Scrap offsets and foreign investment caps

Galvanising military modernisation requires radical changes to the procurement mindset

Sushant K Singh, head of Takshashila’s national security programme and an editor of Pragati has an op-ed in the Wall Street Journal’s Asian edition, commenting on the Indian government’s new, more-of-the-same, defence procurement policy. Excerpt:

The defense ministry in New Delhi won’t admit it, but the turn-around is not just a tacit acknowledgment of India’s limited capacity to absorb offsets, but also an indictment of the offsets policy itself. If the policy is to succeed, the foreign vendor should want to operate in a country where it actually derives commercial benefits from partnering with locals. But in India, the poor quality of the state-run defense units and ordnance factories rules them out as partners. The country simply does not also have a large enough private defense manufacturing sector that a Boeing or Lockheed could buy parts from or invest in.

The final nail in the offset coffin is India’s FDI policy. Which among the decrepit public-sector companies or near-absent private ones would Boeing choose from to invest in? Or, rather, which local manufacturer does it trust enough to share its proprietary technology with? A joint venture could be trustworthy, but because of the FDI cap, a local firm will have to put up 74% equity—no small potatoes in an industry where contracts easily total $100 million and upward. This is why over 10 years the 26% FDI regime brought in only $150,000 of investment.

If the Indian government wants to use offsets as an interim measure to bring in foreign manufacturers, it should do away with the FDI cap. Higher stakes in companies could help add value to the offsets policy: Boeing’s purchase of 34% of Aero Vodochody, a Czech firm, as an offset deal in 1998 is a good example.

The FDI regime has wrecked such opportunities. A proposal last year by India’s Ministry of Commerce to increase the FDI cap in defense manufacturing was rejected outright by the defense ministry. By both sheltering local firms from real competition and yet requiring foreigners to invest in them with offsets, the government wants the best of the old socialist way of nurturing its infant industries and the new capitalist way of acquiring foreign know-how. So far it has failed to secure either. [WSJ]


DISCLAIMER: This is an archived post from the Indian National Interest blogroll. Views expressed are those of the blogger's and do not represent The Takshashila Institution’s view.