Mumbai: The government’s decision to liberalize the foreign direct investment rules for the defence sector could force Indian companies to re-look at their plans as it reduces the dependence of original equipment manufacturers (OEMs) on domestic manufacturers.

On Monday, India opened up the defence sector allowing foreign companies to own as much as 100% equity in the local defence sector through the government approval route in cases where it is likely to result in access to modern technology. The current foreign direct investment (FDI) regime permits foreign companies to own 49% in Indian units through the automatic approval route.

“Foreign investment beyond 49% has now been permitted through government approval route, in cases resulting in access to modern technology in the country or for other reasons to be recorded. The condition of access to ‘state-of-art’ technology in the country has been done away with," the statement said. The FDI limit for the defence sector has also been made applicable to manufacturing of small arms and ammunitions covered under Arms Act 1959, it added.

The new rules could mean that Indian companies that were rushing to tie up with OEMs in expectation of future business may find that their partners choose to enter the market on their own.

Under the previous rules, foreign OEMs (original equipment manufacturers) were required to form joint ventures with domestic firms if they wanted to establish a manufacturing base in India. With the amendment, an OEM can independently plan and implement operations in India.

This would save the time spent on lengthy negotiations with Indian companies, said Kabir Bogra, associate partner at consulting firm Khaitan & Co.

The new guidelines could also mean greater competition for domestic firms.

“The 2016 iteration of the Defence Procurement Procedures (DPP) has defined an Indian company to include within its scope wholly owned subsidiaries. With the amendment, foreign OEMs and manufacturers can compete in the Indian defence procurement space similar to Indian companies," Bogra said.

Anuj Prasad, partner, Shardul Amarchand Mangaldas & Co., has a different view. Prasad says that OEMs are aware that they need to tie up with Indian companies and the latest FDI relaxations will ensure a level playing field.

Tata Motors Ltd, which is well entrenched in the defence sector, shared that view.

“A 100% FDI in defence will create a win-win situation for the country’s defence forces, local industries and international OEMs. It will ensure availability of cutting edge technologies for the defence forces, boost local manufacturing in India and provide assured returns for international OEMs. The move will also enhance overall R&D to develop and deploy solutions catering specifically to the country’s security needs," the company’s spokesperson said in a statement.

Surjit Haridas, deputy director general, Confederation of Indian Industry (CII), noted that Indian firms may not take too much of a hit from the new policy, which clarifies that FDI will be allowed only for technologies that are not available in India.

The new policy also eases procedural hurdles.

Under the earlier policy, an OEM or manufacturer looking to set up a wholly owned subsidiary required approval from the Cabinet Committee on Security. This entailed getting a clearance from ministry of defence, ministry of external affairs, ministry of home affairs and the ministry of defence and proving that the technology/product sought to be manufactured was modern and state of the art.

“By removing the burden to prove the product/ technology as modern and state of the art, a significant regulatory hurdle has been removed," Bogra said.

An added benefit of the new rules will be encouraging defence exports. Removing the provision that required OEMs to prove that their products are modern and state of the art, will allow these companies to relocate production of slightly older and off-the-shelf products to India, which was not possible earlier.

Prasad of Shardul Amarchand Mangaldas says that the new rules provide flexibility in examining proposals and giving approvals quickly.

“It will also allow the government to look at proposals at more proactive basis," he added.

Not everyone agrees and some feel the changes are cosmetic.

“There’s no material change in the policy, it’s just the semantics— they have replaced ‘state of-the-art-technology’ with ‘modern technology,’ said Laxman Behera, research fellow at the Delhi-based Institute for Defence Studies and Analyses (IDSA).

This, he added, is unlikely to make any visible change in the flow of technology or investments. According to Behera the policy fails to address the ‘missing link’ with regard to a procurement policy.

“It has no enabling factor which assures the investors that the government will source from them," he said while adding that the export of defence items from India remains highly regulated as well.

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