Transnational Corporations Review

FDI inflows in Indian defence manufacturing

--Manuscript Draft--

Full Title: FDI inflows in Indian defence manufacturing

Manuscript Number:

Article Type: Original Article

Keywords: FDI, Defence Manufacturing, DPP, Arms and Ammunition

Abstract: India successively opened its defence manufacturing sector for foreign participation in
2001. India allowed 100 per cent domestic private sector participation and up to 26 per
cent FDI in 2001, which was earlier reserved for public sector companies.
Subsequently, several other policies were also designed to attract FDI in the defence
manufacturing sector. But, until 2020, India could attract only around US $10 million in
foreign capital in this sector. This study explores the factors that led to hesitation
among foreign investors to invest in India. The study finds a series of internal and
external factors that act as obstacles in attracting FDI in the defence manufacturing
sector in India.

Order of Authors: Rahul Nath Choudhury, PhD

Powered by Editorial Manager® and ProduXion Manager® from Aries Systems Corporation
Manuscript - anonymous

An evaluation of FDI inflows in Indian defence manufacturing

1. Introduction
India successively opened its defence manufacturing sectors for foreign participation since
2001. India allowed 100 per cent domestic private sector participation and up to 26 per cent
Foreign Direct Investment (FDI) in 2001, which was earlier reserved for public companies 1.
The foreign capitals were allowed through the government route only and both domestic and
foreign private firms were subject to compulsory industrial licensing under the Industries Act
1951. Since then through different instances, India raised the FDI limit to 100 per cent while
allowing 74 per cent under automatic route and remaining through government route2. India
further tried to incentivise foreign manufacturers through various scheme. Even after this, it
could attract only a handful of foreign companies to establish their manufacturing plants in
India in association with an Indian firm, investing only around US $ 10 million since 20013.
The available data suggest 09 foreign companies operate under the defence industry in India,
that too they manufacture only auxiliary items in collaboration with their Indian partners
which hardly require any state of art technology4. India is the second biggest importer of
defence equipment’s and spends around 3 per cent of its Gross Domestic Product (GDP)5 it
naturally raises the question of why it could not attract any big investors in this sector so far6.
Though a lot of policy initiatives like offset policy, import embargo, Make in India were
launched, the results were far from satisfactory. Thus, it becomes imperative to examine what
lagged India behind in attracting a sizable volume of foreign investment even with a
significant market. Why foreign investors hesitated to invest their capital in a market which is
the second largest recipient of FDI in the world. It warrants a scholarly investigation. The
current study is an attempt to answer these pertinent questions.

The rest of the study is organised in the following manner. The second section of the study
outlines a theoretical framework and attempts to find the fitness of the Indian economy to
attract FDI from a theoretical perspective. The next section describes how the defence FDI
policy in India has undergone successive change and was open to foreign capital
participation. The fourth section explores the current scenario in the Indian defence
manufacturing sector. This section is followed by an assessment of FDI inflows in the Indian
defence manufacturing sector, while the final section concludes the study.

2. The theoretical framework

1
Press Note no 4, 2001series. Dated- May 21, 2001.DPIIT.Ministry of Commerce and Industry. Government of
India.
2
See Consolidated FDI Policy 2016, Press Note 5 2016 series and Press Note no 4 2020 series of DPIIT.
Ministry of Commerce and Industry. Government of India.
3
See Fact sheet on FDI from April 2000 to September 2020 Ministry of Commerce and Industry. Government of
India.
4
Make India website. Available at: https://www.makeinindia.com/sector/defence-manufacturing accessed on
02.06.2021
5
Bhatnagar, A. (January 30, 2021) India’s Defence spending in 7 charts.Times of India.Available at :
https://timesofindia.indiatimes.com/india/indias-defence-spending-in-7-charts/articleshow/80600625.cms
accessed on 02.06.2021
6
Roche, E.( March 10,2020) India was world’s second largest arms importer 2015-19: Report. The Live Mint.
Available at : https://www.livemint.com/news/india/arms-imports-from-russia-decreased-in-2015-19-due-to-
drop-in-india-sales-report-11583772984894.html Accessed on 02.06.2021
The FDI theories recommend that foreign capitals tend to flow to a relatively large market with
imperfections. Hymer (1960) postulates that the existence of market imperfections will influence an
investor to make cross border investment. Extending the works Hymer (1960), Knickerbocker (1973)
also developed his theory capturing market imperfections. It has been asserted in the economic
literature that there two important motives for choosing a particular country as a location for setting
up a new facility:(a) firms seek increased access to the host country’s market; and (b) firms want to
utilize the relatively abundant factors available in that country. Commenting on the same direction,
Professor John Dunning (1977) in his seminal work identified four distinct motives of undertaking a
FDI, Viz. (a) Resource seeking, (b) Market seeking, (c) Efficiency seeking and (d) Strategic asset
seeking. Though India fulfils all the motives of investment, it specifically qualifies to attract a market
seeking investors. In market seeking investment, a firm invests in a market which is relatively big in
size with a promising growth rate and with the expectation of absorbing skilled labour; exploiting the
better supply chain or other infrastructure facilities.

Dunning also suggests location of the host economy plays a crucial role in attracting FDI. Dunning
(1979) explains the locational advantage as the preconditions for a firm to produce goods
internationally. An international firm makes an investment in a location that has an abundance of raw
materials used for production, skilled labour force with competitive wages among others. It also
investigates the strategic importance of the location e.g. distance and proximity of the country with
other important markets. A firm also examines if the host country is politically and diplomatically
aligned with other potential markets so that they can export from that country to other nearby
destinations. India also fulfils this condition of FDI inflow as it shares a very deep and close
relationship with almost all the countries in this region.

Tariff protection has long been perceived as an effective policy measure to influence foreign
investors. It has been observed, when a country applies high tariff as a trade barrier, multinational
enterprises (MNEs), faced with a choice between catering the market through export or produce in
order to ‘jump’ over the domestic tariffs. Many empirical studies support this insight as they have
found a positive correlation between the level of tariff and non-tariff protection and the levels of
inward FDI (Brainard, 1997). India levies tariffs ranging from 6 per cent to 12.5 per cent on arms and
ammunition and other related items. Though the rate is not very high, but the high value of the
defence items makes it a significant amount. Several factors influence the choice between FDI and
licensing/exports, including the local government policy, local market conditions and size, the
reaction of rival firms and the riskiness of the investment. FDI facilitates a firm to exploit its
advantages to the full so that it can capture all the rents provided by that control. It is also a concern to
the foreign enterprise that a lack of direct control will increase the risk of technology leaking to
competitors (Sodersten and Reed, 1994).

Most of the theories establish that a market like India has huge potential to attract foreign investment.
Currently, India is the second largest recipient of FDI in the world and it verifies the theoretical
arguments. Despite that, India’s performance is not satisfactory in the case of the defence industry.
One of the possible reasons behind that is losing control and technology as put forwarded by Hymer
(1976). Most MNEs hesitate to invest in a foreign country when they are very protective of their
technological know-how. Such a view is also shared by Nayak and Choudhury (2014). Defence
equipment manufacturers have very strategic designs and highly advance technology which they don’t
want to share with others at any cost. They don’t want to risk their technology by investing in a
country where Intellectual Property Rights (IPR) is not up to their expectation. This is evident from
the production network of the major defence equipment manufacturers. They have established their
plants producing critical parts of the final product only in a developed economy. Common factors
like market size, an abundance of labour etc. have not played any vital role in their investment
decision. In addition countries like the United States which is home to a large number of world-class
defence equipment manufacturer, prohibits its firms to sell or share their contemporary critical
technologies with any foreign company or nation7.

7
See for more information. https://www.govinfo.gov/content/pkg/STATUTE-90/pdf/STATUTE-90-Pg729.pdf
A lot of empirical studies also attempted to explain these critical features of the defence industry.
However, most of the studies are conducted by scholars of international studies and political science
describing the diplomatic perspective of the issue. Economist explaining the trade and investment
perspective of the issue is limited. Among them, one of the important studies is by Mohanty (20048).
Examining the current status of the Indian Defence industry, Mohanty comments that from the
beginning India quest for self-reliance in defence production. With this ambition, India reserved the
sector for public enterprises and developed a few companies as well. But to cope with the changing
global scenario it opened the sector for private participation. India’s decision to allow private
participation in the defence industrial sector is seen as a dual aim, namely to achieve much-needed
capital and production enhancement and, secondly, to open up to the external market through their
presence. Singh (20109) presents a pessimistic view about this sector to attract FDI. He opines the
removal of the investment cap will not influence a foreign investor to transfer its technological know-
how to a company where it owns a minority share. Companies procure advanced technologies
spending billions of dollars and it would not be attractive to them to invest in a minority-owned firm.
Singh (2010) argues, increasing the FDI cap will allow the foreign firms a larger share of the risks and
profits and the confidence to transfer sensitive technology to joint ventures in India. Similar views
were also expressed by Kartik (202010) advocating the removal of the ceiling in foreign ownership in
the defence manufacturing sector. He believes the dynamics of defence manufacturing is very
complex and the recent announcement in hiking FDI limits across all types of defence manufacturing
does not adequately address this complexity. It may provide a significant fillip to investments through
collaborations with Indian firms. However, foreign collaborations in technologically sophisticated
aerospace defence will find it difficult to take off.

Analysing the above literature, we find there is a dearth of academic papers exploring the economic or
trade perspective of this issue. The available studies are mostly in the form of commentaries and
opinion pieces. The scholars are predominantly favoured of removing the ceiling related to FDI. They
believe the removal of the ceiling will attract more foreign firms to make an investment in India. On
the contrary, we believe that FDI policy is not the only factors that solely responsible for shapes the
FDI inflows in an economy. Researchers have proved along with FDI policy various others policies
and factors play a leading role in attracting FDI. Only a robust FDI policy is never a sufficient
condition for attracting a higher volume of FDI inflows (Choudhury and Nayak 2019). The result of
increasing the FDI limit in India validates this argument. The existing studies fail to point out the
factors that barred India from receiving higher FDI inflows in its defence industry. This is the lacuna
in the literature that the current paper attempts to fill. In addition, the study will examine a series of
reforms in the defence sector that the government has brought in with an aim to change the current
scenario. An analysis of various initiatives in the policy spectrum is presented in the following section
of the study.

3. Evolution of Defence FDI policy in India

Since independence, India adopted an import substitution policy with an aim to develop the
indigenous manufacturing industry. Obtaining a licence under the Industries Act 1951 was mandatory
for many industries while several others were reserved for the public sector only. This policy practice
helped India to develop some of its industries well and a few strong Public Sector Enterprises
emerged from this. Foreign investment in India was not allowed until 1991. Since then, India
successively started opening its industries for foreign capital participation. However, select sectors
were still prohibited from accepting any foreign capital on the ground of national security. Defence

8
Mohanty, Deba R. (2004). “Changing Times? India’s Defence Industry in the 21st Century.” Paper No.36,
Bonn International Center for Conversion, Germany.
9
Singh Sushant k. (2010) Foreign Direct Investment in Defence Sector- Go beyond 51%.Discussion
Document.The Takshashila Institution.Banglore.
10
Karthik, P. (May 22, 2020) India’s defence FDI rules should not treat the sector as homogenous. Observer
Research Foundation.
manufacturing is one such sector. The policy shift in this regard was first noticed in 2001 when India
opened defence manufacturing with 100 per cent ownership for domestic private firms and allowed
accepting FDI up to 26 per cent11. Lists of riders were also applicable to the investors. The next
amendment in this direction took place in 2013 when the limit on foreign firms was allowed to hold
investment above 26 per cent on case to case basis if case they offer state of art technology 12. An
important point to note from this announcement is that the government did not set any upper limit for
foreign ownership if the investor is bringing in state of art technology.

In 2010 with a proposal to increase the FDI limit to 74 per cent, Department of Promotion of Industry
and Internal Trade (DPIIT) circulated a Discussion paper seeking suggestions and feedback from the
various stakeholders. The discussion paper highlighted higher ownership in defence manufacturing
firms will not bring any challenge to national security rather it would boost indigenous manufacturing
and bring competition. However, the proposal was rolled back due to strong opposition from the
Ministry of Defence.

In Union-Budget 2014-2015, the government announced that companies manufacturing defence

equipment can hold foreign capital up to 49 per cent while keeping the management control with an
Indian(s). The entire investment would be allowed through the government’s approval route.
Following this announcement, press note 7, of 2014 was issued by DPIIT giving details of the newly
amended rule. In 2014 the newly formed federal government in India partially relaxed the requirement
for obtaining an industrial licence for manufacturing select items (Rao and Dhar 2016).The Industrial
licensing policy followed further relaxations in 2015.

In 2016, India significantly departed from its earlier policy stand. First, it allowed the entire volume of
foreign capital up to 49 per cent under automatic route13. Second, it allowed 100 per cent foreign
ownership to a firm with 49 per cent allowed under automatic route and rest under government
route14. It also removed the clause to have state of art technology and introduced a term modern
technology. Notably, it did not define a term modern technology.

In 2017, India abolished Foreign Investment Promotion Board (FIPB) thereby removing a leg in the
approval process. FIPB was entrusted to scrutinise the FDI proposals before giving clearance. The
Government of India highlighted that the regime for foreign investment needs to be simpler in
execution and expeditious in the disposal. Following this, the government released a Standard
Operating Procedure on June 2017 recommending that FDI proposals will now be directed by the
Department of Industrial Policy and Promotion (DIPP) currently known as DPIIT, to the concerned
competent authority. In the case of defence, the new Competent Authority for processing of FDI
proposals has been identified as the Joint Secretary, Department of Defence Production, Ministry of
Defence. Security clearance will be sought in parallel from the Ministry of Home Affairs.

In 2020 government further relaxed the FDI limit up to 74 per cent under automatic route in defence
manufacturing15. Thus, through different policy amendments, India opened this sector for 100 per cent
foreign investment. Along with the gradual relaxation of FDI policy a few other policies were also
initiated to boost the manufacturing sector in India. National Manufacturing Policy (NMP16) launched
in 2011, Defence Production Policy 2011, Make in India introduced in 2014 are some of the crucial
policies in this regard. With so many efforts, it becomes important to understand the current state of

11
Press Note no 4, 2001series. Dated- May 21, 2001.DPIIT.Ministry of Commerce and Industry. Government of
India.
12
Press note 6 2013 series, DPIIT. Ministry of Commerce and Industry.Government of India.
13
Consolidated FDI policy, 2016, DPIIT.Ministry of Commerce and Industry.Government of India.
14
Press note 5 2016 series, DPIIT. Ministry of Commerce and Industry.Government of India.
15
Press note 4 2020, DPIIT. Ministry of Commerce and Industry.Government of India.
16
See Press No 2, 2011 Series. DIPP.Available at- https://dipp.gov.in/sites/default/files/po-ann4.pdfAccessed on
20.02.2020.
the defence manufacturing industry in India. The next section of the study will analyse this issue in
detail.
4. Overview of Indian defence manufacturing

Despite so many efforts, the Indian defence manufacturing sector could not perform expectedly.
Although there is a robust defence manufacturing sector in India, it caters only 30 per cent of its total
requirement (Behera, 2016). Several efforts have also been made during the last few years to reduce
dependence on import. Recently government banned import of more than 200 items17. It also awarded
several contracts of a huge amount to domestic firms18. India Defence Industrial Base (DIB), consist
of 52 defence laboratories and establishments under Defence Research and Development Organisation
(DRDO); and 9 defence public sector undertakings and 39 ordnance factories under the Department of
Defence Production of the Ministry of Defence. The DIB is responsible for the design, development,
production and up-gradation of various types of arms primarily for the Indian armed forces (Behera,
2016). The defence public sector undertakings contribute 79 per cent of the total production in India
which was US$ 11 billion in 2019. The figure is forecasted to reach US$ 25 billion in 202519. The
value of the production from the defence PSUs are presented in figure 1 which shows a constant rise
during the last five years.

Figure: 1 Defence Production in India by DPSUs (US$ Bil)

6.6
6.4
6.4 6.3
6.2
6.2

6 5.9

5.8 5.7

5.6

5.4

5.2
2015 2016 2017 2018 2019

Source: India Brand Equity Foundation.

Along with the public sector there is an emerging group of private manufacturing companies in Indian
defence industry. Of which 9 are foreign owned and around 100 are Indian owned ventures (Desai
2018).The foreign companies are operating in the form of joint venture with their Indian partners.
Among the joint venture prominent are, Airbus with Mahindra Defence Systems to manufacture

17
PTI (May, 31, 2021) India expands negative list for defence imports with 108 new items. The New Indian
Express. Available at: https://www.newindianexpress.com/nation/2021/may/31/india-expands-negative-list-for-
defence-imports-with-108-new-items-2310016.html accessed on 11.06.2021

18
India Brand Equity Foundation. Available at: https://www.ibef.org/industry/defence-manufacturing.aspx
accessed on 5.6.21
19
India Brand Equity Foundation. Available at: https://www.ibef.org/industry/defence-
manufacturing/infographicaccessed on 5.6.21
helicopters for the Indian Military, Boeing with Tata Advanced Systems to produce fuselages of
Apache Helicopters. Many of these private firms have secured large volume of manufacturing
contracts from government. One such major deal signed recently with Mahindra Defence Systems
(MDSL) for supply of 1,300 light specialist vehicles to the Indian Army. The contract value was US$
143.3 million20.

As aforementioned, India relies on foreign supply for 70 per cent of its total defence requirements.
The major supplier of arms and ammunition to India are US, Russia, France, Israel and UK (Behera,
2016). India’s defence import value stood at US$ 463 million for FY20 and is expected to be at US$
469.5 million in FY2121. Also India exports a small volume of defence goods. India’s defence export
was estimated to be at US$ 1.29 billion in 2019-2022. Maldives, Sri Lanka, Nepal, Mauritius were the
major destination of Indian export23.

Table1: India's Defence Trade

Major Major
Year Import Source Export Destinations
2010 2911 5
2011 3598 3
2012 4392
2013 5381 15
2014 3347 Russia, 36 Myanmar,
2015 3117 Israel, 42 Mauritius, Sri
2016 3003 US, UK 46 Lanka
2017 2909 56
2018 1485 44
2019 3075 18
2020 2799 151
Source: SIPRI Arms Transfer Database

The table above depicts Indian arms and ammunition trade with the world. The data shows Indian
trade is concentrated in a few countries. It reveals Russia and Israel are the largest suppliers of
defence equipment to India. They contribute to around 90 per cent of India’s total demand.

In the case of export, India supplies to only a few small developing countries in a very small volume.
Moreover, most of its export destinations are in the South Asian region. Interestingly India’s
defence exports for the previous year cracked the global top 25. From struggling to acquire
specialised weapon locating radars (WLRs) from the USA and Israel in the 1990s, India is now
exporting them to Armenia in a deal worth some $40 million24. India sets an ambitious export target
of $5 billion in the aerospace and defence goods and services sector annually by 2025. To achieve this

20
India Brand Equity Foundation. Available at: https://www.ibef.org/industry/defence-manufacturing.aspx
accessed on 5.6.21
21
Indian Defence Manufacturing Industry Report.India Brand Equity Foundation. Available at:
https://www.ibef.org/industry/defence-manufacturing.aspx accessed on 5.6.21
22
Indian Defence Manufacturing Industry Report.India Brand Equity Foundation. Available at:
https://www.ibef.org/industry/defence-manufacturing.aspx accessed on 5.6.21
23
Department of Defence Production, Ministry of Defence.Government of India.Available at:
https://www.ddpmod.gov.in/defence-exportsaccessed on 5.6.21
24
Singh, A. (March, 23 2020) Taking India’s Defence Export to $ 5 billion.ORF.Available at:
https://www.orfonline.org/expert-speak/taking-indias-defence-exports-to-5-billion-63599/ accessed on 5.6.21
target Government formulated the ‘Defence Production and Export Promotion Policy 2020’ to
provide impetus to self-reliance in defence manufacturing under the ‘Aatmanirbhar Bharat’ scheme25.

5. FDI inflows in Indian defence manufacturing

The FDI inflows in the Indian defence sector are really in an abysmal situation. Even after 20 years
of opening the sector to foreign participation, it could attract only US$ 10 million of foreign capital.
Further, until 2014, total investment was mere US$4.94 million which increased afterwards (Rao and
Dhar 2016). Analysing the company wise data provided by DPIIT, we find three companies have
invested more than one million in India. The majority of the capital has flown from Israel including
the three largest investments (see Annexure 1).Given the efforts made to influence the foreign
investors in defence manufacturing could not generate expected results. It should have been an
obvious decision for arms manufacturers to produce in the country that is second largest importer. But
the reality is different. It is the scenario of the country that is second largest recipient of global FDI
inflows. It offers one of the largest markets in the world, a conducive policy and well protected
investment. Yet, it could not attract any sizable amount of foreign capital in its defence sector. This
clearly reflects that the determinants of FDI inflows in the defence sector are different than that of
others. The common factor such as market size, GDP or other institutional variables does not attract
FDI in the defence sector. This has been true at least in the Indian case so far. It generates scholarly
interest to examine why the foreign investor kept them away from India. Why India performed so
poorly in attracting FDI in the defence sector while showing tremendous achievement in attracting
overall FDI inflows. The next section of the study will attempt to answer these questions.

The reasons behind India’s failure to attract FDI in the defence sector so far lies in two factors. The
first is internal and the second is external. In case of internal issue, reasons lie in its FDI policy and a
few other policies that affect foreign investment. One of the most important policies in this regard is
the Defence Procurement Procedure, 2020 (DPP).The DPP does not permit Indian companies in
which the FDI exceeds 49 per cent to bid for all acquisition programmes as prime vendors. Only an
indigenous company owned and controlled by Indians with an equity share of a minimum 51 per cent
can participate in an acquisition program as a principal vendor. DPP mandates domestic production of
aircraft, helicopters, submarines, and armoured fighting vehicles, including main battle tanks via
collaborative ventures between private Indian companies and overseas original equipment
manufacturers (OEMs). The policy condition practically limits foreign investment in a project above
49 per cent. A similar problem was also reason for hesitation among foreign investor was India’s
defence offset policy. The complexities of India’s defence offset policy is thoroughly examined by
Behra (2009) and concludes that FDI in defence, including in R&D, towards suppliers’ offset
obligation, have kept away the foreign investors from Indian market.

Indian defence import has been concentrated to two single sources, Israel and Russia. Around 90 per
cent of the items are procured from companies based in these nations. Hence, it will be profitable
only for an Israel and Russia based firm to manufacture in India given its existing business relation.
For companies based in other parts of the world, there is no attractive business opportunity in
investing in an Indian defence company or setting up a wholly owned subsidiary. Companies will not
it lucrative if there are no reasonable prospects for the investor to locally market his wares or services
or both, or to export them. (Cowshish, 2017, 202026). Further the business model of the defence
industry is different from others. In defence, first products are designed and then they find the
potential buyers. In most cases, products are produced only after securing a procurement order.
Hence, a company will not easily invest in a market that has any kind of uncertainty.

25
Indian Defence Manufacturing Industry Report. India Brand Equity Foundation. Available at:
https://www.ibef.org/industry/defence-manufacturing.aspx accessed on 5.6.21
26
Cowshish, A. (Sep. 18, 2020) Can a Higher FDI Cap for the Defence Sector Stimulate Investment? The Wire.
Available at: https://thewire.in/economy/higher-fdi-cap-defence-india-investment Accessed on 08-06.2021
Another discouraging factor in Indian defence FDI policy is over cautiousness about national security.
Foreign Investments in the Defence Sector should pass through mandatory scrutiny on grounds of
National Security. All foreign investment needs to seek clearance from the Ministry of Home Affairs
and as per guidelines of the Ministry of Defence. Government reserves the right to review any foreign
investment in the Defence Sector that affects or may affect national security. (Consolidated FDI
Policy 2020, DPIIT). Scrutiny is not an easy task when it involves complex technology. The task is
made more difficult due to the involvement of multiple ministries and agencies. Getting approval
becomes too lengthy and time consuming and also uncertain. In the past French company Direction
des Constructions Navales (DCNS) has faced such uncertainty when their proposal of 100 per cent
FDI was rejected by FIPB claiming that their technology is not modern27. Such incidences greatly
discourage foreign investors. It is also difficult to understand how importing defence equipment from
a foreign country made by a foreign company is less threat to the national security compared to
making it in India by a wholly owned subsidiary of a foreign company.

It seems India practices dual policies in the defence sector. On the one hand it is making continuous
efforts to attract foreign investors. Necessary amendments have also been made to respective policies.
On the other, India encourages public sector procurement and promotes indigenous production. It
aims to procure maximum volumes of equipment from its public sector units. It is reflected in the last
few orders by the Ministry of Defence28. It strives for self-reliance in defence sectors and designs
policies like ‘Atmanirvar Bharat’. This is logical for a country that depends on foreign companies for
70 per cent of its needs. But, the dual nature of the policy framework creates confusion among the
investors. One will never find it lucrative to invest in a market with such an ambiguous policy milieu
without any reasonable business prospect.

Along with the above discussed internal factors, a few external factors also appear to be the reason
behind the hesitance of the foreign investors to invest in India. As India buys most of its defence
equipment from Israel and Russia, it makes sense only for the Israel and Russia based firms to invest
in India. But the world five largest arms manufacturers are based in the US. India occasionally buys
arms and ammunition from the US. Manufacturing advanced defence and aerospace technologies is a
costly and complex process and required a huge investment. Hence, it is not in the business interest of
the US firms to invest in India if they do find it alluring. Moreover, the US based companies are
guided bythe United States Arms Control Export Act, 1976. This act makes it almost impossible for
the US arms manufacturers to sell or share their contemporary critical technologies with any foreign
company or nation.

Governments attempt to attract a higher amount of FDI by reducing the ownership limit is less likely
to get a positive result. The basis of this argument lies in the ownership pattern of the major arms
manufacturer and the choice of location for establishing a subsidiary. The evidence suggests the
manufacturing projects launched defence sector is very minimal and only a very small amount of
cross border Greenfield investment has taken place in the recent past. In addition, most of the
manufacturing projects are located in developed parts of the world like America and Europe (Rao and
Dhar, 2016). Arms manufacturers have always looked into developing nations as their customer and
accordingly, they have made an investment in sales and marketing. Analysing the existing data from
2000 to 2013, Rao and Dhar (2016) observes majority of the top defence manufacturers have their
subsidiaries in developed countries only. In this scenario, it will be a long shot if India can receive a
big amount from any of these major arms manufacturers.

6. Conclusion

27
Cowshish, A. (Sep. 18, 2020) Can a Higher FDI Cap for the Defence Sector Stimulate Investment? The Wire.
Available at: https://thewire.in/economy/higher-fdi-cap-defence-india-investment Accessed on 08-06.2021
28
India Brand Equity Foundation. Available at: https://www.ibef.org/industry/defence-manufacturing.aspx
accessed on 5.6.21
The above paper analysed how India gradually relaxed its defence FDI policy and for the factors that
deter India to receive a higher volume of FDI in the defence sector so far. Although India has been a
major export destination for global defence manufacturers, they never looked at India as a potential
investment destination. The primary reasons behind this are explored in the paper. The paper
highlights the common factor such as market size, GDP or other institutional variables does not attract
FDI in the defence sector. The study finds lack of synchronisation in India’s policies related to
defence production and FDI has caused confusion among the investors. A few reasons which are
beyond the control of the Indian authority are also found to be responsible for India’s failure in
attracting FDI in its defence industry. The existing scenario also suggests the defence manufacturers
are very much selective in their investment choice and they preferably invest in a developed nation.
However, this does not rule out the possibility of attracting FDI in this sector. Companies have
invested in remote Africa as well and expecting a sizable volume of investment in India is very much
logical. Further, India has opened its defence manufacturing sector to full foreign ownership only a
few years ago. And since then it has experienced a small hike in its FDI inflows, even though the
volume was negligible. We believe, attracting investment in this sector will be tough compared to
other sectors but not impossible. Sooner or later India will make it happen.
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Choudhury, R. and Nayak D. (2019). Trade and Investment in South Asia: Analysis. World Scientific.
Singapore

Cowshish, A. (2017). India–Israel Defence Trade: Issues and Challenges, Strategic Analysis, 41:4,
401-412,

Desai N. A. (2018). The Indian Defence Industry Redefining Frontiers. Nishith Desai and Associates.

DPIIT (2020) Consolidated FDI Policy 2020. DPIIT, Government of India

Dunning, J.H (1979). Explaining changing patterns of international production: In defense of the
eclectic theory, Oxford Bulletin of Economics and Statistics, vol. 41, No. 4.

Dunning, J.H. (1977). Trade location of economic activity and the MNE: A search of an eclectic
approach, in B. Ohlin, P.O. Hesselborn and P.J. Wijkman (eds.), The International Allocation of
Economic Activity. Macmillan, London.

Hymer, S.H. (1960/1976). The International Operations of National Firms: A Study of Direct Foreign
Investment. Cambridge, MIT Press

Knickerbocker, F.T. (1973). Oligopolistic reaction and multinational enterprise, Division of Research,
Harvard University, Cambridge, MA, United States

Mahajan, D. (2016). Foreign Direct Investment in Defence Sector in India: Problems and Prospects.
Journal of Commerce and Trade.Vol XI, No-1, Pp-77-84

Ministry of Finance (2014-15). Union Budget 2014-15. Ministry of Finance, Government of India

Nayak, D. and Choudhury R. (2014).A selective review of foreign direct investment

theories.ARTNeT Working Paper Series No. 143, March 2014, Bangkok, ESCAP.

PTI (May, 31, 2021). India expands negative list for defence imports with 108 new items. The New
Indian Express.

Rao, KSC.andDhar, B. (2016). India’s defence FDI Policy: Issues and Prospects. Discussion Note,
No-2020/03. May, 2020. ISID New Delhi.

Sodersten, B. and G. Reed (1994). International Economics. Macmillan Press, London.

Websites Used
Invest India- www.investindia.gov.in
Make in India – www.makeinindia.com
Brand Equity Foundation of India- www.ibef.org
Stockholm International Peace Research Institute (SIPRI)-www.sipri.org
DPIIT- www.dipp.gov.in
 Annexure

FDI inflows in Indian Defence Sector

Year FDI equity Total FDI Percentage

inflows in equity inflows share in total
Defence (INR Cr.) FDI equity
Sector inflows
2000-2005 2.36 954,815.27 0.0002
2006 00 503,573 0.0000
2007 00 654,950 0.0000
2008 00 1,595,295 0.0000
2009 00 1,309,799 0.0000
2010 00 960,150 0.0000
2011 174.4 1,599,349.20 0.0109
2012 22.10 1,215,914.41 0.0018
2013 44.72 1,294,824.81 0.0035
2014 0.04 1,753,134 2.2816
2015
(upto 4.80 1,681,922.01 0.0003
September )
Cumulative
248.42 13,523,726.70 0.0018
Total
Source:Adopted from Mahajan, D. (2016)

FDI inflow in India from 2015-2020

Country of In Rs In US$
Indian Company Origin Name of Foreign Collaborator million) million)
Bel-Thales Systems Limited France Thales Air Systems Sas 4.8 0.08
Sds Tech Solutions Private Limited Israel S.D.S (Star Defence Systtems) Ltd 2.24 0.03
M/S AdaniElbit Advanced Systems
India L Israel Elbit Systems Ltd 7.3 0.1
Kalyani Rafael Advanced Systems Rafael Advanced Defense Systems
Pvt Ltd Israel Pvt Ltd 95.02 1.29
Rafael Advanced Defense Systems
Astra Rafael Comsys Pvt Ltd Israel Ltd 159.25 2.21
M/S AdaniElbit Advanced Systems
India L Israel Elbit Systems Ltd 0.05 0
M/S AdaniElbit Advanced Systems
India L Israel Elbit Systems Ltd 134.63 1.83
South
Reliance Sed Limited Korea Eo System Co. Ltd 0.13 0
Source: SIA Newsletters, DPPIT.
 List of Indian Public Sector Defense Undertakings29
1. Airbus (France)
2. BAE India Systems (UK)
3. Pilatus (Switzerland)
4. Lockheed Martin (USA)
5. Boeing India (USA)
6. Raytheon (USA)
7. Israel Aerospace Industries (Israel)
8. Rafael Advanced Defense Systems Ltd. (Israel)
9. Dassault Aviation SA (France)

List of Defence Public sector undertakings30

1) Hindustan Aeronautics Limited (“HAL”)
2) Bharat Electronics Limited (“BEL”)
3) BEML
4) Bharat Dynamics Limited (“BDL”)
5) Mishra Dattu Nigam Limited (“MIDHANI”)
6) Goa Shipyard Limited (“GSL”)
7) Garden Reach Shipyard and Engineers (“GRSE”)
8) Mazagon Dock Limited (“MDL”)
9) Hindustan Shipyard Limited (“HSL”)

29
Make in India India, Website.
30
Department of Defence Production, Ministry of Defence.Government of India.
Manuscript - with author details

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11 FDI inflows in Indian defence manufacturing
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15 Rahul Nath Choudhury
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18 New Delhi
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 FDI inflows in Indian defence manufacturing
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5 Abstract
6 India successively opened its defence manufacturing sector for foreign participation in 2001. India
7 allowed 100 per cent domestic private sector participation and up to 26 per cent FDI in 2001, which
8 was earlier reserved for public sector companies. Subsequently, several other policies were also
9 designed to attract FDI in the defence manufacturing sector. But, until 2020, India could attract only
10
around US $10 million in foreign capital in this sector. This study explores the factors that led to
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12 hesitation among foreign investors to invest in India. The study finds a series of internal and external
13 factors that act as obstacles in attracting FDI in the defence manufacturing sector in India.
14 Key words: FDI, Defence Manufacturing, DPP, Arms and Ammunition
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 An evaluation of FDI inflows in Indian defence manufacturing
1
2
3
4 1. Introduction
5 India successively opened its defence manufacturing sectors for foreign participation since
6 2001. India allowed 100 per cent domestic private sector participation and up to 26 per cent
7 Foreign Direct Investment (FDI) in 2001, which was earlier reserved for public companies 1.
8 The foreign capitals were allowed through the government route only and both domestic and
9 foreign private firms were subject to compulsory industrial licensing under the Industries Act
10 1951. Since then through different instances, India raised the FDI limit to 100 per cent while
11 allowing 74 per cent under automatic route and remaining through government route2. India
12
further tried to incentivise foreign manufacturers through various scheme. Even after this, it
13
14 could attract only a handful of foreign companies to establish their manufacturing plants in
15 India in association with an Indian firm, investing only around US $ 10 million since 20013.
16 The available data suggest 09 foreign companies operate under the defence industry in India,
17 that too they manufacture only auxiliary items in collaboration with their Indian partners
18 which hardly require any state of art technology4. India is the second biggest importer of
19 defence equipment’s and spends around 3 per cent of its Gross Domestic Product (GDP)5 it
20 naturally raises the question of why it could not attract any big investors in this sector so far6.
21 Though a lot of policy initiatives like offset policy, import embargo, Make in India were
22
23
launched, the results were far from satisfactory. Thus, it becomes imperative to examine what
24 lagged India behind in attracting a sizable volume of foreign investment even with a
25 significant market. Why foreign investors hesitated to invest their capital in a market which is
26 the second largest recipient of FDI in the world. It warrants a scholarly investigation. The
27 current study is an attempt to answer these pertinent questions.
28
29 The rest of the study is organised in the following manner. The second section of the study
30 outlines a theoretical framework and attempts to find the fitness of the Indian economy to
31
attract FDI from a theoretical perspective. The next section describes how the defence FDI
32
33 policy in India has undergone successive change and was open to foreign capital
34 participation. The fourth section explores the current scenario in the Indian defence
35 manufacturing sector. This section is followed by an assessment of FDI inflows in the Indian
36 defence manufacturing sector, while the final section concludes the study.
37
38
39 2. The theoretical framework
40
41
42
The FDI theories recommend that foreign capitals tend to flow to a relatively large market with
43 imperfections. Hymer (1960) postulates that the existence of market imperfections will influence an
44 investor to make cross border investment. Extending the works Hymer (1960), Knickerbocker (1973)
45 also developed his theory capturing market imperfections. It has been asserted in the economic
46
47 1
Press Note no 4, 2001series. Dated- May 21, 2001.DPIIT.Ministry of Commerce and Industry. Government of
48 India.
49 2
See Consolidated FDI Policy 2016, Press Note 5 2016 series and Press Note no 4 2020 series of DPIIT.
50 Ministry of Commerce and Industry. Government of India.
51 3
See Fact sheet on FDI from April 2000 to September 2020 Ministry of Commerce and Industry. Government of
52 India.
53 4
Make India website. Available at: https://www.makeinindia.com/sector/defence-manufacturing accessed on
54 02.06.2021
55 5
Bhatnagar, A. (January 30, 2021) India’s Defence spending in 7 charts.Times of India.Available at :
56 https://timesofindia.indiatimes.com/india/indias-defence-spending-in-7-charts/articleshow/80600625.cms
57 accessed on 02.06.2021
58 6
Roche, E.( March 10,2020) India was world’s second largest arms importer 2015-19: Report. The Live Mint.
59 Available at : https://www.livemint.com/news/india/arms-imports-from-russia-decreased-in-2015-19-due-to-
60 drop-in-india-sales-report-11583772984894.html Accessed on 02.06.2021
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 literature that there two important motives for choosing a particular country as a location for setting
1 up a new facility:(a) firms seek increased access to the host country’s market; and (b) firms want to
2 utilize the relatively abundant factors available in that country. Commenting on the same direction,
3 Professor John Dunning (1977) in his seminal work identified four distinct motives of undertaking a
4 FDI, Viz. (a) Resource seeking, (b) Market seeking, (c) Efficiency seeking and (d) Strategic asset
5
seeking. Though India fulfils all the motives of investment, it specifically qualifies to attract a market
6
7 seeking investors. In market seeking investment, a firm invests in a market which is relatively big in
8 size with a promising growth rate and with the expectation of absorbing skilled labour; exploiting the
9 better supply chain or other infrastructure facilities.
10
11 Dunning also suggests location of the host economy plays a crucial role in attracting FDI. Dunning
12 (1979) explains the locational advantage as the preconditions for a firm to produce goods
13 internationally. An international firm makes an investment in a location that has an abundance of raw
14 materials used for production, skilled labour force with competitive wages among others. It also
15
16
investigates the strategic importance of the location e.g. distance and proximity of the country with
17 other important markets. A firm also examines if the host country is politically and diplomatically
18 aligned with other potential markets so that they can export from that country to other nearby
19 destinations. India also fulfils this condition of FDI inflow as it shares a very deep and close
20 relationship with almost all the countries in this region.
21
22 Tariff protection has long been perceived as an effective policy measure to influence foreign
23 investors. It has been observed, when a country applies high tariff as a trade barrier, multinational
24
enterprises (MNEs), faced with a choice between catering the market through export or produce in
25
26 order to ‘jump’ over the domestic tariffs. Many empirical studies support this insight as they have
27 found a positive correlation between the level of tariff and non-tariff protection and the levels of
28 inward FDI (Brainard, 1997). India levies tariffs ranging from 6 per cent to 12.5 per cent on arms and
29 ammunition and other related items. Though the rate is not very high, but the high value of the
30 defence items makes it a significant amount. Several factors influence the choice between FDI and
31 licensing/exports, including the local government policy, local market conditions and size, the
32 reaction of rival firms and the riskiness of the investment. FDI facilitates a firm to exploit its
33 advantages to the full so that it can capture all the rents provided by that control. It is also a concern to
34
35
the foreign enterprise that a lack of direct control will increase the risk of technology leaking to
36 competitors (Sodersten and Reed, 1994).
37
38 Most of the theories establish that a market like India has huge potential to attract foreign investment.
39 Currently, India is the second largest recipient of FDI in the world and it verifies the theoretical
40 arguments. Despite that, India’s performance is not satisfactory in the case of the defence industry.
41 One of the possible reasons behind that is losing control and technology as put forwarded by Hymer
42 (1976). Most MNEs hesitate to invest in a foreign country when they are very protective of their
43
technological know-how. Such a view is also shared by Nayak and Choudhury (2014). Defence
44
45 equipment manufacturers have very strategic designs and highly advance technology which they don’t
46 want to share with others at any cost. They don’t want to risk their technology by investing in a
47 country where Intellectual Property Rights (IPR) is not up to their expectation. This is evident from
48 the production network of the major defence equipment manufacturers. They have established their
49 plants producing critical parts of the final product only in a developed economy. Common factors
50 like market size, an abundance of labour etc. have not played any vital role in their investment
51 decision. In addition countries like the United States which is home to a large number of world-class
52 defence equipment manufacturer, prohibits its firms to sell or share their contemporary critical
53
technologies with any foreign company or nation7.
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56 A lot of empirical studies also attempted to explain these critical features of the defence industry.
57 However, most of the studies are conducted by scholars of international studies and political science
58 describing the diplomatic perspective of the issue. Economist explaining the trade and investment
59
60 7
See for more information. https://www.govinfo.gov/content/pkg/STATUTE-90/pdf/STATUTE-90-Pg729.pdf
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 perspective of the issue is limited. Among them, one of the important studies is by Mohanty (20048).
1 Examining the current status of the Indian Defence industry, Mohanty comments that from the
2 beginning India quest for self-reliance in defence production. With this ambition, India reserved the
3 sector for public enterprises and developed a few companies as well. But to cope with the changing
4 global scenario it opened the sector for private participation. India’s decision to allow private
5
participation in the defence industrial sector is seen as a dual aim, namely to achieve much-needed
6
7 capital and production enhancement and, secondly, to open up to the external market through their
8 presence. Singh (20109) presents a pessimistic view about this sector to attract FDI. He opines the
9 removal of the investment cap will not influence a foreign investor to transfer its technological know-
10 how to a company where it owns a minority share. Companies procure advanced technologies
11 spending billions of dollars and it would not be attractive to them to invest in a minority-owned firm.
12 Singh (2010) argues, increasing the FDI cap will allow the foreign firms a larger share of the risks and
13 profits and the confidence to transfer sensitive technology to joint ventures in India. Similar views
14 were also expressed by Kartik (202010) advocating the removal of the ceiling in foreign ownership in
15
16
the defence manufacturing sector. He believes the dynamics of defence manufacturing is very
17 complex and the recent announcement in hiking FDI limits across all types of defence manufacturing
18 does not adequately address this complexity. It may provide a significant fillip to investments through
19 collaborations with Indian firms. However, foreign collaborations in technologically sophisticated
20 aerospace defence will find it difficult to take off.
21
22 Analysing the above literature, we find there is a dearth of academic papers exploring the economic or
23 trade perspective of this issue. The available studies are mostly in the form of commentaries and
24
opinion pieces. The scholars are predominantly favoured of removing the ceiling related to FDI. They
25
26 believe the removal of the ceiling will attract more foreign firms to make an investment in India. On
27 the contrary, we believe that FDI policy is not the only factors that solely responsible for shapes the
28 FDI inflows in an economy. Researchers have proved along with FDI policy various others policies
29 and factors play a leading role in attracting FDI. Only a robust FDI policy is never a sufficient
30 condition for attracting a higher volume of FDI inflows (Choudhury and Nayak 2019). The result of
31 increasing the FDI limit in India validates this argument. The existing studies fail to point out the
32 factors that barred India from receiving higher FDI inflows in its defence industry. This is the lacuna
33 in the literature that the current paper attempts to fill. In addition, the study will examine a series of
34
35
reforms in the defence sector that the government has brought in with an aim to change the current
36 scenario. An analysis of various initiatives in the policy spectrum is presented in the following section
37 of the study.
38
39 3. Evolution of Defence FDI policy in India
40
41 Since independence, India adopted an import substitution policy with an aim to develop the
42 indigenous manufacturing industry. Obtaining a licence under the Industries Act 1951 was mandatory
43 for many industries while several others were reserved for the public sector only. This policy practice
44
helped India to develop some of its industries well and a few strong Public Sector Enterprises
45
46 emerged from this. Foreign investment in India was not allowed until 1991. Since then, India
47 successively started opening its industries for foreign capital participation. However, select sectors
48 were still prohibited from accepting any foreign capital on the ground of national security. Defence
49 manufacturing is one such sector. The policy shift in this regard was first noticed in 2001 when India
50 opened defence manufacturing with 100 per cent ownership for domestic private firms and allowed
51
52
53
54
55 8
Mohanty, Deba R. (2004). “Changing Times? India’s Defence Industry in the 21st Century.” Paper No.36,
56 Bonn International Center for Conversion, Germany.
57 9
Singh Sushant k. (2010) Foreign Direct Investment in Defence Sector- Go beyond 51%.Discussion
58 Document.The Takshashila Institution.Banglore.
59 10
Karthik, P. (May 22, 2020) India’s defence FDI rules should not treat the sector as homogenous. Observer
60 Research Foundation.
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 accepting FDI up to 26 per cent11. Lists of riders were also applicable to the investors. The next
1 amendment in this direction took place in 2013 when the limit on foreign firms was allowed to hold
2 investment above 26 per cent on case to case basis if case they offer state of art technology 12. An
3 important point to note from this announcement is that the government did not set any upper limit for
4 foreign ownership if the investor is bringing in state of art technology.
5
6
7 In 2010 with a proposal to increase the FDI limit to 74 per cent, Department of Promotion of Industry
8 and Internal Trade (DPIIT) circulated a Discussion paper seeking suggestions and feedback from the
9 various stakeholders. The discussion paper highlighted higher ownership in defence manufacturing
10 firms will not bring any challenge to national security rather it would boost indigenous manufacturing
11 and bring competition. However, the proposal was rolled back due to strong opposition from the
12 Ministry of Defence.
13
14 In Union-Budget 2014-2015, the government announced that companies manufacturing defence
15
16
equipment can hold foreign capital up to 49 per cent while keeping the management control with an
17 Indian(s). The entire investment would be allowed through the government’s approval route.
18 Following this announcement, press note 7, of 2014 was issued by DPIIT giving details of the newly
19 amended rule. In 2014 the newly formed federal government in India partially relaxed the requirement
20 for obtaining an industrial licence for manufacturing select items (Rao and Dhar 2016).The Industrial
21 licensing policy followed further relaxations in 2015.
22
23 In 2016, India significantly departed from its earlier policy stand. First, it allowed the entire volume of
24
foreign capital up to 49 per cent under automatic route13. Second, it allowed 100 per cent foreign
25
26 ownership to a firm with 49 per cent allowed under automatic route and rest under government
27 route14. It also removed the clause to have state of art technology and introduced a term modern
28 technology. Notably, it did not define a term modern technology.
29
30 In 2017, India abolished Foreign Investment Promotion Board (FIPB) thereby removing a leg in the
31 approval process. FIPB was entrusted to scrutinise the FDI proposals before giving clearance. The
32 Government of India highlighted that the regime for foreign investment needs to be simpler in
33 execution and expeditious in the disposal. Following this, the government released a Standard
34
35
Operating Procedure on June 2017 recommending that FDI proposals will now be directed by the
36 Department of Industrial Policy and Promotion (DIPP) currently known as DPIIT, to the concerned
37 competent authority. In the case of defence, the new Competent Authority for processing of FDI
38 proposals has been identified as the Joint Secretary, Department of Defence Production, Ministry of
39 Defence. Security clearance will be sought in parallel from the Ministry of Home Affairs.
40
41 In 2020 government further relaxed the FDI limit up to 74 per cent under automatic route in defence
42 manufacturing15. Thus, through different policy amendments, India opened this sector for 100 per cent
43
foreign investment. Along with the gradual relaxation of FDI policy a few other policies were also
44
45 initiated to boost the manufacturing sector in India. National Manufacturing Policy (NMP16) launched
46 in 2011, Defence Production Policy 2011, Make in India introduced in 2014 are some of the crucial
47 policies in this regard. With so many efforts, it becomes important to understand the current state of
48 the defence manufacturing industry in India. The next section of the study will analyse this issue in
49 detail.
50
51
52 11
Press Note no 4, 2001series. Dated- May 21, 2001.DPIIT.Ministry of Commerce and Industry. Government of
53 India.
54 12
Press note 6 2013 series, DPIIT. Ministry of Commerce and Industry.Government of India.
55 13
Consolidated FDI policy, 2016, DPIIT.Ministry of Commerce and Industry.Government of India.
56 14
Press note 5 2016 series, DPIIT. Ministry of Commerce and Industry.Government of India.
57 15
Press note 4 2020, DPIIT. Ministry of Commerce and Industry.Government of India.
58 16
See Press No 2, 2011 Series. DIPP.Available at- https://dipp.gov.in/sites/default/files/po-ann4.pdfAccessed on
59 20.02.2020.
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 4. Overview of Indian defence manufacturing
1
2 Despite so many efforts, the Indian defence manufacturing sector could not perform expectedly.
3
Although there is a robust defence manufacturing sector in India, it caters only 30 per cent of its total
4
5 requirement (Behera, 2016). Several efforts have also been made during the last few years to reduce
6 dependence on import. Recently government banned import of more than 200 items17. It also awarded
7 several contracts of a huge amount to domestic firms18. India Defence Industrial Base (DIB), consist
8 of 52 defence laboratories and establishments under Defence Research and Development Organisation
9 (DRDO); and 9 defence public sector undertakings and 39 ordnance factories under the Department of
10 Defence Production of the Ministry of Defence. The DIB is responsible for the design, development,
11 production and up-gradation of various types of arms primarily for the Indian armed forces (Behera,
12 2016). The defence public sector undertakings contribute 79 per cent of the total production in India
13
which was US$ 11 billion in 2019. The figure is forecasted to reach US$ 25 billion in 202519. The
14
15 value of the production from the defence PSUs are presented in figure 1 which shows a constant rise
16 during the last five years.
17
18
19
20 Figure: 1 Defence Production in India by DPSUs (US$ Bil)
21
22 6.6
23 6.4
24 6.4 6.3
25 6.2
26 6.2
27
28
6 5.9
29
30
31 5.8 5.7
32
33 5.6
34
35 5.4
36
37
5.2
38
39 2015 2016 2017 2018 2019
40
41
Source: India Brand Equity Foundation.
42
43 Along with the public sector there is an emerging group of private manufacturing companies in Indian
44 defence industry. Of which 9 are foreign owned and around 100 are Indian owned ventures (Desai
45 2018).The foreign companies are operating in the form of joint venture with their Indian partners.
46 Among the joint venture prominent are, Airbus with Mahindra Defence Systems to manufacture
47 helicopters for the Indian Military, Boeing with Tata Advanced Systems to produce fuselages of
48 Apache Helicopters. Many of these private firms have secured large volume of manufacturing
49
50
51
17
52 PTI (May, 31, 2021) India expands negative list for defence imports with 108 new items. The New Indian
53 Express. Available at: https://www.newindianexpress.com/nation/2021/may/31/india-expands-negative-list-for-
54 defence-imports-with-108-new-items-2310016.html accessed on 11.06.2021
55
56 18
India Brand Equity Foundation. Available at: https://www.ibef.org/industry/defence-manufacturing.aspx
57 accessed on 5.6.21
58 19
India Brand Equity Foundation. Available at: https://www.ibef.org/industry/defence-
59 manufacturing/infographicaccessed on 5.6.21
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 contracts from government. One such major deal signed recently with Mahindra Defence Systems
1 (MDSL) for supply of 1,300 light specialist vehicles to the Indian Army. The contract value was US$
2 143.3 million20.
3
4
5
As aforementioned, India relies on foreign supply for 70 per cent of its total defence requirements.
6
7 The major supplier of arms and ammunition to India are US, Russia, France, Israel and UK (Behera,
8 2016). India’s defence import value stood at US$ 463 million for FY20 and is expected to be at US$
9 469.5 million in FY2121. Also India exports a small volume of defence goods. India’s defence export
10 was estimated to be at US$ 1.29 billion in 2019-2022. Maldives, Sri Lanka, Nepal, Mauritius were the
11 major destination of Indian export23.
12
13
14
15 Table1: India's Defence Trade
16 Major Major
17 Year Import Source Export Destinations
18 2010 2911 5
19
20 2011 3598 3
21 2012 4392
22
2013 5381 15
23
24 2014 3347 Russia, 36 Myanmar,
25 2015 3117 Israel, 42 Mauritius, Sri
26 US, UK Lanka
27 2016 3003 46
28 2017 2909 56
29 2018 1485 44
30
31 2019 3075 18
32 2020 2799 151
33 Source: SIPRI Arms Transfer Database
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35
36
The table above depicts Indian arms and ammunition trade with the world. The data shows Indian
37 trade is concentrated in a few countries. It reveals Russia and Israel are the largest suppliers of
38 defence equipment to India. They contribute to around 90 per cent of India’s total demand.
39
40 In the case of export, India supplies to only a few small developing countries in a very small volume.
41 Moreover, most of its export destinations are in the South Asian region. Interestingly India’s
42 defence exports for the previous year cracked the global top 25. From struggling to acquire
43 specialised weapon locating radars (WLRs) from the USA and Israel in the 1990s, India is now
44
exporting them to Armenia in a deal worth some $40 million24. India sets an ambitious export target
45
46 of $5 billion in the aerospace and defence goods and services sector annually by 2025. To achieve this
47
48
49
50 20
India Brand Equity Foundation. Available at: https://www.ibef.org/industry/defence-manufacturing.aspx
51 accessed on 5.6.21
52 21
Indian Defence Manufacturing Industry Report.India Brand Equity Foundation. Available at:
53 https://www.ibef.org/industry/defence-manufacturing.aspx accessed on 5.6.21
54 22
Indian Defence Manufacturing Industry Report.India Brand Equity Foundation. Available at:
55 https://www.ibef.org/industry/defence-manufacturing.aspx accessed on 5.6.21
56 23
Department of Defence Production, Ministry of Defence.Government of India.Available at:
57 https://www.ddpmod.gov.in/defence-exportsaccessed on 5.6.21
58 24
Singh, A. (March, 23 2020) Taking India’s Defence Export to $ 5 billion.ORF.Available at:
59 https://www.orfonline.org/expert-speak/taking-indias-defence-exports-to-5-billion-63599/ accessed on 5.6.21
60
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 target Government formulated the ‘Defence Production and Export Promotion Policy 2020’ to
1 provide impetus to self-reliance in defence manufacturing under the ‘Aatmanirbhar Bharat’ scheme25.
2
3 5. FDI inflows in Indian defence manufacturing
4
5
6 The FDI inflows in the Indian defence sector are really in an abysmal situation. Even after 20 years
7 of opening the sector to foreign participation, it could attract only US$ 10 million of foreign capital.
8 Further, until 2014, total investment was mere US$4.94 million which increased afterwards (Rao and
9 Dhar 2016). Analysing the company wise data provided by DPIIT, we find three companies have
10 invested more than one million in India. The majority of the capital has flown from Israel including
11 the three largest investments (see Annexure 1).Given the efforts made to influence the foreign
12 investors in defence manufacturing could not generate expected results. It should have been an
13
obvious decision for arms manufacturers to produce in the country that is second largest importer. But
14
15 the reality is different. It is the scenario of the country that is second largest recipient of global FDI
16 inflows. It offers one of the largest markets in the world, a conducive policy and well protected
17 investment. Yet, it could not attract any sizable amount of foreign capital in its defence sector. This
18 clearly reflects that the determinants of FDI inflows in the defence sector are different than that of
19 others. The common factor such as market size, GDP or other institutional variables does not attract
20 FDI in the defence sector. This has been true at least in the Indian case so far. It generates scholarly
21 interest to examine why the foreign investor kept them away from India. Why India performed so
22 poorly in attracting FDI in the defence sector while showing tremendous achievement in attracting
23
24 overall FDI inflows. The next section of the study will attempt to answer these questions.
25
26 The reasons behind India’s failure to attract FDI in the defence sector so far lies in two factors. The
27 first is internal and the second is external. In case of internal issue, reasons lie in its FDI policy and a
28 few other policies that affect foreign investment. One of the most important policies in this regard is
29 the Defence Procurement Procedure, 2020 (DPP).The DPP does not permit Indian companies in
30 which the FDI exceeds 49 per cent to bid for all acquisition programmes as prime vendors. Only an
31 indigenous company owned and controlled by Indians with an equity share of a minimum 51 per cent
32
can participate in an acquisition program as a principal vendor. DPP mandates domestic production of
33
34 aircraft, helicopters, submarines, and armoured fighting vehicles, including main battle tanks via
35 collaborative ventures between private Indian companies and overseas original equipment
36 manufacturers (OEMs). The policy condition practically limits foreign investment in a project above
37 49 per cent. A similar problem was also reason for hesitation among foreign investor was India’s
38 defence offset policy. The complexities of India’s defence offset policy is thoroughly examined by
39 Behra (2009) and concludes that FDI in defence, including in R&D, towards suppliers’ offset
40 obligation, have kept away the foreign investors from Indian market.
41
42
43
Indian defence import has been concentrated to two single sources, Israel and Russia. Around 90 per
44 cent of the items are procured from companies based in these nations. Hence, it will be profitable
45 only for an Israel and Russia based firm to manufacture in India given its existing business relation.
46 For companies based in other parts of the world, there is no attractive business opportunity in
47 investing in an Indian defence company or setting up a wholly owned subsidiary. Companies will not
48 it lucrative if there are no reasonable prospects for the investor to locally market his wares or services
49 or both, or to export them. (Cowshish, 2017, 202026). Further the business model of the defence
50 industry is different from others. In defence, first products are designed and then they find the
51
potential buyers. In most cases, products are produced only after securing a procurement order.
52
53 Hence, a company will not easily invest in a market that has any kind of uncertainty.
54
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56 25
Indian Defence Manufacturing Industry Report. India Brand Equity Foundation. Available at:
57 https://www.ibef.org/industry/defence-manufacturing.aspx accessed on 5.6.21
58 26
Cowshish, A. (Sep. 18, 2020) Can a Higher FDI Cap for the Defence Sector Stimulate Investment? The Wire.
59 Available at: https://thewire.in/economy/higher-fdi-cap-defence-india-investment Accessed on 08-06.2021
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 Another discouraging factor in Indian defence FDI policy is over cautiousness about national security.
1 Foreign Investments in the Defence Sector should pass through mandatory scrutiny on grounds of
2 National Security. All foreign investment needs to seek clearance from the Ministry of Home Affairs
3 and as per guidelines of the Ministry of Defence. Government reserves the right to review any foreign
4 investment in the Defence Sector that affects or may affect national security. (Consolidated FDI
5
Policy 2020, DPIIT). Scrutiny is not an easy task when it involves complex technology. The task is
6
7 made more difficult due to the involvement of multiple ministries and agencies. Getting approval
8 becomes too lengthy and time consuming and also uncertain. In the past French company Direction
9 des Constructions Navales (DCNS) has faced such uncertainty when their proposal of 100 per cent
10 FDI was rejected by FIPB claiming that their technology is not modern27. Such incidences greatly
11 discourage foreign investors. It is also difficult to understand how importing defence equipment from
12 a foreign country made by a foreign company is less threat to the national security compared to
13 making it in India by a wholly owned subsidiary of a foreign company.
14
15
16
It seems India practices dual policies in the defence sector. On the one hand it is making continuous
17 efforts to attract foreign investors. Necessary amendments have also been made to respective policies.
18 On the other, India encourages public sector procurement and promotes indigenous production. It
19 aims to procure maximum volumes of equipment from its public sector units. It is reflected in the last
20 few orders by the Ministry of Defence28. It strives for self-reliance in defence sectors and designs
21 policies like ‘Atmanirvar Bharat’. This is logical for a country that depends on foreign companies for
22 70 per cent of its needs. But, the dual nature of the policy framework creates confusion among the
23 investors. One will never find it lucrative to invest in a market with such an ambiguous policy milieu
24
without any reasonable business prospect.
25
26
27 Along with the above discussed internal factors, a few external factors also appear to be the reason
28 behind the hesitance of the foreign investors to invest in India. As India buys most of its defence
29 equipment from Israel and Russia, it makes sense only for the Israel and Russia based firms to invest
30 in India. But the world five largest arms manufacturers are based in the US. India occasionally buys
31 arms and ammunition from the US. Manufacturing advanced defence and aerospace technologies is a
32 costly and complex process and required a huge investment. Hence, it is not in the business interest of
33 the US firms to invest in India if they do find it alluring. Moreover, the US based companies are
34
35
guided bythe United States Arms Control Export Act, 1976. This act makes it almost impossible for
36 the US arms manufacturers to sell or share their contemporary critical technologies with any foreign
37 company or nation.
38
39 Governments attempt to attract a higher amount of FDI by reducing the ownership limit is less likely
40 to get a positive result. The basis of this argument lies in the ownership pattern of the major arms
41 manufacturer and the choice of location for establishing a subsidiary. The evidence suggests the
42 manufacturing projects launched defence sector is very minimal and only a very small amount of
43
cross border Greenfield investment has taken place in the recent past. In addition, most of the
44
45 manufacturing projects are located in developed parts of the world like America and Europe (Rao and
46 Dhar, 2016). Arms manufacturers have always looked into developing nations as their customer and
47 accordingly, they have made an investment in sales and marketing. Analysing the existing data from
48 2000 to 2013, Rao and Dhar (2016) observes majority of the top defence manufacturers have their
49 subsidiaries in developed countries only. In this scenario, it will be a long shot if India can receive a
50 big amount from any of these major arms manufacturers.
51
52
53 6. Conclusion
54
55
56 27
Cowshish, A. (Sep. 18, 2020) Can a Higher FDI Cap for the Defence Sector Stimulate Investment? The Wire.
57 Available at: https://thewire.in/economy/higher-fdi-cap-defence-india-investment Accessed on 08-06.2021
58 28
India Brand Equity Foundation. Available at: https://www.ibef.org/industry/defence-manufacturing.aspx
59 accessed on 5.6.21
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 The above paper analysed how India gradually relaxed its defence FDI policy and for the factors that
1 deter India to receive a higher volume of FDI in the defence sector so far. Although India has been a
2 major export destination for global defence manufacturers, they never looked at India as a potential
3 investment destination. The primary reasons behind this are explored in the paper. The paper
4 highlights the common factor such as market size, GDP or other institutional variables does not attract
5
FDI in the defence sector. The study finds lack of synchronisation in India’s policies related to
6
7 defence production and FDI has caused confusion among the investors. A few reasons which are
8 beyond the control of the Indian authority are also found to be responsible for India’s failure in
9 attracting FDI in its defence industry. The existing scenario also suggests the defence manufacturers
10 are very much selective in their investment choice and they preferably invest in a developed nation.
11 However, this does not rule out the possibility of attracting FDI in this sector. Companies have
12 invested in remote Africa as well and expecting a sizable volume of investment in India is very much
13 logical. Further, India has opened its defence manufacturing sector to full foreign ownership only a
14 few years ago. And since then it has experienced a small hike in its FDI inflows, even though the
15
16
volume was negligible. We believe, attracting investment in this sector will be tough compared to
17 other sectors but not impossible. Sooner or later India will make it happen.
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 References
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12 Choudhury, R. and Nayak D. (2019). Trade and Investment in South Asia: Analysis. World Scientific.
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Cowshish, A. (2017). India–Israel Defence Trade: Issues and Challenges, Strategic Analysis, 41:4,
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19 Desai N. A. (2018). The Indian Defence Industry Redefining Frontiers. Nishith Desai and Associates.
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59 Websites Used
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 Invest India- www.investindia.gov.in
1
2 Make in India – www.makeinindia.com
3 Brand Equity Foundation of India- www.ibef.org
4
5 Stockholm International Peace Research Institute (SIPRI)-www.sipri.org
6
7 DPIIT- www.dipp.gov.in
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 Annexure
1
2
3
4 FDI inflows in Indian Defence Sector
5
6 Year FDI equity Total FDI Percentage
7 inflows in equity inflows share in total
8
Defence (INR Cr.) FDI equity
9
Sector inflows
10
11 2000-2005 2.36 954,815.27 0.0002
12 2006 00 503,573 0.0000
13
14 2007 00 654,950 0.0000
15 2008 00 1,595,295 0.0000
16
2009 00 1,309,799 0.0000
17
18 2010 00 960,150 0.0000
19 2011 174.4 1,599,349.20 0.0109
20
21 2012 22.10 1,215,914.41 0.0018
22 2013 44.72 1,294,824.81 0.0035
23
2014 0.04 1,753,134 2.2816
24
25 2015
26 (upto 4.80 1,681,922.01 0.0003
27 September )
28
29 Cumulative
248.42 13,523,726.70 0.0018
30 Total
31 Source:Adopted from Mahajan, D. (2016)
32
33
34
35 FDI inflow in India from 2015-2020
36
Country of In Rs In US$
37
Indian Company Origin Name of Foreign Collaborator million) million)
38
39 Bel-Thales Systems Limited France Thales Air Systems Sas 4.8 0.08
40 Sds Tech Solutions Private Limited Israel S.D.S (Star Defence Systtems) Ltd 2.24 0.03
41 M/S AdaniElbit Advanced Systems
42 India L Israel Elbit Systems Ltd 7.3 0.1
43 Kalyani Rafael Advanced Systems Rafael Advanced Defense Systems
44 Pvt Ltd Israel Pvt Ltd 95.02 1.29
45 Rafael Advanced Defense Systems
46 Astra Rafael Comsys Pvt Ltd Israel Ltd 159.25 2.21
47
M/S AdaniElbit Advanced Systems
48
India L Israel Elbit Systems Ltd 0.05 0
49
M/S AdaniElbit Advanced Systems
50
51 India L Israel Elbit Systems Ltd 134.63 1.83
52 South
53 Reliance Sed Limited Korea Eo System Co. Ltd 0.13 0
54 Source: SIA Newsletters, DPPIT.
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 List of Indian Public Sector Defense Undertakings29
1
2 1. Airbus (France)
3
4 2. BAE India Systems (UK)
5 3. Pilatus (Switzerland)
6
7 4. Lockheed Martin (USA)
8 5. Boeing India (USA)
9
10 6. Raytheon (USA)
11 7. Israel Aerospace Industries (Israel)
12
13 8. Rafael Advanced Defense Systems Ltd. (Israel)
14 9. Dassault Aviation SA (France)
15
16
17
18 List of Defence Public sector undertakings30
19
20 1) Hindustan Aeronautics Limited (“HAL”)
21
22 2) Bharat Electronics Limited (“BEL”)
23 3) BEML
24
25 4) Bharat Dynamics Limited (“BDL”)
26
5) Mishra Dattu Nigam Limited (“MIDHANI”)
27
28 6) Goa Shipyard Limited (“GSL”)
29
7) Garden Reach Shipyard and Engineers (“GRSE”)
30
31 8) Mazagon Dock Limited (“MDL”)
32
9) Hindustan Shipyard Limited (“HSL”)
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59 29
Make in India India, Website.
60 30
Department of Defence Production, Ministry of Defence.Government of India.
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