Foreign Direct Investment in India’s Defense Sector
Even before Narendra Modi began his much anticipated visit to the United States, it was expected that pushing for enhanced bilateral defense cooperation sat high on his list of priorities.
In recent years, even as other aspects of the Indo-US relationship have been lagging, collaborative defense initiatives have been on the upswing. As the world’s largest defense importer, India has signed deals to purchase C-17 Globemaster and C-130J transport aircraft and P8-I naval surveillance planes from US companies. Total Indian defense purchases from the US now total almost $10 billion, a remarkable increase from a zero base in the early 2000s. Indeed Modi’s maiden US visit was immediately preceded by a high level Indian defense delegation to discuss the joint production of anti-tank missile systems that had been proposed during US Secretary of Defense Chuck Hagel’s June 2014 visit to India.
Even as India continues to expand its purchases from overseas manufacturers, the government seeks to indigenize the defense manufacturing process, for reasons of fiscal prudence and strategic autonomy. Building an indigenous defense manufacturing capability is also in keeping with Modi’s clarion call to “come, make in India.”
An announcement to further liberalize the sector came in the Finance and Defense Minister Arun Jaitley’s first budget speech in June, which promised an increase in Foreign Direct Investment (FDI) from 26 to 49 percent, albeit with significant qualifications. On August 26 and 27, 2014, India’s Department of Industrial Policy and Promotion (DIPP) formally put in place the increased caps via its Press Note 7 (2014 series), inviting fresh investment to help modernize a historically guarded sector of the economy. As India currently meets 60 percent of its defense requirements through imports, the invitation to foreign investors is also an attempt to shrink the country’s trade deficit while equipping India with up to date manufacturing abilities.
Previous efforts to liberalize the defense sector in 2001 were met with a lackluster response. One of the key reasons for this was that private defense firms lacked control in the companies they were expected to invest in. Ultimately, the sector saw negligible interest from foreign investors who spent only $5 million since the sector was liberalized. This was in stark contrast to the billions being poured into other sectors and in 2010, the defense industry was ranked the least attractive for foreign direct investment, coming behind soap and timber.
Thus, the debate in recent years has not been whether more FDI is necessary, but how much is needed. In 2010, India’s Ministry of Commerce and Industry circulated a discussion paper arguing for FDI limits to be raised to 74 percent. Plans to increase FDI in defense were key to the BJP’s election manifesto. Prior to the government’s budget announcement, there had been high profile disagreements on the limits of foreign investment in defense among India’s two largest industry bodies, the Federation of Indian Chambers of Commerce and Industry (FICCI) and the Confederation of Indian Industry (CII).
While CII argued for greater foreign investment in the sector for its ability to boost jobs in manufacturing, FICCI warned that raising the FDI cap to 74 percent would hinder the development of Indian intellectual property (a FICCI insider argues, "If permitting 100 per cent FDI for building products for the world's largest cellular phone market has not spawned a single world-class Indian company that manufactures cellular handsets or infrastructure, how will it happen in defense?").
Features of India’s new FDI policy
Under the recently notified rules, licenses will be awarded by the DIPP in consultation with the Ministry of Defence and will not require additional oversight from the Department of Defence Production, as had previously been the case. However, the major qualifying condition for FDI continues to be that the firm must be owned and controlled by Indian residents, largely for security concerns (for more, see below). Other new stipulations include the opening up of investment to portfolio investors, who had previously been prevented from making investments in an August 2013 ruling.
In another development, there would be no lock in period for transfer of equity and thus equity can be transferred from one nonresident to another pending government approval. All sales can only be made to central and state governments (except in the case of non-lethal products). Further, production capacity will be decided at the time of granting a license.
While the new government has kept its promise to raise FDI caps, certain riders on investment have prevented the move from generating much enthusiasm. As Phil Shaw, head of Lockheed Martin’s India operations, puts it: “Over 50 percent is the key where you are able to control the business a little bit more than at 26 or 49 percent. Where we have a lot of intellectual property and investment in a particular product, we are not necessarily going to want to send it to India and then not have control over that particular technology.”
Modi’s recently concluded visit to the US certainly bodes well for greater defense cooperation with the United States. Soon after his first meeting with President Obama, Modi announced his invitation to US defense firms to be part of India’s defense industry. Other positive signals came in the form of the renewal of the US-India Defense Cooperation Agreement until 2025, the positive acknowledgment of the Defense Trade and Technology Initiative (DTTI) in the Joint Statement of the two leaders, and in one-on-one meetings Modi held with major defense equipment suppliers GE and Boeing.
A more balanced tone was struck by Frank Kendall, the Pentagon’s chief defense buyer and key official for the US on the DTTI which, when implemented, according to the Joint Statement, “would have a transformative impact on bilateral defense relations and enhance India's defense industry and military capabilities.” . While Kendall described developments on the DTTI as being “very constructive” he added there shouldn’t be any expectation of “instantaneous major announcements.”