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Will 49% FDI in Defence Serve the National Perspective?

Allowing 49% FDI in the Defence Sector is a much needed step. Will the  decision be a right step towards national capability and capacity building in the strategic sector of defence and aeronautics?

Industry associations and stake holders have been debating this matter and divergent opinions have been reported in the media for almost a month. As in the past, the call for capping FDI has been raised, but it is in the narrow self-interest of a few stakeholders and is detriment to the core national interest of building a national capacity in this strategic sector. The policy change announced in the budget was the increase Foreign Direct Investment in the defence sector from the present 26 per cent to 49 per cent. It is expected, the increase in the FDI cap will attract a number of foreign players to invest in the sector. We need to examine the issue from all perspective before we assume it will serve our intended purpose. It is pertinent to point out; we could only attract around $0.35 million per year since 2000 until March 2014 as FDI in defence.  How the increased limit going to get investment and critical technologies is the issue?

The purpose of FDI is not to build or bankrupt the fortune of one company or the other but to deliver on the crucial matter of attracting foreign direct investment in building a “local” defence industrial base by leveraging the domestic market potential to advantage. Such investment would complement the national effort of rapid modernisation of the Indian armed forces through locally procured and maintained equipment with attendant benefits of local asset creation, local capability building, and effect much needed savings of vital FE in defence procurements.

The argument for higher FDI also rests on the fact that the total equipment induction budget over the next 15 years, going by public information, is valued at about INR 20, 00,000 Crs.  This would require a capital investment of about INR 60-70,000 Crs if even 70% of these requirements are to be sourced from India. In other words the GoI/Private Sector would have to invest and create 2 HALs, 2 MDLs, 3 BDLs/BEL, and other OFB over the next 3-4 years to meet the15 year requirements of the armed forces. This is simply unachievable. If we import, then no national capacity is built and vitally important FE is expended. On the other hand the Indian private sector, being risk averse, would not put up facilities unless there are assured orders  a condition that would be a breach of financial prudence. Hence, FDI is a logical option. Will 49% FDI limit attract the Foreign OEM to invest to our requirement?

Besides, there are critical deficiencies in in-country high technology industrial capability in the defence and aerospace sector, despite the claims of Indian companies, where the entire onus of achieving the acquisition targets has been put on DPSUs or on imports, which is unreasonable. Hence, if through FDI, in country manufacturing can bridge these capability gaps it is incomprehensible that the policy should encourage their import and discourage FDI to create in country facilities.

Looking at the Investors Perspective
A decision for FDI into a target country is taken at the Board level of any company and requires stakeholder acquiescence.  This requires a long term view of the investment, identification and validation of the business model, resource requirements, anticipated volumes and revenues through domestic sales and exports, taxation, legal and compliance considerations and the nuances of  setting up of a manufacturing facility. Hence FDI is a highly deliberate and well considered corporate decision and there is very little possibility of such a decision to be capricious. Hence, FDI investment must result in asset creation, long term sustainable business operations and growth of the industry in India for it to be approved by the Board/AGM. The automobile sector is a sterling example of the benefits of FDI and there is no reason why that cannot be replicated in the aerospace and defence sector.

The second issue is about control. Control is exercised by Board representation in companies. These aspects are defined in the Indian Companies Act 2013 and even if a foreign OEM creates a WOS in India it has to still adhere to the laws of the land failing which civil and even criminal proceedings can be initiated. Therefore, control of a company does not give any real benefits and no real danger to Indian interests since capital assets are captive on Indian soil and can be attached for violations under Indian law and the IDR Act. So, this is not a matter of “utmost concern” as is being made out by some Indian companies. Precedence already exists with several 50:50 JVs concluded by the DPSUs on major strategic projects and these have been very successful. The Indian Private sector can replicate and perhaps even improve on that record. It is unfair to permit DPSUs to conclude 50:50 and even in one case a 51:49 JVs and deny the same to the private sector.

26% 0r 49% Equity How the Control of Activities Differs?
As is known the extent of shareholding provides the shareholder with an ability to pass or block resolutions required for the regular conduct of the business affairs of a company. The table below summarizes the implications.

FDI EquityExisting RouteProposedOrdinary ResolutionSpecial Resolution
 Upto 26%  Automatic  Automatic  Can not pass
Can not block
 Can not pass
Can block
 From 26-49%  Approval  Automatic  Can not pass
Can not block
 Can not pass
Can block
 From 51-74%  Approval  Automatic  Can pass
Can block
 Can not pass
Can block
 From 76-100%  Approval  Approval  Can pass
Can block
 Can pass
Can block

From the foregoing it is clearly evident that a FDI limit of 49% has no real benefit or change over the 26% stipulation as the exercise of control to grow the new firm is completely constrained. For the firm to progress and expand its operations an ability to pass special resolutions for example on raising of funds through equity or borrowings, creating strategic business units, compensation for highly qualified members of the Board etc are required.

Way Forward.
Therefore, in view of the above arguments and considering that the Foreign Investment Promotion Board (FIPB) is empowered to take decisions on investments up to INR 1200 cr on balance, the following FDI policy would be more appropriate in the national interest.:-

Shareholding LimitApproving Authority
 Upto 74%  No Approval/Automatic Route
 More than 74% including 100 % Wholly Owned Subsidiaries for manufacturing high technology defence and military aerospace products (essentially the 16 items listed for industrial licence)  FIPB
 Investment more than INR 1200 Cr irrespective of equity holding     CCEA

Note: All proposals would attract the attendant matters of permanent establishment, transfer pricing, withholding tax and relevant provisions of the applicable Double Taxation Avoidance Treaty.

CORE BENEFITS OF FDI IN DEFENCE
1.  Acquisition and Product Life Cycle Support Issues

  • Remove middlemen and agents of OEMs from defence contracts.
  • Promote Buy Indian, Buy and Make Indian or even make Indian (which includes JVs with foreign OEMs and even WOS so long as they are Indian companies as defined in the Company Act 2013),  as the key cornerstone of defence acquisitions. So no more Buy Global acquisitions.
  • Faster acquisition of defence products for the Indian armed forces through reduced time for trials, direct communications for clarifications, quicker negotiations and contract conclusion since vendors would be in-country.
  • Ensure better understanding of the Capital Budget outlays by way of high visibility in committed liabilities, exchange fluctuations and huge savings on FFE content. Indian companies, foreign owned or otherwise, would have to be paid in INR and not FFE.
  • Better and low cost maintenance of such products through the “revenue” budget   route under delegated powers of the armed forces since no FFE will be used as manufacturing units are local and hence relieve MoD of cumbersome processes applicable for import of spares.
  • Higher operational availability of platforms and assets and much lower downtime being in country manufacture.
  • Reduced inventories of expensive imported Depot level spares and thus improve budget utilization substantially.
  • Remove duplication of test beds and test equipment since the main facility would be able to support the MRO of these equipment and hence effect major savings.

2. Industrial Growth and Promotion of Manufacturing Sector

  • Create a core ultra-modern state of the art industrial capability in the defence manufacturing and aeronautics sector with huge potential to attract significant investment into India at no cost to the GoI or at low/ no cost to Indian private sector. The potential investment can be upto US $ 10-12 billion.
  • Promote growth of SME clusters (akin to the automobile industry) as part of the local supply chain of the OEM. This will reduce the manufacturing cost of the equipment, making Indian manufactured products more competitive in the global market, thus making these products exportable and earn vital FE for the country.
  • Osmosis of several dual use technologies into other related sectors to promote the overall industrial base in India.
  • Process and product improvement through in country R & D which is inescapable if the new company has to remain globally competitive in technology, cost, delivery schedules and quality.
  • Promote world class local R&D if OEM is to remain competitive in the global defence market.

3.  National Skill Development and Job Creation

  • Develop and build system integration expertise which is largely lacking in India.
  • Mentoring by Expats of Indian engineers and technicians in a high technology sector to world class levels.
  • Job creation in a high technology sector. As a thumb rule every US$ 2 million of sales is 3 jobs. (HAL has annual revenues of about US$ 1.8 billion and directly employs 32500 employees).
  • Indirect jobs in multiple sectors. The multiplier can be as high as 3-5 times of direct employment.
  • Skill development at the technician level and higher level managerial competencies in dealing with high technology business.
  • Align High technology education and training with international best practices.

4.  Revenue Generation and National Income

  • Immediate infusion of much needed foreign exchange through FDI in defence.
  • Source of subsequent foreign exchange earnings through exports of high technology goods in markets already penetrated and developed by the OEM.
  • Source of substantial annual revenues through taxation on income derived from domestic and foreign sales.
  • INR payments and not USD payments for supplies to Indian armed forces and thus better visibility on committed liabilities, exchange risk mitigation and huge savings on FFE content in the Defence Capital and Revenue Budget.
  • Improve the balance of payments situation through reduced foreign exchange outgoes for defence contracts by reducing import dependency.
  • Rapid improvement in Gross Domestic Product.

5.  Legal and Compliance Issues.  

  • FDI funded companies in India will have to comply with all Indian Acts, Laws, Regulations and Rules and seek all necessary licenses and approvals to manufacture in India. Therefore, control over the foreign OEM is well established through the prevalent regulations of our country.
  • FDI funded plants in India are under TOTAL Indian authority and subject to the laws of our country. If we buy from OEM abroad then we are at their mercy.
  • The foreign OEM have to carry the risk and cost when investing in India.
  • Corruption in global defence deals comes to ZERO if manufacturing is in India.
  • There is global competition for investments. Higher FDI, friendly investment and industrial climate are crucial incentives for investment. Such aspects need to be addressed to attract FDI into India's Aeronautics and Defence sector; else other Asian countries such as China, Indonesia and Vietnam may become more attractive alternates. Global OEMs are looking for off shoring manufacturing facilities. It would be a matter of some national shame if India were to import from OEM facilities in such countries. Therefore, allowing over 49% FDI in the Defence Sector is welcome change, and increasing it on case to case basis will be the correct decision and the right step towards national capability and capacity building in the strategic sector of defence and aeronautics.

(The author thanks the defence industry experts for sharing the views.)

Ritika Behal

Ritika Behal

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