India is the second largest importer of arms and armaments. The majority of the country's military requirements are met through procurement from the foreign defence manufacturers. With a view to encourage domestic manufacturing and reduce its reliance on imports, Indian government has launched its flagship and ambitious 'Make in India' Initiative.
While India had opened the doors of the defence industry for the private sector in 2001, the foreign direct investment (FDI) was permitted upto 26% only for defence manufacturing. Further, prior government approval was required for FDI in defence. During the period from 2001 to 2014, a total FDI inflow of about INR 14 billion was reported. Since the change of guards in the Indian government in 2014, the defence industry has witnessed a series of reforms including the enhancement of FDI limit for the defence manufacturing activities, relaxation in licensing regime, focus on indigenisation of imported spares and putting embargo on import of certain weapons/platforms.
The first major reform was the liberalisation of the FDI limits. While, in 2014, the Indian government raised the FDI limit from 26% to 49%, the foreign investors were still required to wait for the prior government approval. As a result, not many players were keen to invest in India's defence industry despite the huge opportunities and potential available in this sector. Therefore, the Indian government announced a paradigm shift in its policy in 2016 and allowed FDI upto 49% in defence manufacturing without any government approval. FDI beyond 49% was allowed with the prior government approval subject to the condition that such investment must result in access to the modern technology.
With equity ownership capped at 49%, the foreign original equipment manufacturers (OEMs) had concerns regarding transfer of the sensitive and cutting-edge technologies to the Indian JVs since the foreign OEMs were not able to exercise 'control'. In order to allay these concerns, the Indian government amended the FDI policy in 2020 and increased the FDI limit upto 74% without any government approval. This revised limit of 74% will enable foreign OEMs to own and control their Indian JVs. However, FDI beyond 74% would require government approval. As a result of the reforms in FDI policy, India has received a total FDI of about INR 33 billion post 2014.
Another major reform witnessed by the Indian defence industry was relaxation in the licensing regime for defence equipments. FDI in defence sector is subject to industrial licence. Prior to 2014, industrial licence was required for arms and ammunition and allied items of defence equipment; parts and accessories thereof. In 2014, the Indian government notified a list of specific items which would be subject to the industrial licence and clarified that the items/parts/components/castings/forgings/test equipment, which are not part of this list, would not require industrial license. The defence products list requiring industrial license has been pruned further.
With a view to reduce its import bills and to make India a hub of manufacturing of military platforms and equipment, the Indian government has notified the list of weapons/platforms/systems/ammunition which will be procured from the domestic players. The guidelines provide that the items falling under the positive indigenisation list cannot be procured under 'Buy (Global)' category. Further, for items being procured under Buy & Make (lndian), Buy & Make, Buy (Global - Manufacture in lndia) categories, the 'Buy' quantity will be restricted to 'Nil'. This would effectively mean that the foreign suppliers may have to set up joint venture entities in India in order to be eligible to supply these items to the Indian armed forces.
The Indian government has also introduced several new provisions in the DAP-20 (which superseded the earlier Defence Procurement Procedure-2016) in order to promote indigenous design capacity and ensure higher localisation. It has amended the definition of the 'Indian vendor' so as to encourage the participation of domestic players. In view of the revised definition, an 'Indian vendor' will have to be owned and controlled by the resident Indian citizens in case the defence equipments are proposed to be procured under certain specified categories, such as Buy (Indian-IDDM), Make I, Make II, and strategic partnership model. It implies that, the FDI (direct as well as indirect) in Indian entities which are willing to participate in the tenders floated under these categories cannot exceed 49%.
Further, in terms of DAP-2020, investments in defence manufacturing (whether through FDI or direct investment or joint ventures or through the non-equity route for co-production, co-development and production or licensed production of defence products) would also be eligible for offset.
In line with its objective to promote "Aatmanirbharta" (i.e. self-reliance) and reduce the dependency on external sources, the Indian government has earmarked 68% of the capital procurement budget for domestic industry. Recently, the Defence Acquisition Council (DAC) has accorded the acceptance of necessity for capital acquisition proposal of the Indian armed forces amounting to INR 763 billion (approx.) under the 'Buy (Indian)', 'Buy & Make (Indian)' and 'Buy (Indian-IDDM)' categories. All these measures taken by the Indian government are likely to encourage the Indian entities to indigenously design, develop and manufacture modern defence equipment and minimize India's imports of defence products to fulfil the requirement of armed forces.
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