Story Of The Week

FDI in Defence: A Lost Cause or a Potential Opportunity?

In 1991, when Prime Minister P.V. Narsimha Rao and then Finance Minister Manmohan Singh opened up the gates of Indian Economy they deliberately left some gaps for the successive governments to fill at later stages. Foreign Direct Investment was one of the salient features of liberalization in 1991. However, some sectors like defence and railways became untouchables when it came to FDI. Successive Governments were reluctant to allow any FDI in the crucial defence sector on the assumption that this might compromise the country’s security. In 2001, under intense pressure from security experts, NDA bit the bullet and opened up the defence sector to private companies allowing the ceiling at 26%. However, since 2001 barely $5 million has flowed into the sector and no breakthrough innovation has changed the sector for good. Recent decision by government to increase FDI cap to 49% is attracting comments from every nook and corner of the economy. Where security experts consider this as a wrong move by the government, there are many others who think that the move will hardly make any difference and this is because there are strings attached to this hike. The hike in FDI cap comes with a condition that control in the Joint Ventures for manufacturing defence equipment will remain in India. The move is aimed at giving thrust to domestic industry, which imports close to 70% of military hardware, but it is actually proving out to be futile because of the condition following it. So essentially it does not matter whether you increase FDI to 49% or 74 % or even 100%, because until and unless government makes the defence sector look like a favorable investment no player would like to play for the reward involved. Government of India should have no connection whatsoever with the industry and open it to private players for the greater good of country. FDI in defence can considerably reduce defence budget without compromising on quality. But there are also some apprehensions about being lenient in an industry as critical as defence. Experts comment that increasing FDI to 100% and letting private players play their game freely can turn out to be harmful in the long run. India runs the risk of being used as a manufacturing hub without any substantial innovation by private players.

In effect, opening the defence sector to private players is actually a catch-22 kind of situation. So what can be done? India should actually go for transferring technology rather than buying fully furnished military hardware. Investing in joint development programs like that of BrahMos can actually pay in the long term. A 100% or 75% FDI in defence is not a solution because companies entering India will guard their technologies and India in the end will end up with nothing. FDI in defence should be well thought out and as ex Finance Minister P. Chidambram once stated “ It should be on case basis and only state-of-the-art sectors as defined by defence ministry should be totally opened up to private players”.  Thus we can say that FDI in defence is an opportunity, provided India uses it to its advantage .However, India has not been able to use this opportunity even remotely and it is proving out to be a lost cause as of now.


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3 replies »

  1. Well analyzed !!
    I have just one doubt that does India even have the sufficient capability or infrastructure to handle the transfer of Technology we aspire ??

    • Shashwat has raised an important issue about India’s capability to absorb very advanced technology–which largely characterizes defence technology. What is the purpose of inviting FDI in defence and giving them a near controlling stake (49%)? The first (broad) objective is to deepen the innovative and manufacturing capability in the country. The way this has worked (at least in theory) is that the MNC brings with it its best practices and also physical equipment which not only enhances the quality of existing domestic products, but also improves the supply through better and more productive manufacturing. One immediate advantage for India, particularly for equipment that it uses, would be gratly enhanced “component security”– there would hopefully be no shortage of spares in a crisis. Thus, for example, if British Aerospace, Mig or Sukhoi invest in India, we can be reasonably sure that most equipment or components will be readily available during replacement and overhaul.

      Second, if these majors are investing in India, they will expect that the Indian operation provides for third country exports and/or replacement/after sales. Thus if GIAT industries sets up operations in India, and bags a new contract for its Leclerc Tanks, many components could be sourced from India. Too, if the tanks sold to Qatar need an overhaul, it would be cheaper for GIAT to source the components from India. This provides India with a great channel to export markets besides earning valuable foreign exchange (this has been one of the biggest benefits of manufacturing FDI to China).

      If the Indian government successfully negotiates local component requirements (LCR) with MNCs, it would create a dedicated and highly skilled vendor supply chain that would be able to produce state of the art equipment in India. There has been noticeable improvement in getting the private sector involved in defence production (mostly at the sub-system level) but this will **potentially** get a huge boost **qualitatively** with FDI.

      India has developed strong sector strengths in advanced materials, electronic warfare systems, radars and embedded software, where we are largely self sufficient. It is in hardcore manufacturing, such as modular design and construction that we are lacking. There are also gaps in human capital, with the critical absence of specialist welders, fitters, experts in forgings etc. We are certainly in for the long haul, but with a single minded vision we could turn things around in 10 years and reduce import dependence down to less than 30% from current levels of 60-70%. The trick going forward is to harmonize India’s MAKE policies with inputs from FDI.