FDI in defence - Why and how much?

Last Updated: Fri, Jun 13, 2014 05:57 hrs

There has been a lot of interest and speculation in the media on the commerce ministry's note asking for views of various departments and ministries on the merit or otherwise of increasing foreign direct investment (FDI) in defence from the current level of 26 per cent to 49 per cent or higher - even up to 100 per cent.

A similar exercise was taken up by the ministry two years ago and various viewpoints emerged - from the "protectionist" lobby arguing for no increase in FDI, to the other extreme that favoured the view of a large number of foreign companies that 100 per cent FDI should be permitted.

The president's address, echoing the views of the new government in support of an increase in FDI limits, makes it important for all stakeholders to analyse this forthcoming decision with due care to ensure that we do the right thing for the right reasons.

Before we get into the numbers game of how much FDI is desirable in the defence industry, it is important that we are clear on the reasons for the push for FDI in defence.

This push should not be to attract investment per se. Investments are better attracted through large-scale infrastructure projects and in sectors such as power, communication and so on. FDI should be viewed as one of the tools that will enable India to achieve a greater level of self-sufficiency in the design, development and manufacture of complex weapons systems.

Defence is a limited and specialised field with technology at the heart of the industry. Sadly, India today does not have the technology, processes and systems to design and manufacture a majority of its defence requirements and perforce has to import them. If, through an increase in FDI, we can attract technology into the country, then it should be necessary and desirable to do so to a level at which foreign defence companies would feel incentivised to invest in India.

It has been a common experience in the defence industry that foreign companies are extremely reluctant to transfer technology to other companies/countries.

As understandable as this may seem, it is vital that India, which is tipped to become the largest importer of defence equipment in the world, leverages this dubious position to its maximum advantage.

Therefore, any increase in FDI in defence must be accompanied by a commitment to transfer technology to the Indian entity in a phased manner (starting, for example, from 30 per cent and going up to the 90 per cent to 100 per cent over a two- to five-year period).

A similar phased percentage of local content must be applicable in the serial production phase and the Indian entity should also undertake to export the equipment being manufactured after a period of three to five years or so. In this manner, it can become part of the global supply chain of foreign defence companies investing in India. The fine print is important and must be unambiguous in its intention and yet responsive to the concerns of investors.

While there is a general agreement that FDI in defence should be increased, the question is how much is enough? It must be remembered that there are many countries in western and eastern Europe as well as the US that do not permit any FDI in their defence sector.

Therefore, for these same countries to ask for an increase of FDI to 100 per cent is unreasonable. As a first step, an increase to 49 per cent is desirable and long overdue.

This would give foreign companies a reasonable incentive to invest in the sector, while at the same time giving them a degree of control over the technology they bring in. It would also ensure that control of the company remains in the hands of the Indian partner. This limit could be reviewed after five years.

In this entire discussion, there is the danger of viewing the question of FDI in defence in isolation. FDI is but one tool in the process of defence production and procurement that, when put together, form the country's defence acquisition capability.

The current philosophy of defence acquisition lacks strategic vision and has been incremental in its evolution. It is not responsive to the needs of the armed forces and not designed for a country that by all reports intends to spend approximately $100 billion over the next five to seven years on capital defence procurement.

Increasing FDI in defence without corresponding and supportive changes in defence production and procurement will not achieve the objective of attaining a greater level of self-sufficiency in the defence sector. It will also act as a disincentive to both the Indian entity and their foreign partners.

There have been a number of high-powered committees constituted by the government over the past 10 years and some very valuable recommendations have been made to restructure and streamline defence production and procurement. Sadly, very few of these recommendations have been accepted and even these have suffered from poor implementation owing to bureaucratic interference.

Defence acquisition must be viewed as one of the pillars of national security and all measures necessary - including but not limited to the increase of FDI - must be implemented to ensure that the country and our armed forces always have the required options to deal with the variety of threats to which we are subjected in the current and future environment.

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