Written Analysis and Communication II

FDI in Defense
Assignment II
Submitted To:Prof. Vidya Jindal
Submitted By:Amit Kumar Singh
Biren Son Timong
PGP I
Section A
On
14/11/2014

Indian Institute of Management, Udaipur

FDI in Defense-Hope or Pessimism?

Indian economy has been growing at a healthy rate for the past couple of years. Earlier we
adhered to socialist policies but embraced ourselves with Globalization, Privatization and
Liberalization in early 90s. It initiated the flow of foreign currency in the Indian economy. Later
on Indian government in late 90s allowed FDI in the Indian Economy.
So, what is so hyped, so called FDI?
FDI is foreign direct investment by the foreign companies in any other foreign economy. It is the
controlling ownership in a business enterprise in one country by an entity based in another
country. The investing company may make its overseas investment in a number of ways - either
by setting up a subsidiary or associate company in the foreign country, by acquiring shares of an
overseas company, or through a merger or joint venture.
The accepted threshold for a foreign direct investment relationship, as defined by the OECD
(Organization for Economic Cooperation and Development) is 10%. That is, the foreign investor
must own at least 10% or more of the voting stock or ordinary shares of the investee company.
However it should not be confused with indirect investments such as investing into an equity
listen in a nations stock exchange.
If its so easy and simple then how and in which sectors the foreign investors can invest?
Earlier the foreign players were allowed to invest cash only and that too in wholesale market,
however later on in mid-2000, policies were amended and they were allowed to invest by two
ways. First, by Automatic Route in which permitted the foreign players to infuse without any
prior permission from the Indian government, in all the activities or sectors which are already
permitted. Another is Government Route, in which they were required to seek permission,
from the Indian Government to invest.
Foreign investment were only allowed in insurance, real estate, fully owned subsidiaries, single
and multiple retail, licensing agreements. But in mid-2000, it was increased to twelve sectors.
This involved increment to 100 percent FDI in asset reconstruction (real estate), telecom and
courier services. In case of stock exchange, power exchanges, clearing corporations, commodity
bourses and PSU oil companies, FDI was allowed up to 49 percent. Similar profits were given to
reconstruction and tea production sector. But most important sectors were fully owned
government sectors railways and defense.
One can clearly understand that Indian Railway were in losses and required funds to be made
profitable again. However, not only to make profitable but also to make it a world class entity

and to promote rail tourism, it required funds. Altogether, it was a brave move and well
appreciated too.
But, how could the Indian government betted on the countrys security and defense? How did
they agree to handover our own safety in someone elses hand? How did they plan to do it? Was
that about making some extra money, cheap politics or genuine national defense concern? And
many more questions were gaining ground in the minds of citizens.
Government has raised the FDI cap to 49 percent and mainly focused on four different reasons to
defend its decision.
By granting FDI in defense, India government would make sure that the foreign entities and
companies would deliver what they have promised. Further the government can envelope itself
from any kind treaty and embargo and would be able to curb any malpractices. The government
can easily bring in necessary and sufficient security clauses in the license involving the right to
entirely control the concerned facility, if required during any emergency or threat.
Even being the third largest economy and second fastest growing economy, we import most of
our critical weapon systems and ammunition. These multi-billion deals often bring in corruption,
but FDI can curb such practices. The government wanted to save foreign exchange, thereby
strengthening Indian currency and also would bring money if the defense goods are exported.
Government reasoned for the creation of couple of million jobs by the foreign investment
resulting in the growth of GDP by 2 percent. Not only jobs, it would also bring in a tough
competition for countries defense research agency- DRDO (Defense Research and Development
Organization), its agencies and HAL (Hindustan Aeronautics Limited) because even after
enormous expenditure the local bodies have failed to deliver up to the mark. By bringing FDI,
the government will be able to create a competitive environment which would push the
government organizations to develop and produce path breaking products.
However even after providing strong ground, still a lot of misconceptions are there. People think
that the foreign technology can be sourced through offsets. One, the foreign vendor can make
investment in Indian enterprises in kind in terms of ToT (Transfer of technology) through joint
ventures or through the non-equity route for co-production, co-development and production or
licensed production and/or maintenance of eligible products and provision of eligible services.
Two, ToT can be provided to government institutions and establishments engaged in the
manufacture and/or maintenance of eligible products and provision of eligible services, including
DRDO. Three, DRDO can acquire technologies and test facilities in areas of high technology.
Another misconception is that the investment decisions are taken by foreign companies and India
has no role to play. The investment in defense facilities and production means a long lasting and
protracted relationship. The foreign investors seek a stable environment with long-term, fair,
consistent and well-defined economic policies of the country. In addition, there are four factors
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which influence such decisions availability of abundant raw material, skilled work force, low
cost of production and lucrative market. Out of four we are abundant in three and have the
capability to acquire raw material.
This is a very long process and will be done surely but steadily. While the defense demands are
constantly increasing and the domestic supply stagnating, shelving more foreign exchange to
procure. The possible viable solution in front of the government is to increase FDI cap which
would share production risks and R&D with the global investing OEMs (Original Equipment
Manufacturer). The solution can ensure purchase of latest technology via direct government to
government interactions. It can strengthen the national security by safeguarding the technology
which is used to manufacture weapons within our boundaries.
Despite of various arguments the question still remains the same will it affect the internal
security of the company? In our country where internal security is a concern with terrorism,
naxalism, regional communist groups and other violent factors present, this could seriously pose
problem. With foreign companies having sole purpose of profit making, it would be very
difficult to have trust to maintain peace in the country. The government has not considered about
those companies or those foreign investors who would like to open fully owned subsidiary where
government does not have much to control. Even in countries like US, they have very stringent
policies regarding FDI in defense sector. Their before any investment forty five days are spent to
completely investigate about the company. The investing companies have to open their
subsidiary where the government holds major portion and is responsible for it control. There the
government strongly believes that technology and systems developed in the country poses less
potential treat of getting into enemies hands rather than completely having it imported.
Other serious concerns which pose threat are what if the foreign investors or companies pull out
before a critical situation-during an emergency or has to cut short their work or completely shut
down due to the change in their parent countrys legal and political system because most of the
European countries have stringent policies regarding supply and production of critical defense
system and ammunition during an emergency or war.
What will happen if theres another major recession? In that case how the companies will have
funds to operate is the biggest problem which could result in layoffs. For some companies the
foreign investment in defense relates to the intellectual property rights over technology, which is
a great concern as they might lose potential business and market share. Apart from these all the
FDI in defense should have national interest and must help the nation to become self-reliant.
As far as the advantages are concerned there are only few disadvantages. But in order to have a
strong defense these disadvantages cannot be looked down and must be dealt with proper
attention and sincerity. Government should be focused to make proper policies and have even
stringent compliance policies to control and monitor them. Government should not provide any
space of corruption as its a matter of national security. Government should also not lose any
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ground to any foreign investor on any matter at any stage. Better management of FDI through
proper channelization would definitely fetch best results.
In our opinion definitely its a hope for our defense sector provided the government plays it with
its all eyes and ears open.

References:1.
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4.
5.
6.
7.

http://www.investopedia.com
http://www.rbi.org.in/
http://www.indiatoday.com
http://moneycontrol.com
http://ibtimes.co.in
http://www.indiandefencereview.com/news/fdi-in-defence-dispelling-the-myths/2/
http:// http://articles.economictimes.indiatimes.com/2014-07-20/news/51780273_1_fditodaydefence-production-defence-market
8. http://firstbiz.firstpost.com/economy/what-india-loses-by-capping-fdi-in-defence43394.html
9. http://www.caclubindia.com/articles/fdi-and-its-possible-consequences-on-defence10. http://scroll.in/article/666232/