FDI taking up arms in the defence sector

India’s defence sector has long been a government-controlled industry with limited private sector participation. However, the need for modernisation, self-reliance and defence exports has led to significant reforms to attract FDI. FDI of 74% is now allowed under the automatic route and 100% through the government route on a case-by-case basis. This encourages foreign companies to establish themselves in India and collaborate with local companies.

The defence sector saw USD3.21 million in FDI in 2023. To boost the domestic industry, the Defence Research and Development Organisation (DRDO) of the Ministry of Defence has introduced schemes and policies such as the Technology Development Fund (TDF) and transfer of technology (ToT). The policies provide transparency, fair competition and level the playing fields for private industries, encourage foreign investment and the ease of doing business.

Private industries manufacturing defence equipment require industrial licences under the Industries (Development and Regulation) Act, 1951. The recent reforms have rationalised the list of products and have scrapped the requirement for many types of equipment. Licence validity under the act has been increased from three years to 15 years, with a further extension of three years on an individual basis. An online application portal has resulted in faster approvals and an increase in the number of licences granted with 523 having been issued.

To encourage investment, the government has made the offset policy flexible. The policy requires foreign vendors to plough back a percentage of the contract value into the defence sector. Under the amendment, original equipment manufacturers (OEM) are allowed to provide details of Indian offset partners after the signing of contracts. Greater transparency, efficiency and accountability have been created by an offset portal with a dispute settlement mechanism involving independent monitors.

Some USD12 million has been allocated to the TDF to enable the localisation of defence products. The fund will cover up to 90% of project costs. Applicants must be registered under Indian law, and be owned and controlled by Indian citizens. However, foreign investment of up to 49% is allowed.

The ToT policy seeks self-reliance through strategic partnerships between Indian companies and foreign OEMs by sharing technical knowledge and expertise. This will reduce dependence on imports and promote the export of Indian defence equipment. The DRDO provides technical knowledge and support either free or at minimal cost.

The DRDO has a significant portfolio of defence patents and grants non-exclusive licences to public and private companies with minimal fees and royalties. This encourages technology transfer and incentivises companies for further development and production by the use of these technologies.

The DRDO has issued a Positive List forbidding the import of some high-technology weapons systems such as artillery, assault rifles, transport aircraft and light combat helicopters. This allows industry, including the private sector, to manufacture such products within the country and promotes exports.

The government has established two defence industrial corridors in Tamil Nadu and Uttar Pradesh. The first includes five nodes and the second connects six. Nodes have been selected because of existing infrastructure and human capital. Many local and foreign businesses have invested in these corridors. Safran of France is collaborating with Hindustan Aeronautics to produce helicopter engines. Boeing, from the USA, is partnering with Mahindra Aerospace in aerospace manufacturing. Israel Aerospace Industries is partnering with Bharat Electronics for production of short-range air defence systems. By April 2023, the corridors had attracted investment of USD700 million, a figure likely to be USD75 billion by 2025.

To promote exports, the government has launched the Open General Export Licence, a one-time permit allowing specified items to be sent to specified destinations. As India encourages a self-reliant defence sector, aiming to be a leading exporter, it is opportune for foreign investors to collaborate with local industry. The government has rolled out attractive policies and incentives, including relaxed FDI regulations, reforms and infrastructure support to boost manufacturing.

Pradeep Jain is the managing partner and Apeksha Lodha is a partner at Singhania & Co.