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Current Affairs for IAS Exam : FDI in Defence

Oct 20, 2016 10:38 IST

    Important Questions

    Is the FDi in Defence imperative for the Security of India? Critically Examine

    FDI in Defence was very much required for the modernisation of Indian Defence. Discuss and Exemplify

    FDI in the critical sectors have their impediments. Discuss

    It very important for the IAS aspirants to understand the basic concepts of Economy. In order to understand various dimensions of General Studies Papers of IAS Syllabus, the terms of the subject economy plays very important role. Here, we have provided each every aspects of FDI in Defence in India, much helpful for IAS Preparation:

    What is FDI

    Foreign Direct Investment is an investment by a foreign business (individual or company) in the country which is not its home country. It establishes control over the business operations or acquires business assets in a company based in another country, called the host country.

    There is no straitjacket definition of FDI. Some economists treat FDI as that component of foreign investment which confers “control” in an enterprise to the foreign investor. All other foreign investments, in such a case, are defined as portfolio investment.

    Regarding the threshold for classifying an enterprise as foreign-controlled or otherwise, most countries have adopted their own definitions. For instance, in India, RBI used to follow the practice of identifying the “foreign controlled, rupee companies”, which included the companies having shareholding of 25 percent or more of total equity or where 40 percent share is held by investors from a single country.

    In recent decades, the International Monetary Fund (IMF) and Organization for Economic Cooperation and Development (OECD) have pushed for a globally acceptable definition of FDI, according to which 10 percent or more of foreign equity constitutes the “controlling share” in an enterprise. But not all countries have adopted the OECD-IMF definition.

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    Difference between FDI and FII


    Foreign Direct Investment, as distinguished from portfolio investment, has the connotation of establishing a ‘lasting interest’ in an enterprise that is resident in an economy other than that of the investor.Foreign Portfolio Investment (FPI) includes Foreign Institutional Investment (FIIs) and Qualified Foreign Investors (QFIs).
    FDI is made to acquire controlling ownership in an enterprise but FII tends to invest in the foreign financial market.
    The differences between FDI and FII can be understood on the following basis:

    Place of investment

    •    In FDI, the foreign company/investor invests in a company based in the host country.

    •    In FII, the foreign company/investor invests in the stock market of the host country.

    Stability

    •    FDI have relatively difficult entry and exit, which makes them less volatile.

    •    FII have relatively easy entry and exit option and thus it brings in mostly short term capital.

    Nature of investment

    •    FDIs invest in funds, resources, technology, strategies, know how, etc.

    •    FIIs invest in funds only

    Control

    •    FDIs have both ownership and management control

    •    FIIs have only ownership control but no control over management

    Based on the recommendations of ArvindMayaram committee report, the threshold of 10 percent has been set since 2014.

    •    Foreign investment of more than 10 percent in a listed company is treated as FDI.

    •    If a smaller (below 10%) stake is raised to 10 percent or beyond within one year from the date of first purchase, the investment can still be treated as FDI.

    •    An existing FDI can continue to be treated as FDI even if its stake falls below the 10% threshold, and even without an obligation to restore it to 10% or above, as the

    original investment was an FDI.

    •    Irrespective of the threshold limit, any foreign investmentin any unlisted company may be treated as FDI.

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    FDI in Defence- What does it really mean

    The defence sector in India has been opened to foreign companies for full 100 % equity through government approval route. The Defence ministry has also brought in new Defence Procurement Procedure (DPP-2016) in March this year. With imperative of self-reliance in defence production the emphasis is on indigenization with procurement categories like ‘Buy (Indian)’ and ‘Buy and Make (Indian)’.

    •    The foreign companies can own upto 49 percent in Indian units through automatic route, i.e., without specific government approval.

    •    For investments resulting in access to modern technology, the foreign investments beyond 49 percent has now been permitted. For other cases also, i.e., where access to modern technology is not the driver, the approval can be granted but the reasons for permission need to be recorded.

    •    The manufacturing of small arms and ammunitions, covered under the Arms Act, 1959, has also been included in the FDI limit for defence sector.

    •    Earlier the foreign Original Equipment Manufacturers (OEMs) were required to create a joint venture with domestic firms in order to establish manufacturing base in India.

    Now, after amendments, the OEMs can implement operations in India independently.

    •    By removing the burden to prove the technology / equipment as modern and state-of-the-art, a significant regulatory hurdle has been removed. The earlier policy entailed clearances from defence ministry, external affairs ministry, ministry of home affairs and proof that the technology / equipmentwas state-of-the-art.

    Is it really required

    Arguments in favour:

    •    The FDI in defence sector was earlier liberalized in 2001, but it had led to a meager inflow of just 4.8 billion dollars, in an overall FDI inflow of 334 billion dollars. The sub-optimal inflow is sought to be improved by making inflow of investment/technology commercially lucrative.

    •    As per a report by Swedish think-tank Stockholm International Peace Research Institute (SIPRI), between 2006-10 and 2011-15, the imports of defence sector increased by 90 percent. Domestic manufacturing would control that.

    •    The dependence of Original Equipment Manufacturers (OEMs) on domestic manufacturers has been reduced, which will lead to savings in terms of time and resources that were earlier spent on lengthy negotiations.

    •    This could also lead to increased competition for domestic firms, which is expected to improve operational efficiency and ultimately benefit to the customer, which in this case is Government of India.

    •    The Indian organizations like National Technical Research Organisation (NTRO), HAL and DRDO have not delivered as per current demand of the armed forces even on basic technologies like INSAS (Indian Small Arms System).

    •    It will ensure cutting-edge technology and may enhance Research and Development (R&D) in development of ‘India specific’ solutions for our security needs.

    •    The wages and pensions of defence personnel has risen this year while the spending on defence-following years of increases- has remained unchanged in the budget this year (2016-17), thereby leaving even less money for modernization. Thus, foreign investment is sought to boost ‘Make in India’ initiative along with modernization.

    Arguments against:

    •    National security may be compromised (as discussed comprehensively in the below section)

    •    Domestic manufacturing companies may suffer.India has to rely on high level of imports mainly due to failure of the domestic arms industry in designing and producing competitive indigenous weapons. Emphasis should be on promoting research and procuring technology, instead of inviting manufacturers.

    •    There is no transfer of technology

    FDI in Defence and National Security

    •    It is argued that opening up the defence sector may make India more dependent on foreign companies for its vital defence requirements and crippling Indian companies simultaneously.

      o    The argument against this point is that FDI calls for establishing the manufacturing units within India, thus lapse of production or refusal to supply would not be the case in situation of war.

    •    Our war-strike capabilities may be known to our adversaries.

    •    Countries like the U.S. are known to impose unreasonable conditions/restrictions over the usage of their technologies at their own terms like maintenance contracts,permission for combat usage, delivery of spares, resale, ammunition testing, etc.

      o    So relying on such foreign origin defence equipment completely is not an option as they may control their usage at that critical juncture when we need them the most.

    •    While India’s arms imports were three times its regional rivals China and Pakistan each, it is due to China’s increased capability of producing advanced weapons domestically, which has brought its imports down.

      o    It is not for war that we need weapons, rather to maintain peace, in a not so friendly neighborhood.

    What will be the consequences

    Impact on domestic forms

    The new policy clarifies that FDI will be allowed only for technologies that are not available in India.  Thus, Indian firms will not be affected much.

    Impact on Economy

    The enhanced manufacturing base will without doubt create space for increased employment opportunities.
    Simultaneously, the imports will come down. India’s dependence on imports has made India world’s sixth largest defence equipment buyer.

    Impact on Global perspective about India

    As per SIPRI, India is the world’s largest arms importer. India’s imports account for 14 percent of the global arms imports.

    A reduction in imports will not only bring India out of the pejorative classification of ‘largest arms importer’, but will also strengthen India’s stance as having self-sustaining defence forces.

    Impact on Defence preparedness

    India’s huge manpower in defence, if provided with advanced equipment, may turn out to be one of the strongest forces, apart from just being one of the largest at present.

    Regulatory measures in the present regime

    •    The DPP-2016 provides clarity as to who is an Indian vendor- an Indian entity established under the Companies Act or any other applicable regulations. The DPP further divides Indian vendors into 2 categories one for defence products requiring industrial licence (IL) and the other for not requiring IL. The list of defence equipment requiring IL has already been announced by Department of Industrial Policy and Promotion (DIPP).

    •    For investments resulting in access to modern technology, the foreign investments beyond 49 percent has now been permitted. For other cases also, i.e., where access to modern technology is not the driver, the approval can be granted, but the reasons for permission need to be recorded.

    •    The offset threshold limit has been raised by the DPP-2016 by more than six times (from Rs.300 crore to Rs.2000 crore).  The hike in the threshold means that fewer arms import contracts are now eligible for offsets. This is a big setback to the local industry.

    What more should be done

    It’s not that India lacked in money to import and upgrade its military technology. The present regime suffered more due to lack of clarity over defence procurement policy. Due to this reason, even the allotted amount remained unspent. The DPP-2016 has provided clarity in this regard.

    While some believe thatthe liberalization done recently would revive the ailing defence manufacturing sector, some critics argue that the changes are mere cosmetic. The condition of access to ‘state-of-art’ technology in the country has been replaced with ‘modern technology’ in the DPP-2016.Critics argue that it is unlikely to make any visible change in the flow of technology or investments.

    Further, there is no actual transfer of technology. True indigenization cannot happen just by local manufacturing. The percentage of indigenization may increase, as has been happening, but actual growth in capability has to be given equal, if not more, emphasis as is being given to domestic manufacturing.

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