Foreign Investment in the Indian Defence Sector
Shivpriya Nanda and Zain Pandit, partners at JSA, explore the options available to foreign investors in the Indian defence sector and the relationship between a government push to drive the growth of indigenous defence manufacturing and the relaxation of foreign investment thresholds in the sector.
The drive to indigenise the Indian defence sector
On 30 November 2023, the Defence Acquisition Council (DAC) of the (Indian) Ministry of Defence (MoD) approved acquisition proposals worth approximately USD2.65 billion – 98% of which will be sourced from indigenous suppliers.
In August 2023, the DAC approved four procurement proposals worth approximately USD930 million. All the proposals were from indigenous suppliers.
In the last three financial years, 122 contracts have been signed for (capital) procurement of defence equipment and platforms, out of which, 100 contracts (accounting for 87% of all contracts) have been signed with indigenous suppliers. For financial year 2023–24, funds have been earmarked in the ratio of 67:33 between domestic and foreign procurement.
“Defence manufacturing remains one of the few non-prohibited sectors that is subject to sectoral conditions and approvals.”
The government of India (GoI) has also created four “positive indigenisation” lists for defence equipment and platforms. Equipment and platforms falling in any of the lists cannot be imported into India.
GoI’s intent is clear – it wants to indigenise defence manufacturing and no longer be reliant on imports.
Against this backdrop, GoI’s Foreign Direct Investment Policy (FDI Policy) plays a pivotal role. A foreign original equipment manufacturer looking to participate in GOIs push for indigenous procurement will need to understand and navigate the FDI Policy.
The policy framework for investment in the Indian defence sector
The FDI Policy sets out the framework for foreign investment in India. It categorises foreign investment into three categories: (i) “prohibited”, (ii) the “Government Route”, and (ii) the “Automatic Route”. While prohibited is self-explanatory, the Government Route entails the prior approval of the concerned Ministry of the GoI and the Automatic Route requires no prior approval of the GoI.
Defence manufacturing remains one of the few non-prohibited sectors that is subject to sectoral conditions and approvals. The conditions specified in the FDI Policy are limited to the manufacturing of, (i) equipment and platforms that require an “Industrial Licence” under the Industries (Development & Regulation) Act, 1951 (the “IDR Act”); and (ii) small arms and ammunition under the Arms Act, 1959 (the “Arms Act”).
If the equipment and platforms fall outside the scope of industrial licensing under the IDR Act or the Arms Act, then the foreign investment will fall under the Automatic Route and nothing set out below will apply. However, if the foreign investment meets the criteria set out above, then the following conditions will apply:
- Foreign investment up to 74% will fall under the Automatic Route – foreign investment beyond this threshold (up to 100%) will fall under the Government Route if it is likely to result in access to modern technology or for other reasons recorded (more on this below).
- Foreign investment up to 74% under the Automatic Route will be permitted for companies seeking new industrial licences.
- Infusion of fresh foreign investment, up to 49% in an entity that is not seeking a new industrial license or which already has GoI approval for foreign investment in defence manufacturing, will be required to satisfy additional conditions (also, any proposal for raising foreign investment beyond 49% will require GoI approval).
- Foreign investment in the sector is subject to security clearance by the Ministry of Home Affairs and as per prevailing guidelines of the MoD.
- The Indian entity should be self-sufficient in the areas of product design and development.
- In addition to its manufacturing facility, the Indian entity should have a maintenance and life cycle support facility for the equipment and platforms being manufactured in India.
- Any foreign investment in the defence manufacturing sector will be subject to scrutiny on the grounds of national security and the GoI has the right to review any foreign investment in the defence manufacturing sector that affects or may affect national security
SAAB become the first overseas entity to receive approval to set up a subsidiary in the defence manufacturing sector
It is worth noting that foreign investment up to 100% in the defence manufacturing sector was first permitted in 2016. At that time, foreign investment up to 49% fell under the Automatic Route and beyond 49% was placed under the Government Route. In 2020, the Automatic Route threshold was increased to 74% and any foreign investment beyond that was under the Government Route. Despite the relaxations in 2016 and 2020, October 2023 was the first time an overseas entity received GoI approval for setting up a wholly owned subsidiary in the defence manufacturing sector. Sweden’s SAAB is the first overseas entity to receive GoI approval for setting up a wholly owned subsidiary that will undertake the manufacturing of defence equipment and platforms which require an Industrial Licence. Given this development and the GoI’s push for indigenisation, the FDI Policy on manufacturing in the defence sector is likely to become a focal point for foreign original equipment manufacturers.
JSA
