Saturday, August 22, 2009

Lack of incentives driving away FDI in defence sector

Pitching for raising foreign direct investment limit to 49 per cent in the defence sector, a study on India's military exports has said global players are reluctant to fund the industry in the capital-intensive sector due to lack of incentives. "The raising of the FDI limit to 49 per cent would go a long way in reducing the risk of Indian companies besides providing them an opportunity to access technical and managerial skills of the foreign companies to rise up the global value-chain rapidly," a joint study by industry body Assocham and research firm Ernst and Young said.

Noting that the existing policy permitted 26 per cent FDI in the defence sector, the report said it did not provide foreign investors incentives with respect to capacity expansion, buy-back guarantees and exports, while subjecting them to purchase and price discriminations vis-a-vis public sector enterprises.

"Given these constraints, major investors are reluctant to invest in Indian companies where they would have little control. Once permitted to increase the FDI limit to 49 per cent, foreign companies will have clear incentives to invest, enabling Indian companies to be part of their global supply chain," it said. If the intent of opening up defence production to private sector in 2001 and allowing FDI was to recognise the private sector's potential to contribute meaningfully to the material cause of the armed forces, the government must ensure the ability is not handicapped, the study said.

"Only returns from investment can guarantee survival of the private sector," the Assocham-Ernst and Young study said, adding that the defence industry being primarily single consumer-driven and highly capital-intensive, the private sector was at a greater risk, which is compounded by little experience and technological know-how. "Arguably, the contributions from international defence majors in the form of both capital and technology can enhance the ability of Indian private sector, which in turn would contribute to India's defence industrial capability and exports," it said.

Ruing that the defence public sector undertakings (DPSUs) continued to be preferred over private players despite policy initiatives in Defence Procurement Procedure (DPP) 2008, the study argued that the protection of DPSUs and Ordnance Factories Board (OFB) from domestic players should be progressively withdrawn.

Favouring early declaration of Raksha Udyog Ratnas among private sector for at-par treatment with DPSUs, the report said the competitiveness would provide Original Equipment Manufacturers (OEMs), their tier 2 and tier 3 vendors an opportunity to work with the Indian private sector in the defence industry. However, there was a need for an appropriate platform for interaction between potential offset partners, the 10-page study report said.

"In the offset policy lies the challenge whereby private industry will have to be prepared to absorb technologies and engineering skills, and then manufacture components, assemble sub-systems, and systems, at a cost that is competitive, yet profitable, and then get into the global supply chain," it said.

The Indian defence production value stood at Rs 22,050 crore in 2006-07 compared to Rs 16,420 crore in 2003-04. Defence exports value was Rs 320 crore in 2006-07, compared to Rs 240 crore in 2003-04, an average of 1.9 per cent of total defence production during the period, the report said. India's defence import-export ratio too was lower than countries that have smaller defence industrial base and the quantum of exports much less than Israel, South Korea and Singapore. While Indian defence imports in 2004 were worth $2.3 billion, exports stood at $26 million. In 2008, the imports were worth $1.8 billion to a lowly $0.5 million exports.

On the offset policy in DPP 2008, it said it could act as a catalyst, as it provided equal status to the private sector to benefit from increased business opportunities, possible inflows of investment and technologies from overseas and tie-ups with major domestic and foreign defence companies.

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