Defence Manufacturing in India: 74% FDI Cap, Offset Policy & iDEX

India's Defence Manufacturing Sector: A Strategic Opportunity for Foreign Investors

India is the world's fourth-largest military spender and one of the largest defence importers globally. The government's Atmanirbhar Bharat (self-reliant India) initiative has transformed the defence manufacturing landscape, creating substantial opportunities for foreign companies willing to establish manufacturing operations on Indian soil. Defence production reached an all-time high of approximately INR 1.51 lakh crore (USD 18 billion) in FY 2024-25 — an 18% increase over the previous year — and the government is targeting INR 1.75 lakh crore for FY 2026-27.

For foreign defence manufacturers, the calculus is straightforward: India will spend over USD 100 billion on defence procurement in the next five years, and the government is systematically closing the door on imports while opening it to domestic manufacturing with foreign participation. Understanding the FDI policy framework, industrial licensing regime, offset obligations, and innovation ecosystem is essential for any foreign entity evaluating this market.

FDI Policy Framework: The 74% Automatic Route and Beyond

India's FDI policy in defence manufacturing operates on a two-tier structure, revised most recently through Press Note 4 of 2020:

Automatic Route: Up to 74%

Foreign investment up to 74% of equity is permitted under the automatic route, meaning no prior approval from the Government of India or the RBI is required for the investment itself. This was increased from 49% in September 2020, representing a significant liberalisation. The investment must comply with FEMA regulations, including FC-GPR filing within 30 days of share allotment and annual FLA returns.

Government Route: Up to 100%

FDI beyond 74% and up to 100% is permitted through the government approval route wherever it is likely to result in access to modern technology. The application is processed by the Department for Promotion of Industry and Internal Trade (DPIIT) in consultation with the Ministry of Defence. In November 2023, Sweden's Saab became the first overseas entity to receive government approval for a wholly-owned subsidiary in defence manufacturing (for its Carl-Gustaf M4 facility) — setting a precedent that 100% foreign ownership is achievable when genuine technology transfer is proposed.

Conditions Applicable to All FDI

• Security clearance: All foreign investments in defence require security clearance from the Ministry of Home Affairs as per MoD guidelines
• Indian management control: The applicant company must be an Indian entity with majority representation on the Board of Directors by Indian citizens and a resident Indian as Chief Executive
• Industrial licence: Manufacturing of defence items requires an Industrial Licence under the Industries (Development and Regulation) Act, 1951, or the Arms Act, 1959
• Offset obligations: Contracts above INR 2,000 crore (approximately USD 240 million) trigger mandatory offset requirements

Industrial Licensing: The Gateway to Defence Manufacturing

No entity — Indian or foreign-invested — can manufacture defence items without an Industrial Licence (IL) from DPIIT. This is distinct from the FDI approval and adds a separate regulatory layer.

Application Process

1. Incorporate an Indian entity: Register a private limited company or public limited company under the Companies Act, 2013, using SPICe+ form
2. Submit IL application: Apply online through the DPIIT G2B Portal with detailed project proposals, manufacturing plans, and technology descriptions
3. Multi-agency review: DPIIT circulates applications to the Ministry of Defence, Ministry of Home Affairs (for security clearance), state governments, and other relevant agencies
4. Licensing Committee: The inter-ministerial Licensing Committee reviews applications and recommends grant, rejection, or deferment
5. Timeline: The stated processing time is 45-60 days, though in practice, security clearances and inter-ministerial consultations can extend this to 3-6 months

Key Conditions in the Industrial Licence

• The IL specifies the defence items permitted for manufacture, production capacity, and investment levels
• Annual reporting to DPIIT on production, employment, and investment progress is mandatory
• Manufacturing must commence within the period specified in the licence (typically 2-3 years)
• Any change in foreign equity beyond 26% requires prior intimation to the Licensing Committee

Defence Offset Policy: Reinvesting Contract Value in India

India's Defence Offset Policy mandates that foreign vendors winning large defence contracts reinvest a portion of the contract value in India. This policy is a critical consideration for foreign OEMs (Original Equipment Manufacturers) bidding on Indian defence procurement.

Offset Thresholds and Percentages

Eligible Offset Activities

Foreign vendors can discharge offset obligations through several categories, each carrying different multiplier benefits:

Offset Banking

Vendors can bank excess offset credits from one contract and use them against future obligations. This mechanism provides flexibility for companies with multiple ongoing or anticipated Indian defence contracts. The Defence Offsets Management Wing (DOMW) within the Ministry of Defence monitors implementation and credits.

Current Status and Practical Challenges

The offset policy has faced significant implementation challenges. Between March 2021 and March 2025, only one offset contract was signed, raising questions about the policy's future. Key issues include difficulty finding qualified Indian offset partners in specialised defence sub-systems, lengthy approval processes for offset proposals, and limited availability of Indian companies with the technical capability to absorb high-technology transfers. Foreign companies should monitor the policy closely, as the government has signalled potential reforms to streamline the process.

Positive Indigenisation Lists: Import Restrictions That Create Manufacturing Opportunity

The government has published five Positive Indigenisation Lists (PILs) through the Department of Defence Production and the Department of Military Affairs, identifying over 5,500 defence items that must be procured from domestic manufacturers after specified timelines.

Impact on Foreign Investors

For foreign defence companies, the PILs create a clear incentive structure: items on the list cannot be imported after the specified date, so the only way to supply them is to manufacture in India. As of February 2025, over 3,000 of the 5,500 listed items have been indigenised. Key categories include:

• Artillery and ammunition: Advanced Towed Artillery Gun System (ATAGS), 155mm howitzers
• Naval systems: Corvettes, sonar systems, torpedo defence systems
• Aerospace: Light Combat Helicopters, transport aircraft, radar systems
• Electronics: Electronic warfare systems, communication equipment, night vision devices

For a foreign OEM that currently exports to India, establishing a manufacturing JV or subsidiary to produce indigenised items is the most direct path to maintaining market access. The choice between a branch office and subsidiary structure is particularly relevant here, as defence manufacturing requires an Indian entity with management control.

iDEX: Innovation for Defence Excellence

Launched in April 2018 by the Prime Minister, iDEX (Innovation for Defence Excellence) is India's defence innovation ecosystem managed by the Defence Innovation Organisation (DIO). For foreign companies, iDEX represents both a competitive threat (Indian startups developing indigenous alternatives) and a partnership opportunity.

Scale and Scope

Defence India Startup Challenges (DISC)

Through the DISC programme, iDEX curates specific problem statements from each of the defence forces — Army, Navy, Air Force, and Defence Space Agency. DISC 12 was re-launched with grant amounts up to INR 1.5 crore per startup. The challenges span areas including AI-driven surveillance, autonomous weapons systems, satellite communication, underwater detection, and adaptive camouflage.

ADITI Scheme: Deep-Tech Critical Technologies

The Acing Development of Innovative Technologies with iDEX (ADITI) scheme, launched in March 2024, specifically targets 30 deep-tech, critical, and strategic technologies. ADITI 1.0 issued 17 problem statements, while ADITI 2.0 (October 2024) brought 19 new challenges in AI, quantum computing, anti-drone systems, military communication, and adaptive camouflage. Grants under ADITI can reach up to INR 25 crore — significantly higher than standard iDEX challenges.

Foreign Company Engagement with iDEX

While iDEX primarily targets Indian startups and MSMEs, foreign companies can engage through:

• Technology partnerships: Partner with iDEX-funded startups to provide components, IP, or co-development
• Joint ventures: Establish JVs with Indian startups that have demonstrated capabilities through iDEX challenges
• Mentorship: Participate as mentors or technology evaluators through the Partner Incubator programme

Defence Corridors and Infrastructure

India has established two Defence Industrial Corridors to concentrate defence manufacturing capacity:

Uttar Pradesh Defence Corridor

Spanning Aligarh, Agra, Jhansi, Kanpur, Chitrakoot, and Lucknow, the UP Defence Corridor has attracted investments of over INR 10,000 crore. Major players include Bharat Electronics Limited (BEL), Bharat Dynamics Limited (BDL), and private sector companies establishing manufacturing units.

Tamil Nadu Defence Corridor

Covering Chennai, Hosur, Salem, Coimbatore, and Tiruchirappalli, the TN Corridor leverages existing aerospace manufacturing capabilities (HAL, L&T, and numerous MSMEs already operate in the region). Chennai's proximity to a major port provides logistics advantages for export-oriented manufacturing.

Foreign investors establishing manufacturing operations should strongly consider locating within these corridors to benefit from infrastructure support, single-window clearances, and proximity to existing defence supply chains.

Tax and Financial Incentives for Defence Manufacturers

Defence manufacturing entities benefit from several fiscal incentives beyond the standard corporate tax framework:

Corporate Tax

Domestic companies — including foreign-invested defence manufacturers incorporated in India — can opt for the concessional 22% rate (effective 25.17% including surcharge and cess) under Section 115BAA. The 15% manufacturing rate under Section 115BAB applied only to companies that commenced manufacturing by 31 March 2024; that window has now closed, so new entrants can no longer avail it. Industry has lobbied for its re-introduction in recent Budgets, but as of FY 2026-27 the 22% Section 115BAA regime remains the relevant concessional option.

Customs Duty Exemptions

Import of defence equipment for licensed manufacturers benefits from customs duty exemptions and concessions. Specific notifications exempt raw materials, components, and sub-assemblies used in defence production from basic customs duty, subject to end-use conditions and certification by the Department of Defence Production.

Transfer Pricing Considerations

Foreign-invested defence manufacturers must maintain arm's-length pricing for all inter-company transactions, including technology licensing fees, component supply from the parent, and brand/IP charges. Transfer pricing documentation must be contemporaneous and is subject to scrutiny by the Indian tax authorities, particularly given the strategic nature of the sector.

Defence Budget and Procurement Pipeline

India's defence budget for FY 2026-27 was INR 6.22 lakh crore (approximately USD 74 billion), with the Ministry of Defence seeking a 20% increase to INR 7.5 trillion for FY 2026-27. The capital acquisition budget — the portion allocated to purchasing new equipment and platforms — has been growing at approximately 10-12% annually, creating a predictable procurement pipeline for manufacturers.

Procurement Categories Relevant to Foreign Investors

The Defence Acquisition Procedure (DAP) 2020, updated through subsequent amendments, defines procurement categories that directly affect foreign manufacturers:

The government has progressively increased the share of Buy (Indian-IDDM) and Buy (Indian) categories in annual procurement plans. In FY 2024-25, approximately 75% of capital procurement orders were placed with domestic manufacturers, up from 58% five years earlier. This trend makes Indian manufacturing presence increasingly important for foreign defence companies seeking sustained market access.

Make in India in Defence: Key Platforms

Several major defence platforms are now being manufactured in India through foreign partnerships, demonstrating the viability of the model:

• Rafale India (Dassault-Reliance JV): Components and sub-assemblies for the Rafale fighter at the DRAL facility in Nagpur
• C-295 transport aircraft (Tata-Airbus JV): India's first private sector military aircraft manufacturing line in Vadodara, Gujarat — 40 of 56 aircraft to be manufactured in India
• Brahmos missiles (India-Russia JV): Manufacturing in India with significant export potential to Southeast Asian and Middle Eastern markets
• Apache and Chinook helicopters (Boeing): Tata Boeing Aerospace facility in Hyderabad manufacturing fuselages for global supply chain

Defence Export Opportunity

India's defence exports have surged to a record INR 23,622 crore in FY 2024-25, growing 12% over the previous year. The government is targeting INR 50,000 crore (USD 5.9 billion) in annual defence exports by FY 2029-30. The Department of Defence Production issued 1,762 export authorisations in FY 2024-25 — a 17% increase over the previous year.

Export-Oriented Manufacturing

A significant recent reform removed the mandate for fully export-oriented defence manufacturers to establish local maintenance and support facilities. This allows export units to outsource such functions, making India a more attractive base for foreign companies seeking to use Indian manufacturing capacity to serve third-country markets.

Companies requiring an Import Export Code (IEC) for defence exports must also obtain specific export authorisation from the Department of Defence Production for each item category. The process has been streamlined through an online portal, with typical processing times of 30-45 days.

Step-by-Step Entry Strategy for Foreign Defence Companies

Phase 1: Market Assessment and Partner Identification (3-6 months)

1. Identify specific defence categories aligned with government procurement priorities and Positive Indigenisation Lists
2. Evaluate potential Indian JV partners — consider defence PSUs, private sector players, and iDEX startups
3. Engage with the Defence Investment Cell (DIC) at the Department of Defence Production for preliminary guidance

Phase 2: Entity Setup and Licensing (6-12 months)

1. Incorporate an Indian entity as a private or public limited company
2. Apply for Industrial Licence through the DPIIT G2B Portal
3. Obtain security clearance from the Ministry of Home Affairs
4. Apply for FDI approval through the government route if seeking more than 74% equity
5. Complete FC-GPR filing and FEMA compliance for capital infusion

Phase 3: Manufacturing Setup and Production (12-24 months)

1. Establish manufacturing facility — preferably within a Defence Industrial Corridor
2. Obtain GST registration and necessary state-level clearances
3. Qualify for defence procurement through Vendor Registration on the MoD procurement portal
4. Engage with BIS and DGQA (Directorate General of Quality Assurance) for quality certification

Total Timeline: 18-36 Months

From initial market assessment to first production, foreign companies should plan for an 18-36 month entry timeline. Companies using the automatic route (up to 74% FDI) can move faster than those requiring government approval for higher equity stakes.

Comparison With Other Defence Manufacturing Destinations

Foreign defence companies evaluating India should contextualise the opportunity against alternative manufacturing destinations:

India's combination of large domestic market, competitive tax rates, deep engineering talent pool, and growing export credentials makes it one of the most attractive destinations for defence manufacturing FDI globally. The primary differentiator is the sheer scale of domestic procurement — no other emerging market offers a comparable defence spending trajectory.

Practical Challenges and Risk Mitigation

Security Clearance Delays

Security clearances from the Ministry of Home Affairs can take 6-12 months. Early engagement with the Defence Investment Cell and clear documentation of the foreign investor's credentials, track record, and proposed technology contributions can help expedite the process.

Offset Implementation Risks

If your company anticipates bidding on contracts above INR 2,000 crore, develop an offset strategy before bid submission. Identify qualified Indian offset partners early and consider establishing relationships with MSMEs in the defence corridors.

Technology Transfer Sensitivity

The government expects genuine technology transfer as a quid pro quo for higher FDI stakes. Companies offering proprietary technology should negotiate clear IP protection frameworks in JV agreements and ensure that technology licensing arrangements comply with both Indian transfer pricing rules and home-country export control regulations.

For comprehensive guidance on establishing a foreign-invested entity in India's defence sector, our FDI advisory services cover the full spectrum of sectoral analysis, entity structuring, and regulatory compliance. See also our detailed comparison of automatic route vs government approval for FDI to understand which pathway applies to your investment.

Key Takeaways

• 74% FDI is permitted under the automatic route, with 100% available through government approval for investments bringing modern technology — SAAB's 2023 wholly-owned subsidiary approval sets the precedent
• Industrial licensing is mandatory for all defence manufacturing, requiring DPIIT approval with security clearance from the Ministry of Home Affairs
• Offset obligations of 30% apply to contracts above INR 2,000 crore, with multiplier benefits for MSME engagement, technology transfer, and critical technology absorption
• Defence production reached INR 1.51 lakh crore in FY 2024-25, with exports at INR 23,622 crore — the government targets nearly doubling both metrics by FY 2029-30
• iDEX has engaged 619 startups with INR 449.62 crore in FY 2025-26 budget — foreign companies should partner with, not compete against, this ecosystem