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Image Courtesy: Defence Ministry
 
The BJP-led National Democratic Alliance (NDA) Government is likely to lift the ban on foreign institutional investment (FII) in the Defence sector. This would pave the way for clearance of pending industrial licence applications from Indian companies that have minority investment by FIIs. It would also facilitate submission of fresh applications by such companies. 
The Government is also expected to make technology transfer mandatory for multinationals seeking to make foreign direct investment (FDI) above 49% in their proposed Indian ventures. 
These two planned initiatives and their significance have been virtually overlooked by the stakeholders arguing for or against allowing 100% FDI in the defence sector as proposed by the Ministry of Commerce and Industry (MCI) in its draft note for the Cabinet.
  
UPA Government had banned FII investment in the defence sector in August 2013 without realizing its fall-out on manufacturing sector and employment generation. Subsequently, officials have played safe and avoided rational interpretation of FII investment ban while handling licensing applications from wholly owned subsidiaries of Indian companies that have inconsequential FII/NRI investment.
According to informed sources, without making any reference to the logjam over such applications, the draft note has implicitly proposed lifting of ban on FII investment. This objective is sought to be achieved by deleting the stipulation in consolidated FDI policy that reads as “Investment by Foreign Portfolio Investors FPIs/FIIs (through portfolio investment) is not permitted.”
The stipulation continues: “FPI/FII (through portfolio investment) in companies holding defence licence as on 22 August 2013 (date of issue of Press note 6 of 2013) will remain capped at the level existing as on the said date. No fresh FPI/FII (through portfolio investment) is permitted even if the level of such investment falls below the capped level subsequently.” 
The stipulation is proposed to be replaced with a new one that reads as “Portfolio Investment beyond 24%, by FPIs/FIIs/NRIs, will require Government approval and not exceed 49% of the equity of the company. FDI in excess of 49% is subject to transfer of technology.”
This relaxation would automatically clear the decks for approval of pending licence applications of Indian companies that minority stakes held by FIIs & NRIs. 
The companies whose applications are pending with Industrial Licensing Committee (ILC) include Tata Advanced Materials Limited (TAPL), Punj Lloyd Industries Limited (PLIL), Reliance Aerospace Technologies Private Limited (RATPL) a step-down 100% -owned subsidiary of Reliance Industries Limited, Rossell India Limited  Elcome Marine Services Limited and Zen 
Technologies Ltd.   
ILC’s hesitation to interpret rationally the existing ban on FII investment has led to repeated deferment of the application of TAPL in which 14 non-resident Indians hold 90 shares in the company. The company had applied for licence to produce aircraft parts at Bangalore in Karnataka in January 2012. 
Similarly, ILC has repeatedly deferred five different applications of PLIL, which is a wholly owned subsidiary of Punj Lloyd Limited (PLL), in which FIIs hold 10.93% stake and NRIs 2.27%, apart from 22.79% FDI. 
PLIL has applied for licences to produce anti-tank weapons, armoured combat vehicles, naval equipment such as torpedoes, defence components and aircraft. 
In the draft note for Cabinet, MCI had proposed increase in cap on FDI to 100% from 26% at present. Applications envisaging FDI above this ceiling have to referred to Cabinet Committee on Security (CCS) for clearance on case-to-case basis by taking into the scope for acess to the modern technology. 
It is now proposed to apply this procedure to applications envisaging FDI above 74%.  
DIPP has pitched for liberalization of foreign investment regulations in the defence sector against the backdrop of the fact that Defence Ministry intends to modernize armed forces with capital procurement budget of more than $ 130 billion over the next seven years. In addition, $ 110 million is expected to be invested by the Central and State Governments on internal security forces. 
DIPP believes that substantial investment in defence manufacturing would have synergetic impact on industries such as automotive, textiles and polymers that have linkages with the defence sector.   Analysts suggest that Modi Government should address the concerns of stakeholders that are against hiking the FDI ceiling in defence sector by creating policy and contractual safeguards.
They suggest that FDI approval should clearly specify that the companies would export equipment subject to clearance by the Government.
To protect national interest, the Government should also stipulate that all multinational-promoted Indian factories would have to strictly comply with the Government directives during hostilities/war with any nation. The failure to comply with directives would result in immediate takeover of the factories by Government-nominated entities.
 

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