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NEW DELHI: Foreign direct investment (FDI) in defence sector will require security clearances, the government said in a notification on Thursday, a move that could be seen as aiming to ring-fence the sector against investments coming in from China or Chinese entities.

In May, the government had allowed foreign firms to directly invest up to 74% in defence sector against an earlier cap of 49% to speed up investments into the manufacturing of military hardware and armaments as India was emerging from one of the strictest lockdowns imposed to slow the transmission of covid-19. The announcement was made by finance minister Nirmala Sitharaman as part of a stimulus package.

In July 2018, the government had relaxed foreign direct investment norms in the defence sector by allowing up to 49% overseas investment under the automatic route. Under the government route, foreign investors have to take prior approval of the respective ministry or department, while in the automatic route, the investor just has to inform the Reserve Bank of India after the investment is made.

The government’s notification issued late Thursday said, "Foreign Investments in the defence sector shall be subject to scrutiny on grounds of National Security and Government reserves the right to review any foreign investment in the defence sector that affects or may affect national security."

It also said that “foreign investment in the sector is subject to security clearance by the Ministry of Home Affairs and as per guidelines of the Ministry of Defence."

There is no official word on why the new stipulation was introduced but speculation is rife that it could be because the government is wary of investments coming from Chinese entities into firms whose other arms could be involved in defence manufacturing. Most of the Chinese investments into India so far have been in the fintech sector with some in infrastructure. New Delhi had been keen to get Chinese companies to invest in India to close the ballooning trade gap but in recent months, there has been a change in strategy.

According to the notification, the “investee company should be structured to be self-sufficient in the areas of product design and development. The investee/joint venture company along with the manufacturing facility, should also have maintenance and life cycle support facility of the product being manufactured in India."

“Now, FDI is allowed up to 74 per cent through automatic route and beyond 74 per cent to be permitted through government (approval) route. This will enhance ease of doing business and contribute to growth of investment, income and employment. In line with our collective vision of Aatmanirbhar Bharat, amendments will enhance self-reliance in defence production, while keeping national interests and security paramount," commerce minister Piyush Goyal said Friday in a Twitter post.

In recent weeks and months India has taken steps to ensure Chinese investments in India is limited especially after a surge in tensions between the two countries since May when India detected multiple intrusions into Indian territory by Chinese soldiers. A violent clash between the two countries on 15 June left 20 Indian soldiers and an unknown number of Chinese troops dead. India had then warned that the bilateral relationship would have consequences. New Delhi later banned 118 Chinese mobile phone apps, including video sharing TikTok and and gaming app PUBG.

According to Srikanth Kondapalli, a professor of Chinese Studies at the New Delhi-based Jawaharlal Nehru University, the government’s action was a “good move" given news reports of China using its companies, investments as well as its nationals to penetrate foreign companies and networks to gain access to information. “I think it’s a right move to put all investments under a scanner," Kondapalli said.

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