By Aman Thakker —
Status: Not Started — Foreign direct investment (FDI) Policy last amended in June 2016 to allow 49 percent FDI; 100 percent FDI allowed based on government approval for cases where FDI “is likely to result in access to modern technology.” But this line is too ambiguous and not attracting FDI.
Medium Difficulty: Regulation, With Opposition — Requires a regulatory decision by the Department of Industrial Policy and Promotion (DIPP). Some opposition from government entities such as the Defence Research and Development Organisation (DRDO), national security policy leaders, as well as government-owned defense production companies who will see this as diminishing their role in defense production.
This is the sixth installment in a new series of articles on the India Reforms Scorecard: 2019-2024 by the staff and experts at the Wadhwani Chair in U.S.-India Policy Studies. The series seeks to provide analysis on why reforms marked as “Incomplete” or “In Progress” have not been completed, and the impact such reforms can have on specific sectors or the economy at large.
On July 18, 2019, the Minister of State for Defense Dr. Subhash Bhamre released the latest FDI data in the defense production sector during the Parliament’s question hour. The data showed that India had received a paltry $5.13 million from 41 FDI proposals from 2000 to 2018, underscoring the need for India to reform its FDI regime in the defense sector.
Although the Narendra Modi-led government has taken some steps already to raise the FDI cap in defense, FDI above 49 percent is still not permitted through the automatic route and is subject to government approvals based on an ambiguous phrase about access to technology.
History of FDI Regime Liberalization in the Defense Sector
The Industrial Policy Resolution, 1948, established the state’s monopoly in the defense sector which lasted until 2001. That year, the government permitted private companies to enter the defense production sector with a maximum of 26 percent FDI, subject to approval from the government. This change, however, did little to attract FDI in the sector. Indeed, data from DIPP showed that between 2001 and 2008, India attracted only $50,000 in FDI.
Calls came from within the government to raise the cap on FDI in the defense sector. The Lok Sabha Standing Committee on Defense noted that, “While giving due weightage to the numerous benefits that would accrue to the industry and economy as a result of increased in-flow of FDI, the committee are of the firm view that the possibility of increasing limit of FDI up to 49 percent in defense sector should be examined by the government.” The United Progressive Alliance also recommended in its Economic Survey for 2008-2009 that the government should “Raise FDI limit in defense industries to 49 percent (from 26 percent),” and even went as far as recommending allowing “up to 100 percent FDI on a case by case basis.”
Still, it was not until August 24, 2014, after the Narendra Modi-led National Democratic Alliance came to power, that the FDI cap was increased from 26 percent to 49 percent. However, it also included a clause that FDI above 49 percent would be sent to the Cabinet Committee on Security for approval, contingent upon whether “it is likely to result in access to modern and ‘state-of-art’ technology in the country.”
FDI in the Defense Sector Today and Why Reform is Needed
The FDI regime was most recently amended on June 7, 2016 to allow 49 percent FDI through the automatic route, or without government approval. FDI above 49 percent would still be subject to government oversight, and includes a clause regarding “access to modern technology or for other reasons to be recorded.” With such vague guidelines and no definition of what “modern technology” or “other reasons” may mean, FDI inflows have remained minuscule. FDI data from DIPP underscores how, despite the 2016 liberalization in defense FDI norms, India attracted only $10,000 in FDI between March 2016 and March 2018.
One of the biggest contributing factors for this lack of investment remains the unclear guidelines for FDI proposals above 49 percent. While the government did drop language stipulating “state-of-art technology” between 2014 and 2016, the changes have not clarified details for foreign firms, and ambiguity on what qualifies as modern technology remains, leading to confusion.
As a result, only one company has, so far, submitted a 100 percent FDI proposal. In 2016, the French firm DCNS had submitted a proposal to open an Indian subsidiary, bringing its submarine technology to India. However, the proposal was rejected reportedly over whether the technology transfer was sufficient for approval. This episode underscores why India needs to relax restrictions and clarify ambiguities to liberalize the FDI regime further.
India has clearly had significant trouble attracting FDI in the defense sector, receiving only $5.13 million over 18 years in investments. With aging and outdated weapons for its armed forces, as well as a publicly articulated goal to increase indigenization of defense production weaponry, the government of India needs to attract modern and state-of-the-art technology. If the government is serious about this goal, it must reform its FDI regime to allow more than 50 percent foreign investment in the sector.
Mr. Aman Y. Thakker is an Adjunct Fellow (Non-resident) with the Wadhwani Chair in U.S.-India Policy Studies at CSIS and the J.B. and Maurice C. Shapiro Scholar at St. Antony’s College at the University of Oxford. Follow him on twitter @AmanThakker.