FDI and the ‘Make In India’ initiative – What do these mean for the defense sector

Two extremely significant economic initiatives by the Modi government are expected to have a widespread impact on India on a generic level, and the defense sector on a specific level. India as many of us might be aware, has the third largest defense force in the world. Our defense budget for 2016-17 is INR 2,491 bn (which is 1.65% of the GDP in 2016-2017). Hence, the two initiatives that are expected to become drivers of the economic growth, are essentially focused on addressing these aspects.

The first one is the decision to liberalize the foreign direct investment regulations in this sector. What it means in simple terms is that foreign companies can own the entire equity in the Indian defense sector after going through the process of government approval. The earlier regulation allowed for a maximum of 49% of stake by foreign entities. However, there is a small caveat in fine-print that also needs to be understood. The government’s approval for 100% stake will only be conditional to the fact that it applies to technologies that are not available in India, for the defense sector.

The second one is the “Make in India” initiative related to defense manufacturing. India is the largest importer of arms in the world, with its share forming 14% of the global share between 2011 and 2015. In terms of procurement, the value of the arms from foreign vendors by Indian Armed Forces was INR 262 bn in FY2016. This data makes the intent behind this initiative even clearer. It is to facilitate the inflow of foreign original equipment manufacturers so that they can partner from a strategic perspective with Indian companies. The recently completed Aero India Show 2017, in Bengaluru, has demonstrated how there has been an increase in the global defense firms agreeing to manufacture locally. This can be a huge advantage for India considering the heavy dependence of the defense sector on equipment and technology that is imported.

Some implications of these initiatives, at a macro-economic level are shared below. This is a set of indicative implications and not exhaustive ones and therefore, there can be many more far-reaching ones that we can further analyze.

  • The Ministry of Defense has shared that an overall number of 29 offset contracts worth USD 6.13 billion have been signed till May 06, 2016, which have to be discharged till 2022. This will help the growth of exports from India. Large Indian organizations like Tata Advanced Systems (TASL) are in a position of manufacturing in their Indian facility to meet global demand. As per the Defense Manufacturing Sector Achievements Report released this month (February 2017), for the financial year 2015-16, INR 2,059.18 crores worth of defense platforms, equipment and spares, all of which were manufactured in India were exported to over 28 countries.
  • There are several global organizations such as Aequs Private Ltd, Israel Aerospace Industries, Ltd. (IAI) , Strata Manufacturing PJSC (Strata) , Rolls-Royce to name a few that are already gearing up to expand their involvement in the defense space in India, through partnerships with Indian companies. If we continued with the current import levels, India’s CAPEX spend is expected to go up since 50% of the country’s defense equipment is obsolete. Hence, the Defense Production Policy, 2011 which was already focused on encouraging local production of defense equipment has undergone further changes, to make the definition clearer. For example, a new category on capital procurement has been added to encourage the manufacturers to focus on Indian components from all aspects – Designed, Developed and Manufactured in India.
  • These initiatives and the FDI are going to translate into a rise in employment for the local workforce by using the current skill-pool that is available or by up- skilling them. This has even larger implications if we consider the involvement of additional agencies or companies in India that work on skill-development and employability. Therefore, tying up the Skill India initiative with this one can actually boost the employment levels.
  • The initiatives can create higher levels of competition for domestic firms. This will support creation of work that is better in terms of quality of output, operational efficiencies and sustainable impact, all of which are important for the defense sector. Indian companies that were possibly looking at business results only, when tying up with OEMs, will now have to look at the bigger picture in the interest of economic growth for the country.
  • The country’s defense forces will gain from both these initiatives in a big way. The equipment and technology that will be available to the forces will far surpass what has been considered “state-of-the-art” so far.
  • It will ensure availability of cutting edge technologies for the defense forces and provide assured returns for international OEMs. The move will also enhance overall R&D to develop and deploy solutions catering specifically to the country’s security needs
  • There are provisions that have been made for the maintenance and transfer of the technology that comes into India via the FDI route, just ensuring that the Indian workforce has access to world-class technology and innovation in the area of defense and can work on the same. Since FDI has been introduced for the defense sector, 36 FDI/ JV proposals have been approved for manufacture of various licensable defense items till date. The FDI policy was revised in June 2016 and post that 6 proposals have been received till date.
  • Tax Incentives and Deductions provided under the Make in India initiative for defense manufacturing will support the Research & Development work being carried out in this space in India, so that it can lead to further technological innovation.
  • The ease of being able to do business in India, in the defense space has gone up further. Foreign players who have value to add to the growth of this sector in India, can access the market more easily now than before. This is an important change since it reduces the degree of red-tape bureaucracy for procedures that need to be fast-tracked.
  • The setting up of new facilities within different SEZs and states in India under these initiatives, will lead to infrastructural improvements as a whole for those areas and have the added advantage of providing jobs of different kinds to the localized population, from various income brackets.

While the overall implications seem to have a positive trajectory and clear line of economic growth, it is important to be cautiously optimistic and assess the impact of these initiatives at various stages. There are many elements and inter-linkages involved for such large scale interventions that have a country-wide as well as a global impact considering India is a key player in the international arena.
This article was originally published in Indian Defence Review.