FDI in Defence Industry and R&D
The defence industry was thrown open to the private sector in May 2001. The Government permitted 100 per cent equity with a maximum of 26 per cent FDI component, both subject to licencing. Subsequently, the Department of Industrial Policy and Promotion issued detailed guidelines, after consultations with the Ministry of Defence, for the issuance of licence for the production of arms and ammunition in January 2002.
As per the Indian policy, a foreign investor is expected to invest his resources in a venture where he has no significant control, strict capacity/product constraints, no purchase guarantee, no open access to other markets (including exports) and an unfair advantage to the local public sector. Such an expectation defies logic. No wonder that things with regard to FDI have not progressed the way the Government had hoped. There has been a total lack of enthusiasm on the part of foreign investors to invest in the Indian defence sector. Many feel that such a lop-sided policy was destined to be a non-starter.
Unless India makes major changes and liberalises the policy, there is hardly any hope of attracting FDI as an offset.
Offset Trade
More than 130 countries are demanding offsets in one form or the other. The current market for offsets is estimated to be close to USD 50 billion and is increasing rapidly. It has given rise to a flourishing world wide trade in offset obligations. A number of web sites and forums provide platform to all players of offset programmes to exchange their concerns and strike mutually beneficial bargains.
There is a new breed of global traders who deal in offset credits. These are bought from companies having surplus credits and sold at a profit to defence vendors who need them to fulfill their offset obligations. It is a highly cost-effective option in cases where a vendor has to execute offsets programmes in areas totally unrelated to his business.
Many companies after having negotiated normal trade transactions hold back announcement of the deals and contact entities needing offsets. They offer to link their deals to offset fulfillment, albeit at a cost. A buyer nation is, thereby, deprived of true benefits of offsets when a normal commercial transaction is shown against offset obligations. It is a highly unfair but commonly prevalent practice.
There is also a school of thought that believes that it may be economically prudent to default on offsets and pay associated penalties. They do not consider it to be unethical as they believe that the very concept of offsets is an anathema and contrary to free-trade practice. According to them, demand for offsets is a coercive measure unjustifiably imposed by a buyer. Therefore, they have no qualms in reneging on their contractual obligations.
Transfer of Technology
Transfer of technology is the most popular and highly preferred type of offsets the world over, especially for the countries that aspire to build indigenous defence industry potential. Up to 30% of all offsets provided relate to technology transfer of varying degree. Ideally, receipt of technology should be utilised as a take off platform for subsequent development of more advanced technologies. This was the route taken by Japan and South Korea. It is commonly agreed that Nokia has become a technology powerhouse due to the technology transfer offsets obtained by Finland from defence deals.
Strangely, India has totally neglected this significant aspect of offsets. As a matter of fact, India should have made transfer of technology to be the only acceptable form of offsets. However, selection of technology should be based on the following parameters:-
Level of Technology - It is an accepted fact that no vendor is going to offer his latest technology unless the main contract is commercially irresistible. Technology in question should be well-stabilised and have an adequate residual effective life. Some recipients insist on a ‘buy back’ clause to guard against getting outdated technology.
Economic Viability - Economies of scale is an important issue that merits due consideration. Any technology, which is product specific and does not have applications in other fields, will invariably not be cost-effective. The technology sought should be such that the recipient can exploit it fully by developing applications across other product spectrum.
Latent Cost Penalty - Even if the technology is obtained free of cost as an offset, the buyer has to expend considerable resources in setting up manufacturing facilities. Additionally, the seller invariably tries to charge an exorbitant price for jigs, fixtures, test beds, training and technical documentation. Therefore, a cost-benefit analysis must be carried out of the technology on offer.
Risk of Over-Capacity - In the case of popular military systems, there is a danger of a large number of countries getting the same technology, thereby creating surfeit of capacity. The US is said to have transferred technology pertaining to the components of F-16 fighters to over 17 countries in full/partial fulfillment of its offset obligations. Having established manufacturing facilities at a considerable cost, the recipient nations are hard pressed to obtain orders to keep their factories going. This must be guarded against.
Ability to Absorb Technology - Seeking technology without matching indigenous capability for smooth absorption can prove to be a highly wasteful exercise. Technology should not be sought merely for flaunting in the domestic political arena.
Evaluation of Efficacy - The greatest drawback of technology transfer as an offset is that it is very difficult to measure its real impact and effectiveness. The recipient nation has to have a dedicated set up to collate and assess the overall value.
Technology with Strings - Invariably, technology is provided with strings attached. These restrictions may inhibit the recipient nation from re-exporting the product or its use for any other unspecified purpose. This is done by the transferor to prevent the proliferation of the concerned technology, as also to forestall competition for its own products.