There is so much brouhaha on the proposal of the Department of Industrial Policy and Promotion (DIPP) to increase the cap in Foreign Direct Investment (FDI) in defence sector from the present 26 per cent to 74 per cent. First to shoot down the proposal was the Minister of Defence, A.K.Anthony stating that the “Indian defence sector is not ready to absorb more FDI.” Industry bodies have rallied behind him and the Federation of Indian Chambers of Commerce and Industry (FICCI) has called for a “cautious approach in this strategic sector”. Why not? When there has been a protectionist drift in FDI policy, post 9/11, by several countries.

USA, Russia, China tighten laws

In 2007, after much debate, the US Congress passed the Foreign Investment and National Security Act (FINSA), which amended the Exon-Florio amendment to the Defence Production Act, 1950, empowering the President to suspend or prohibit foreign acquisitions of US companies that may harm national security. The 2007 law also requires heightened scrutiny of acquisitions by government-owned companies, mandates the involvement of high-level officials in CFIUS (Committee on Foreign Investment in the United States), and requires additional reporting to the Congress.

In 2005, the then Russian President, Vladimir Putin called for a new law to protect “strategic industries”. Over a two-year period, Russia introduced two new foreign-investment related laws one of which is “strategic industries law” through which government officials will review foreign investments in 43 strategic industries such as military equipment, aerospace, nuclear power etc. The law creates a mandatory filing process for foreign acquisitions of Russian companies in these sectors, bans state-owned entities from acquiring controlling stakes in companies that have “strategic significance for the Russian Federation’s national security”.

China which has always been stringently regulating and screening foreign investments, recently added a “national security test” to its FDI flows. Japan, too, has revised its FDI regulations, requiring prior notification of foreign investments in Japanese companies that manufacture certain dual-use items, defence products and technology.

The case being such the world-over (see Table 1), the statements of the Minister of Defence and also those of the varied industry associations seem justified. Cautioning, the Secretary General of FICCI, Dr. Amit Mitra states, “We have to be very careful and thoughtful while moving forward. There has to be a very high level of scrutiny in FDI in defence, unlike FMCG or other sectors where we are open for 100 per cent FDI.”

OEM’s fine with 26 per cent

FICCI study has indicated that many OEMs (Original Equipment Manufacturers) had entered into Joint Ventures or expressed to tie-up with Indian companies at 26 per cent cap itself. The list of JVs or proposed JVs include – BAE Systems – Mahindra & Mahindra (addressing multiple platforms in Land Systems); Sikorsky-Tata (to manufactur S-92 cabin); EADS-L&T Manufacturing Co. (proposal for EW systems); Speck-IAI (for UAVs); Lockheed Martin-Tata (for aerostructures); Elettronica Defence Systems- Alpha Design Technologies (for Solid state trans-receiver); Sofema Engineering & Systems – Alpha Design Technologies (for engineering, warehousing and supply of spares and assemblies for Cheetah and Chetak helicopters to HAL).

Stringent conditions for 49 per cent

However, FICCI is categorical that 49 per cent FDI cap can only be considered on the basis of set of conditions such as – linking higher FDI with the full platforms being produced and has to be a minimum capitalization of US $100 million; proprietary technology content to form the basis of further indigenous technological development; to source between 50 per cent and 70 per cent of components/subsystems by value by nurturing Indian vendors; export obligation of 10 times the equity within 10 years of entering the contract; management of the company to be Indian; these companies will quality for participation in the “Buy and Make Indian” category projects; and post the transfer no retrospective law should be applicable to restrict the technology exploitation, getting clearance from the home governments of the OEM.

Level-playing field

Arguing that increased FDI may not result in technology flows as evidenced by the telecom equipment business in India, Dr. Mitra asks “where are India’s ZTE, Huawei or HTC? Making a case for “empowering” the Indian private sector, Dr. Mitra emphasizes “We must create a level-playing field first, only then will the joint ventures be meaningful. About 13 companies had been selected for the proposed ‘Raksha Udyog Ratna' status, but to this day the RUR is yet to be notified. So the level-playing-field must be created first.” The 13 companies shortlisted by the MoD for the RUR status included Tata Motors; Larsen and Toubro; Tata Power Company; Mahindra & Mahindra; Ashok Leyland; Tata Advance Materials; Kirloskar; HCL; Godrej & Boyce; Bharat Forge; Infosys Technologies; Wipro Technologies and Tata Consultancy Services. There have been murmurs that the list has been scrapped.

Dr. Mitra underlines the urgency for implementation of the “Make” scheme in its entirety with RUR, operating flexibility to Defense Public Sector Undertakings and Defense Research Development Organisation and Technology Development Fund Scheme for SME (small and medium enterprises). The joint ventures with higher than 26 per cent FDI should not be eligible to participate in a “Make” consortium receiving 80 per cent development fund from MoD as per the “Make” procedure. This will be a consistent and logical step towards indigenization.

Lockheed Martin is “fine” with 26 per cent

Lockheed Martin, a global aerospace and defense major, which is foraying into the Indian defence sector through a joint venture with Tatas, is “fine” with the present cap as of now. Roger Rose, CEO, Lockheed Martin India, told SP’s Aviation “We will live by FDI. India is a good bet and we will go by the rules, we will play by the rules.”

Dismissing the school of thought which has been equating low foreign equity to low end technologies, Roger Rose says “low end technology is not inherent at 26 per cent”. However, down the road is what major players such as Lockheed fear. “When Lockheed looks at the MMRCA (medium, multi-role combat aircraft) bid, we know there is a 5 billion dollar offset requirement and what we need to do is find one Indian company. We need to have a partner that would have 74 per cent of the equity. So if we have 5 billion USD, we will need a company which has 15 billion USD. I think the disconnect is going to be here.”

Quoting an Indian government official who had said “it has taken 50 years for us to get to 26 per cent FDI, give us little more time”, Rose adds “it is an evolutionary process”. “We take a look at the business case and in India’s case there is a huge rush for defence. Lockheed will be very steady here, grinding through the process and not by demanding changes in the policies.”

EADS echoes similar views

EADS, a large pan-European aerospace and defence corporation, has similar views. A top executive in India, on condition of anonymity, said “I think 49 per cent FDI in defence with stringent conditions is a good proposition. We do understand the national concerns.” Dismissing any co-relation between higher equity and high-end technologies being introduced, “it depends on what the needs (defence) here are”.

JV Alpha for 49 per cent

Col. (Retd.) H.S.Shankar, the Chairman and Managing Director of Alpha Design Technologies (joint venture with Elettronica Defence Systems), endorses that the maximum cap on FDI in defence should not be more than 49 per cent. “The OEM who has a limited stake has a better opportunity of keeping production costs lower and to boost exports (buy back).” And as a joint venture partner, Alpha does not have any constraints with regard to funds.

Considering the rush for defence sector, particularly in India and China the two countries where spending on new defense platforms and systems is growing at a considerable pace, irrespective of the FDI limits, the operative words indeed are “cautious approach”.

Laws and Regulations Addressing Foreign Investment Restrictions

Country	Laws and regulations	Reasons for review or restrictions
Canada	Investment Canada Act, 1985	To ensure net benefit to Canada
China	2006 Regulations for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, Catalog for the Guidance of Foreign Investment Industries	National economic security, protection of critical industries, purchase of famous trademarks or traditional Chinese brands
France	Law 2004-1343, Decree 2005-1739	Public order, public safety, national defense
Germany	2004 Amendment to 1961 Foreign Trade and Payments Act	Ensure essential security interests, prevent disturbance of peaceful international coexistence or foreign relations
India	Foreign Exchange Management Act, 1999	National security and domestic, cultural, and economic concerns
Russia	1999 Federal Law on Foreign Investments	Protection of foundations of the constitutional order, national defense and state security, anti-monopoly
United States	Exon-Florio Amendment to the Defense Production Act of 1950, as amended	National security

Source: United States Government Accountability Office