74% FDI In Defence Is Here, But It's Hardly Automatic
India has amended the Foreign Exchange Non Debt Instrument Rules, 2019 paving the way for 74% foreign direct investment in the defence sector through the automatic route—without prior approval of the government. Yet, there’s nothing automatic about it.
The new limit was notified earlier by the Department of Promotion of Industry and Internal Trade or DPIIT. The changes in foreign exchange rules was notified on Tuesday (Nov. 8). But these came with multiple conditions. The investments will be allowed in new ventures operating on licensed segments—or simply, they will require permits.
The higher foreign investment cap requires end-to-end capabilities, starting from design and development to lifecycle support. That’s a continuation of earlier policy that allowed FDI of up to 49%.
The investments are now also subject to security clearance by the Ministry of Home Affairs. While the higher FDI cap allows overseas original equipment makers—or manufacturers—to bring in intellectual property rights and technology, it will also be subject to national security scrutiny. Investments from neighbouring and unfriendly countries are unlikely to be allowed.
That’s not all.
The new rules, notified on Sept. 18, retain restrictions on acquiring up to 49% stake in existing joint ventures without the government’s approval.
Meaning, existing foreign investors with 26% stake in defence joint ventures can’t increase stake without scrutiny.
A senior executive at a domestic defence company, speaking on the condition of anonymity to comment candidly, said the move protects Indian interests. Any control in foreign hands is bad as it can choose not to help India at a crucial time, citing parent government restrictions, he said.
This appears to be giving a favourable treatment to companies seeking new industrial licences as opposed to those who already have existing licences, said Karishma Maniar, associate director at law firm Economic Laws Practice. But the decision, she said, is subject to language of Foreign Exchange Management Act, 1999, and there’s a need to see the fine print.
The new rules, however, add one more layer of complexity for all companies.
New and existing companies will now require security clearance from the Ministry of Home Affairs based on the guidelines of the Ministry of Defence, instead of just defence earlier. That will increase scrutiny of existing foreign partners seeking to increase stake in their joint ventures.
According to the industry executive cited earlier, if all firms with 74% FDI are allowed in across the range of Indian programmes, existing Indian companies will get killed. Companies controlled by overseas manufacturers will get access to Indian Defence Ministry funding for development, something that has not been granted to companies set up in India, including joint ventures, he said.
What Happens To Existing JVs?
The government has effectively kept control on foreign investment since, instead of DPIIT approving FDI, now they will approve the industrial licence, said Maniar. This would mean more bureaucratic paperwork and longer time for approval.
The executive cited earlier said existing joint ventures won’t be wound up for new ones. It just does not make sense for any joint venture partner to waste years to start a new company and seek licences and build infrastructure, said the first person.
It’s “unnecessary bureaucracy”, said Rahul Chaudhry, principal and chairman and managing director at GTM Consulting, and former managing director of Tata Power Strategic Engineering Division. He said 74% control can be passed at the holding-company level to foreign investors.
The executive cited earlier said Indian companies, which had previously formed joint ventures, held 74% stake but didn’t have design and development capabilities. They may set up another joint venture for end-to-end capability and merge the two later through NCLT process, he said.
For years, foreign defence manufacturers have been arguing against transfer of technology or intellectual property rights unless they have control of the joint venture. With requirement of bringing in end-to-end capabilities, only select few—who think India will offer an advantage—will venture in with 74% ownership.
The bluff of all foreign original equipment makers saying they can’t bring in FDI as they don’t have control will get exposed, said the executive cited above. They can now bring in 74% but can’t do the work that Indian companies already can, he said. They will have to bring in end-to-end capability, he said.
The executive, however, cautioned that the current system does not assure repeat buying from India, like in many other nations. A reason, he said, why FDI has not and will not come in a big way.
(Updates an earlier version after the new foreign exchange rules were notified on Nov. 8)