Unlocking India for the Defence industry

Defence IQ asked Graham Carberry, Director at Livingstone for his views on the Modi administration’s impact on Foreign Direct Investment in the Defence sector.

The arrival of the Modi administration in India is starting to show evidence of a more progressive approach to competition. A country that now accounts for over 17% of the world’s population has struggled to keep pace with its fellow Asian giant China’s growth, held back by an ageing and under-invested infrastructure that has fallen badly behind population growth, industrialisation and urbanisation.

At the same time the problem of pervasive corruption and stringent limits on foreign ownership of businesses has prevented much-needed inward investment from abroad into what should be, with its large English-speaking population and highly educated middle class, a first-tier investment market for western countries.

Foreign Direct Investment

Between 2012 and 2013, Foreign Direct Investment (FDI) in India grew by 8.5% to c. $24.4 billion with telecoms, pharmaceuticals and construction being the key beneficiaries. This trend appears to be accelerating in 2014, with growth rates of up to 30% predicted, but this gets nowhere near what is needed. It is estimated that India needs up to a staggering $1 trillion over the next five years to overhaul its road, rail, port and airport infrastructure. This is before considering the utilities space where there is a pressing need to address power shortages and acute sanitation issues in cities.

FDI in the Defence sector

The new Modi government appears to be taking decisive action and has quickly moved to relax FDI caps in several key markets. Historically, the only PPI opportunities for non-domestic companies were in low value mass transit. Unsurprisingly, not much progress was made. Furthermore, FDI participation beyond the historic 49% cap will be allowed on a case-by-case basis.

Potentially most interesting is the government’s removal of the hard FDI cap of 26% in the defence sector – moving it up to the 49% mark. Previously, foreign investment in India’s defence sector has been negligible, totalling less than $5 billion since 2001, against an annual defence budget of over $47 billion. A failed attempt to leverage its size to create a domestic industry with export potential has left India, with active border disputes with both China and Pakistan, with a legacy of deeply-flawed internal projects and fractious relationships with equally poorly-performing overseas partners such as Russia. Western defence contractors have held back from sharing their key intellectual property given the limits on the potential share of the commercial upside and amid concerns around data security.

If the Modi government can continue to free up programmes for international investment, we would expect to see FDI in these key sectors grow substantially over the next three to five years. In the short to medium-term this will benefit incoming investors and corporates, in the long-term it may be the key to finally unlocking India’s true potential.

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