India: Defence FDI: The Truth Behind The Numbers

Last Updated: 13 April 2017
Article by Anuj Prasad and Kanishk

On March 24, 2017, while responding to a question in Parliament, the Minister of State for Defence informed us that the FDI equity inflow for April 2013-December 2016 in the defence sector was 1 million USD. As expected, this response elicited dismay from the national media, which covered this story alluding to policy failures of the current regime.

Ever since the current government took over at the Centre, it has consistently touted the Defence Sector as a special focus area. From Make in India to modernisation plans worth billions of dollars, the Defence sector has consistently occupied pride of place. The much publicised reform brought by Press Note 12 of 2015, which permitted foreign investment up to 49% under automatic route and up to 100% under government approval route in the Defence sector, was one such bold move by the government, which truly reflected what the industry had been asking for many years.

However, even after nearly 3 years of the current Government being in power and more than one year after liberalisation of FDI in Defence, the investment numbers remain dismal. In attributing a justification for this lack lustre performance, while a lot has been said about uniqueness of the Defence sector including technology restricting regimes and reluctance of foreign companies to transfer high end technology without having control of the joint venture company, the most crucial aspect has been overlooked by most: 'FDI in Defence' represents only such foreign investment which falls under para 5.2.6 (Defence Industry and small arms and ammunition) of the Consolidated FDI Policy.

By way of Press Note 3 of 2014, the current Government brought about the much needed clarity on what constitutes "Defence" under para 5.2.6 and in effect drastically reduced the items which were hitherto considered to be "Defence". Importantly, items, parts, components, castings, forgings and tests equipment (unless specifically listed) were excluded and the definition of "Defence". As such, "FDI in Defence" now only meant FDI in an entity that manufactures only complete equipment such as tanks, armoured vehicles, aircraft, warships and arms and ammunition, not a company that manufactures parts or components of such equipment. Therefore, though investment in manufacture of military aircraft in its entirety would be included under "Defence" but manufacture of all its parts separately will not.

Much like most other manufacturing industries, well before manufacture of complete products or integration of complexed systems, units manufacturing parts and components have to be established. The Indian market is also seeing this happen in a big way and a significant amount of foreign investment has already come in for manufacture of parts and components of defence equipment, especially of fighter jets, helicopters and allied products.. However, these FDI inflows are counted under the general "Manufacturing" head and not under the defence head, as after the introduction of Press Note 3 they do not attract the provisions of para 5.2.6 of the Consolidated FDI Policy and do not require an industrial license.

Investment in the manufacture of significant parts and components of purely defence equipment certainly contributes to defence industrial infrastructure and is probably the first concrete step in establishing self-sufficient defence manufacturing eco-system in India in the private sector.  In this backdrop, it would make sense to abstain from placing undue reliance on FDI statistics in the defence sector. The defence manufacturing sector is well on its way in India, even though FDI numbers suggest otherwise.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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