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FDI Policy 2014: No Game Changer for the Defence Sector

The cumulative inflow of foreign direct investment (FDI) in the defence sector in India from April 2000 till the end of February 2014 was a paltry INR 24.36 crore (US$ 4.94 m). The amount is so insignificant that in percentage terms it does not make up for even 0.01 per cent of the total FDI inflow during this period, for which data is available on the Department of Industrial Policy & Promotion (DIPP) website. At INR 13.75 crore (US$ 2.71 m), only the coir sector received lesser FDI than the defence sector. Sixty odd sectors received higher FDI than the defence sector - one of them being glue and gelatine sector!

The Consolidated Foreign Direct Investment Policy for 2014, which came into effect on April 17, 2014, is not going to change this situation anytime soon in future, for it merely reiterates the decision, already notified through Press Note 6 of August 22, 2013 that FDI above 26 per cent will be permitted with the approval of the Cabinet Committee on Security (CCS) on a case-to-case basis, wherever it is likely to result in access to modern and state-of-art technology in the country.

The foreign investors did not find the relaxation in policy introduced through the Press Note 6 of 2013 very stimulating which is quite evident from the fact that there has been no addition to the total quantum of FDI in the period following the relaxation in the FDI policy.

This appears to be primarily because the relaxation in the cap did not meet the aspirations of the foreign investors. The Press Note 6 of 2013, which talked about FDI beyond 26 per cent being allowed in the defence sector, did not prescribe any cap, did give rise to the speculation that FDI could go up to a 100 per cent. But it soon became evident that this was not going to be possible because of the stipulation in the policy regarding ownership and control of the companies receiving FDI.

As per the provisions of the FDI policy of 2014, in the Information & Broadcasting and the Defence sectors, where the sectoral cap is less than 49 per cent, the company (receiving the FDI) would need to be 'owned and controlled' by resident Indian citizens and Indian companies, which, in turn, are owned and controlled by the resident Indian citizens. This is not a new provision. It was there earlier also. The current policy has not relaxed the sectoral cap beyond 49 per cent. Therefore, it would not be incorrect to draw the inference that the condition relating to ownership and control by the Indian citizens will continue to be applicable to all proposals for FDI in the defence sector.

This effectively caps FDI in defence to 49 per cent, even in those cases where it might potentially result in access to modern and state-of-art technology. That being the case, foreign investors are unlikely to bring in greater FDI into the defence sector, especially if there is no requirement of equipment made by using the technology accompanying the FDI and if there is no clear cut export policy in place. In short, what business sense would it make to bring in modern and state-of-art technology if the products cannot be sold either to the Indian armed forces or exported to other potential buyers?

Even if the entity receiving the FDI is able to sell the product and make profits, it may, at best, entail a greater share in the profit for the investor. But, with 49 per cent FDI, it will make no difference for the foreign investor in regard to control over the management of the Indian entity. It is doubtful if any foreign investor would like to trade its control over the state-of-art technology for a higher share in the profits. The consolidated policy thus continues to reflect government's half-heartedness in dealing with the question of relaxing the cap on FDI in defence.

Assuming that the foreign investors would find the FDI of cap of 49 per cent also quite stimulating, some other issues could come in the way of smooth implementation of the policy. Of course, the primary and vital question is as to what would qualify as state-of-art technology. The Press Note 6 of 2013 had a provision which has been incorporated in the consolidated policy of 2014 without any further elaboration that applications seeking permission for FDI beyond 26 per cent will, in all cases, will be examined additionally by the Department of Defence Production (DoDP) from the point of view particularly of access to modern and state-of-art technology but neither the FDI policy nor any MoD notification makes it clear as to how would this assessment be made.

It is true that as per the Government of India (Allocation of Business) Rules, 1961, DoDP is responsible for, inter alia, Indigenisation, development and production of defence equipment, and participation of the private sector in the manufacture of defence equipment. One cannot, therefore, find much fault with the decision to entrust the responsibility to DoDP. But its secretariat is largely manned by non-technical generalists. Though it also has a large complement of personnel drawn from the ordnance factories and the defence public sector undertakings/shipyards, it is doubtful if they would be in a position to carry out the kind of examination that proposals for bringing in modern and state-of-art technologies would require.
Surely, any technology that is not available with the Indian companies will not, ipso facto, qualify as modern and state-of-art. But then, the question is, what would? It is unlikely that MoD will come out with any comprehensive definition as it is going to be very difficult to do so. But that is precisely the reason why it must be attempted to ensure consistency in the long run in assessment of various proposals and to minimize subjectivity.

The absence of a clear definition of what constitutes modern and state-of-art technology or the yardsticks to be applied for making such determination could make the task risky as a technology proposed to be brought in may be modern and state-of-art when the proposal is made but it may not remain so for long. The term used in the policy is 'access to the modern and state-of-the art' technology, which itself could be subject to different interpretations. How will those examining the proposals take a call on these aspects?

All these uncertainties could complicate the process of assessment within the DoDP.

The process of examination of a proposal has to culminate in a decision being taken by the appropriate authority. No such authority is prescribed. It could well be the Defence Minister's (Production and Supply) Committee but this must be laid down in black and white, as also the procedure to be followed for bringing the proposals before this committee, or any other prescribed authority. In this context a crucial question would be whether the foreign investor should be associated with this process.

It also remains unclear whether the Defence Research & Development Organization (DRDO) will have any role to play in the process of assessment. It is no secret that the DRDO is also technology-hungry. The offset guidelines of 2012 contain a list of critical technologies that the DRDO wishes to acquire. Those offering the listed critical technologies stand to benefit because such transfer entails multipliers. If a foreign investor wants to bring in one of the listed technologies, should it still be subjected to the process of internal assessment by DoDP? If such assessment is to be carried out, should it involve DRDO?

In fact, the question about involvement of DRDO is important not only in those cases where the FDI proposal is linked with transfer of one or more of the listed critical technologies. The DRDO is arguably a better judge of whether the offered technology even if it does not figure in the list of critical technologies is modern and state-of-art. It will, therefore, help if DRDO is also associated with the process of internal assessment of the proposals. It could prove to be counter-productive if the DRDO is kept out of the process.

Foreign investment is a complex operation. The Press Note 6 of 2013 had put a ban on investment by the Foreign Portfolio Investors (FPIs) and Foreign Institutional Investors (FIIs) through portfolio investment. This ban has been reiterated in the consolidated policy. The details furnished by the Ministry of Defence in response to parliament question No 172 on Joint Ventures in the Defence Sector answered in the Lok Sabha on August 5, 2013 show that at least two Indian ventures had an element of FII investment in their equity.

The 2014 policy protects such past investments in companies holding defence licence as on August 22, 2013, i.e. the date on which the aforesaid Press Release was issued. These investments will remain capped at the level existing as on that date. But the consolidated policy also provides that no fresh investment by FPI/FII (through portfolio investment) will be permitted even if the level of such investment falls below the capped level subsequently. This will put the anxiety of the entities that had received such investments in the past at rest but ensuring this could pose a challenge.

The Press Note 6 of 2013 had promised as does the consolidated policy of 2014 that government decision on all applications made to the secretariat of the Foreign Investment Promotion Board (FIPB) will normally be communicated within a time frame of 10 weeks from the date of acknowledgement. This is a laudable objective, but it could easily get defeated if the procedures are not laid down carefully, especially for internal processing within the DoDP where the proposals would need to be examined to assess whether the country is going to benefit by way of access to modern and state-of-art technology. Similar promise made in the context of grant of industrial license has remained largely unfulfilled. It is better not to raise expectations, rather than failing to deliver on lofty promises.

Written By

Amit Cowshish

Amit Cowshish

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