COMMENTS ON PROPOSAL FOR

INCREASE IN FDI IN DEFENCE

INTRODUCTION
1. It has been widely reported on TV and Newspapers during last few days that
Government of India is seriously considering approval of following with respect to
FDI in Defence: -
a. From 26% to 49% - probably by Automatic Route
b. FDI upto 74% to be allowed subject to a few conditions, like ToT to
Indian Industry, etc. This may be through FIPB Route.
c. FDI upto 100%, provided the OEM abroad establishes full-fledged
development & manufacturing unit, with all investments for land/
building/facilities/test set-up, etc are fully made by OEM abroad. Such
proposals may be considered on case-to-case basis and with approval
of competent authority of Government of India.
2. Pros & Cons of above propositions are analysed in succeeding paras.
INCREASE IN FDI FROM 26% TO 49%
3. This has been on the cards for past few years and it is now fairly certain to be
approved. However, at present, 26% FDI is being approved by FIPB, whereas it is
now proposed to be upto 49% & that too through Automatic Route!!
4. PROS
a. FDI increase from 26% to 49% will not affect the requirement of
majority shareholding (more than 50%) by Indian Citizens/entities and
the exercise of majority right in Board Proceedings/Resolutions.
b. However, the OEM from abroad will feel more assured / secured as it
will now hold 49% shares as compared to 26%, at present.
c. Being 49% equity holder, the OEM abroad will also get higher portion
of dividends declared by the Board out of profits earned. This will also
be re-assuring to the OEM abroad.
d. With respect to investments in plants / machinery / test equipment /
facilities, the OEM can be made to share 49% costs, instead of earlier
26%. This will help Indian Industries.
e. ToT arrangements or manufacture of units can be negotiated in a
better way with 49% FDI as compared to 26%.
f. If 49% FDI is through Automatic Route, the approval processes can
be simplified considerably and quicker results can be expected. FIIs /
NRI investments can also be included in FDI category either partially or
fully.
g. Possibilities for exports can marginally increase (as compared to JVs
with 26% FDI).
h. OFFSETS: OEMs abroad may find it more attractive to establish JVCs
with 49% FDI as compared to 26% to cater for Offsets through such
JVCs. This may result in reduction of Offset Orders to Indian Industries
(both Public & Pvt Sectors) as JVCs themselves may become IOPs.
However, the later will result in larger investments by OEMs abroad in
JVCs.
5. CONS
a. As OEMs abroad do not hold majority share, OEMs may adapt, sort of,
lackadaisical approach in the activities of Indian JVC.
b. OEMs may still withhold critical technologies (as is happening now with
26% FDI).
c. IP Rights will be held by OEM abroad as at present.
d. OFFSETS: As per 4 (h) above, Indian Public & Pvt Sector Industries
may lose out Offset orders, as the OEMs abroad may prefer to route
them through 49% equity owned JVCs.
INCREASE IN FDI UPTO 74%
6. The situation with respect to OEMs abroad owning 74% shares with respect
to Indian Shareholders (upto 26% only) will be exactly opposite to the present state,
i.e., FDI limited to 26%, due to reversal of role/equity holdings of OEMs abroad.
7. PROS
a. OEMs abroad can be expected to invest more, as compared to 26% /
49% FDI.
b. There can be larger employment opportunities for both
engineers/technicians/skilled labour.
c. Better possibilities of flow of critical high-end technologies to India, as
at present.
d. Indian Industry can pick up larger level of capabilities in terms of
manufacturing, QA & testing.
e. Higher level of investments by OEM abroad (being 74% equity holder)
which will help in establishing modern state-of-art facilities.
f. Capabilities of Indian engineers/technicians will increase as larger
quantum of high end products may be manufactured in India.
g. Higher employability at all levels, dividends / profits & collection of
taxes by Government of India.
h. OFFSETS: As per para 4 (h) above.
8. CONS
a. Indian equity holders (26%) will be minority partner in Board Meetings
and hence, OEMs abroad may Bull-doze the decisions.
b. IP Rights will still be with OEMs abroad, as at present.
c. As there may be restrictions in grant of 74% equity, there may be
delays in the process of taking decisions/ proposals.
d. It will be difficult for Indian Industries (with 100% Indian equity) to
compete with higher end products brought into Indian market in larger
numbers by OEMs abroad to India (with 74% equity).
e. It will adversely affect the Indian R&D initiatives as everyone will look
for the easy way of acquiring technology.
f. May adversely affect DRDO Projects & investments already made by
Government of India.
g. OFFSETS: As per Para 5 (d) above.
100% FDI
9. PROS
a. If Government of India ensures proper regulations/conditionalities,
denial of critical technology by Governments to OEMs abroad / India
can be removed fully.
b. OEMs abroad can invest very high amounts in India which will benefit
industrial and social structure as a whole.
c. Such 100% owned Companies can be developed as the base for
manufacture by OEMs abroad for their world-wide supplies. In fact,
India can be the nodal point for the global supply chain for manufacture
& supply of high-end defence products. Hence, exports from India can
be expected to increase considerably.
d. Indian engineers/technicians can learn/absorb high end technologies.
e. Government of India can collect larger taxes & other duties.
f. All the Defence equipment / systems being planned to be procured by
MOD, at present, under Buy Global category can now be Buy Indian
or Buy & Make Indian with large indigenous content of 60 to 70% can
be insisted by Government of India. Through this, FE outgo can be
considerably reduced.
g. There will be larger employment benefits.
h. Infrastructure development - such as roads/electricity/transportation/
ancillary services can be additional boons & the industrial and social
structure will improve.
i. For an OEMs abroad to establish its own factory in India, preferable
route could be buying Medium / Small Scale Indian Industries who are
having experienced / skilled engineers / technicians and to invest /
develop these SMEs into fully owned (by OEM abroad) large scale
Companies. This will result in quite a few Indian SMEs (which are not,
at present, expanding due to lack of funds) to get larger money-share
for selling their expertise and also later, if the OEMs abroad so wish
(quite probable) to continue to contribute by becoming employees of
the 100% FDI held Companies. It is possible that SMEs may, at last,
get their value for the sacrifices they have made!
j. If SMEs are not bought out by OEMs abroad (who invest 100% FDI),
they may possibly be developed by OEMs abroad through their 100%
owned Companies in India as TIER 1 or TIER 2 sub-contractors, thus
benefiting SMEs.
10. CONS
a. 100% FDI will surely result in the death-knell of Indian SMEs to directly
supply products to MOD, other than those which are of low cost / high
volume.
b. DPSUs will surely be affected as they will now have to compete directly
with global giants who would have set up shop in India.
c. DPSUs will not get any ToT oriented products henceforth and may
have to depend on their own R&D products or DRDO developed
products. Hence, DPSUs will have to compete with products developed
in small quantities with stabilized, well packaged global products.
Hence, at least, in the initial stage, DPSUs may lose large chunk of
their current market though if exploited properly, in the long run,
quality & specifications of Indian R&D products may mature / become
global due to competition.
d. DRDO will be another big casualty. Most of their current projects are
related to something which is already in service with advanced
Countries but being denied to India due to foreign Governmental
restrictions. With 100% FDI, the later may not be an issue with respect
to OEMs abroad. Hence, DRDO may well have to look for developing
products which may not be available in the world market. Hence, this
can be considered, in the long run as PROS but in the short / medium
term, it is certainly CONS.
e. With respect to DRDO projects & other R&D projects from DPSUs /
major Pvt Sector Industries and SMEs, Government of India may have
to consider seriously whether in the long run, our Country should have
larger numbers of high technology products / equipment / systems
developed in the Country by indigenous R&D efforts or go for obtaining
manufacturing technology (not even acquired and with no IP rights)
from OEMs abroad who would dump such products to exploit 100%
FDI which is being offered to them on a platter. So, the choice is for
Indian defence to be dependent on large number of foreign state of
art equipment (but will now be manufactured in India by OEMs abroad
at their 100% owned factories) with the advantages of Government of
India / Indian people getting taxes, duties and other investment benefits
at the cost of losing our R&D base. Of course, since MOD imports to-
day directly 75% of its requirements from BUY-GLOBAL category, it
does give a handy argument to the pro 100% FDI crowd that these
75% imported equipment will now be manufactured in India and hence,
what is the problem?.
CONCLUSION
11. While fully understanding and appreciating the new Governments
anxiety to push for reforms and take bold and quick decisions, with respect to
Defence R&D and manufacturing sector, it is preferable to go through the
steps in a deliberate and time-bound manner as follows: -
a. To increase FDI straightaway from 26% to 49% through
Automatic Route.
b. To include FIIs / NRI investments also, either partially or fully.
c. To consider FDI to be 74% if the OEM abroad establishes
manufacture of critical technologies. This can be through FIPB
route.
d. To consider 100% FDI (to be approved by CCEA/CCS) by studying
all implications by having a dialogue with all stake holders
DRDO, DPSUs, CII, FICCI, ASSOCHAM, etc. For this purpose, i.e.,
to decide on 100% FDI, high power Committee consisting of
Secretary, Defence Production, Serving Officers of the rank of Lt.
Gen. or equivalent from the 3 Services, CMDs of HAL, BEL, DG
OFB and CMD of one of the Shipyards, Senior Reps of CII, FICCI &
ASSOCHAM, Director Defence Studies, may be constituted to
submit a detailed report within 3 months of constitution of the
Committee so that Government of India can take a decision on
this basis.