‘Make in India’ Initiative Could Get a Jolt After Government Relaxes Defense FDI Requirements

by Dan Darling, International Military Markets Analyst, Forecast International.

The Union government of Prime Minister Narendra Modi has opted to ease foreign direct investment (FDI) requirements in India’s defense industry in a step viewed as necessary for improving the country’s defense sector, as well as groundbreaking in terms of opening the Indian economy up to the world.

India has long been protective of its defense industry, viewing it as a strategic anchor in the country’s economic development. While that view is hardly unique among industrial nations, India’s still-developing defense industry requires great capital input and foreign technological know-how in order to advance beyond its basic capabilities.

The country currently imports around 70 percent of its weaponry despite being home to a sizable defense sector that employs around 1.4 million people. The reliance upon foreign-sourced hardware to supply the 1.3-million-strong active-duty Indian armed forces not only proves costly for India in terms of the weakness of the local currency, the rupee, on the international exchange market, but leaves the military vulnerable to the whims of the providing nation should any political fallout with New Delhi occur. Despite such recognition of this risk factor, the Indian armed forces nonetheless continue to seek foreign-sourced hardware when possible, as their trust in local industry – particularly state-owned Hindustan Aeronautics Ltd (HAL) – remains quite limited.

Yet the Indian military has had to contend with a succession of governments preaching the defense self-reliance mantra ever since the mid-1990s, when the collapse of the Soviet Union propelled policy makers to focus on indigenization of the domestic defense sector. The goal put forth was to provide the Indian armed forces with 70-75 percent of their hardware from local industry. Yet fast forward from 1995 to 2016 and the exact same breakdown between foreign and domestic equipment content exists.

India’s powerful state-run Defence Research and Development Organization (DRDO) – charged with designing, developing and managing all indigenous defense programs – has a long track record of failing to meet weapons requirements (the latest Indian Army INSAS Excalibur rifle debacle being one such example), while its projects suffer from cost overruns and delays. Most Indian defense producers merely perform local assembly of foreign-derived platforms, for instance the Sukhoi Su-30 fighters that are shipped to HAL from Russia in kits.

The heavy-handed state approach since 1995 has done little to advance Indian weapons-making capability.  Despite 50 government labs, eight state-owned defense corporations (referred to as Defence Public Sector Undertakings, or DPSUs), and 41 ordnance factories, there have been few scientific breakthroughs save for a smattering of achievements such as variants of the Prithvi and Agni surface-to-surface missiles.

Efforts by the Modi government to bring the private sector into localized defense projects are part of a crucial step forward, but even here there appears to be an effort to pick winners within industry rather than pit local producers on an even playing field with state-run enterprises. Further, many local private firms – traditionally lacking the sheer scale of investment provided by the state sector – are still in the early stages of building the infrastructure necessary to tackle ambitious projects.

Foreign investment and partnership represent a crucial plank in the effort to improve the viability of India’s defense industry.  Here the Modi government took a first step shortly after assuming power in May 2014 by raising the FDI threshold from a mere 26 percent of total value (a ceiling enforced from 2001 through 2014) up to 49 percent. Anything above and beyond this still-minority stake, however, would only be allowable on a case-by-case basis, when such a result would come with access to “state-of-the-art” technology. The latter hurdle scared away most foreign investors, who deemed the language too ambiguous to merit the risk of investment.

The actions taken on June 20 offer the opportunity for a much more profound effect on the defense industry: allowing up to 100 percent FDI without the anchor requirement of state-of-the-art technology in the country.

While the new FDI regime must be accompanied by caution until it begins bearing fruit, it nonetheless represents a monumental step toward liberalizing the economy and opening up the defense sector for business. Foreign investors may now rethink their previous unwillingness to invest in a market long regarded as too protectionist and overseen by a vast bureaucracy that has at various times proven corrupt, inefficient, too eager to blacklist foreign vendors, and possessing a byzantine procurement process frustrating to sellers.

With India’s host of major defense projects valued at well over $100 billion stretching into the next decade, and majority ownership stakes in joint venture tie-ups with local industry now allowable, a foreign original equipment manufacturer (OEM) line at the Indian door may suddenly form where previously none existed.

Please feel free to use this content with Forecast International and analyst attributions, along with a link to the article. Contact Ray Peterson at +1 (203) 426-0800 or via email at ray.peterson@forecast1.com for additional analysis.

The Forecast International International Military Markets series examines the military capabilities, equipment requirements, and force structures inventories of 140 countries, with corresponding coverage of the political and economic trends shaping the defense market outlook for individual countries and regions.

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