic requirements but also to cater to the export market. As an exporter of defence hardware, India would be in a position to expand its sphere of influence.

It was in 2001 that the Indian defence sector opened up for private participation, with the FDI limit capped at 26%.  The Indian Parliament’s Standing Committee on defence has proposed raising the FDI cap to 49%. Similarly, many industry bodies have made a strong case for increasing the FDI limit in the Indian defence sector with a view to boost defence hardware production capability. But without a level playing field it would be impossible to attract a higher level of FDI into the Indian defence sector. After all foreign companies willing to invest in the Indian the defence sector should not expect benefits as high as their Indian counterparts. While formulating a policy aimed at boosting FDI in the Indian defence sector, this issue needs to be addressed.

The Indian Defence Ministry is opposed to the idea of boosting the FDI limit in the Indian defence sector on the grounds of “security concern.”   Whether Indian Defence Minister A.K. Antony’s overdrive for self reliance in defence production is a major hindrance in the way of boosting FDI, one is not sure.  Even so, an increased FDI flow into the defence sector has the potential to decrease imports in which the role of agents and middlemen have been conspicuous. On its part, the Department of Industrial Policy and Promotion (DIPP) of the Ministry of Commerce and Industry has pleaded for allowing 100% FDI in the defence sector. ”The abolition of FDI limit would outweigh any perceived drawbacks as also bring additional benefits. Most importantly, foreign companies could determine the extent of the FDI they could make depending on the technology they plan to induct to make a success of their venture,” observes Thomas Mathew, Deputy Director General of the New Delhi based think-tank, the Institute for Defence Studies and Analysis (IDSA).

With India emerging as a lucrative market for defence hardware, foreign companies are keen to invest in the Indian defence sector if a favourable environment is created.  A.K.Barbora, Vice Chief of the Indian Air Force (IAF) has made a strong plea for initiating an action plan to attract an increased FDI into the defence sector. “We have to take steps. We need to be bold enough to invite FDI more so into the defence sector,” observed Barbora. It is high time that the suggestion of Barbora is taken by the Defence Ministry with the seriousness it deserves. Moreover, the issue of “security concern” involved in facilitating a higher level of participation by foreign companies in India’s defence sector needs to be discussed before a decision on boosting FDI in to the defence sector is taken.

A joint study by the Confederation of Indian Industry (CII) and the consulting firm KPMG, opines that foreign companies would not be satisfied with anything less than a controlling stake of 51%. The CII-KPMG study states that foreign investors reject the argument of “national security concerns.” As pointed out by a joint study by the industry body ASSOCHAM and research firm Ernst and Young (E&Y), 26% FDI in defence sector does not provide foreign investors incentives with respect to capacity expansion, buy back guarantee and exports while subjecting them to purchase and price discrimination vis-à-vis public sector enterprises. It is high time that the Indian Defence Ministry realized that for India to stay in step with rapidly changing technological trends in defence production, foreign participation is an unavoidable step.  

As things stand now, India’s defence manufacturing base leaves much to be desired. For instance only three Indian enterprises—Hindustan Aeronautical Ltd (HAL), Bharat Electronics Ltd and Ordnance Factory Board (OFB)—make it to the list of top 100 defence outfits in the world.

It is obvious that the Indian Defence Ministry has a strong bias towards state owned enterprises. But it is high time that the Indian Defence Ministry transforms its image of being partisan to state owned enterprises. Industry sources say that the Indian Defence Ministry should support research and development in private sector industries through a variety of measures including appropriate incentives. This step along with an increased FDI flow could galvanize the private sector to increase the quantum of resources and time to develop futuristic weapons systems that Indian defence forces are keen on acquiring.