FDI in India's Defence and Security Sector
(By Mr Julian Scopes, President, BAE Systems, India)
The government of India (GoI) aspires to transform the defence industrial sector so that it can achieve a 70% level of selfsufficiency from domestic sources. At the same time, GoI currently maintains a ceiling of 26% on foreign direct investment (FDI) in the defence industrial sector, with some exceptions permitted for project-specific joint ventures and for dual-use activities. Raising — and eventually removing — this 26% ceiling would be an important enabler in bringing about the transformation that GoI seeks.
Achieving a higher level of self-sufficiency would bring obvious benefits to India. It would give the defence customers (the armed and security forces) access to a stronger and more innovative indigenous industry to meet their own particular requirements. It would enhance security of supply, and, as importantly in this age, strengthen India’s ability to support and upgrade systems through their whole life-cycle within India’s own industrial base.
And a vibrant, successful defence industry brings obvious economic benefits — balance of payments, more skilled jobs, export potential, strengthening of Indian supply chains and links for those supply chains to the global defence market.
The challenge to India in achieving 70% selfsufficiency is that the present industrial structure is not delivering transformation at a satisfactory rate. There are huge strengths — in the public sector with strong basic research, customer understanding and domain knowledge — in the private sector with world-class project management, engineering, software and manufacturing skills. But the reality is that between them, and for a variety of reasons, the public and private sectors in India are not yet delivering the aspiration of greater selfsufficiency in the defence sector.
The problem with the present 26% ceiling on FDI in the sector is that it limits the economic incentive to the foreign investor. Why would a company bring its investment (capital, people, skills and technology) to a market in which it can only secure a limited economic return?
Of course, in some cases, companies will have good strategic reasons to invest at the 26% level. In the case of the joint venture between BAE Systems and Mahindra & Mahindra, we have taken a conscious decision that we will jointly develop a business across the land sector in India, with a view to the long-term growth potential and with the positive hope that the FDI regime will change and BAE Systems will be able to increase the level of our participation in due course.
But in many cases, companies will agree to invest at the 26% level more because they have to, in order to win a particular programme or to deliver against offset obligations. However, this approach does not lead to a long-term perspective that will prosper beyond the time horizon of a particular programme — it is about the Indian regulations driving companies to do what they have to for short-term considerations, rather than encouraging them to do what they want to for longterm growth. India’s offset regulations by themselves will not lead to transformation of the sector, because at present the sector lacks the capacity to efficiently absorb and deliver the volumes of offset work envisaged, and because there is no recognition for the value of technology transfer.
But there are global defence and security companies that will choose to invest in India under the right conditions and for an adequate economic return, which recognises the value of technology, so that they can develop operations that are part of India’s own defence industrial base and that will work alongside the existing public and private sector entities, including the research entities like DRDO and the IITs, to deliver enhanced indigenous capability. The aim of such operations would be to grow capability within India — to develop operations led and staffed by Indian citizens, designing and delivering systems specifically to meet Indian requirements, and growing India’s own defence and security technology base.
Examples of this are already evident around the world. For instance, BAE Systems has multiple home markets outside the country (UK) in which we are headquartered and listed on the stock exchange; indeed, our business in the United States is now larger than in our original UK domicile. We have grown our businesses around the world by means of investment for both acquisition and organic growth, and we are able to leverage our global capabilities to bring the best to our many markets. Moreover, our multiple home markets develop to become technology and export centres in their own right — not dependent on the technologies supplied from ‘head office’. In these home markets, we work with both public and private sector partners, and bring our global skills at supply chain management to enhance the capability of the whole supply chain — including small and medium-sized enterprises — and providing them with access to our global markets.
Concerns are expressed here that allowing greater FDI will reduce India’s ‘control’ over a sector that is obviously very sensitive for national security. This is not an argument that has relevance in the debate about raising the ceiling from 26% to 49%, as this change makes no fundamental difference to the control that the 51% majority Indian partner retains. Beyond 50%, then it does become a legitimate consideration — but it is an issue that can be managed. There cannot be an important defence market that is more concerned about its own national security and defence industrial base than the US. Yet BAE Systems has been accepted as a major investor (now the fifth largest defence/security supplier in the US) under arrangements that provide assurance to the US authorities about the conduct of our operations in that country. In essence, BAE Systems Inc operates as an entity led and staffed by US citizens acting in the interests of US defence and security as well as of our shareholders. Similar arrangements have been agreed in other markets, such as Australia. There is no reason why in due time similar arrangements could not be agreed with GoI.
Another concern expressed is that foreign investors could at some point be prohibited from transferring technologies into the Indian market. Well, it is certainly the case that global defence companies will remain subject to licensing requirements for technologies in the countries of origin for those technologies. But that does not mean that they cannot do business — still less that they will not invest and work with the existing research organisations in order to develop India’s own technology base — and then in turn GoI will be responsible for the export licensing of those Indian indigenous technology capabilities. As an aspiring investor in this sector, we accept that the goal must be to develop indigenous technologies and to reduce reliance on imports and on support and upgrades that are dependent on capabilities outside India.
As an aspiring foreign investor into these sensitive industrial sectors in a nation like India, which faces significant challenges in protecting its territory and its citizens, we do recognise that we need to earn the trust and confidence of the customer — both the military and security users of our systems and the government of India overall. BAE Systems has been such a reliable supplier for over 60 years, and we will build on that confidence by delivering efficiently what is needed and by demonstrating the industrial, economic, technological, export and sovereignty benefits of opening the door to greater FDI in this sector. We, therefore, hope GoI will look favourably on lifting the current cap on FDI in this sector.
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Credit: The Economic Times.