India shares a 3,323km land border with Pakistan, and an even longer 3,488km border with the People’s Republic of China (PRC), and has territorial disputes with both countries over the ownership of the Northern State of Kashmir and the North Eastern State of Arunachal Pradesh, respectively. Indian military planners consider worst scenario as a two-front war along with another “internal security half-front” comprising of Kashmiri militants disrupting lines of communications in the interior.
Indian military’s missions include border protection, warfighting preparations and stocking, counter-insurgency, maritime domain protection, out of area contingencies and humanitarian aid and disaster relief (HADR). These factors have played a crucial role in spurring growth in Indian base defense expenditure (excluding pensions) over the historic period, which increased from US$39.3 billion in 2016 to US$47.3 billion in 2020, reflecting a CAGR of 4.80% over the historic period. However, as a percentage of overall government spending, defense allocations have fallen steadily from 17.7 percent in 2017-18, to 16.5 percent in 2018-19, to 15.5 percent in the current year.
Between 2014-2018, India was ranked as the second largest importer of defense equipment, behind only Saudi Arabia. The acquisition of defense equipment is mainly driven by the need to gain a significant technological advantage over Pakistan, while retaining a level of strategic parity with respect to China. There is a slow ongoing shift away from Russian military hardware to the procuring systems from other countries including France and the United States.
As India faces complex security threats, the government has firmed up a mega plan to spend $130 billion to modernise the armed forces to bolster combat capability of the armed forces over rivals in the region in the next five to seven years, according to an official document. Sources said government is aware of China significantly ramping up its air and naval powers, adding the aim is to equip both the the Indian Air Force and the Indian Navy with capabilities at par with its adversaries.
The plan includes procurement of a range of weapons, missiles, air defence systems, fighter jets, submarines and warships, drones, surveillance equipment and developing infrastructure for extensive use of artificial intelligence, official sources said. They said the government’s immediate priority is to fast-track infantry modernisation, including procuring 2,600 infantry combat vehicles and 1,700 future ready combat vehicles for the Indian Army. The Indian Army Modernization with an explicit emphasis on development and induction of new wheeled armored vehicles and the Futuristic Infantry Fighting Vehicle (FICV) program will drive the Indian Army defense modernization spending. India is expected to procure and invest in segments such as multirole aircraft, frigates, destroyers, corvettes, submarines, tanks, artillery guns, multi-barrel rocket launchers (MBRL), helicopters, surface-to-air missiles and unmanned aerial vehicles (UAV).
Another key priority is to procure 110 multirole fighter aircraft for the IAF. A large number of Tejas fighters are needed to replace the IAF’s obsolescent MiG-21 and MiG-27 fighters, most of which have retired without replacements. The IAF’s current strength of 30 squadrons is accepted even though 42 fighter squadrons are assessed as the minimum needed for a two-front war. The IAF also badly needs more force multipliers, particularly air-to-air refueling tankers and airborne warning and control systems (AWACS).
The government is also working on a mega defence project to make the airspace over almost all its major cities, including Delhi and Mumbai, virtually impregnable, the sources said. It is also inducting the first batch of its intercontinental ballistic missile system — Agni V — which is expected to significantly bolster the country’s air defence system. The missile, with a strike range of 5,000 km, is capable of carrying a nuclear warhead. Very few countries, including the US, China, Russia, France and North Korea, have intercontinental ballistic missiles. In its missile armoury, India currently has Agni-1 with a 700 km range, Agni-2 with a 2,000-km range, Agni-3 and Agni-4 with 2,500 km to more than 3,500-km range.
Indian Navy which accounts for the smallest portion of defense capital spending is anticipated to focus on modernization of its submarine arm and induction of new minesweepers. the Navy has already finalised a plan to have 200 ships, 500 aircraft At present, the Navy has around 132 ships, 220 aircraft and 15 submarines.
To bolster its operational capability, navy’s Maritime Capability Perspective Plan – 2012-2027 envisions a force of 200 warships, 500 aircraft and 24 attack submarines in the next 3-4 years to control its Indian Ocean in the face of encroachments from Pakistan and China. However the navy currently operates just 140 warships and 220 aircraft. The navy, which aspires to be a key security provider in the Indian Ocean, needs more surveillance assets, including satellites, long-range shore-based radar, and long-range maritime surveillance aircraft such as the manned P-8I Poseidon and the unmanned Sea Guardian drone. Its surface warship fleet is badly short of helicopters for anti-submarine and airborne early warning roles. Also essential is a line of six nuclear attack submarines (SSNs) that are under development, but could take another decade to enter service. A third aircraft carrier is proposed to be built indigenously but is awaiting official sanction.
The sources said the CDS will play a key role in implementing the modernisation drive in the three forces. The sources said establishing India as a military power in the outer space will be another key aspect of the plan. On India’s independence day, August 15, 2019, Prime Minister Narendra Modi announced the government would appoint a Chief of Defense Staff (CDS), a single point commander for all three services.
Increasing Foreign Direct Investment limit in defence manufacturing from 49 per cent to 74 per cent under the automatic route, creating a negative list for imported weapons, a separate budget for Indian-made defence equipment and the corporatisation of the Ordnance Factory Board have been announced by the Narendra Modi government as part of the stimulus package to counter the Covid-19-affected economy. The amended rules are aimed to boost the ‘Make in India’ programme, attract private sector in defence production and reduce the import bill on weapons purchase.
Changes in FDI Policy and its impact
India gives orders worth $100 billion a year for defence procurement, making it one of the world’s lucrative markets for defence companies. Net FDI inflows grew 14.2 per cent in 2018-19. The top sectors attracting FDI equity inflows are services, automobiles and chemicals. To make the defence sector more attractive for foreign investors, the Indian Government raised the sectoral cap on foreign direct investment (FDI) from 49 to 74 per cent. The decision was notified by the Department for Promotion of Industry and Internal Trade (DPIIT) via Press Note 4 on September 17, 2020.
A new condition imposed on all foreign investments, and not just those exceeding 49 per cent, is that these will be subject to scrutiny on grounds of national security and the government reserves the right to review any foreign investment in the defence sector that affects or may affect national security.
Defence Industry in India is subject to Industrial License under the Industries (Development & Regulation) Act, 1951 and manufacture of small arms and ammunition under the Arms Act, 1959. The defence sector was opened to the private sector and FDI up to 26 per cent via the government route was allowed in 2001. Faced with the foreign investors’ persistent disinterest, the government decided in 2013 to allow higher investment where it provided access to the modern and state-of-the-art technology but it required approval of the Cabinet Committee on Security (CCS). This and subsequent relaxations in the FDI policy failed to generate the investors’ interest.
Previously, India had relaxed foreign direct investment norms in defence sector, doing away with the clause that allowed only “state of the art” technology to be considered for stakes of more than 49% and thereby giving the government more power to decide on investment proposals by foreign entities. Under earlier policy, the government kept the FDI limit unchanged – at 49% under the automatic route and 100% under approval route – it ushered in a major boost to the small arms manufacturing sector.
DIPP vide Press Note No. 5 of 2016 Series dated 24/06/2016 notified review of Foreign Direct Investment (FDI) Policy on various sectors which includes conditions related to FDI in defence at Para 5 of the said Press Note. According to the revised guidelines, Foreign Direct Investment Cap is 100%. Foreign Direct Investment up to 49% is allowed through automatic route and above 49% under government route wherever it is likely to result in access to modern technology or for other reasons to be recorded. The other conditions governing FDI Policy in defence manufacturing sector as notified in the Press Note 5 of 2016 Series dated 24/06/2016 are as under:
- Infusion of fresh foreign investment within the permitted automatic route level, in a company not seeking industrial licence, resulting in change in the ownership pattern or transfer of stake by existing investor to new foreign investor, will require Government approval.
- License applications will be considered and licenses given by the Department of Industrial Policy & Promotion, Ministry of Commerce & Industry, in consultation with Ministry of Defence and Ministry of External Affairs.
- Foreign investment in the sector is subject to security clearance and guidelines of the Ministry of Defence.
- Investee company should be structured to be self-sufficient in areas of product design and development. The investee/joint venture company along with manufacturing facility, should also have maintenance and life cycle support facility of the product being manufactured in India.
Further, subsequent to abolition of the Foreign Investment Promotion Board (FIPB) by the Government vide O.M No. 01/01/FC12017-FIPB dated 05.06.2017, the work of granting approval for foreign investment under the extant FDI Policy, has been entrusted to the concerned Administrative Ministries/Departments. The Department of Industrial Policy & Promotion, Ministry of Commerce & Industry has been given the responsibility of overseeing the applications filed on the Foreign Investment Promotion Portal (FIFP) and to forward the same to the concerned Administrative Ministry. DIPP has finalized a Standard Operating Procedure (SOP) for examination of foreign investment proposals by Administrative Ministries.
After opening up the sector for Indian private sector participation, 42 FDI proposals were approved in defence sector for the manufacturing of various defence equipment. The government also issued 439 industrial licenses to private companies till March 2019 for the manufacturing of a wide range of defense items. But, to date no big-ticket MNC investments have been made in India, barring few offset contracts by Indian companies for MNCs. In 2016-17, India failed to attract any FDI in defence. In 2017-18, it received $0.01 million, and in 2018-19 that stood at $2.18 million.
Experts said the Indian defence sector has a huge potential to attract FDI but with the current FDI limit of 49 per cent, the overseas investors were not comfortable sharing their technology without having the majority stake in the Indian JV company. A study has suggested that a minimum of 51 percent FDI must be allowed in defence sector without any conditions so that global players can exercise adequate control over joint ventures that will bring in capital for establishing new facilities and scaling up the current ones while benefiting India through large scale job creation. The increase in FDI limit to 74 per cent is good, because without having the control of the company, being liable for the quality and performance of the product was an issue for foreign original equipment manufacturers (OEM).
The DPIIT statistics show that the total investment received in the defence sector since 2001 rose marginally from Rs 25.63 crore at the end of June 2018 to Rs 56.88 crore by June 2020.It does not amount to even 0.01 per cent of the total FDI received by India between April 2000 and June 2020, though in the process defence has climbed one notch to become the third least attractive sector for foreign investment; the laggards being Mathematical, Surveying and Drawing Instruments, and Coir Sectors in that order.
Not only has India failed to attract FDI in defence, but it has also failed to attract any substantial private sector investments. India is notorious for delays in taking decisions, placing piecemeal orders, cancelling tenders and unreasonable qualitative requirements by the armed forces. Private companies that have invested in defence production hoping for government support have been left disappointed. From warship building to Howitzers, they have suffered due to the lack of orders or small orders. An example of this is the K-9 Vajra self-propelled Howitzer being manufactured by Larsen and Toubro, whose factory in Gujarat was inaugurated by PM Modi. In the absence of new orders, the production line will go idle after the last of the 100 guns on order is delivered later this year. The total requirement was projected to be at 250 guns. Recently, a private company, Tonbo Imaging, wrote an open letter to PM Modi lamenting cancellation of orders and delays in making payments. Such policies even hurt the DPSUs.
Amit Kalyani, deputy managing director at Bharat Forge, said the higher FDI in defence will take the Make in India journey a step further. “It will create larger technology capability, overall competitiveness in order to sell solutions not only in India but also for exports. It’s a plus for the whole ecosystem. We have relationships with various partners across the world. The move will allow them to step up their technology deployment. Once the lockdown is over, we can quickly chalk a strategy that enables us to take benefit of the relaxation in the FDI norms,” said he.
Further, the government also cleared ‘strategic partnership’ policy to create a vibrant defence manufacturing ecosystem in the country through involvement of both the major Indian corporates as well as the MSME sector. Under the policy, selected private firms will be roped in to build military platforms like submarines and fighter jets in India in partnership with foreign entities. It said the government must restore and strengthen tax incentives for R&D activities to encourage investments in technological innovations by MSMEs. Given the industry is extremely capital-intensive, steps towards creating infrastructure and policy environment would propel growth of small and medium enterprises.
Experts said this will finally kick start the production of advanced defence systems in India. “Control over technology and manufacturing quality were the big concerns of foreign companies which should stand substantially addressed with this move,” said Anuj Prasad, Partner & Head, Defence, Cyril Amarchand Mangaldas.
The current defence procurement procedure has the provision under ‘Buy Indian-IDDM (Indian Designed, Developed and Manufactured)’ category. There is also ‘Buy Indian’, and ‘Buy and Make Indian’ categories. Perhaps this can be simplified to ‘Made in India’ and ‘Make in India’ with the former being Indian design and manufactured and the latter being a foreign design manufactured in India under joint venture or fully OEM owned.
Indian Joint ventures
India has so far approved more than 40 joint ventures and foreign direct investment proposals with foreign companies to manufacture defence equipment in the country. These joint ventures include both public and private sector Indian defence manufacturer. Government policies and initiatives encourage all foreign companies including Russian companies to set up their manufacturing facilities in the country through partnerships and joint ventures with Indian companies, Shripad Naik, minister of state for defence, informed the Lok Sabha in Nov 2019.
Many defence offset JVs are already underway or on the anvil in India: between HAL and SNECMA of France; Lockheed Martin (USA) and Wipro Technologies; Boeing and Tata; Thales and Samtel Group (France) with an Indian company; TCS and SAAB; L&T and DRDO; Dassault Systems (DS) and Cummins Info Sys Ltd; Wipro and GE Security (USA); Taneja Aerospace and TIDCO; HAL and CAE (Canada); SAERTEX and KEM – ROC; Sikorsky and Tata Advanced Systems; Airbus, Airspace Infrastructure Ltd and Airlogic Ltd; Wipro and CAE (Canada); BEL and Surinam Armed Forces; Rolls Royce and HAL; M&M Ltd and BAE; L&T and Cassadian; Augusta Westland and Tata Sons Ltd, and: between L&T and Europe’s EAD.
Ray Challis, Head of Sales and Marketing for UK-based Ultra Electronics, says the company has already signed an MoU with Mahindra Defense for manufacturing systems for the Indian Navy. “Ultra is a pioneer in precision control system and has a global supply chain. We are willing to bet on a 100-percent transfer of technology if need be. India has problems that we have already solved in Brazil and the US and it is our endeavor to partner with local companies here in India,” Challis told at Aero India 2017 UK Pavilion. Israel and India are deepening defense industry ties as Israeli companies seek long-term partnerships through India’s efforts to encourage products to be locally produced under joint ventures.
Israel Aerospace Industries and India’s Bharat Electronics Limited have signed a memorandum of understanding to establish a new center for technical and maintenance support for India’s air defense systems. In addition, IAI signed a strategic collaboration memorandum with Indian firms Hindustan Aeronautics Limited and Dynamatic Technologies Limited to work on UAVs that will be made in India. Elbit Systems sees India is a strategic market, noting that it is “involved in a range of programs across the Indian defense sector.” Rafael Advanced Defense Systems said it has been doing business in India for more than two decades “supporting the Indian Armed forces with state-of-the-art systems.” The ecosystem built by joint ventures between Israeli and Indian defense companies is complex and involves sensitive defense technology, know-how from which India hopes to acquire to lessen its dependence on foreign defense imports.