Max. 49% FDI in defense: FICCI

The Federation of Indian Chambers of Commerce and Industry (FICCI) has published a paper in response to the solicitation of views by the Department of Industrial Policy and Promotion (DIPP), arguing for conditional increase, if at all, in the limits to investment by foreign players in Indian defense industry beyond the current limit of 26 per cent, to 49 per cent. The DIPP, in its discussion paper, was considering hiking FDI limit up to 74 per cent, and even 100 per cent in some cases.

The Indian Ministry of Commerce allowed the participation of the private sector in the defense industry in May 2001, permitting 100 per cent equity with a maximum of 26 per cent of FDI, subject to licensing. Under the Defense Procurement Procedure (DPP) 2008, limit was raised to 49 per cent FDI on a case-by-case basis. But the Foreign Investment Promotion Board (FIPB) has not, so far, approved the formation of a venture with a 49 per cent FDI component.

FICCI sees little reason to permit FDI above 26 per cent, considering the existing FDI into the Indian defense sector, saying in a statement, “The 26% FDI cap in the defense sector has already attracted top overseas defense OEMs like BAe, EADS, Sikorsky, Lockheed Martin, Electtronica Defence Systems, etc to hugely invest in India’s defense sector. Therefore, any increase in FDI Cap in a strategic sector like defense will require careful thinking and analysis.”

The statement says, “Globally, there are restrictions on allowing foreign capital in strategic sectors like defense for safeguarding of national security interests,” adding that, “FDI & transfer of technology are not always directly proportional, so raising FDI is no guarantee for true transfer of technology. The fact is that leveraging latest technologies from overseas suppliers would be difficult even if the FDI ceiling were raised as the OEMs exercise no control over the release of technology which is exclusively under their government’s control.”

“FICCI strongly believes that India would continue to attract OEMs for co-development and JVs at the existing FDI ceiling of 26%. This is so because India and China are only two countries where the spending on new defense platforms and systems will continue to grow in the post–global economic crisis period. In western countries, firstly, the defense markets are more or less saturated and secondly, the defense budgets have already started declining in the post economic crises period. For example in USA even a program like F-22 was capped and their exports to Japan have been prohibited though Japan wanted to import F-22. Thus India is undoubtedly a promising destination for the foreign defense players,” said the federation on Monday.

The statement cited the ‘significant involvement of OEMs (Original Equipment Manufacturers) in the Indian defense sector at the existing 26% FDI Cap’ and ‘recent global trends of a measured approach on FDI in defense’ to explain the reasons for this stance, pointing out, “Countries like Germany, China, South Korea, and Canada have recently revised their FDI policies in defense, post September 11, 2001 (9/11), making the policies much more stringent. They have inducted methodologies to punitively scrutinize FDI inflows in this sensitive and strategic sector.”

According to FICCI, an increase of the limit of FDI to 49 per cent should conditional upon ‘linkage with the full platforms being produced’, ‘a minimum capitalization of US$100 million’ and induction of proprietary technology content in the JV as per the requirement of the country and should form ‘the basis of further indigenous technological development’.

FICCI also prescribes other conditions for raising the FDI limit, saying the joint venture should provide an undertaking to source between 50 per cent to 70 per cent of their ‘components/subsystems by value, indigenously, by nurturing tier-ised Indian vendor industries’, export obligations worth ten times the equity should be committed by the OEM within ten years of entering into the contract, technology received should have no restrictions on its global exploitations once cleared by the government of the home country.

“Post the transfer no retrospective law should be applicable to restrict the technology exploitation. All these should be in writing from by the home country government of the OEM/defence major. (Since there are dual use technology restrictions and a technology denial regime in many developed countries),” says FICCI in its statement, adding, “The companies cleared with more than 26% FDI should not be eligible for ‘Make’ funding.”

FICCI also warns against further dilution of 51 per cent Indian ownership, saying management should remain Indian with transparency of transaction between shareholders. “All requests for up to 49% FDI must be linked with the fact that these companies will qualify for participation in the “Buy & Make Indian” category projects. Therefore, they must be mandated to at least 20% extra indigenous content in their products than the currently stipulated 50% limit applicable for all other Indian companies within 26% FDI limits,” the statement adds.

This comes after a report published in May by another industry body, the Confederation of Indian Industry (CII), which too argued for easing of limits on Foreign Direct Investment (FDI) up to 49 per cent in this sector. The CII report said, “More than 50 percent of the CII members had a view that increasing the FDI limit to 49 percent would be beneficial.”

The CII report cited conditions for allowing such an increase in FDI limits, saying, the existing 26 per cent FDI in this segment may be increased subject to the following:

1. JV should also be engaged in R&D (Research and Development) and the IPR (Intellectual Property Rights) should rest with JV.
2. Foreign partner should ensure JV access to the global market (subject to government approval).
3. Foreign partner should bring high level specialized technology that is not easily available.

The report said, “The FDI issue is driven by a number of factors comprising: sovereignty concerns in respect to the ownership of core strategic industries like defence; Government’s desire rapidly to acquire more advanced technologies; the assistance foreign players can provide to SMEs (Small and Medium Enterprises); and the concerns of the larger players, both private and DPSUs (Defense Public Sector Units), that greater foreign involvement would be at the expense of their own businesses.”

CII had also pointed out that ‘Restricting the limit of FDI to 26 per cent has been challenged by certain foreign companies as they believe that it acts as an inhibiting factor towards their entry into the Indian defence market’. “Despite the attractive pipeline of projects issuing from the Ministry of Defense, certain foreign vendors feel that, where ToT is involved, the returns likely to be generated on the basis of current FDI regulations, coupled with the lack of control they would have over the technologies and know‐how they are being asked to provide, makes entry in to the Indian market an unattractive proposition,” said CII in its report, adding, “The result has been limited FDI inflows to India, with a total of only INR 7 Mn between April 2000 and February 2009 (As per the DIPP FDI Statistics, February 2009).”

According to CII, “The case against increasing the limits for FDI is founded primarily in Indian sovereignty. It is believed that allowing greater levels of FDI, even below 49 per cent level, would increase the amount of control exercised by foreign partners and this in turn would reduce the actual level of indigenisation and maintain the reliance on foreign suppliers. Also, it is believed that that the level of technology required by the country can be achieved within the existing FDI limits and it is for the domestic industry players to rise to the challenge and ensure that they capture the ‘know‐why’ along with the “know‐how” of manufacturing techniques, technology and efficiency.”

But the report also says, “One of the arguments put forward for increasing the FDI cap from 26 per cent to 49 per cent is that there is no significant difference in the control over a business between these levels. Opponents argue that a company’s board with 49 percent foreign members is significantly different in terms of influence, culture and management approach to one with 26 percent. Policy makers argue that an increase to 49 per cent would be largely ineffectual in achieving India’s main aim of technology enhancement, as foreign vendors will not transfer critical technologies without ownership and management control of the Indian venture. Several foreign vendors have themselves pointed out that an increase in FDI levels to 49 per cent would not be a panacea. The debate, they argue, should focus whether the FDI cap should remain at 26 per cent or be increased to 51 per cent or above. The clear expectation is that the FDI cap will be increased above 26 per cent. Despite the on‐going uncertainty as to whether the permissible FDI levels will be raised, many of the large foreign OEMs are already setting up joint ventures (JVs) in India, within the existing investment limits, but in the stated expectation that FDI limits will soon be increased.”

The Indian Secretary, Defense Production, RK Singh, said at the Eurosatory 2010 exhibition in Paris last month that the Ministry of Defense is in favor of continuing with the FDI limit of 26 percent, while releasing the CII-Deloitte report, Prospects for Global Defence Industry in the Indian defense market.