The defence sector occupies a huge space in India’s long term strategic planning and government is leaving no stone unturned for tapping its potential. It allowed 100% FDI in the sector, and investments allowed by foreign companies into venture capital funds as part of their offset discharge obligations.
Despite criticism from opposition parties this is one of the biggest gamble the government has taken in its “Make-in-India” initiative. It will bring along technology, skills, jobs and prosperity. However, the 100% FDI does not mean automatic approval to establish industry in India. Government approval will still be for FDI above 49%. Only the earlier mandatory requirement for a state-of the art technology has been done away with.
The government has been aggressively pursuing global defence manufacturers to set up industry. The earlier cap of 49% FDI under the direct route, with FIPB approvals would have meant no management control of the Indian entity that they create with an Indian partner. The provision was not encouraging enough as Indian companies partnering with global firms were not too keen on giving up the management control of the joint ventures. Further, the 49% relaxation was allowed on a case-to-case basis and was dependent on the technology that the global company would have got to India.
The key benefit that will accrue because of the 100% FDI is technology transfer which will have a spillover effect in terms of employment, enhancement of skills set, etc. The benefit to the foreign company comes as a huge opportunity to manufacture products in India, which has cheap labour supply and a vast pool of engineers. The return however, will come with a huge gestation period.
Policies for investing in VCs for defence have been in discussions since 2007. In 2009, “The India Rising Fund” was announced by the government for Micro, Small and Medium Enterprises (MSMEs) engaged in defence sector. However, it was put on hold due to non-clearance from ministry of defence (MoD). Recently, MoD has floated a concept note which states that foreign original equipment manufacturers (OEMs) will be allowed to discharge part of their offset obligations through investment in MoD approved VC funds. These, in turn, would be allocated to MSMEs working on defence equipment manufacturing or research and development (R&D).
Currently, MSMEs are unable to mobilise funding as these enterprises are in nascent stage. VCs with their expertise in fund management can assist MSMEs in accessing capital and using it for their manufacturing and R&D activities. The government has estimated multi-billion dollar potential for such VCs in the coming five years. There are some clear advantages of investing via Vcs. In the case of VC investment via OEMs, there is no bureaucratic involvement and funds can reach MSMEs directly. However, there are certain concerns as well. The impact on MSMEs is a function of the size of investment that reaches them. While VC funding will initiate flow of capital into MSMEs, they will be restricted by a cap of 49% in the defence sector. Further, to get quicker returns, VCs may channel their funding into manufacturing companies and not R&D companies.
To ensure checks and balances, the concept note will enforce conditions like:
* OEMs will have the option to invest in VC funds duly registered with Securities and Exchange Board of India (Sebi)
* Foreign companies can invest up to 25% of their offset obligations in such funds
* Capital won’t be repatriable. Only emanating dividend from investment will be
In India’s quest to become a global leader, this move will prepare the Indian defence sector for a quantum leap.
The author is senior fellow, Pahle India Foundation. Views are personal