Defence ministry opposes increase in FDI limit

The Ministry of Defence (MoD) plans to oppose a proposal from the Ministry of Commerce and Industry (MoCI) to allow foreign defence corporations to establish fully-owned defence units in India.

The new Consolidated Foreign Direct Investment (FDI) Policy, effective from April 1, limits FDI in defence units to 26 per cent. But the Department of Industrial Policy & Promotion (DIPP) of the commerce ministry is in favour of raising this limit.

The MoD apprehends that raising the FDI cap significantly would seriously damage India’s nascent defence industry, particularly the eight MoD-owned defence public sector undertakings (DPSUs).

“The Commerce Ministry cannot raise the FDI cap without first consulting us, and we will definitely not allow 100 per cent FDI anytime soon,” a senior MoD official told Business Standard on condition of anonymity. “We have already rejected two applications for setting up Joint Venture companies with 49 per cent FDI. Where is the question of allowing 100 per cent FDI?”

The first application the MoD rejected was that of a proposed JV involving Mahindra Defence Systems (74 per cent) and UK-based BAE Systems (26 per cent); the second rejection involved L&T (74 per cent) and Franco-German corporation, EADS (26 per cent).

Explaining the rationale for raising the FDI limit, DIPP Secretary R P Singh, told Business Standard : “As an industry department, we realise that if the defence sector is opened to FDI, its impact upon the manufacturing sector in India will be great. Foreign defence majors will be more likely to bring in sensitive technology if you allow them higher FDI. Defence production requires technology, and also huge capital investments. 

If we can address security concerns, there is a chance of opening it up to 100 per cent.”

Singh revealed that the DIPP had already sent a written proposal to the MoD after preliminary discussions. The DIPP letter proposes greater foreign equity in defence JVs, but does not suggest a specific FDI level.

“Things are still at a discussion stage. Our stance will get crystallised after we discuss and only then will the Government of India change the policy,” pointed out the DIPP Secretary. “My personal view is that 100 per cent FDI should be allowed; but all stakeholders will contribute to the final decision.”

The MoCI claims that Indian private defence manufacturers, such as L&T and the Tata Group, support the raising of FDI caps in order to allow a larger share to foreign companies.

But Business Standard has learned that R&D-oriented private sector companies are apprehensive that global majors will use their Indian subsidiaries to get the MoD to fund the development of weapons systems under the “Make” category of the Defence Procurement Policy of 2008 (DPP-2008).

The DPP-2008 allows any Indian company — and a 100 per cent Indian subsidiary of a global major would be eligible for this — to receive funding from the MoD for developing defence platforms under the “Make” category. The MoD has undertaken to fund up to 80 per cent of the development cost, with the private vendor paying just 20 per cent of the development cost.

“With defence budgets coming under severe pressure in the west, what better way of obtaining funding than setting up a 100 per cent subsidiary in India that can draw from the Indian MoD”, asks the CEO of a prominent private sector defence company. “It would be entirely legitimate, and it would wipe out the Indian defence manufacturers entirely”.

For smaller, less R&D-oriented Indian defence manufacturers, however, a raise in FDI caps would come as a blessing. This would allow them to benefit from borrowed technology and also reduce capital costs in setting up new manufacturing units.

The MoD’s opposition, however, to increasing FDI caps stems from the fear that the entry of large private manufacturers will lead to job losses with DPSUs and Ordnance Factories. The DIPP counters that foreign vendors are likely to partner the defence public sector in setting up manufacture.

Speaking to a CII gathering on April 1, the DIPP Secretary said, “If full investment comes here, (the foreign vendors) are not going to manufacture everything themselves. Lot of it will be outsourced from the Ordnance Factories. ”

Since 2001, when the private sector was allowed into defence manufacture, there has been a cap of 26 per cent on FDI in defence. The government’s Economic Survey for 2008-09 had flagged the possibility of raising this to 49 per cent. The US government and industry bodies like the US-India Business Council  have also lobbied for raising the cap to at least 49 per cent.