FOREIGN DIRECT INVESTMENT IN THE INDIAN DEFENCE SECTOR : PROSPECTS AND CHALLENGES

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1 FOREIGN DIRECT INVESTMENT IN THE INDIAN DEFENCE SECTOR : PROSPECTS AND CHALLENGES Sarthak Gupta Shri JJT University Abstract : The next decade will be marked by an increase in global defence spending from U.S, Europe and all the way to China. India s defence expenditure is only 2.5 % of its Gross Domestic Product and we need to increase it to match the world trend. To attain this, we need to encourage foreign direct investment in defence sector in a serious way and on a priority basis. The present paper is an attempt to analyze the trends of foreign direct investment in Indian defence sector from the period The paper tries to visualize the challenges in attracting FDI and various ways to overcome these challenges. The paper also discusses the future prospects of FDI in Indian defence sector particularly in the light of the various initiatives taken by the Government of India, viz. Make in India, increasing the FDI caps, increasing the defence budget etc. Keywords : Defence, Foreign Direct Investment, Trends, Problems, Prospects Introduction : National defence and security is of prime importance for any Government or nation. U.S. ranks first in military expenditure by spending $611.2 billion dollars which is 3.3 of its GDP. India stands in the fifth place by spending $55.9 billion dollars which is 2.5% of its GDP whereas China has gained second rank by spending $215.7 billion dollars which is 1.9% of its GDP in Trends in World Military Expenditure, 2016" (PDF). Stockholm International Peace Research Institute. Retrieved 24 April India needs huge investment in defence sector to become military power to sustain its economic power in the world scenario. For this one of the ways is to liberalize the defence sector to attract FDI. India ranks among the top ten countries in the world in terms of military expenditure. As per the estimates, nearly 70% of our defence requirements are met through imports and only 30% being met through domestic production2. India took the first step towards opening the defence sector to foreign investment in 2001 when foreign investors were allowed to hold up to 26% share in the equity holding of a joint venture.31.1% of the defence budget is spent on capital acquisitions. 60% of defence related requirements are met by imports which offers a huge opportunity for import substitution4. India s focus on indigenous manufacturing in the defence space is paying off as the Ministry of Defence over the last two years unveiled several products manufactured in India like the HALTejas Light Combat Aircraft, the composites Sonar dome, a Portable Telemedicine System (PDF) for Armed Forces, Penetration-cum-Blast (PCB) and Thermobaric (TB) ammunition specifically designed for Arjun tanks, aheavy weight torpedo called Varunastra manufactured with 95% locally sourced parts and medium range surface to air missiles (MSRAM).The Defence Acquisition Council (DAC) under Rex Journal Volume 4 Issue 2, 2017 Page 396

2 Ministry of Defence, cleared defence deals worthmore than INR 82,000 crore under Buy andmake (Indian) and Buy Indian category. Thedeals include the procurement of Light Combat Aircraft (LCA), T-90 Tanks, MiniUnmannedAerial Vehicles (UAV) & light combat helicopters. Objectives of the study : The following study presents the following objectives : 1. To exhibit the trends of FDI inflows in defence sector in India. 2. To examine the problems of FDI inflows in defence sector in India. 3. To highlight the prospects of FDI inflows in defence sector in India Database and Methodology : Secondary data has been used to attain the objectives of the study. The time period covered herein ranges from 2000 to For the purpose of present study, various issues of Secretariat of Industrial Assistance (SIA) Newsletter, journals, newspapers and websites havebeen extensively used. The various statistical tools used in this study are tables and percentages. Table 1 TRENDS OF FDI INFLOWS INTO DEFENCE SECTOR DURING Year Cumulative Total (2000 to September 2016) FDI equity inflows in Defence sector Total FDI equity inflows 954, , , ,599, ,215, ,294, ,753,134 2,525,615 1,219, Percentage share in total FDI equity inflows Rex Journal Volume 4 Issue 2, 2017 Page 397

3 Source: Compiled from Various issues of SIA, Newsletters Table 1 shows that FDI equity inflows into defence sector in India during the time period 2000 to 2016 (upto September) and their percentage share in total FDI equity inflows. FDI inflows have fluctuated from Rs million in the years to Rs million in the year 2016 (upto September). It is evident from the table that defence sector has not been able to attract a significant FDI upto Due to the impact of global recession there has been fluctuating trend in the inflows of FDI and its percentage share in the total FDI inflows in this sector during As this sector is very much significant and is concerned with security of the citizens of India, the Government of India has to follow a balanced approach while allowing FDI in this sector. Still, India needs tremendous FDI in this sector to make India self-reliant in this sector and save the outflow of foreign exchange. Table 2 Comparison of FDI Inflows in Defence Sector with Other Sectors ( ) S.No Sector Total FDI Inflows Services Sector (Fin., Banking, Insurance, NonFinical/Business, Outsourcing, R&D, Courier, Tech. Testing and Analysis, others) Construction Development: Townships, housing, built-up infrastructure and construction development projects Computer Software & Hardware Telecommunications Automobile Industry Drugs and pharmaceuticals Chemicals (Other than Fertilizers) Trading Power Metallurgical Industries Defence Industries Rex Journal Volume 4 Issue 2, 2017 Page 398

4 Source: SIA Newsletter, October, 2015 Table 2 exhibits the comparative position of FDI inflows in defence sector with other viable sectors which have received FDI inflows in large quantity. It is evident from the table that maximum FDI inflows have been attracted by services sector followed by construction development and computer software & hardware etc. It is very disappointing that FDI inflows in defence sector are very much meager during the period of study i.e. Rs million. This is a cause of concern for the Government of India also. Now the present Government has made efforts to bring FDI in this sector by taking measures like raising FDI cap to 49% and by launching Make in India, campaign. These measures would help in increasing FDI inflows in this sector. Still much is required to be done to motivate the foreign investors to invest in this sector. Challenges concerning FDI inflows in defence sector 1.Will Jeopardize the Safety and Security One of the major reasons given by the critics is that it will compromise the country s defence capabilities and will jeopardize the safety and security of our nation. Sharing of the information such as source design and code with the countries which are not aligned with India s interests can prove damaging. 2. Increase in competition : Another reason to go against FDI is that entry of foreign players in the market will stifle the indigenous arms producing industries. There is great amount of concern that whether defence PSU s will be able to face competition posed by foreign players. 3. Capital intensive industry : Defence manufacturing is a sector that remains highly capital intensive and the risk levels for investors remain quite high as the ultimate payoff is unpredictable. The investment period also often drags on for decades. The exceptionally high risk levels may make the sector unattractive for investors while at the same time leaving our nation vulnerable. The balance between security and investment may remain skewed due to the government s policy of 100 percent FDI. 4. Technology is main consideration : India needs more technology rather than foreign investment in this sector. India has unfriendly neighbors so it needs more protection of its borders. Due to this more sophisticated weaponry is required for our armed forces with latest up gradations. A huge expenditure is required to import this weaponry. Therefore, government has realized the importance to have manufacturing base for defence sector to keep control over the superior technology. The countries having superior technology are not much willing to share their superior technology with India to keep their monopoly intact in defence sector. 5. Problem of intellectual property rights : The investors are also concerned about safety of their intellectual property rights. As huge expenditure is done on the development of these advanced technologies and the equipments therefore investors expect assurance from Indian Government regarding this. The Government is also not having clear cut regulations to address this problem which is acting as an important hindrance in the inflows of FDI in this sector. Rex Journal Volume 4 Issue 2, 2017 Page 399

5 Prospects regarding FDI inflows in defence sector : Drivers of growth through Defence production policy : Defence Production Policy, 2011 has encouraged indigenous manufacturing of defence equipment. Defence Procurement Procedure (DPP) has been amended in 2016.New category of capital procurement - Buy Indian IDDM (Indigenously Designed, Developed and Manufactured) introduced to encourage indigenous design, development and manufacturing of defence equipment. Preference to Buy (Indian-IDDM), Buy (Indian) and Buy and Make (Indian) over Buy(Global) categories of capital acquisition.clear and unambiguous definition of indigenous content. Provision for Maintenance TOT (Transfer of Technology) to Indian Industry partners. Provisions to allow foreign OEM (Original Equipment Manufacturer) to select Indian Production agency. Requirement of minimum indigenous content has been enhanced. Opening up of FDI policy : 100% FDI is allowed in defence sector, out ofwhich up to 49% is under automatic route. FDIabove 49% is permitted through Governmentroute on case to case basis where it is likely toresult in access to modern technology.a lock-in period of three years on equity transfer has been done-away with in FDI for defence. But is subject to other security conditions. Streamlining of Granting of Industrial Licenses : The initial validity period of industrial licenses has been increased from 3 years to 15 years with a provision to grant extension for a period of 3 years.guidelines for the extension of validity of industrial licenses have been issued. Partial commencement of production is treated as commencement of production of all the items included in the license. Increased financial assistance from the budget : In budget , defence budget hasreceived a boost of 6.2% as compared to budget INR 86,488 crore has beenallocated for Defence Capital out INR 2,74,114 crore allocated for defence expenditure(excluding pension) in the budget. Exchange rate and custom duty exemption : Exchange Rate Variation protection hasbeen made applicable for Indian private sectorat par with Public Sector Undertakings for all categories of capital acquisitions (August 2015). The custom duty exemption on import of defence equipment has been removed toencourage imports and incentivize domestic manufacturing. Tax and State incentives : A weighted tax deduction is given under Section 35 (2AA) of the Income Tax Act.Apart from the above, each state in India offers additional incentives for industrial projects. Incentives are in areas like subsidised land cost, relaxation in stamp duty exemption on sale/lease of land, power tariff incentives, concessional rates of interest on loans, investment subsidies/tax incentives, backward areas subsidies, special incentive packages for mega projects. Export incentives : There is export promotion capital goods scheme and duty remission scheme.some of the major defence equipment exported by Defence Public Sector Undertakings (DPSUs) and Ordnance Factory Board (OFB) are Patrol Vessels, Helicopters & their spares, Sonars & Radars, Avionics, Radar Warning Receivers (RWR), Small Arms, Small Caliber Ammunition, Grenades and Rex Journal Volume 4 Issue 2, 2017 Page 400

6 Telecommunication equipment. Focus is on product scheme and market scheme. Incentives as per merchandise Exports from India Scheme (MEIS) under new Foreign Trade Policy are there. Special focus on MSME : In the Make category of capital acquisition, government funded projects with estimated costof prototype development phase not exceeding INR 10 crore and industry funded projects withestimated cost of prototype development phasenot exceeding INR 3 crore are reserved formsmes.msme associations are being involved forcarrying out feasibility studies for Make projects. MSMEs have also been granted relaxation in the registration and profitabilitycriteria for consideration as eligible Indian Vendor for participation in the Make projects. Research and Development : Centres of Excellence for Defence Research and Development Organisation (DRDO) have beensetup for conducting research in the defence sector. The following three Centers of Excellence were established during 2016, Centre of Propulsion Technology (CoPT), IIT Mumbai was established in June 2016, Jagdish Chandra Bose Centre for Advanced Technology (JCBCAT), Jadavpur University, Kolkata was established in June 2016, Joint Advanced Technology Centre (JATC), IIT-Delhi was established in Oct Skill development : Under Skill India initiative, National Skills QualificationFrame Work (NSQF) compliant skill training is being promoted. 8 ITIs have been selected to upgrade their training infrastructure. Spare equipment in working condition are being donated to ITIs by OFB/DPSUs for training.ofb/dpsus have stepped up trainings under Apprenticeship Act from 2.5% to 10% of the strength. Conclusion : Defence sector is very crucial sector as it is concerned with the safety of a nation. The present study exhibits the trends of FDI inflows in the defence sector and to examine the problems of FDI inflows in this sector in India. The prospects for FDI inflows in defence sector have also been highlighted. The time period covered herein ranges from 2000 to 2016 (upto September). The study reveals that FDI inflows in this sector have fluctuated from Rs million in the year to Rs million in the year 2016 (upto September). The major problems in FDI inflows in this sector are security and safety, increased competition, requires capital intensive industry, selection of private partner, insufficient FDI limit, safety of intellectual property rights, technology, availability of finance and quality of work force. The prospects for FDI in this sector are drivers of growth through Defence production policy, opening up of FDI policy, streamlining of granting of industrial licenses, increased financialassistance from the budget, exchange rate and custom duty exemption, tax and state incentives, export incentives, special focus on MSME, research and development, skill development. Bibliography : 1. Government of India (2015). Secretariat of Industrial Assistance (SIA) Newsletter, New Delhi. 2. Government of India. Secretariat of Industrial Assistance (SIA) Newsletter, Various Issues, New Delhi. Rex Journal Volume 4 Issue 2, 2017 Page 401

7 3. Bitzinger, Richard A. (2014). The State of Defense Innovation in India: Can It Catch Up With Global Leaders? Retrieved from 4. Federation of Indian Chambers of Commerce and Industry (2015). India:Aerospace & Defence. Retrieved from 5. Press Trust of India (2016). L&T sees huge potential in defence under Make in India. Retrieved from 6. Janu, Raveen and Kaur, Karanpreet (2015). Make in India Programme : Industry Perspective. Retrieved from Januand Karanpreet Kaur. pdf Websites : *** Rex Journal Volume 4 Issue 2, 2017 Page 402