Joint Ventures in Defence Sector in India

Defence Sector in India: Introduction

• India is ranked among the top 15 producers of defence hardware in the world, yet the existing defence industrial base has not been able to meet the requirements of modern weapons, equipment and ammunitions of our Armed Forces.
• The path of growth for the Aerospace and Defence Industry in India is positive and expected to reach $70 billion by 2029. India currently exports defence equipment to 42 countries.
• There is an immense market in India for forming JVs and collaborating on variety of technologies, ranging from small arms, tanks, artillery guns, air defence systems to radars, missiles, fighter aircrafts and ships, in the Defence Sector
• India approved 36 JV proposals for manufacture of defence equipment, with Indian Public / Private Companies till March 2016. Additional 14 JV proposals, for design, development and manufacturing of defence weapons & equipment, between foreign and Indian companies have been inked from Apr 2016 till Jul 2018 bringing the total number to 50 JV proposals.
• The JVs will enable leveraging the benefits of vast infrastructure and resources of the Defence PSUs in defence manufacturing; and the marketing skills, flexibility of the Private Industry.
• Joint Ventures (JVs) in Defence Sector can help expand our defence industrial base and catapult India into the league of major defence manufacturers in the world. Through JVs with established partners from friendly foreign countries, India can take rapid strides and become a hub for global defence design, development and manufacturing.
• As part of the urgent response to the economic effects of the COVID 19 pandemic, the Indian Government in May 2020 announced an economic package meant to provide stimulus to the economy. One of the proposals was also to further liberalize the FDI framework in India for the defence sector. The government of India permitted foreign investors to hold up to 74 percent of the companies which fall under the defence sector in India under the automatic route (without Government approval). This meant that foreign companies were now allowed to hold a majority and controlling stake in joint ventures involving an Indian company.

Conditions to be fulfilled by any investor to meet the new FDI Policy of the Defence Sector by the Government of India:

• 74% FDI is permitted without the approval of the government i.e. the automatic route
• Any FDI above 74% would require prior Government approval. Reasons for approval will be access to modern technology or other reasons to be recorded.
• One key condition for the FDI to go through is Infusion of fresh foreign investment up to 49% in a company not seeking an Industrial License or which already has Government approval for FDI in defence, will require mandatory submission of a declaration to the Ministry of Defence (MoD) in case of change in equity/shareholding pattern or transfer of stake by existing investor to new foreign investor for FDI up to 49%, within 30 days of such change. Proposals for raising FDI beyond 49% in such companies will require prior Government approval.
• Other basic conditions are that the foreign investment is subject to security clearance and guidelines of the Ministry of Defence.
• The company which is investing must be self-sufficient in areas of product design and development. Their manufacturing facility should also have maintenance and life cycle support facility of the products being manufactured in India.
• Foreign investment is subject to scrutiny on grounds of national security and the Government reserves the right to review any foreign investment in the defence sector that affects or may affect national security.

Key Aspects of the FDI changes in the defence sector to be considered by investors:

• Increased governance and control rights for Foreign Companies:

The increase in foreign ownership percentage to 74% of the share capital of the investee company in India will allow major foreign defence companies to exercise substantial ownership and control over the domestic company it is investing in through majority voting rights as shareholders and having a representative on the seat of the board of such investee companies. This is a paradigm shift as previously due to the 49 % foreign shareholder automatic route limitation, the foreign companies were reluctant to transfer critical components of important technology to the domestic company due to their inability to exercise control over the board and the operations of the JV. This move to increase the FDI percentage upto 74 % will mean foreign companies will be open to transferring proprietary technology to the domestic company.

• FDI in Indian defence manufacturing companies not seeking an Industrial License can be made up to 49% with submission of a declaration post investment/share transfers

Prior approval from the government was required for injection of fresh foreign investment up to 49% in a company not looking for an industrial license should there be a change in the pattern of ownership or transfer of stake by a current investor to a new investor. That has been changed with a simple declaration to the Ministry of Defence post investment sufficing now. Further, injection of fresh foreign investment up to 49% in a company not seeking an Industrial License or which already had Government approval for FDI in defence, now requires a compulsory submission of a declaration with the MoD in case of a change in the structure/pattern of the equity/shareholding. The Ministry of Defence has to be submitted the declaration within 30 days of such investment or change in shareholding or share transfer taking place. Do note that companies will continue to need prior approval from the government if there is a proposal to raise their FDI beyond 49 percent. There is ambiguity in the current FDI rules which have been carried forward as to whether the defence sector and the FDI limits on it are applicable on companies whose activities do not require an industrial license or which under the Arms Act, 1959 manufacture smalls arms. Government clarification is awaited as the rules continue to include the phrase “company not seeking an industrial license”.

• The change in rules will be prospective

As per the new rules, any fresh increase of FDI or alteration in foreign shareholding in companies which manufacture defence equipments currently beyond 49 % and holding an Industrial License will still need prior Government approval. However, for companies in defence manufacturing and seeking a new Industrial License, FDI upto 74 % under Automatic Route is permitted.

• National Security as a ground for approval and rejection of proposals:

Investments in the defence sector are subject to security clearance by the Ministry of Defence under the current FDI Guidelines. Foreign investments in the defence sector have always been made subject to necessary scrutiny on grounds of national security and the right to review any foreign investment that may or may not affect national security is reserved by the government. Government has reserved the right to review any foreign investment in the defence sector that affects or may affect national security. However, there is ambiguity regarding evaluation of FDI from the lens of national security so far and that is something which potential investors will have to factor in.