Fixing defence's FDI blind spot: Why the 'make' category needs a clearer rulebook

India’s Union Budget 2026-27 allocated a historic ₹7.85 lakh crore to the Ministry of Defence (MoD), marking an unprecedented 15.19% increase over the previous year. Following Operation Sindoor, which catalysed emergency procurement and accelerated modernisation timelines, the allocation underscores defence’s centrality to India’s economic and security architecture. As the 77th Republic Day celebrations showcased indigenous defence systems under the banner of Aatmanirbharta, the juxtaposition between policy ambition and regulatory clarity has become starkly visible.

Also read: Budget 2026: How the size of India's budget has grown in 10 years

The Government’s Aatmanirbhar Bharat targets – ₹3 lakh crore in defence production and ₹50,000 crore in exports by 2029 – demand private and foreign capital participation. Yet the regulatory infrastructure meant to channel this investment contains a structural gap that has quietly become a significant friction point. The recent release of the draft Defence Acquisition Procedure 2026 by the Ministry of Defence (to replace the Defence Acquisition Procedure, 2020) (DAP) is the right moment to address it.

The Procurement Framework

In the absence of a parliamentary statute, the MoD exercises executive powers to procure defence equipment, and the DAP is the primary instrument governing all capital acquisitions (except medical equipment, land and works) by the MoD, defence services, and the Indian Coast Guard. The DAP organises procurement into several categories: Buy, Make and Innovation, Leasing, Strategic Partnership (SP), and others.

Two categories matter most here. The Make category, especially Make-I (government-funded design and development by domestic industry), is the principal vehicle for building an indigenous Tier-1 vendor base – companies manufacturing critical sub-systems in airborne electronics, RF systems, and precision engineering. The SP model, by contrast, is designed for a limited number of high-value segments where the Government seeks to create a near-monopoly Indian partner for long-term programmes with global Original Equipment Manufacturers (OEM).

Additional Eligibility: Ownership, Control, and the FDI Cap

For most DAP categories, the basic requirement is that the bidder be an Indian-registered entity. However, certain categories – Make-I and SP among them – impose additional conditions. For instance, the DAP requires Make-I bidders to demonstrate that ownership by resident Indian citizens exceeds 50%, and that control (the right to appoint a majority of directors or direct management decisions) vests with resident Indian citizens. Total FDI in Make-I bidders is consequently capped at 49%. These ownership-and-control requirements are safeguards to ensure that Make-I bidders are substantively Indian in decision-making authority and economic ownership.

The Pyramiding Problem

The trouble begins with an additional stipulation. Alongside the ownership and control requirements, the DAP prohibits “pyramiding of FDI in Indian holding companies or in Indian entities subscribing to shares or securities of the applicant company”, and states that indirect foreign investment will count towards the 49% cap. But it neither defines “pyramiding” nor prescribes a computation methodology for Make-I.

Under India’s general foreign exchange framework – the Foreign Exchange Management (Non-debt Instruments) Rules, 2019 and the consolidated FDI Policy – there is a well-established methodology.

Indirect foreign investment through an Indian entity is not counted if that entity is “owned and controlled” by resident Indian citizens – an Indian Owned and Controlled Company (IOCC). This is the default method across all sectors. If a foreign entity holds 49% in an IOCC, and that IOCC invests in a defence company, the foreign investment attributable to the IOCC’s stake is nil.

The SP model adopts a different approach. It provides an explicit, more stringent mechanism: even where an Indian shareholder qualifies as an IOCC, foreign shareholding within that IOCC is proportionately attributed to the applicant company. The DAP’s own illustration makes this clear: if Company A has 25% FDI and holds 50% of the applicant Company, the applicant is deemed to have 12.5% foreign investment from Company A – a significant departure from standard FDI computation.

Which method applies to Make-I? The DAP is silent. A narrow reading would treat the pyramiding restriction as aligned with Section 186 of the Companies Act, 2013 (limiting investment layers to two) and rely on standard FDI computation. An expansive reading could import the SP model’s proportionate attribution – even though the DAP never says so.

Why the SP Standard Does Not Belong in Make-I

The SP model contemplates a deep, exclusive, long-term partnership for manufacturing high-end strategic platforms like submarines, fighter aircraft or armoured vehicles. The quasi-monopolistic position of a strategic partner, the scale of investment, and the sensitivity of technology involved justify a conservative FDI computation.

Make-I serves a fundamentally different function. It is the broad-based engine of indigenous capability-building, designed to draw a wide pool of Indian companies into defence design and development. The ownership and control requirements already ensure these bidders are substantively Indian. Importing the SP’s proportionate attribution model – without any express mandate – would impose a level of regulatory conservatism the drafters clearly did not intend for this category, and would deter exactly the foreign investment India’s defence sector needs.

Consider a foreign company acquiring a stake in an Indian defence firm with established credentials in airborne electronics. To stay within the 49% cap, it structures through a joint venture with an Indian partner qualifying as an IOCC. Under standard FDI computation, the structure works. Under the SP model’s proportionate attribution, the foreign investor’s stake in the IOCC layer gets counted, potentially pushing deemed FDI beyond the limit or creating a compliance question mark that could disqualify the bid. In Make-I projects, where prototype costs run into hundreds of crores and timelines span years, this ambiguity functions as a material friction cost – discouraging investment into the very companies India needs for its Tier-1 defence vendor base.

The Way Forward

The Government has progressively liberalised FDI limits in defence, raising the automatic route threshold from 49% to 74% (for companies seeking new industrial licenses). Yet the procurement rulebook meant to operationalise this policy contains a gap that creates disproportionate risk. Persistent interpretive uncertainty signals to foreign OEMs and institutional investors that India’s defence market, despite its scale and budgetary ambition, carries elevated regulatory risk. Countries with mature defence-industrial bases – Israel, South Korea, Singapore – have shown that clear, predictable FDI rules accelerate technology absorption and export competitiveness.

The current release of the draft DAP 2026 for stakeholder consultation presents the ideal window for a targeted reform. The MoD should clarify that indirect foreign investment in Make-I projects will be computed in accordance with the standard FDI Policy methodology – investment through an IOCC will not be attributed to the downstream applicant. The ownership and control requirements provide more than adequate protection. The SP model’s proportionate attribution can and should remain for strategic partnerships, where the unique nature of the engagement justifies it. But extending that standard to the Make-I category, by silence or implication, would be a policy error.

A simple clarification in the DAP 2026, such as an explicit safe harbour for IOCC-routed investment in Make-I procurements, would remove a significant barrier to capital participation, strengthen India’s indigenous manufacturing base, and bring the DAP into alignment with the broader direction the Government has consistently championed. Re-invigorating the Make category is critical for deepening India’s Tier-1 vendor ecosystem. Regulatory clarity is the first step. In a defence landscape where capital, technology, and manufacturing expertise flow to jurisdictions that offer predictable rules, this is a reform whose time has come.

Alina Arora, Partner; Parth Singh, Partner; and Somil Garg, Principal Associate (has also contributed to the article), at Shardul Amarchand Mangaldas & Co. Views expressed are personal.