By Dhruv C Katoch
August 30, 2014
The recently released Press Note 7 of 2014, dated 26 August 2014, notifies the changes brought about by the Department of Industrial Policy & Promotion (DIPP) in Foreign Direct Investment (FDI) in the defence sector. The revised policy allows FDI in defence production up to 49 percent under the Government approval route. Beyond 49 percent, FDI is allowed on a case-to-case basis on upper end technology products, subject to the approval from the Cabinet Committee on Security (CCS). The policy marks a welcome departure from earlier years where policy decisions pertaining to the defence sector stagnated. This occurred due to an inadequate understanding of issues involved and due to a lack of professionalism in dealing with the complex subject of defence capability building. For too long, the defence public sector has simply been used as a means of providing employment, without looking into issues of productivity. Some important changes brought about are as under:
The applicant company seeking permission of the Government for FDI up to 49 percent should be an Indian company owned and controlled by resident Indian citizens. Its management should be in Indian hands with majority representation on the Board. The Chief Executives of the company/ partnership firm as well as the Chief Security Officer (CSO) must be resident Indian citizens.
The Government has the right to verify the antecedents of the foreign collaborators and domestic promoters including their financial standing and credentials in the world market. It would give preference to original equipment manufacturers or design establishments, and companies having a good track record of past supplies to Armed Forces, space and atomic energy sections and having an established R & D base.
Based on the recommendation of the Ministry of Defence and FIPB, approval of the CCS will be sought by the Ministry of Defence in respect of cases where FDI beyond 49 percent could result in access to modern and ‘state of the art’ technology in the country.
Further approval of the CCEA is not required for FDI proposals beyond 49 percent, with proposed inflow in excess of Rs 1200 crore, once approved by the CCS. The government will also communicate its decision on applications to FIPB for FDI in defence industry within a period of 10 weeks from the date of acknowledgement.
While there is no minimum capitalisation for the FDI, the licensing authority would satisfy itself about the adequacy of the net worth of the non-resident investor taking into account the category of weapons and equipment that are proposed to be manufactured.
There will be no purchase guarantees of the products to be manufactured. However, the planned acquisition programme for such equipment and overall requirements would be made available to the extent possible. The capacity norms for production will be provided in the licence based on the application as well as the recommendations of the Ministry of Defence.
The Investee/ joint venture company should be structured to be self-sufficient in areas of product design and development. Where required, the Government will permit import of equipment for pre-production activity including development of prototype by the applicant company.
The standards and testing procedures for equipment to be produced under licence from foreign collaborators or from indigenous R & D will have to be provided by the licensee to the Government nominated quality assurance agency under appropriate confidentiality clause
.
The Government could give purchase preference and price preference to the Public Sector organisations.
Arms and ammunition produced by the private manufacturers will be primarily sold to the Ministry of Defence.
Analysis
The conditions which have been laid down, while easing investment in the defence sector to some extent, are unlikely to lead to FDI inflows to the desired extent. Despite India having a strong defence industrial base, with a robust Defence Research and Development Organisation, 42 Defence Ordnance Factories and Eight Defence Public Sector Undertakings, the nation remains dependent on imports to about 70 percent of its defence requirements. Critical weaknesses remain in the field of aircraft design and production, armoured vehicles, artillery guns and even infantry small arms among a host of others. India needs FDI in large measure in the defence sector, if import dependency is to be reduced to 30 percent as a desired state. This has been propagated for the last two decades, but little has been down in terms of policy initiatives to achieve the above aim. There is a requirement to make the environment more conducive for large inflow to come in. This is especially pertinent in case of critical technology, which no country will easily part with. For specific cases, we could look into even 100 percent FDI, if it could lead to development of such technology within the country.
The government has however sent out a positive signal that it is opening out the defense sector by hiking the FDI cap to 49 percent. The caveat that ownership of the new venture will remain in Indian hands signals government intent to achieve self-sufficiency in greater measure from the present levels, by reducing reliance on imports and indigenising defence production. Further, removal of the stringent single largest ownership rule will allow multiple Indian companies to cumulatively hold 51 percent stake in the venture thereby granting a foreign investor an opportunity to hold the largest stake in the company. Corporatisation will also lead to better investment inflow.
However, on a more restrictive note, the government has decided not to allow investments by FPIs/FIIs/NRIs/QFIs/FVCIs beyond 24 percent. This means that unlike the other sectors, FPIs/FIIs/NRIs/QFIs/FVCIs will not be able to invest up to the FDI cap of 49 percent and will be restricted at the prescribed level of 24 percent. Resultantly, this will affect the liquidity of the stock of listed entities that deal in defence.
The positives pertain to insistence that only Indian companies owned and controlled by resident Indians, can aim for the 49 percent cap. The defence sector is a sensitive one and having the CSO as a resident Indian is logical. It is also mandated that companies with foreign equity must be self-sufficient in design and development while also ensuring that maintenance and life-cycle support facility is readily available in India. This will clearly ensure that the foreign partner not only shares its proprietary knowledge and technology but also ensures the sustainability of the joint venture company.
For proposals with foreign investment beyond 49 percent, the applicant does not necessarily need to be an Indian company and the condition of Indian management control is waived thereby encouraging foreign investment in core sectors. Finally, doing away with the prescribed lock in period of 3 years for transfer of equity from one non-resident investor to another will undoubtedly provide more flexibility to these investors who were till now deterred to invest owing to the complex and at times convoluted rules. However, the clause that government could give purchase and price preference to the Indian Public Sector is unlikely to yield appropriate dividends. Their performance thus far has been sub optimal and examples of the Tatra deal, ALS trucks, production of armoured vehicle and even the dismal state of small arms production fails to inspire confidence. A level playing field is required to remove the sloth in the defence public sector. For the moment, the above policy represents some forward movement, but how far the above policy will succeed in drawing in FDI remains to be seen. Perhaps, based on the feedback a review may be mandated sooner rather than later.
The author is Director CLAWS.
Notes: Press Note No 7 (2014 Series), Govt of India, Ministry of Commerce and Industry, Dept of Industrial Policy and Promotion.
- See more at: http://www.claws.in/1246/review-of-policy-on-fdi-dhruv-c-katoch.html#sthash.DtzNEREo.dpuf
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