Laxman Kumar Behera, India Strategic, January 2009
In early October 2008, the Foreign Investment Promotion Board (FIPB) of the Ministry of Finance (MoF) rejected a proposal of the Mahindra Defence Systems (MDS) – a special division of Mahindra and Mahindra (M&M) – to form a Joint Venture (JV) company in India with the UK’s largest and world’s fourth largest defence company, BAE Systems. The JV proposal, based on equity ownership of 51 per cent for MDS and 49 per cent for its British partner, was to “develop, manufacture and provide through life services support for Land Systems defence equipment” and reportedly envisaged a capital in.ow of over Rs. 55 crore.
The decision of the MoF can be termed unfortunate for several reasons.
In early October 2008, the Foreign Investment Promotion Board (FIPB) of the Ministry of Finance (MoF) rejected a proposal of the Mahindra Defence Systems (MDS) – a special division of Mahindra and Mahindra (M&M) – to form a Joint Venture (JV) company in India with the UK’s largest and world’s fourth largest defence company, BAE Systems. The JV proposal, based on equity ownership of 51 per cent for MDS and 49 per cent for its British partner, was to “develop, manufacture and provide through life services support for Land Systems defence equipment” and reportedly envisaged a capital in.ow of over Rs. 55 crore.
The decision of the MoF can be termed unfortunate for several reasons.
The MoF did not specify the reasons for rejection. According to media reports, the MDS-BAE’s proposal was shut down on “technical grounds” that the proposed JV was not consistent with foreign direct investment (FDI) guidelines for defence industry.
Technically, the MoF’s argument is logical. As per the present guidelines stipulated in Press Note No. 4 (2001 Series) of the Ministry of Commerce and Industry ’s Department of Industrial Policy and Promotion, a foreign vendor can not hold more than 26 per cent equity ownership in any of India’s defence industrial infrastructure. The above logic however does not hold ground from the perspective of the Ministry of Defence (MoD) which had made it announced, on earlier occasions, to allow greater FDI in defence industry on “case-by-case” basis. The said proposal, which was doing rounds for several months, was clearly a special case for the MoD and therefore widely expected to get the .nal nod from the Finance Ministry.
Indications though also are that some of the leading industries in India were also opposed to foreign companies holding more than 26 per cent in defence ventures.
Nonetheless, by turning down such a proposal, the MoF’s difference in perceptions with the MoD are shown in poor light.
In late April 2008, MoD had proposed to relax FDI cap of 26 per cent to allow Russia’s Ilyushin Aviation Complex to own 49 per cent stake in a JV with India’ State controlled HAL for co-development of multi-role transport aircraft. If the public sector company is able to get favourable treatment, why the same can not be extended to a reputed private company?
If the MoD’ aim is to treat both the public and private sectors equally, it should have fought hard to see the proposal pass though, or at best deferred the proposal till a suitable redressal mechanism was found. Either way, the MoD’s efforts could have satisfied the private sector which is critical of the government’s protectionism attitude towards the defence public sector enterprises.
Perhaps, the greatest damage caused by this incident is the palpable loss of confidence of the foreign companies in India’s decision makers responsible for defence production. It is to be noted that if the MDS-BAE JV had passed thorough, it would have been the .rst one in India’s defence industry involving a domestic private player and an international partner with near 50-50 ownership rights. A successful passage of this JV would have paved the way for many such ventures in future. By turning down the JV the decision-makers have not only silenced the expectation of a particular case but created a situation where the foreign companies looking for greater Indian presence become more suspicious of the government’s seriousness of attracting higher investment.
While the MoF’s action has made MDS to “comply” with the present investment norms, the issue of allowing FDI into defence production needs to be examined with renewed vigour. It is to be noted that since the opening up of defence industry for foreign participation, very little by way of FDI has entered India’s defence industry.
For instance, among the 16 FDI proposals – amounting to Rs. 794.37 crore – cleared recently by the Finance Ministry, only one was for defence production sector, and that too without any fresh in.ows. Besides, according to open sources, in the last 7-8 years, only three FDI proposals involving domestic private companies have been cleared by the MoF. The FDI in.ow of those proposals is less than even Rs 7 crore, and that is a fraction of the total FDI in.ows to India in the same period.
The reason behind little FDI into defence production is not difficult to fathom. The policy, under present form, can at best be described as dissuasive. It does not provide foreign investors incentives with respect to capacity expansion, purchase guarantee and exports while subjecting them to purchase and price discriminations vis-à-vis the public sector enterprises. Given these constraints, the major investors are reluctant to invest in Indian companies where they would have little control. That is why not a single FDI of any signi.cance is seen in defence industry while billions of rupees are being infused in civilian sectors with liberal FDI guidelines.
At present, the greatest obstacle for liberal FDI policy for defence production sector is the conservative approach, not the security reasons which are argued by some that allowing greater stakes to foreign companies in strategic industries would compromise India’s security. If this is so then how arms imports from other countries guarantee India’s security which could not be guaranteed by procuring the same arms from within the domestic boundaries, produced by foreign companies in partnership with Indian companies.
Obviously, the rationale behind such approach lies elsewhere.
The policy makers need to factor in the very logic that led to opening up of defence production to private sector with an added instrument of FDI.
If the logic was in recognition of the private sectors’ potential to contribute meaningfully to the materiel cause of Armed Forces, the government must ensure that the ability is not handicapped. Bear in mind that the private sector, unlike the public sector, does not have the luxury of state protection.
Only the returns from investments can guarantee its survival.
Because the defence industry is high capital intensive and primarily sole consumer-driven, the private sector is at a greater risk. The risk is compounded in the face of private sector’s lack of experience in technological knowhow that goes into defence production.
Arguably, the contribution from international defence majors in the form of both capital and technology has the potential to enhance the ability of private sector which in turn would contribute to India’s defence industrial capability. The present policy of FDI for defence sector does not allow this to happen.
It may be noted that high technology companies like Lockheed Martin, Boeing, EADS and Sikorsky etc. have also indicated major proposals for investments in India.
The MDS case now provides an opportune time to rethink of allowing greater FDI in defence industry.
Technically, the MoF’s argument is logical. As per the present guidelines stipulated in Press Note No. 4 (2001 Series) of the Ministry of Commerce and Industry ’s Department of Industrial Policy and Promotion, a foreign vendor can not hold more than 26 per cent equity ownership in any of India’s defence industrial infrastructure. The above logic however does not hold ground from the perspective of the Ministry of Defence (MoD) which had made it announced, on earlier occasions, to allow greater FDI in defence industry on “case-by-case” basis. The said proposal, which was doing rounds for several months, was clearly a special case for the MoD and therefore widely expected to get the .nal nod from the Finance Ministry.
Indications though also are that some of the leading industries in India were also opposed to foreign companies holding more than 26 per cent in defence ventures.
Nonetheless, by turning down such a proposal, the MoF’s difference in perceptions with the MoD are shown in poor light.
In late April 2008, MoD had proposed to relax FDI cap of 26 per cent to allow Russia’s Ilyushin Aviation Complex to own 49 per cent stake in a JV with India’ State controlled HAL for co-development of multi-role transport aircraft. If the public sector company is able to get favourable treatment, why the same can not be extended to a reputed private company?
If the MoD’ aim is to treat both the public and private sectors equally, it should have fought hard to see the proposal pass though, or at best deferred the proposal till a suitable redressal mechanism was found. Either way, the MoD’s efforts could have satisfied the private sector which is critical of the government’s protectionism attitude towards the defence public sector enterprises.
Perhaps, the greatest damage caused by this incident is the palpable loss of confidence of the foreign companies in India’s decision makers responsible for defence production. It is to be noted that if the MDS-BAE JV had passed thorough, it would have been the .rst one in India’s defence industry involving a domestic private player and an international partner with near 50-50 ownership rights. A successful passage of this JV would have paved the way for many such ventures in future. By turning down the JV the decision-makers have not only silenced the expectation of a particular case but created a situation where the foreign companies looking for greater Indian presence become more suspicious of the government’s seriousness of attracting higher investment.
While the MoF’s action has made MDS to “comply” with the present investment norms, the issue of allowing FDI into defence production needs to be examined with renewed vigour. It is to be noted that since the opening up of defence industry for foreign participation, very little by way of FDI has entered India’s defence industry.
For instance, among the 16 FDI proposals – amounting to Rs. 794.37 crore – cleared recently by the Finance Ministry, only one was for defence production sector, and that too without any fresh in.ows. Besides, according to open sources, in the last 7-8 years, only three FDI proposals involving domestic private companies have been cleared by the MoF. The FDI in.ow of those proposals is less than even Rs 7 crore, and that is a fraction of the total FDI in.ows to India in the same period.
The reason behind little FDI into defence production is not difficult to fathom. The policy, under present form, can at best be described as dissuasive. It does not provide foreign investors incentives with respect to capacity expansion, purchase guarantee and exports while subjecting them to purchase and price discriminations vis-à-vis the public sector enterprises. Given these constraints, the major investors are reluctant to invest in Indian companies where they would have little control. That is why not a single FDI of any signi.cance is seen in defence industry while billions of rupees are being infused in civilian sectors with liberal FDI guidelines.
At present, the greatest obstacle for liberal FDI policy for defence production sector is the conservative approach, not the security reasons which are argued by some that allowing greater stakes to foreign companies in strategic industries would compromise India’s security. If this is so then how arms imports from other countries guarantee India’s security which could not be guaranteed by procuring the same arms from within the domestic boundaries, produced by foreign companies in partnership with Indian companies.
Obviously, the rationale behind such approach lies elsewhere.
The policy makers need to factor in the very logic that led to opening up of defence production to private sector with an added instrument of FDI.
If the logic was in recognition of the private sectors’ potential to contribute meaningfully to the materiel cause of Armed Forces, the government must ensure that the ability is not handicapped. Bear in mind that the private sector, unlike the public sector, does not have the luxury of state protection.
Only the returns from investments can guarantee its survival.
Because the defence industry is high capital intensive and primarily sole consumer-driven, the private sector is at a greater risk. The risk is compounded in the face of private sector’s lack of experience in technological knowhow that goes into defence production.
Arguably, the contribution from international defence majors in the form of both capital and technology has the potential to enhance the ability of private sector which in turn would contribute to India’s defence industrial capability. The present policy of FDI for defence sector does not allow this to happen.
It may be noted that high technology companies like Lockheed Martin, Boeing, EADS and Sikorsky etc. have also indicated major proposals for investments in India.
The MDS case now provides an opportune time to rethink of allowing greater FDI in defence industry.
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