On the defensive for no good reason?

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Illustrations: Vikram Nongmaithem
Illustrations: Vikram Nongmaithem

INDIA GETS more foreign direct investment (FDI) in soaps than defence. You may think that weird, but it’s a fact. Given the rising security concerns — evidenced recently in the border stand-off with China — and great technological advancements made in weaponry, now perhaps is a good time to ask why that is so?

Is foreign investment in defence being avoided because of “national security” concerns? Or are we protecting our monster public sector undertakings (PSUs) from overseas competition?

Consider this. India boasts of a $100 billion potential market in defence, yet in the past 10 years, we have got only $ 4-odd million of foreign investment. Has blocking higher FDI — the current cap is 26 percent — in defence been counter productive? Or will increasing foreign investment put us at the mercy of foreign companies with vested interests?

Opinions are divided on this, but many experts feel now is the time to increase the FDI cap because our defence manufacturing leaves much to be desired. The armed forces resolutely refuse to use homemade inferior quality equipment and we import 70 percent of our defence needs.

But, before jumping the gun on making a case for more foreign investments, there are actual and real concerns that need to be addressed first.

In May 2001, the Ministry of Commerce & Industry opened up the sector, allowing private players to hold 100 percent stake and FDI of up to 26 percent. As events have turned out since, this hasn’t been enough to attract global players.

According to Air Marshal (Retd) Ajit Bhavnani, senior adviser, Tata Group, 26 percent is too little an incentive. “Foreign manufacturers are wary of investing in the Indian defence sector as they find the bidding process cumbersome,” he says. “A minimum 49 percent FDI has to be allowed to bring in reasonable investments and cutting edge technologies, which we urgently need in order to kickstart the process of indigenisation.”

In May 2010, the Union Commerce Ministry rolled out a Discussion Paper that clearly stated: “By merely increasing the limit from 26 percent to 49 percent we may be accused by posterity of doing too little too late. Therefore, in case we really want to have the state-of-the-art-technology, we have to permit anything above 50 percent, if not 100 percent.”

The contours of the argument haven’t changed for years. A cap on foreign investments is necessary to protect national interests. All governments want to ensure that their defence architecture is not open to abuse or sabotage. However, India does not have the weapons and defence capabilities like, say, the USA, and therefore, has to procure from contractors. We need foreign investment in domestic companies. Worries of sabotage and blackmail can be addressed by putting in appropriate riders in any agreement with such a company.

That said, all foreign investments come with inherent and unwritten rules that may sometimes go against a nation’s interest, says Bharat Karnad, senior fellow at the Centre for Policy Research. But Karnad says the solution doesn’t lie with the government either; instead, he feels the domestic private sector should be preferred to foreign firms. “Why don’t we let the private sector lead the effort?” he asks. “Let them decide if they need foreign investment. The government should be kept out of this completely.”

The other argument that an FDI cap would help promote organic industry development does not pass muster. In the 65 years since independence, we should have been able to absorb technology and understand it. “All these years we left things to the Defence Research & Development Organisation (DRDO) and look where we stand today,” says Air Marshal Bhavnani. “The Light Combat Aircraft (LCA) took 25 years to make. The Arjun Battle Tank was also delayed. The fact that we are still buying T-90 tanks from Russia tells us that depending on our own technology has not got us anywhere.”

When India bought the Sukhoi Su-30 from Russia, it was decided that eventually they would transfer technology and equipment and we would put them together here in our factories. The fact that producing an aircraft cost us Rs 420 crore, when an imported plane costs Rs 350 crore — a difference of Rs 70 crore — tells the story.

India’s experiments with indigenisation have, at best, been tardy. Homegrown companies can continue researching with grants and doles but that could take a while before we achieve anything. According to a paper published by the Institute for Defence Studies and Analyses (IDSA):

“…even if India increases its R&D efforts in a big way, the benefits, in terms of equipping the armed forces with proven technologies, will not accrue in the near future.”

India even lags the nations in its own neighbourhood. China, for instance, has reduced dependence on imports, created its own industry and has begun exporting indigenously developed military equipment. We haven’t yet produced enough for domestic consumption. “The Chinese are masters at reverse engineering,” says Bhavnani. “We are not able to do that either. We can’t understand how a plane is made by interpreting its technology.”

In 2012, Reliance Industries partnered with France-based Dassault Aviation to enter the defence and homeland security sectors in India and also applied for the licence to design, develop and manufacture equipment and components for military and civilian aircraft. Dassault has been keen to give Reliance priority in new projects in India if the FDI cap is raised.

The Rafale project, under which India will acquire 126 planes from Dassault, is stuck because of the manufacturer’s reluctance to bank on a PSU’s competence. Eighteen of these will be imported, while the remaining 108 are to be assembled indigenously by the Hindustan Aeronautics Limited (HAL). The Indian government is insistent that the French manufacturer guarantee the timely deliverance and quality of the plane by the Bengaluru-based PSU, something the company is not willing to do. “Dassault is asking how they can do that?” says a source privy to the deal. “You’re not permitting them to give it to a private sector firm and you know HAL isn’t a performer.”

Saj Ahmed of the London-based Strategic Aero Research (SAR) is surprised at the resistance to a higher FDI in defence. He calls this a “protectionist bluff”, as he feels State-run firms will benefit most from more investments. “Companies like HAL will get the most benefits, not just because they are backed by the State, but also because the financial risks are lesser and the government will support them through thick and thin,” explains Ahmed.

Dhiraj Mathur, senior adviser at PricewaterhouseCoopers (PwC) and a former IAS officer, says that a higher FDI will not only put pressure on the PSUs to perform better, “it also opens up a global market for them”.

HOWEVER, THIS is where Karnad has a unique idea, different from the arguments put out by Mathur and Ahmed. He believes the way to avoid a security risk is to do away with government involvement in defence deals. “Keep the defence PSUs out of the loop; they should not be part of the FDI,” he says. “Get ethical private sector companies to grow the defence business by giving them India’s defence research organisations, scientists and ordinance factories on lease.”

In Karnad’s model, the government doesn’t need to deal with middlemen but has the power to moderate, oversee and even gain royalty for letting out their units to the private sector. “As soon as there is government role of any kind, corruption and laxity is bound to creep in,” says Karnad. “In the US, most of the Boeing and Lockheed plants are owned by the government but are rented out to various companies. The government periodically participates in the upgradation, but the firms run it and pay the government.”

The idea may be utopian — after all, who’s to say what makes an “ethical company” — but, there’s no doubt that our defence manufacturing needs a shake-up.

Another concern to allowing more FDI in defence is that during war, foreign owners could restrict supplies at will. However, a foreign player investing in India will have its stake in the project and hence, will lose out if it restricts supplies. Even if it is driven to do so by financial and vested interests, the government has considerable muscle to wrench any such move if the company is based in India.

Gokul Chaudhri of BMR Advisors, a New Delhi-based financial advisory firm, explains it is always strategically better to manufacture equipment locally, even if foreign capital and technology is invested. “The threat of a ‘takeover’ is unreal as there is no non-government domestic industry that can be acquired,” he says.

Seconds Dhiraj Mathur of PwC: “Who do we have more control over? A defence firm with a considerable stake and operations in India or imports that can be clamped down at any time?”

Entry of the private sector in the early 2000s was meant to create a level-playing field and open up the sector to competition to improve research, development and innovation. Very little of that has happened.

Bhavnani says the fervour with which the Indian private sector launched into defence is nearly dead. “We started out in a big way with over a 100 people, today we have only 25 percent of that staff,” he says of one of the divisions in Tata Group’s operations.

If more FDI is allowed in this sector, we would not only need more experts but enough capability and capacity on the ground to learn, convert and implement new technology. Are we already “too little too late” then?

Mathur feels it’s never too late to start. “We have missed a lot of opportunities. Whatever needs to be done should be done now,” he feels.

Karnad though believes that the fears of security are not unfounded and that it would be naïve to believe “anyone would give the full technology to you”. Two, he says, bilateral relationships may play a role and possibly interfere over which country India can or cannot do business with.

More important, a higher FDI could also mean that India risks being sucked into a geopolitical situation it has so far avoided. Could we refuse supplies to a nation at war even if it is supplying defence technology to us? If American firms invest in Indian companies, could it hamper India’s relationship with countries like Iran? The fragile links between large defence suppliers like the US, Israel and other Middle Eastern nations should not imply that India will become a hub, supplier or even a participant in geopolitical flashpoints.

Fact is, India’s defence sector needs modernisation as nearly half its equipment is obsolete. Recent scams and corruption scandals have not made things easier. Decision-making has come to a halt, officers are averse to putting their signatures on any document and the image of doing business with the Indian government has scared the global investor.

The defence market is lumpy and the procedures opaque. Such challenges make it harder for companies to enter the sector. Opening up the defence sector to higher investments will not only require giving more power to the private sector, clear guidelines will also have to be set and regulations put in place before allowing more FDI so that fears are allayed. After all, we are not the first ones to do so.

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2 COMMENTS

  1. Shaili, Although you have made a valid point but than what is important is that Indian Govt has always treated defence sector casually with bofors and latest scams involving trucks, it is used as an means of making money through back channels and as far as local manufacturing is concerned big corporates always want easy money so selling packaged water or potatoes is more profitable and easy than working full time to develop weapons and that too for one monopoly buyer i.e Indian Govt

  2. Interesting reading. Even if it takes years and years for benefits to accrue, we simply have to take a long term view. Unless huge investments are made in collaborations and R&D, either foreign or local, the arms industry in this country is going nowhere. As it has been doing for the last 60 plus. An odd success here and there is all we have to show and is just not what we need.

    As India grows, its defense will need to keep pace too. Our defense PSUs have proved beyond any doubt that they are incapable of meeting the challenge, to them it is just grants that matter, not results. They detest challenges. Yet, they will become the biggest hurdle to privatising defense manufacture. No one, specially a PSU likes competition and will fight tooth and nail to maintain monopoly. We will keep hearing loud voices claiming PSUs, like HAL, have the ‘expertise’ ‘knowledge’ and ‘experience’ to lead the way and that the private sector should be under their overall control. Sure fire recipe for further stagnation and frustration. The Private sector will simply wash its hands off in desperation.

    Only solution is strong political will and management. Right now something not on the horizon either.

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