The Author, Himja Singh, is an Associate of Suman Khaitan & Co.
The Defence sector in India has been ascending on the ladder of success with a notable surge in Defence exports of about USD 2.63 Billion which is about 32.5% of growth in the financial year 2023-24. Foreign Direct Investment (“FDI”) inflows worth USD 50.77 Billion as propounded by the Ministry of Defence (“MoD”) on 09.02.2024 exhibits a substantial quantum of expansion each year. The Defence procurement regime was completely refurbished in the year 2020 with a significant relaxation in the FDI cap pouncing from the threshold of 49% to 74% through the automatic entry route under the FDI policy together with a 100% lobby via the Government route pertaining to scrutinization of access to modern technology or any pressing rationale as may be recorded. India’s aim to accomplish self-reliance and indigenisation is impetus to lowering the guard of regulations for Foreign Original Equipment Manufacturers’ (“FOEMs”) along with seamless integration of the ‘Make in India’ policy. Due to India’s chronic dependence on imports for technology principally in the Defence sector, the government has been incessantly concocting varying procedures, policies and mechanisms vis-à-vis Transfer of Technology (“ToT”), Offset Policy, Strategic partnership, Innovation of Defence Excellence (“iDEX”), Technology Development Fund (“TDF”) to attract FDI.
In order to streamline procurements, MoD issued a comprehensive document titled "Defence Procurement Procedure (DPP)" which has been since revised from time-to- time, the most recent one being Defence Acquisition Procedure (“DAP”) issued on 30.09.2020. DAP 2020 encapsulates a new procurement classification of Buy (Global-Manufacture in India) i.e. 50% of Indigenous manufacture of the entire/part of the equipment either through its subsidiary in India or a Joint Venture/Production Agency.
This post unravels and analyses the obstacles in defence manufacturing along with schemes and policies rendered in the defence sector with the aid of indigenisation. It further evaluates implications and the groundbreaking shift on account of relaxation in FDI threshold to 74%. At the end, it attempts to unsheathe the impulses, challenges and opportunities in the defence eco-system of India.
The conundrum of Defence Manufacturing
To elevate India’s Defence manufacturing landscape, several schemes and policies have been encompassed to facilitate ease in doing business, thereby endorsing iDEX specifically to encourage and fund start-ups, micro, small and medium enterprises (“MSMEs”), individual innovators, Research & Development (“R&D”) institutes. The Defence Research and Development organization (“DRDO”) has the budgetary assist for Rs 23,855 crores for FY 2024-25 with greater portion allotted to capital expenditure and TDF has been allocated Rs 60 crores explicitly for start-ups and MSMEs conducive to advancement of niche technology in coalition with DRDO. However, when setting this long-term integrated perspective plan, the government decided to deviate from the principle of equal opportunity by mapping the allocation disproportionately amongst defence public-sector undertakings (“DPSUs”) and private entities despite witnessing the frugal attempts of DPSUs equipment manufacturing for past many years in existence. The favorable allotment is unfavorable for the defence sector in toto as it craves inclusivity of private entities and collaborations to succeed. In order to counter the locus of collaboration, anew establishment of SRIJAN portal is one progressive approach undertaken to reinforce indigenisation of equipment through an interactive platform among all private vendors and DPSUs. Nonetheless, it is a matter of conjecture at present.
For the nonce, investment and growth qua defence manufacturing has been appreciable, however, the same shall not negate India’s dependency on imports. The Stockholm International Peace Research Institution (“SIPRI”) reckoned 49% of India’s military equipment originating from Russia. Complications ensuing the heightened geopolitical tensions amidst Russia and Ukraine war has relinquished Russia’s competence in fulfilling the delivery of five S400 missile systems to India in time. This USD 5.43 Billion deal between Russia and India was executed in the year 2018. As a result, the Indian Air force formally apprised with respect to the deferral of delivery.
In light of the aforementioned, failure in conformance with the posed international standards has been a huge point of concern detrimental to the maintenance of quality control. In tandem with this, the quality control and testing of equipment is contingent on funds allocated for R&D which as of now is not proportionate with the aim of complete indigenisation. For instance, the testing of specific technologies in the United States of America or Russia i.e. fly-by-wire technology of Tejas tested in the US or the Kaveri engine consigned to Russia.
FDI: A bird’s eye view
The crux of any investment ispo facto is to perpetually draw profits as the investor, ergo the revision of 74% FDI cap from 49% in 2020 has mitigated the risk from investor’s shoulders and this increase in threshold has conceded a substantial boost of influx in FDI. In 2022, Tamil Nadu and Uttar Pradesh were entrenched as the latest defence industrial corridor to bolster the industry wherein the Uttar Pradesh defence corridor has already engaged worth Rs 25,397 crores and Tamil Nadu defence corridor worth Rs 11,821 crores of investment commitments. In furtherance to this, the Government of Uttar Pradesh set forth a new FDI policy eminently for FOEMs incorporating various incentives as well as valuable exemptions on land acquisition, stamp duty and capital investment. The first beneficiary subsequent to introduction of this FDI policy is a major Japanese manufacturer Fuji Silvertech investing more than USD 12.01 Million.
Conversely, the feasibility of 74% FDI cap for the entirety of defence sector is substandard at best, it is incumbent to engage flexibility in certain areas of expertise by amplifying the FDI cap to 100% under the automatic route which entails supplemental R&D and thereupon, disburse complete control to the Foreign companies whilst maintaining moderate security. DAP 2020 is an amalgamation of mechanisms for public procurement as well as dictums for interested foreign investors, the silver lining here is participating nations’ apprehension to the wall of red tape which the government perceives as essential safeguards for national security leading to the augmentation of avoidable hinderances and needless barriers. With FOEMs resistance to transfer technology peculiarly with state-of-the-art technology, it is imperative to dispense 100% control in certain expositions to acquire ultra-modern technologies pursuant to the goal concerning modernization of armed forces.
The gateway to 100% FDI unlocked
The Swedish aerospace and defence company SAAB has pioneered the road to attain 100% FDI in defence sector estimated at Rs 500 Crore. It is a striking step towards India’s beacon of hope to evolve as self-reliant. The relaxation of FDI in this case manifests a pivotal stance for India to escalate a slew of Foreign investments and strategic alignments as well as to reinforce conviction with respect to the scheme of technology transfer. The wholly owned subsidiary of SAAB i.e. Saab FFVO India Private limited will operate as the first complete foreign owned defence production facility in the Reliance MET City at Jhajjar, Haryana and soon establish the manufacturing plant. The facility is positioned to manufacture Carl-Gustaf M4 Weapon System in India subject to its conformance with Indian suppliers to foster indigenisation and fulfill the requisites of ‘Make in India’ policy. This is an unambiguous leap for future enhancement of quality to propel equipment manufacturing in the defence sector. In tandem with this, the M4 is sketched out to subsequently be exported to Sweden in accordance to India’s Defence Production and Export Promotion Policy, 2020 maneuvered by end user license agreements.
Impulses, Challenges & Opportunities
The G20 summit hosted in India and the recent liberalization of 100% conditional FDI cap in the space sector has showcased Government’s intent to acquire a cutting edge in the defence sector in the dynamic geopolitical scenario. India’s success in the space sphere exposes its contrasting pace of development with the defence sector. Firstly, the point of issue being severe lack of R&D in the aircraft, submarine and missile manufacturing which should be the norm to inculcate new amendments and schemes, however, the same has been consistently neglected by the government. Secondly, the utter necessity of a separate specialised committee for the procurement procedure which needs to be embodied in order to subdue the agonizing delays in acquisition. Thirdly, despite a few initiatives specifically devised for start-ups, still, it is crucial to effectuate differing procurement frameworks for DPSUs, private entities and start-ups. Moreover, it is vital to construct a level playing field among DPSUs and private entities in terms of budget allocation and preferential treatment. Lastly, the analysis concludes with two concise solutions for the rocky road ahead to indigenisation:
(i) the segregation of priorities in accordance to the necessities and requirements, along with; (ii) minimizing the dependency on external partners by holding off on long term commitments by effectuating incentives for short-term partnerships and alliances.
