In line with the 2020 revised FDI rules, GoI permitted foreign OEMs to bid for defence contracts through 74% majority-held JVs with local partners. GoI expected huge FDI inflows, and that foreign OEMs would set up JVs to manufacture and sell weapon systems. Hasn’t happened.
The challenge for foreign defence OEMs to manufacture here centres on three issues:
- Investment While FDI cap has been raised to 74%, GoI’s most preferred category, ‘Buy (Indian-Indigenously Designed, Developed and Manufactured)’ is restricted to 49% foreign ownership. 74% FDI is not enough. Foreign OEMs are hesitant to transfer cutting-edge weapons tech to India without 100% ownership and control.
- IP challenge Policy relating to ‘Buy (Indian-IDDM)’ requires local partners to either purchase IP rights from foreign OEMs, or own the system-level design rights. This presents two challenges for foreign OEMs who are either unwilling to sell IP of advanced weapon systems or, in some cases, unable to sell it as IP resides with foreign govts than OEMs.
- Indigenous content (IC) rule This mandates that 50% of the contract value be locally sourced. This forces foreign OEMs to restructure their global supply chains for local manufacturing, a deterrent, especially under FDI and IP restrictions.
These 3 ‘I’s particularly impact 44 government-funded Make-1 projects under ‘Buy (Indian-IDDM)’. Despite these projects’ dependence on foreign collab, no foreign defence OEM has participated in it.
Foreign OEMs are confined to the role of a tier-1 tech partner to the Indian defence contractor, limiting their contribution to India’s defence manufacturing capabilities. Despite policy reforms allowing increased FDI, foreign OEMs in JVs have also shown no interest in raising their foreign shareholding from 49% to 74%. This must change.
Breaking this impasse requires a paradigm shift, allowing foreign defence OEMs to be the main systems contractors manufacturing in India with full ownership and control. This is possible under the Defence Acquisition Procedure (DAP) 2020 policy framework if 100% FDI wholly-owned subsidiaries of foreign OEMs are deemed to be Indian vendors, without mandating ownership and control by resident Indian citizens.
Such an approach would enable Indian subsidiaries of foreign OEMs from trusted partner countries to locally bid for weapon systems contracts and ‘make in India to sell in India’. Through these subsidiaries, foreign OEMs could make substantial investments, transfer advanced weapons tech, create local manufacturing capabilities and generate jobs. This is permitted in relation to providing defence services but not for manufacturing weapon systems. This approach may also position India as an exporter of weapon systems to friendly countries.
GoI may be thinking along these lines. Recently, a foreign defence OEM has received approval to set up a 100% FDI wholly-owned subsidiary for manufacturing weapon systems. This is the first government approval since 2014, when the 100% FDI policy on a case-to-case basis was introduced.
Although the subsidiary is expected to manufacture only for exports, it will be watched. GoI also introduced a new procurement category, ‘Buy (Global-Manufacture in India)’ in DAP 2020. This allows foreign OEMs to bid for contracts from outside India while permitting manufacturing here through wholly-owned subsidiaries. Although the new category is expected to be in relation to the indigenisation of spares, no programmes have been identified.
The liberalised FDI framework would incentivise foreign defence OEMs to bring their global tier-1 and tier-2 suppliers to India to partner with Indian companies to meet IC conditions. This integration would strengthen local manufacturing capabilities at the subsystem and component levels, develop robust defence tech supply chains, and enhance control and security of supply.
Prioritising IC over IP, with IC increasing to 80% and eventually 100% without any IP restrictions, would build resilience against geopolitical uncertainties and supply chain disruptions. With their extensive experience and established networks, foreign OEMs are best positioned to drive this.
These regulatory changes should not only result in higher defence-related FDI flows into India but would also help accelerate aatmanirbharta in defence. The forthcoming DAP in 2025 presents an opportunity to implement these reforms.