India likely to scrap ban on FII investments in defence

NEW DELHI: India may scrap the ban on portfolio investments in the defence sector, a move that would come as a big relief to listed equipment manufacturers including Larsen & Toubro and Pipavav Defence besides giving more flexibility to the likes of the Tata and Mahindra groups that have big stakes in the industry.

The finance and defence ministries are reviewing the five-month-old foreign direct investment (FDI) policy, a government official told ET.

The defence procurement policy that came into force in June gave local vendors the right of first refusal to help promote indigenous industry. In August, as part of this strategy, the Union Cabinet allowed foreign direct investment (FDI) in defence up to 26% through the automatic approval route and above 26% to select proposals that provide access to technology once they were cleared by the Cabinet Committee on Security. A press note subsequently issued by the Department of Industrial Policy and Promotion (DIPP) said portfolio investment was not permitted even though this is not barred under the Foreign Exchange Management Act (Fema) and the Cabinet note had not sought it.




This led to confusion for a number of listed companies that already had foreign institutional investment.

“It does not make sense to ban FII (investment) now that had been allowed earlier,” said the official cited above. A clear foreign investment policy will give companies the impetus needed to expand business to the scale needed to meet demand.

“The restriction should be technically effective only after a specific amendment is made in Schedule II (Portfolio Investment Scheme) of Fema 20 regulations. In the interim, confusion will prevail, including on existing FII investments in the sector,” said Akash Gupt, executive director, PwC.

The uncertainty has kept FII investments low even though it is widely expected that private sector companies will get a much bigger share in defence procurement in the years ahead. Foreign institutional investors had a 2.31% stake in Pipavav Defence at the end of September, up marginally from 2.2% at the end of June. Since April 2000, the defence sector has got just $4.94 million of FDI.

Under Fema, foreign institutional investors cannot invest in a sector that is on the prohibited list. Investment up to 24% is permitted if a sector is not on the list. The government has, however, not put any sector on the prohibited list as the move could send out negative signals to foreign investors at a time when it is making efforts to attract foreign investment.

The defence and finance ministries have already had one round of discussions to resolve the issue. The Confederation of Indian Industry and others have also lobbied hard with the government for a friendlier FDI policy.

The defence procurement policy 2006 already allowed more than 26% FDI on a case-by-case basis through the Cabinet Committee on Security in state-ofthe-art technology areas but the DIPP wanted it incorporated in the FDI policy for more clarity.

The review of FDI policy was taken up after a panel headed by economic affairs secretary Arvind Mayaram recommended raising the overseas investment limit in defence to 49%. The defence ministry had shot down the idea because of security concerns and suggested a higher investment limit only on a case-to-case basis and if the proposal involved the transfer of state-of the-art technology.