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Analysis

Foreign Direct Investment norms in the Indian defence sector liberalised further

24 Sep 2020

Foreign Direct Investment norms
The Government has issued Press Note 4 of 2020 to increase the FDI limit in the Indian defence sector to 74% from 49% under the automatic route. The liberalized FDI limit is intended to permit foreign investment into companies seeking new industrial license only and is subject to the prescribed FDI linked conditions under this press note.

Introduction

In May 2020, the Indian Government as part of an economic stimulus package to respond to the Covid-19 pandemic, announced a proposal to liberalize the foreign direct investment (FDI) framework in India for the defence sector. The Indian Government outlined its intention to permit foreign investors to hold up to 74% of the equity share capital of Indian companies engaged in activities falling within the defence sector under the automatic route (i.e. without prior Government approval), potentially paving the way for foreign companies to hold a majority controlling stake in such Indian companies.

Following this announcement, the Indian Government has issued Press Note 4 of 2020 on 17 September 2020 (Press Note) to amend India’s Consolidated FDI Policy (FDI Policy). The Press Note will take effect upon an amendment being made to India’s exchange control framework by way of a notification to be issued under the Foreign Exchange Management Act, 1999.

In this update, we have outlined the key changes introduced through the Press Note to the existing FDI framework in the defence sector and its implications on global defence majors currently doing business in India or those planning to set up a defence manufacturing presence in India.

Existing FDI framework and changes under the Press Note

Existing FDI Framework Proposed Changes under the Press Note
100% FDI in defence industry subject to industrial license (Industrial License) under the Industries (Development & Regulation) Act, 1951 and manufacturing of small arms and ammunition under the Arms Act, 1959 where:
(a)  49% FDI is permitted under the Automatic Route.

(b)  any FDI above 49% would require prior Government approval where it is likely to result in access to ‘modern technology’ or other reasons to be recorded.

(a)  74% FDI is permitted under the Automatic Route.

(b)  any FDI above 74% would require prior Government approval where it is likely to result in access to ‘modern technology’ or other reasons to be recorded.

Key conditions: Key conditions:
(a)  Infusion of fresh foreign investment within the permitted Automatic Route level (i.e. up to 49%) in a company not seeking an Industrial License will require prior Government approval in case of a change in the ownership pattern or transfer of stake by existing investor to new foreign investor. (a)  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.
(b)  Foreign investment is subject to security clearance and guidelines of the MoD. (b)  Same as existing framework.
(c)  The investee company must be self-sufficient in areas of product design and development. The investee/joint venture company and its manufacturing facility, should also have maintenance and life cycle support facility of the product(s) being manufactured in India. (c)  Same as existing framework.
(d)  FDI up to 74% under Automatic Route will be permitted for companies seeking new Industrial License.
(e)  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.

Preliminary analysis of the Press Note

The proposed liberalization of the FDI Policy for defence manufacturing is a welcome move and could attract large scale investments by foreign defence majors in the sector, thereby adding significant momentum to the Government’s Make in India programme.

Some of the key aspects of the FDI changes in the Press Note are summarised below:

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