fdi in indian defence sector

FDI IN INDIAN DEFENCE SECTOR: DECODING THE 3PS

Prof. R. K.SRIVASTAVA

HNB Garhwal University

Department of Economics, India

E-mail: [email protected]

Abstract

The aim of the paper is to find out progress, problems and prospects of FDI in Indian defence

sector. India is the World’s biggest defence importer; has the second largest military force and

is the ninth highest defence spender. Its half of defence hardware is near to obsolete. Its two

nuclear armed neighbours, China and Pakistan, have a long history of enmity with it. These

challenges can be faced by India through strong defence manufacturing complex coupled with

economy might. If it can attract FDI in defence sector in a large proportion, it can face

challenges successfully. The main finding of the study is that although a lot of changes have

been made for FDI policy and procedures by govt. of India, a lot of efforts are still needed to

plug the loopholes in smooth flow of FDI in defence sector. For this, some options have been

identified. Indian experiences can be very useful to others especially erstwhile socialist

countries which emulated their economies into market-oriented.

Keywords: Foreign Direct Investment(FDI), globalisation, development, Original Equipment

Manufacturers ( OEMs), Department of Industrial Policy and Promotion (DIPP), Defence

Public Sector Undertakings (DPSUs) , Defence Procurement Procedure (DPP), Financial

Year(FY).

JEL classification: F210

1. INTRODUCTION

Economists suggest two strategies for development viz., inward looking and

outward looking. The former is based on failed socialist model. It divorced from

reality. The latter is more realistic, though it has own flaws. For example, economic

recession in 2008 had engulfed most of the part of world through globalisation. One of

the most important ingrain of the strategy is development through external linkages.

Foreign Direct Investment (FDI) is one of them. It is considered one of the most

JOURNAL OF ACADEMIC RESEARCH IN ECONOMICS

VOLUME 7 NUMBER 3 DECEMBER 2015 393

important vehicles of development if local resources/efforts are handicap to enhance

the efficiency/productivity of the economy. For long, Indian Private Sector and FDI

were prohibited in defence sector. It was only in 2001 when it was opened to Indian

Private Sector participation with FDI permissible upto 26 per cent. In 2014 it was

increased to 49 per cent and in special case it can go upto 100 per cent. It is assumed

that raising FDI cap would attract latest high-end technologies into India and assumes

that defence Original Equipment Manufacturers(OEMs) who control technologies and

will supply /bring it to their own operations in India, if equity cap is

raised(FICCI,2010).

The Indian Defence Sector has been confronting many folds problem. First, it

had emerged the largest importer of major arms in 2010-14,accounting for 15 per cent

of global total. Between 2005-2009 and 2010-14 imports increased by 140 per cent. In

2010-14 India’s imports were three times larger than those of either of its regional

rivals China and Pakistan (Wezeman &Wezeman, 2015). Clearly, it reflects that

indigenous efforts have been lagging in this direction. Second, out of total defence

equipment held by the Indian armed forces, only 15 per cent is considered ‘state of the

art’ and nearly 50 per cent has become obsolete (DIPP, 2010). This is a major

deterrent to the operational capability of the armed forces. Third, due to deteriorating

security environment, China-Pakistan nexus and proxy war against India are well

known facts of increasing its defence expenditure. India has allocated defence

expenditure by hiking 7.7 per cent in the financial year (FY) 2015-16 over the

allocation for 2014-15. It is allocated to US$40.4 billion in 2015-16 from US$38.35

billion in 2014-15. Its military budget is still less than a third of China’s US$145

billion expenditure as estimated by the Pentagon. Both China and India have allocated

around 2 per cent of their GDP towards defence allocation, and given the difference in

their respective GDP, the China-India gap is over US$100 billion in Beijing’s favor.

Total defence spending and that the actual amount allocated to the People’s Liberation

Army may be closer to US$250 billion (Tribune News Service, 2015, March 16).

Currently, a large part of Indian defence budget consists of revenue

expenditure (60 per cent) and remaining 40 per cent is concerned with capital

expenditure (Capex). Most of the weapons imported are dependent on Russian

equipment and technologies. It is estimated that India’s cumulative defence

expenditure over FY14-FY22 will close to US$620 billion. Capex will form half of

this. New armament spend will be US$251billion with imported equipment spend at

US$146 billion(FICCI &Centrum, 2015). The other important projections in Table 1

are made on the basis of assumptions made in Table 2.The above stated problems of

Indian defence sector have opened huge investment opportunities in defence

manufacturing in India. Reasons are (DIPP, 2015):

India’s current requirements of defence hardware are catered largely by

imports. The opening of defence sector for private participation will help


394 VOLUME 7 NUMBER 3 DECEMBER 2015

foreign OEMs to enter into strategic partnerships with Indian companies for

cultivating domestic and global markets.

It is estimated that opportunities of defence offset obligations to the tune of

approximately Rs250 billion during the next 7-8 years. The offset policy

(which stipulates the mandatory offset requirement of a minimum 30 per cent

for procurement of defence equipment in excess of Rs3 billion) introduced in

the capital purchase agreements with foreign defence players would ensure that

an eco-system of suppliers is built domestically.

The government policy of promoting self-reliance, indigenization, and

technology-up gradation will develop capabilities for exports in the defence

sector.

The country’s extensive modernization plans of defence forces and an

increased focus on homeland security will increase India’s growing

attractiveness as a defence sourcing hub.

High government allocation for defence expenditure will ensure defence

manufactures to develop smart weapons in India.

The experiences of other countries can be helpful to India to replicate the

success of FDI in defence sector. For example, Brazil has the Embraer (earlier a 100

per cent Govt. company and then with partnering with Alenia/Aeromachhi has now

become the 4th largest aircraft manufacturer) and Helibras with Euro-copter success

story. South Korea has the KAI-EC a 50:50 Joint Venture with Euro-copter and they

are now developing the world’s most sophisticated sub 10 tonne helicopter. South

Africa has also succeeded in the MEKO frigate program, Infantry vehicles and the

Roofolk helicopter apart from being the world leaders in fuzing technology and GIS

(Diamond aircraft). In the United States the third largest supplier of defence equipment

to its armed forces is a wholly owned subsidiary of a British company. None of these

countries have collapsed or their security compromised because of higher FDI in the

sector. In fact all of them have benefitted and prospered (Samaddar,2014).Though no

tangible progress has been made in FDI flow into defence manufacturing in India, a lot

of ground work in the policy and procedures levels has been made. More importantly,

a lot of perception has changed in the minds of global OEMs about India and its

leadership. India is being considered an alternative destination of China because it’s

inherent position in Asia from geo-political and business angles. These things can alter

the position of India to attract FDI in defence manufacturing in a big way. Major

Indian houses from Reliance to Bharat Forge have established their shops with World

defence majors and some negotiations are in pipeline. FDI is considered one of most

important component of whole story. It is already considered one of the ‘game

changers’ for boosting India’s home-grown capability in the production of state-of-the

art combat systems. Therefore, the main objective of the paper is to decode the 3Ps

(progress, problems and prospects) concerning to FDI into the Indian defence sector.



Table 1: Projections of India’s defence sector

Table 2: Assumptions made in Projections



2. HISTORICAL BACKGROUND

The production of defence equipment was, until relatively recently, entirely a

government function. The Industrial Policy Resolution, 1948, restricted the entry of the

private sector into this industry. The defence industry in India was declared open to the

private sector in May 2001 (Press Note 4 of 2001 Series) when the government

permitted 100 percent equity with a maximum of 26 per cent FDI component, both

subject to licensing. Subsequently, it issued detailed guidelines, after consultations

with the Ministry of Defence (MoD), for the issuance of licence for the production of

arms and ammunition in January 2002 (Press Note 2 of 2002 Series) (Tripathy, 2012).

Indian defence industry is primarily dominated by Defence Public Sector

Undertakings (DPSUs) and ordinance factories. Their share in total defence output is

estimated to 90 per cent. The 41 ordinance factories employ close to 125000 people

across 26 locations. These factories a wide spectrum of products including weapons

(small, medium and large caliber, and motor equipment), ammunition (small, medium

and large caliber, mortar bombs, grenades, signaling smoke, rocket bombs, demolition,

explosives, propellants and chemicals), vehicles(armored and transport), clothing,

general stores and equipment for defence services.

The DPSUs and ordinance factories have played a critical role in building a

domestic industrial base in this sector as they typically outsource 20 to 25 per cent of

their production requirements to private companies. In addition to these Public Sector

Undertakings, a number of medium and large private companies have entered or some

are seriously considering it to take stake in this sector. The import-export ratio of

India’s defence industry is less than the countries with small defence industrial base.

Therefore, Indian Government is seriously contemplating to correct it. Its main goal is

to promote the investment in both in R &D and manufacturing of defence hardware.

The sector is included in the ‘Make in India’ campaign (ASSOCHAM & PWC,

2014).

On the other side, India ranks among the top 10 countries in the world in terms

of military expenditure and as stated one of the largest importers of conventional

defence equipment as it strives to modernise its forces and replace obsolete equipment.

Its arms imports are now almost three times as high as those of the second and third

largest arms importers—China and Pakistan. India is among the top five arms

importer, besides China, Pakistan, the UAE and Saudi Arabia (Table 3).It isprojected

that the ranks of China and India will be second and third respectively in world’s

military expenditure in 2045.India’s defence expenditure in terms of Purchasing Power

Parity (PPP) in US$654 billion and China’s expenditure on the same head projected

US$1270 billion for the year 2045. Projection of defence expenditure of major powers

for the year 2045 has been made (Table 4).



Table 3: The 10 largest exporters of majors weapons and their main clients

Source: SIPRI

Table 4: Projected military expenditure of the world’s major powers in 2045

Rank Country Spending in PPP ($ Bn.)

1 United States 1,335

2 China 1,270

3 India 654

4 Russia 295

5 United Kingdom 108

6 Brazil 97

7 France 87

8 Japan 67

9 Germany 63

Source: Global Strategic Trends out to 2045, gov.uk, 15 July 2014

3. REGEULATORY REGIME

The policy for FDI in the Defence Sector was first notified vide Press Note 4

of 2001, wherein the Defence Industry Sector was opened up to 100 per cent for Indian

private sector participation, with FDI permissible up to 26 per cent later it was

increased to 49 per cent, both subject to licensing and Government approval.

Subsequently, guidelines for production of Defence equipment were notified, vide

Press Note 2 of 2002. Other than the FDI policy, two other policy regimes govern the



http://en.wikipedia.org/wiki/Purchasing_power_parity

https://www.gov.uk/government/publications/global-strategic-trends-out-to-2045

defence sector. These are the Defence Procurement Procedure and the Industrial

License regime.

The Defence Procurement Procedure (DPP) that governs the defence

procurement was first enumerated in 2002. After several iterations to the original

policy, the latest one is in pipeline. It is reported that Ministry of Defence has given its

nod to some amendments to the much awaited Defence Procurement Procedure(DPP)

emphasizing on higher indigenization in line with the ‘Make in India’ programme and

providing a major role for the private sector in arms manufacturing. However, the new

DPP 2016 would be issued in two months time as some parts of the revised DPP needs

to be approved and will apply to only new projects and not to those which are already

in process. The new DPP basically plans to ease the procurement processes. The

highlight of the new DPP is a new category to promote indigenous design and

development and domestic manufacturing including Government funding for Research

& Development (R&D) and recognition of the Micro, Small and Medium Enterprises

(MSME) in technology development.

The DPP will have a new category called the ‘Indigenously Designed,

Developed and Manufactured (IDDM)’ platforms. The Buy Indian (IDDM)

procurement category will be given the first preference. The significant proposed

changes/provisions to the DPP 2016 are as follows (DEFENCE PROCURMENT

PROCEDURE (DPP) 2016 :

It will be mandatory to have 40 percent local content in case the design is also

indigenous.

In case, the design is not Indian, 60 percent local content will be mandatory.

The domestic companies eligible under this will have majority Indian control

and operated by Indian nationals.

In DPP-2016, the “Make” procedure will be expanded into three types.

Make -I (Government funded) -- Government funding to the Indian private

entities for R&D in order to encourage more local development. The

Government will fund up to 90 per cent of the R&D, of which 20 percent will

be given in advance and in 24 months the entity will be given tender. In case

the company develops a prototype and it is not given order within 24 months,

its remaining 10 per cent of the development cost would be reimbursed.

Make- II (Industry Funded) – This category will involve industry funding,

rather than government funding, for prototype development. If a tender is not

issued within two years of the successful prototype development, the Defence

Ministry would refund the entire development cost to the duly selected vendor.



Make- III (MSME funded) –While procedurally similar to Make II (Industry-

Funded), this is reserved for projects with a development cost of less than Rs 3

crore, which will be exclusively reserved for MSMEs.

Under the Industries (Development and Regulation) Act 1951, an Industrial

license (IL) is required in India for manufacturing defence equipment. The applicant

must be an Indian company or partnership and has to apply to the Department of

Industrial Policy and Promotion (DIPP) (DIPP, 2010). India is not a only country

which exercises restrictions in defence sector but also defence majors in the world

have been following restrictions too in strategic sectors as listed by FICCI(Table 5)

(FICCI, 2010).

Table 5: Selected laws and regulations addressing foreign investment restrictions



4. PROGRESS

Table 6 shows that FDI in Indian defence sector attracted mere US$4.94

million out of total FDI of US$238747.65 million during the period April 2000 to

December 2014. It represents only .002 per cent of total FDI which flowed into

defence sector in India.

Table 6: FDI equity inflows into Defense sector in India from April 2000 to December 2014

Items Amount(US$ million)

Defence industries 4.94

Total (FDI) 238747.65

Source:DIPP

According to the Ministry of Defence press release, FDI amounting to

US$1.31 million has been received in the defence sector since 2012.In a written reply

to Lok Sabha, Minister of State for Defence, Rao Inderjit Singh said that since the

opening up of FDI in defence sector, 34 proposals involving foreign investment have

been approved so far.287 industrial licenses have been issued till date in defence

sector.

In quantity term, FDI in defence sector is received in negligible amount. In fact

FDI in defence sector was opened in 2001 and it was further liberalised in 2014. Since



then major overhaul in the sector has been made on the policy as well as

implementation levels. A lot of changes are in pipeline on DIPP, offset, export fronts,

etc. A new enthusiasm has been poured into defence manufacturing but it will take

some time to translate into reality. Overall perception about India and its growth story

have changed. Now India has been perceived differently. World cannot ignore India

because of its 4 Ds—demographic dividend, demand, deregulations and democracy.

5. HINDRANCES

Though beginning has been made in India to attract FDI in defence sector, a lot

of problems/roadblocks still exist. The major hindrances are:

Policy/Procedure: Defence sector has been opened up to 49 per cent FDI cap.

It is apprehension in some circles that global armament majors will not set up base or

transfer crucial technologies without management control of the joint ventures. It is

speculated that FDI cap of 49 per cent is a hurdle of transfer of front line U.S. defence

technology to India. Cumbersome procedures for establishing a defence unit is still

exist in India. Therefore, Indian firms, engaged in the manufacture of defence

equipments, have urged the government to simplify procedures so that they can

contribute effectively to the Make in India programme. They have asked the defence

ministry to create a single window for registration of their entities and products to cut

down the time taken for the process. Currently, entrepreneurs need to register with

each of over 40 defence agencies, and this process takes more than three years to

complete. The process for registering private entrepreneurs interested in serving the

Indian defence needs to be dramatically streamlined. The current process is a

needlessly expensive and time consuming process (Business Standard, 2015,

February 24). In front of policy of arms exports too, there is a need for greater clarity

and time bound clearances.

Technical Manpower: Shortage of a skilled workforce is a serious challenge

to the growth of the Indian defence and aerospace industry. For long, industry has

struggled to hire ‘industry-ready’ personnel who can hit the shop floor running

(ASSOCHAM & PWC,2014). The state of India’s defence capabilities in terms of

design, development, manufacturing, training and maintenance of cutting-edge defence

equipment is significantly lower than the best. The dimension of the problem is also lie

in rigid labour laws which restrict the number of overtime hours employees may put in.

These labour laws are responsible to transform slow growth of the indigenous

manufacturing sector and stifle India’s ability to capture a larger share of the global

market of precision engineering. Thus, it may impact Make in India a “win-win”

opportunity (Business Standard, 2015, February 24).



Tax Regime: Though it has been resolved tax anomalies among foreign

OEMs, DPSUs and private sector players, the government needs to rationalize taxes

and duties especially for Maintenance, Repair and Overhauls (MROs) and Special

Economic Zones (SEZs) and resolve the inverted duty structure that makes domestic

companies uncompetitive, thereby placing the Indian private industry at a

disadvantageous position (ASSOCHAM & PWC, 2014). In this context Chinese

experiences are well eye-opener. One of the lesser known aspects of China’s

emergence as a global manufacturing hub is the manner in which it completely

revamped its tax system in the early 1990s. The reforms have provided impetus for the

washing out of market distortions and have increased the incentive to invest in China.

India can look and replicate its success (Srivastava, 2008).

Cost Structure: A critical issue impacting investment in India is the high cost

of capital. While this impacts all Indian companies across sectors, it severely impact

MSMEs who face an even higher interest rate regime. While various schemes have

been launched to provide interest rate subsidy to MSMEs, these have largely remained

on paper. In addition, a lot of raw material, a number of sub system and components

for defence industries are not produced in India and have to be imported. But due to

fluctuations in forex markets often costs of defence products which are produced in the

country are overrun ((ASSOCHAM & PWC, 2014).

Intellectual Property Protections: The importance of intellectual property in

India is well established at all levels- statutory, administrative and judicial. India

ratified the agreement establishing the World Trade Organization (WTO). This

Agreement, inter-alia, contains an Agreement on Trade Related Aspects of Intellectual

Property Rights (TRIPS) which came into force from 1stJanuary 1995. It lays down the

minimum standards for protection and enforcement of intellectual property rights in

member countries which are required to promote effective and adequate protection of

intellectual property rights with a view to reducing distortions and impediments to

international trade. The obligations under the TRIPS Agreement relate to provision of

minimum standards of protection within the member countries legal systems and

practices (Lakshmana, Suriyaprakash, Kumar). In fact India has good IP protection

laws, but their track records of enforcement are poor. It would need to strengthen its

Intellectual Property (IP) protection regime to give confidence to defence sector

investors. The Global Intellectual Property Centre of the U.S. Chamber of Commerce

has scored India a very low 6.96 on a scale of 30 for IP protection, while the UK has a

score of 27.59 (KPMG,2014).



6. OPTIONS

Recently Government of India has taken a number of steps to iron out the

problems in promoting FDI as well as increasing Private sector role in defence

manufacturing. These are (The Economic Times, 2015 July 25):

1) The FDI policy for the defence sector has been reviewed and as per the revised

policy, the composite foreign investment up to 49 per cent is allowed through

government route (FIPB) and beyond 49 per cent with the approval of the Cabinet

Committee on Security (CCS) on case-to-case basis wherever it is likely to result in

access to modern and state-of-the art technology in the country.

Besides, the restrictions such as single largest Indian shareholder to hold at least 51 per

cent equity and complete restriction on Foreign Institutional Investor (FII) existing in

the earlier policy have also been removed to facilitate investment in the sector.

2) Preference to 'Buy (Indian)', 'Buy & Make (Indian)' & 'Make' categories of

acquisition over 'Buy (Global)' category, thereby giving preference to Indian industry

in procurement.

3) To establish a level-playing field between Indian private sector and the public

sector, the anomalies in excise duty/ custom duty have been removed. As per the

revised policy, all Indian industries (public and private) are subjected to the same kind

of excise and custom duty levies.

4) The Defence products list for the purpose of issuing industrial licences (ILs) under

IDR Act has been revised and most of the components, parts, sub-systems, testing e ..

5) Process of applying for Industrial License (IL) and Industrial Entrepreneur

Memorandum (IEM) has been made completely online and this service is now

available to entrepreneurs on 24X7 basis at eBiz website without human interface.

6) Guidelines have been issued to streamline the processing of applications for grant

of extension of validity of Industrial License. The initial validity of the Industrial

Licence granted under the IDR Act has been increased from 3 years to 7 years with a

provision to further extend it by 3 years on a case-to-case basis.

7) The 'Security Manual for Licensed Defence Industry' has been issued. With the issue

of the Security Manual, the requirement of affidavit from the applicants has been done

away with.

8) Partial commencement of production is treated as commencement of production of

all the items included in the license. Restriction of annual capacity in the Industrial

License for defence sector has been removed.

9) Licensee has been allowed to sell the defence items to the government entities under

the control of MHA, PSUs, state governments and other defence licensee companies

without approval of Department of Defence Production.



10) Application forms for Industrial License & Industrial Entrepreneur Memorandum

have been simplified.

11) To promote the participation of private sector, particularly SMEs for defence

manufacturing, outsourcing and vendor development guidelines for DPSUs and OFB

have been formulated and circulated to them. The guidelines mandate that each DPSU

and OFB to have a short-term and long-term outsourcing and vendor development plan

to gradually increase.

12) The Standard Operating Procedure (SOP) for the issue of No Objection Certificate

(NOC) for export of military stores has been revised and put on the website. Under the

revised SOP, the requirement of End User Certificate (EUC) to be countersigned/

stamped by the government authorities has been done away with for the export of

parts, components, sub-systems etc.

13) The list of military stores has been finalised and has been put in the public domain

to make the process transparent and unambiguous. The process of receiving

applications for NOC for export of military stores and for issuing NOC has been made

online to reduce the delay and to remove human interface in the process.

14) The advanced version of NIC Code (NIC 2008) has been adopted, which is a

highly contemporary industrial classification.

In addition, a number of options/suggestions have been identified to remove

bottlenecks in promoting FDI in defence sector. These are:

Policy: The government’s immediate focus should be to come out with a

comprehensive vision and roadmap for India’s aerospace and defence sector. The

vision should specify where India sees itself in the global world order 10 to 20 years

down the line. It should also highlight critical defence technology areas where India

should develop its complete self-reliance.

To avoid crossing through cumbersome procedures and time consuming jobs,

it would be desirable to suggest that defence ministry may create a single window for

registration of their entities and products to cut down the time taken for the process.

PPP MODEL: A key obstacle in public-private partnerships in India is

inadequate experience in designing contracts so as to address issues relating to

accountability, monitoring and measuring performance and outputs. Internationally,

there have been multiple instances of successful collaboration between the government

and the private sector, with the government taking the lead. One of the most prominent

examples of successful R&D programmes and implementation of new technologies

with government support and private sector collaboration exists in the form of the

Defense Advanced Research Projects Agency (DARPA) in the US (ASSOCHAM &

PWC,2014).



The legacy in India has been to focus on defence PSUs. However, it is felt that

a very strong PPP model is required in defence sector. If we look at the global model,

except for the final integration of an aircraft, they have strong consortium partners, say,

in Boeing etc, where outsourcing work is done. On the other hand, in India everything

is done in-house in Hindustan Aeronautics Limited (HAL). They have a few Joint

Ventures (JVs) and also outsource work. The Indian government should take a leaf out

of U.S. government’s DARPA model. DARPA has roughly 200 employees about half

of whom are technical experts. They work closely with the private sector, universities,

government laboratories and talented individuals to come out with cutting-edge

defence technologies (KPMG, 2014). It has no laboratories of its own as compared to

the 52 laboratories of India’s DRDO. However, the scene in defence manufacturing in

India has been changing. Now, the govt. is seriously contemplating to manufacture

Light Combat Aircraft (LCA), Tejas, under PPP.

Clusters: A business cluster is a geographic concentration of interconnected

businesses, suppliers, and associated institutions in a particular field. Clusters are

considered to increase the productivity with which companies can compete, nationally

and globally (Januska,2011, Januska, Kurkin, Millar 2011, Porter 2000).

Porter (2000) claims that clusters have the potential to affect competition in three

ways: by increasing the productivity of the companies in the cluster, by driving

innovation in the field, and by stimulating new businesses in the field. Successful story

of business clusters are well known examples of Silicon Valley and City of Bangalore.

Therefore, India should replicate a cluster-based approach, with each aerospace and

defence cluster focusing on a particular sub-system or technology. This could help in

creating a focused ecosystem and capability building across three to four defence

clusters spread around the country. The government should work with the global

OEMs and Tier1 suppliers to set-up Centers of Excellence and vocational training

Centers at the proposed clusters. It may be pointed out that about6000 Micro,Small and

Medium Enterprises (MSMEs) operate across the country supplying components and

sub-assemblies to DPSUs,ordnance factories,DRDO and private players. The

government of India needs to developMSMEs into cluster line ((ASSOCHAM &

PWC, 2014).

Offsets: Offset agreements are a popular tool used by governments around the

world when they engage in large military procurement deals with foreign Defence

manufacturers. An offset is essentially an additional compensation given to a buyer by

a seller. In relation to Defence procurement, this means that foreign contractors are

required to fulfill certain offset obligations (in the form of FDI or purchase of

domestically manufactured products) when they supply arms to a country. The Indian

Ministry of Defence (MoD) approved offsets guidelines in 2005 and the

implementation process began after their inclusion in DPP-2006. Offset obligations in

India vary depending upon the acquisition category. In India, Defence Offsets was



initiated on account of Kelkar Committee Recommendation to leverage buy-in power

of the Defence Industrial Base. The primary objective of Defence Offsets is to become

self-reliant by developing Fledging Defence Industry in to Military Industrial Complex

through leveraging capital acquisitions. Unfortunately, offset obligations are estimated

to indirectly increase the acquisition costs of defence equipment by 10 per cent to15

per cent on average. The policy provides incentives to the suppliers through offset

banking credits. If a supplier facilitates offset more than the requirements, the accruing

credits maybe carried forward for seven years from the approved date (FICCI &

Centrum, 2015).

In fact, US, Russia and a handful of western nations have been at the forefront

of developing cutting edge weapons systems, most other countries which have scaled

up the learning curve in defence technologies have done so via use of offsets. Turkey

has effectively used offsets to develop its domestic defence capabilities and has

become a sizeable exporter.

7. CONCLUSIONS

The paper commences with the hypothesis that FDI in Indian defence

manufacturing can cure its miseries. Modern defence hardware can be domestically

manufactured through FDI channel. Though India’s defence sector has wide network

under Public Sector Units, they have been unable to fulfill its defence needs.

Consequently, India ranks among the top 10 countries in the world in terms of military

expenditure and one of the largest importers of conventional defence equipment as it

strives to modernise its forces and replace obsolete equipment. Due to deteriorating

security environment around it, India cannot forgo its defence preparedness, though

huge defence expenditure is stressing its development.

It was realised in 2001 that Indian Public Sector defence units cannot fulfill

emerging needs of defence forces. Thus, the sector was opened up for private sector

and FDI was welcomed. In the recent past a lot of FDI policies and procedures in

defence sector have been overhauled and some changes are also in pipeline. The

success of a liberal FDI policy critically depends on how it is managed. As far as

progress of FDI inflow into India’s defence sector is concerned it is not satisfactory in

terms of amount. But due to highly capital-intensive and technology driven sector, it is

assumed that it will take time to get momentum. Perception about India and its

economy has changed. It is considered an emerging and vibrant economy which can

lead to the world economy.



The challenges/problems of FDI inflow into defence sector have been

identified as lack of investor friendly procedure, shortage of technical manpower,

unfriendly tax regime, uneconomical cost structure, lack of enforcement of intellectual

property protection, etc. Therefore, there is need to plug these loopholes. In addition,

we should not ignore but to continuously look into depth on regulatory regime of FDI,

PPP model, clusters, special defence zone, offsets, etc. More importantly, while

reviewing FDI proposals it should be taken care of that India should not become

dumping ground of inferior technology. Various incentives such as tax rebates could

also be used as a lever to induce higher technology through FDI. If India is succeeded

in its efforts in establishing modern defence manufacturing complex through FDI

route, it will be path breaking concept of erstwhile socialist countries which remodeled

their economies into market-oriented.

The experiences of other countries like Brazil, South Korea, Turkey, etc can be

helpful to India to replicate the success of FDI in defence sector. Even in the United

States the third largest supplier of defence equipment to its armed forces is a wholly

owned subsidiary of a British company. India’s own successful joint venture with

Russia in production of Brahmos cruise missile can be considered as useful model. But

on the other side of the picture of coin is not very rosy. For instance, recently U.S.

Department of State refused to grant licenses on four of the 25 Lockheed Martin

technologies promised to South Korea for its 5th generation fighter jets programme

dubbed KF-X. It also denied Moog Inc re-export clearance for actuators which were to

be installed on India’s Rustom-2 HALE Class UAV. In case of Russia too, in 2007

Russia and India agreed to jointly develop the Fifth Generation Fighter Aircraft

(FGFA).But India is not taken in loop in the development of FGFA. In fact, no defence

majors will share front line technology to others.

NOTES

The terms:

1US$ = 65 Indian Rupees(Rs)

1 Crore =10 million

In India calendar year and financial year are not the same. Indian Financial Year (FY)

commences from 1st April and ends 31st March of the next calendar year; therefore,

year like 2014-15 is used.



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