Government likely to hike FDI in defence later this year. Driven by the urgent need to establish a strong defence-industrial base in the country, a notification to raise the foreign investment from the present 26% to 49% in the defence sector, is expected to be issued by the government later this year.

A senior ministry of defence official told FE that, ?A notification on the hike in FDI is likely by year end. Although the Economic Survey?that was tabled in the Parliament earlier this month?which has sought raise in the FDI from 26% to 49 %, has no legal binding, but it has found favour among the defence planners who have been seeking a hike in the FDI for the defence industry.?

The Economic Survey for 2008-09 had also suggested 100% FDI be permitted for high-technology defence equipment. The Survey has also suggested 100 % FDI on a case by case basis, in high technology, strategic defence goods, services and systems that can help eliminate import dependence. It is to be noted that since the opening up of defence industry for foreign participation in 2001, very little by way of FDI has entered India?s defence industry.

According to sources in the MoD ?the government is fully committed to the development of a vibrant and proactive defence industry in India. It was in May 2001 that the defence industry sector was opened up to 100% private investment, with up to 26% FDI. The defence sector till then was strictly the preserve of the public sector.?

However, the progress has been slow since then, with the Indian armed forces continuing to import the major chunk of their military hardware and software from countries like Russia, Israel, France, UK and now, increasingly the US.

It may be noted that companies, which have the state of the art technologies like Lockheed Martin, Boeing, EADS and Sikorsky etc, have also indicated major proposals for investments in India.

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?

Talking to FE, Julian Scopes?, president, BAE Systems, India, said, ?The government of India aspires to transform the defence industrial sector so that it can achieve a 70% level of self-sufficiency from domestic sources. At the same time, the government 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.?

Welcoming the recommendation that the Economic Survey had made, Scopes said, ?raising this 26% ceiling would be an important enabler in bringing about the transformation. Achieving a higher level of self-sufficiency would bring evident 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.?

?Proposal to allow 49% FDI in defence, will permit greater inflow of money to the economy which is the need of the hour for the economy and will ensure indigenisation of India?s defence imports,? Ficci president Harsh Pati Singhania told FE.

In January this year, the UK based BAE Systems and Mahindra and Mahindra set up a JV with the Indian company holding 74 % stake in the new joint venture, while BAE Systems is to hold the remaining 26 %.

Their earlier application for 51:49 joint venture was rejected by the FIPB. While no specific reason was cited by FIPB, the proposal was rejected on ?technical grounds? that the proposed JV was not consistent with FDI guidelines for defence industry.

The contribution from international defence majors in the form of both capital and technology has the potential to enhance the ability of private sector that in turn would contribute to India?s defence industrial capability. The present policy of FDI for defence sector does not allow this to happen.

Indian forces are also the world?s largest importer of defence equipment, with their hardware arm importing goods worth $6 billion. The defence sector spending is expected to increase from 2.8 % to 3 % of the gross domestic product (GDP), which could be utilised to finance additional capital outlays for modern equipment. The defence offset policy is expected to bring in $10-billion during the 11th Five-Year Plan period as every foreign firm involved in the defence deals is required to spend 30% of the value on offset goods or services purchased from Indian defence companies.