India FII Ban in Defense may be Partially Lifted, More Comprehensive Changes to Come

April 21, 2014 Posted by India Briefing Reading Time: 3 minutes

DELHI – As India’s Department of Industrial Policy and Promotion (DIPP) prepares to carry out its annual review of the country’s foreign direct investment (FDI) policy, many are predicting the current ban on foreign portfolio investment in India’s defense sector will be partially lifted next month, and more comprehensive changes outlined after the elections.

While FDI in India’s defense production sector was previously capped at 26 percent, amendments last year raised that cap for FDI approved by the Foreign Investment Promotion Board and cabinet committee on security.

Alongside this change, however, a press note from DIPP stated foreign institutional investment (FII) in the industry would be prohibited.

Last week, the Economic Times (ET) cited a government official involved in the DIPP’s annual FDI policy review as saying some aspects of the current FII prohibition would be lifted soon with approval from the Election Commission, and more comprehensive changes would likely follow after the a new government is formed in late May.

According to ET, the unnamed government official said the change would clarify the status of shares purchased by FII prior to the ban on investment.

After the ban was announced by the DIPP, several defense manufacturers, including Larsen & Toubro and Pipavav Defence, were unclear as to the status of existing FII investments in their companies.

“Some companies had portfolio investment before the ban came into effect,” the official said. The official elaborated that while the issue of future investment in the industry through the FII route would not be addressed until after elections, a new circular would soon clarify the status of existing FII investments.

The DIPP’s policy of grandfathering in investment is relatively common, and has historically occurred in a number of sectors.

In addition to the partial lifting of the DIPP’s FII ban in defense, many analysts are predicting a significant liberalization of the country’s FDI cap in the defense industry if the frontrunner BJP is victorious in ongoing national elections.

According to Reuters, the BJP currently plans to raise the FDI cap on defense from 26 to 49 percent if elected.

“We can save huge foreign exchange by producing defense equipment at home. [We would] raise the FDI cap [and] allow Indian companies to enter joint ventures with foreign companies. It could be an arrangement where Indian partners hold the majority stake, say 51 percent,” a Reuters-quoted BJP source said.

As the world’s largest arms buyer by a significant margin, India increased its arms imports by 111 percent over the past five years and currently accounts for 14 percent of the world’s arms imports. India’s primarily Russian-supplied flow of arms is perceived by many in the Indian government as a security concern, and policymakers are increasingly advocating for the private-sector led development of India’s state-dominated defense industry.

As defense spending continues to rise across Asia, countries with state-dominated defense industries, such as India and China, may begin exploring FDI as a possible solution to catalyzing domestic industry development.

Dezan Shira & Associates is a specialist foreign direct investment practice, providing corporate establishment, business advisory, tax advisory and compliance, accounting, payroll, due diligence and financial review services to multinationals investing in emerging Asia. Since its establishment in 1992, the firm has grown into one of Asia’s most versatile full-service consultancies with operational offices across China, Hong Kong, India, Singapore and Vietnam in addition to alliances in Indonesia, Malaysia, Philippines and Thailand as well as liaison offices in Italy and the United States.

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