FII ban in defence sector likely to be revoked

Finance ministry in talks with DIPP and defence ministry.

The government is working to undo the ban on portfolio investments in the defence sector with the finance ministry now in talks with the department of industrial policy (DIPP) and promotion and the ministry of defence.

“The ban on FIIs is an unexpected consequence of changes in the FDI policy announced last year, which has created a lot of uncertainty amongst investors. We are reviewing the provision,” said a senior government official, adding that the issue is now being taken up with DIPP and the defence ministry.

As an alternative, the government can consider freezing investments by foreign institutional investors in such firms at the current level, said the official.

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At present, up to 26 per cent foreign direct investment is allowed in the defence sector. But as part of its move to liberalise the foreign direct investment regime, the Cabinet Committee on Economic Affairs in August last year had permitted FDI over the mandated cap in the defence sector on a case-to-case basis after being vetted by the Cabinet Committee on Security.

However, the subsequent notification by the DIPP had banned investments by FIIs in defence production companies. “Investment by FIIs through portfolio investment is not permitted,” according to Press Note 6 of 2013 by the DIPP.

The move has impacted listed defence equipment makers such as Larsen & Toubro as well as companies including the Tata and Mahindra groups that have a big presence in the sector.

For instance, FII investment in L&T stands at 17.85 per cent for the quarter ended December 2013 while it amounted to 2.23 per cent in Pipavav Defence and Offshore Engineering Ltd in the same period, according to filings with the Bombay Stock Exchange.

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If the current ban on FII investments in the defence sector continues, it would also require change sin the Foreign Exchange Management Act and include the sector in the prohibited list.

Significantly, the finance ministry has also been trying to convince the defence ministry to increase foreign investment in the sector to 49 per cent by including an internal cap of 23 per cent for FII investment.