Thursday , October 09, 2014 at 11 : 50
Can Videshi be used to benefit Swadeshi? Examining FDI in defence
IBNLive
As military modernization gathers pace under the new Modi-led dispensation in Delhi, liberalized foreign direct investment (FDI) rules for the defence sector in its first budget seem to have taken cognizance of the the broad consensus among various domestic stakeholders that the previous 26 per cent cap on FDI in defence may have been too restrictive. Though no military industrial complex (MIC) in the 20th century was really built through foreign investment, India could nevertheless in this era of globalization leverage 'FDI in defence' as a force multiplier with adequate safeguards. However to make the most of 'FDI in defence' it is important to leave aside the rhetoric and closely examine what it can and cannot do. Moreover domestic aims vis a vis FDI will also have to be clear in terms of its role in boosting the defence industrial base(DIB) as well as generating employment. One overall political direction could be to use FDI to boost military exports and increase the domestic component supplier base that can be simultaneously leveraged through greater indigenous research & development (R&D) efforts.
Prior to the budget, the Ministry of Commerce(MoC) circulated a note that proposed to create a three-tier rule structure governing FDI in defence with caps of 49, 74 and 100(i.e no cap) per cent based on the level of technology transfer (ToT) that a foreign original equipment manufacturer (OEM) would be willing to bring into India. The new government's first budget of course raised the level of automatic approval for FDI in defence to 49 per cent from the existing 26 per cent. The fact that the MoC was involved in this matter along with the Ministry of Defence (MoD), is indicative of the fact that the growth of the indigenous DIB is now being seen as an important part of India's objective of raising the share of manufacturing from 16 to 25 per cent of gross domestic product (GDP) as soon as possible.
Indeed it is understandable that for India (like all non-petrostates), which uses a debt leveraged model for growth, it is imperative that public expenditure not 'leak' out of the economy as military imports and in that general sense having something built domestically even under FDI is preferable to direct imports from abroad. But then the devil is always in the details and while something may seem ridiculously simple, it often isn't.
For one, the automatic route should not become an avenue for foreign OEMs to effectively takeover small and medium enterprises (SMEs) that have developed niche capabilities in the last twenty years while working on various strategic deterrence programs. It is standard practice across the world to maintain a strict database of such companies and closely monitor foreign attempts to gain managerial control. The inputs of our intelligence agencies working with DRDO, ISRO and DAE should be paramount in this regard. Such takeovers will neither generate jobs nor result in ToT but could serve to jeopardize India's security and have to be prevented at all times, obviously.
Indeed 'FDI in defence' should be used to increase India's supplier base rather than stunt it. In that context, strict localization norms should accompany non-automatic approvals i.e of say up to 74 and 100 per cent. It should be made clear that any foreign OEM with a majority stake in an Indian subsidiary will have to accomplish domestic sourcing targets in a time-bound and credible manner barring which it will not be allowed to bid for a whole range of Indian procurement programs or repatriate profits easily. There is no point in having 'FDI in defence' if it only ends up becoming another route to assemble semi-knocked down(SKD) or completely knocked down(CKD) kits in India under the garb of promoting indigenization as known as the Tatra model. OEMs may look to use 'FDI in defence' to simply skirt various import duties to source foreign components via the back door. Too much glib talk goes on in the media about buying 'technology' when just a 'product' is actually being bought. The idea is to bring the 'know why' behind the product and not mistake the product as the technology itself. FDI has to be leveraged to make India part of global value chains in the military industrial sphere.
While ToT may be the chief factor being touted by the usual suspects as the raison for FDI in defence, it really isn't. The chief draw of FDI as it were is to grow the Indian eco-system for Tier-I to Tier-3 suppliers while generating employment. Essentially the idea is to use the pull of the Indian defence market to ultimately set the grounds for global export of Indian military products across the value chain. Indeed any 100 per cent FDI approvals should be dovetailed to encouraging sub-system suppliers for what are essentially domestically developed platforms and systems. India today can put together very credible platforms such as tanks, helicopter, fighters and ships. The chief gap is in terms of domestic supply of key sub-systems with the biggest challenges being in the domain of propulsion technology. It is these gaps that foreign companies can be enticed to fill with the draw of large orders, export potential and even relaxed profit repatriation norms.
Fully owned foreign subsidiaries however cannot be allowed to bid directly for 'buy and make' (Indian) and 'make' categories of procurement in cases where credible domestic capability exists and for overall operational security purposes. Flagship indigenization programmes such as the Future Infantry Combat Vehicle (FICV) and Tactical Communication Systems (TCS) would be examples of tenders were 'Swadeshi' must be given preference.
Such subsidiaries must also be almost fully staffed with Indian citizens since a major way in which ToT can take place from such a set-up is through diffusion and 'learning by doing'. Besides such an arrangement will also make it easier to prosecute a firm or its employees in the event that a violation of national laws takes place and this issue will become more important as India rises as a military exporter. The other method to gain ToT while allowing 100 percent FDI would be to create fully funded Centers-of-Excellence (CoE) in India for identified critical sub-system technologies. In this aspect Pratt & Whitney's (P&W) 'Turkish Engine Center' which is a joint venture between it and Turkish Technic specializing in CFM56 and V2500 engine overhaul and repair is indicative of what more India should leverage given our far greater strength. More over through the JSF program Turkey is also going to site P&W industrial facilities.
A more direct way of ToT however would be to promote the Brahmos model wherein DRDO holds 50.5 per cent and Russia's NPOM holds 49.5 per cent. Such joint ventures (JVs) can now be envisaged across a spectrum of areas where large domestic programmes are underway. For instance, this model could conceivably be used for a next generation anti-tank missile which could be a collaboration between DRDO and America's Raytheon leveraging technology from India's Nag project and Raytheon's Javelin. Indeed as China has shown across a range of industries, JVs are the way forward once domestic industrial capabilities have crossed a certain threshold. It is here that the automatic 49 per cent route becomes important wherein large Indian majors bidding for key programmes can leverage their bargaining power for sourcing foreign technology on a case-by-case basis. It is these Indian majority stake-holding JVs that should be allowed to participate directly in the more than 150 buy and make (Indian) programmes that are in the process of being rolled out.
In all of this it is important note, that leveraging FDI in defence requires a continuous focus on domestic R&D. No OEM in the world will part with intellectual property for the love of God or for a few dollars more. They would do so when they know that DRDO and Indian companies will ultimately succeed anyway in an area and it is better if they (i.e the foreign OEMs) can make some profits now by participating in large Indian orders via the JV route. Indian industry believes that 49 per cent via the automatic route coupled with a commitment to CoEs is adequate to bring in foreign OEMs.
The need to boost domestic R&D budgets even while FDI in defence in being liberalized cannot be stressed enough however. Since South Korea's (ROK's) example often crops up while talking about the use of foreign investment in strategic industrial sectors, it must be observed that the Koreans have also invested heavily in domestic defence research since the 1980s and their own literature acknowledges that it is this thrust along with the diffusion of industrial innovation that has primarily helped it indigenize. ROK policy also looks closely at where 'gaps exist' in capability before entering into collaborative arrangements or allowing direct foreign participation. And ROK's achievements in naval shipbuilding and military metallurgy notwithstanding, the fact is that it still does not have any great satellite launch capability nor could it build credible ballistic missiles without clandestine Russian ToT of the Iskander system. India of course can send probes to Mars and also has multi-level domestically developed strategic deterrence systems. The point being made is that the Indian approach should recognize domestic strengths and leverage FDI in defence as part of an overall strategy for enlarging India's MIC.
That overall strategy must include serious commitment to buying domestic in the form of very large orders. For instance if the HAL Tejas was firmly committed to in the high hundreds, it is conceivable that GE could be enticed to set up a subsidiary in India fabricating various engines for this procurement. Moreover with an assured engine sourced domestically, the HAL Tejas immediately becomes rather attractive for exports to a number of countries looking for a cheap and easy to maintain fighter. What is being illustrated is the kind of possibilities that can be opened up if there is domestic clarity on the future of the Indian defence sector. Obviously the need of the hour is to design proper export norms for Indian weapons besides setting up a defence technology commission as recommended by the Rama Rao committee. Ultimately getting the best out of 'Videshi' requires a hard core 'Swadeshi' mindset.
For updates follow Saurav Jha on twitter @SJha1618. Send your feedback to geekatlarge1618@gmail.
