FDI In Defence Sector: What Are The Repercussions?

Last week Department of Industrial Policy and Promotion (DIPP) has allowed hiking the foreign direct investment (FDI) in the defence sector. The plan is to increase the FDI limit to 100% from the present level of 26%. Although the finance ministry has not made any official announcement of this, but the plan has stirred the defence companies of India. As India has permitted FDI in defence only since 2001, before that private companies were not allowed to enter in the defence sector for production.

However, even when 26% of FDI was allowed, the private sector attracted very few foreign investors. From then, the total FDI in the defence route was very limited to around Rs 30 crore. From this it can be elicited that due to low FDI, the foreign investors were less interested and as FDI is increased to its maximum level it may attract more investment from the foreign investors.

If the FDI cap is raised, this will allow the foreign companies to buy out their Indian partners with whom they had joined hands to meet the investment norms for operating in India or those companies will most likely establish their own manufacturing base in the country. India imports around 70% of the parts and technologies used in the defence sector. If FDI is allowed the foreign companies will set up their plants in India and this will reduce the import bill of the country. Due to better technologies, the work efficiency will increase and will help to cut down the cost of the companies.

But as the defence technologies developed by foreign original equipment manufacturers is controlled by their governments, this may not translate into greater participation from the foreign players. Therefore, the transfer will depend on the strategic considerations not on the company ownership patterns.

However, if the FDI in defence is hiked, this is going to increase the competition among the domestic and the foreign players. The private players which are engaged in the business of defence will be the maximum gainers. The private defence companies are facing huge debts in their balance sheet and this fresh infusion of capital will lead to reduce the debt on the company. Now let’s have a look how the companies will like to take benefit of 100% FDI.

Ashok Leyland, the largest supplier of logistic vehicles to the India Army and the defence sector contributes around 7% of the total revenue. The company has total debt of Rs 3884 crore in its balance sheet. The company by infusing fresh capital will like to reduce the debt burden and will like to increase its operation in the defence sector.

Pipavav Defence & Offshore Engineering Company which builds ships for the navy and coast guards has a total debt of Rs 4625.7 crore in their balance sheet. Bharat Forge develops, assembles and manufactures defence systems, particularly artillery guns, mortar guns and ammunition. The company has total debt of around Rs 1467 crore in their book. Rolta provides IT services to the defence sector and has a total debt of Rs 2460 crore during the fiscal year 2014. On one side this will create an opportunity for the mentioned companies to reduce their debt burden from itself and will also help the companies to perform better in future, while on the other side the competition will raise among them.

Looking on the performance of the stocks since the start of this month, the scrip of Ashok Leyland, Bharat Forge and Rolta has gained by 3%, 12% and 4% respectively, while the scrip of Pipavav Defence has lost by around 6.6%, after the announcement of FDI cap to increase, from June 2, 2014.