Defence Industry

Defence Offsets and Transfer of Technology
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Issue Vol. 30.1 Jan-Mar 2015 | Date : 13 Aug , 2015

LCA Tejas

India today has the distinction of being the world’s biggest arms importer buying 12 per cent of the global total as per Stockholm International Peace Research Institute (SIPRI). India’s national aim has been to promote growth of Indian defence industry, introduction of new technologies through direct transfers, promote indigenisation and to achieve the same, had put in place a robust offsets mechanism. The ‘Offsets’ policy is to ensure that for every dollar that goes to a foreign arms supplier, 30 to 50 per cent of the same will be re-invested in India for a defence related investment or activity.

Defence offsets have yet to find substantial success as major Western countries have started labeling offsets regulations as protectionist…

The aggressively nationalist government headed by Narendra Modi has been driving the need to promote indigenisation from the very first day in power. ‘Make in India’ is now a national slogan. The message from Prime Minister Modi to the world community is “No more Red Tape, Only Red Carpet”. China had taken a similar route nearly two decades ago. The Indian government has finally realised that a high degree of self-reliance in the production of defence equipment is a key result area for a nation to attain the status of a super power.

The Defence Acquisition Council (DAC) headed by Arun Jaitley, the then Raksha Mantri, had directed that instead of procurement from a foreign source, the Light Utility Helicopter (LUH) to replace the fleet of Chetak/Cheetah helicopters would be ‘Made in India’ albeit with foreign collaboration. The tender for the long delayed acquisition of the 197 LUH for the Indian Army and Indian Air Force (IAF) from abroad valued at $1 billion has finally been scrapped. As the nation moves toward ‘Make in India’, it will have an interim step of ‘Someone help us Make in India’. With 49 per cent FDI cleared in defence production, a figure that is likely to be increased further, those who see promise in India’s global story will surely join the race.

Global Defence Offsets

The policy of Defence Offsets has been in place for nearly a decade but without any substantial success till date because some of the big ticket purchases like the Boeing C-17 Globemaster III Heavy Lift aircraft and Lockheed Martin C-130J-30 Super Hercules tactical transport aircraft, both for the IAF, were procured through the Foreign Military Sales (FMS) programme of the US government. The Dassault Rafale Medium Multi-Role Aircraft (MMRCA) would be the first real test of an Offset contract whenever it is awarded. With Offset obligation pitched at 50 per cent for this particular contract, the foreign vendor would be required to invest over $10 billion in the Indian aerospace industry.

The policy of Defence Offsets has been in place for nearly a decade but without any substantial success…

India today has the distinction of being the world’s biggest arms importer buying 12 per cent of the global total as per Stockholm International Peace Research Institute (SIPRI). India’s national aim has been to promote growth of Indian defence industry, introduction of new technologies through direct transfers, promote indigenisation and to achieve the same, had put in place a robust offsets mechanism. The ‘Offsets’ policy is to ensure that for every dollar that goes to a foreign arms supplier, 30 to 50 per cent of the same will be re-invested in India for a defence related investment or activity.

The Indian armed forces have a long shopping list. If all goes well, the IAF itself is going to procure equipment and platforms worth $150 billion in next fifteen years. The key objective of the Ministry of Defence (MoD) as stipulated in the Defence Offset Guidelines was to leverage capital acquisitions to develop the Indian defence industry, improve defence research and encourage development of synergistic sectors like civil aerospace and internal security.

The US introduced defence offsets as a marketing tool in the form of inducement to sell arms to under-developed friendly countries and in return, either purchase goods or make local investments. Many countries around the world followed. Some form of barter system had existed for centuries. India used to buy aircraft and naval vessels from the Soviet Union in the 1960s in exchange of shoes, hosiery and bananas. Meanwhile, most countries of the world chose to introduce high percentages of defence offsets regulations. Currently, Austria, Belgium, Brazil, Czech Republic, Denmark, Finland, Greece, the Netherlands, Switzerland, Spain, Sweden, Poland, Portugal and Norway have 100 per cent offsets requirement. Brazil insists on full Transfer of Technology (ToT) and co-production. Offset requirements of some other countries are Israel – 35 per cent, Romania – 80 per cent, Saudi Arabia – 35 per cent, South Korea – 30 per cent and Turkey – 50 per cent.

No nation would like to part with painfully hard earned technology even at substantial cost…

China has no formal Offsets policy. Australia does not accept indirect (civilian) offsets, unless they bring some specific benefits to their defence industry. Recently, the European Union has introduced a Code of Conduct for its members on Offsets. Indian Offset obligations are applicable to all contracts valued at Rs 300 crore ($60 million) or more. The 30 per cent Offsets in most categories could be discharged through direct purchase, FDI in joint ventures and investment in kind in ToT to an Indian manufacturer. Products and services have to be for defence, inland and coastal security or for civil aerospace only.

Offsets guidelines allow subcontract in outsourced services such as engineering, design, and defence software. All countries are very sensitive to defence offsets and in fact, India’s policy is docile by international standards. Defence offsets have yet to find substantial success as major Western countries have started labeling offsets regulations as protectionist.

Complexity of Transfer of Technology

No nation would like to part with painfully hard earned technology even at substantial cost. To evolve a defence Offset contract is a complex exercise. It involves local partner identification, offset certificates, penalties and confidentiality clauses. Nearly 122 open defence offset contracts signed around the world between 1997 and 2010 have only partially been executed due to various imponderables. Sometimes, there are conflicting views on levels of transfers of sensitive technologies. The US, being one of the largest exporters of high technology weapons, has been most vocally moderating the Offset policies around the world.

The policy of Offsets, though complex to implement, should help us get value for our money…

The Brazilian Minister for Strategic Affairs said in 2008, “We will not simply be buyers or clients but partners.” Major defence contractors are conscious of the psychological power of offsets in democracies. The physical valuation and specific areas of Offsets is complex. The value of parts locally sourced could be straight forward but cost of ToT is usually vague. Co-production and subcontracts are the best form of direct offsets. Technology transfer, military training, licensed productions are also often counted as sort of direct offsets.

Through a US Presidential Decree of 1990, no Offset clause can be applied to a FMS agreement. The US government considers Offsets to be “market distorting and inefficient”. It has been made clear that “the decision whether to engage in offsets resides with the companies involved” and that “no agency of the US government shall encourage, enter directly into or commit US firms to any offset arrangement in connection with the sale of defence goods or services for foreign governments”, effectively sounding a death knell for the instrument of Offsets.

Defence Offsets: the India Story

“Offset” industry partnership management organisations have emerged. Offsets credits get built in various contracts. These credits could be traded, bought, sold or redeemed. Surplus credits of a particular contract could be redeemed on another contract. Offset India Solutions (OIS), an Indian company, extends a partnering approach to provide customised expertise to international companies for fulfilling their Offset obligations. It provides customised advisory and management services related to strategy, policy formulation, partnering, implementation and compliance related to Offsets obligations. With some other Indian business houses venturing into the arena, Offsets management itself has become an industry.

A Jane’s Financial Times study predicts 15,000 defence contracts in the decade ending 2022, with offsets obligations of $100 billion…

The Offsets guidelines also promote investment in Micro, Small and Medium Enterprises (MSMEs) by allowing a multiplier factor of 3.0 to the offset calculations. It also facilitates technology acquisition from a select list by the Defence Research and Development Organisation (DRDO). The Offset discharge banking period is now seven years. Period of execution of Offset contracts can extend beyond the period of main procurement contract. Defence Offset Monitoring Wing (DOMW) has now replaced the erstwhile Defence Offset Facilitation Agency (DOFA) has more powers. Since large amounts are involved, there is a need for expertise both for officials and industry. The policy of Offsets, though complex to implement, should help us get value for our money.

Indian military with British inheritance, mostly used Russian equipment, and Western doctrines has pulled off only through resilience. The psyche of the DRDO and Defence Public Sector Undertakings (DPSUs) of grossly exaggerating achievements, glossing over screw-driver technology successes, ultra-sensitiveness to criticism over failure and reluctance to work together as a combined force has affected real growth. Even though defence is becoming an emerging industry, Indian industry’s capability to absorb offsets is still evolving. The ‘real’ indigenous content has actually progressively reduced from 45 to 35 per cent.

The so-called indigenous Light Combat Aircraft Tejas has a fully imported engine, radar, major avionics and bulk of the fly-by-wire system among many other things. There are similar stories with other projects. Foreign companies that are currently supplying equipment to India under large contracts obliging them to offset a substantial portion of the contract value to Indian companies are finding it difficult to find private sector partners precisely due to lack of capability and infrastructure.

The IAF currently has nearly 50 platforms from Original Equipment Manufacturers (OEMs) in different countries…

Meanwhile, the private sector is surfacing. Tata Power and Larsen & Toubro manufactured the Pinaka multi-barrel rocket launchers. While L&T was involved in developing a hull for a nuclear submarine for the India Navy, Tata Power is handling the modernisation of airfield infrastructure and Reliance Industries is active in aerospace and homeland security. Mahindras have designed a small aircraft. Due to lack of investment in R&D, local technologies are still low-end.

One recent successful Offsets management case was that of Pilatus Aircraft Ltd., Switzerland, setting up along with Bharat Electronics Ltd. (BEL) an electrical harness manufacturing capability at BEL’s Bangalore Complex. Locally made harnesses would be for the Pilatus global supply chain. Pilatus Aircraft Ltd is supplying 75 PC-7 Mk II turboprop basic trainer aircraft to IAF. There is a high possibility of IAF exercising the options clause for additional PC-7s. It is obvious that the companies which want to build long term defence relations with the world’s biggest arms importer will find good offsets solutions. In addition to HAL making Boeing aircraft doors, there are many other small Indian companies that are making looms, connectors, aggregates and aviation grade software for foreign defence manufacturers who are sourcing from India for their global supplies.

Evolving Dynamics

A Jane’s Financial Times study predicts 15,000 defence contracts in the decade ending 2022, with Offsets obligations of $100 billion. Top US defence contractors such as Boeing, General Dynamics, Lockheed Martin Corporation, Northrop Grumman and Raytheon would be saddled with $42 billion of the Offsets obligations. Even as Indo-US defence trade reaches new highs, Offsets and defence FDI policies would continue to be a challenge and may act as a roadblock. Prime Minister Modi’s bonhomie with the US establishment has a promise of privileges as reserved for its closest allies in respect of transfer of defence technology, co-production and co-development.

61 critical technologies have already been identified India badly needs for developing higher technological capabilities…

US sales of military equipment to India have grown from near zero in 2008 to around $9 billion in 2013 and billions more are on the horizon. Deals for 22 Boeing AH-64D Apache helicopter valued at $1.4 billion, 145 BAE Systems’ M-777 ultra-light howitzers for $885 million and 15 Boeing CH-47 await finalisation. The West, led by the US, is awaiting FDI increase to 74 per cent. The foreign defence contractors are not only worried about Intellectual Property Rights or the technology moving to unintended sources, they are also concerned about some of the recipients developing technologies and later becoming competitors at their expense.

India has a significant manufacturing industrial base. It has licence produced thousands of aircraft over five decades. It has a very successful space programme. Therefore, it should not be difficult to find local Offsets partners. Offsets are here to stay. Win-win solutions have to be evolved.

The Way Ahead

One day, India should be in a position to export arms to neutralise its heavy imports. China’s foreign sales of major conventional weapons surged 162 per cent (five per cent of world exports) and has begun exporting indigenously developed military equipment such as JF-17 combat jets to Pakistan. Absorption of ToT would require promoting indigenous capability to imbibe technology. The Ministry of Defence (MoD) has clarified to the Department of Industrial Policy and Promotion that dual use items will not require licensing. It has been decided to earmark Rs 500 crore for loans and Rs 50 crore as equity for smaller enterprises involved in defence manufacturing. Rules for India-based joint ventures with foreign partners will be relaxed but 50 per cent indigenous content will be expected.

Dynamics of defence technology can best be resolved through a Military Industrial Commission…

The IAFs proposal for the replacement of its fleet of 56 Avro HS-748 medium transport aircraft has been offered to the private sector. Tatas, L&T, Reliance and Bharat Forge are known to be contenders. The selected Indian player will have the option to seek an Indian or foreign partner for this near Rs 12,000 crore project. The IAF currently has nearly 50 platforms from Original Equipment Manufacturers (OEMs) in different countries. This makes it more complex to build a reasonable vendor base and take advantage of scale of production. This will require rationalisation. The ‘miserly’ defence R&D budgets have to go up.

The DRDO has had a hierarchical structure with seniority taking priority over talent and innovation. The pulls and pushes of the annual confidential reports based promotions results in the sacrifice of true R&D. This needs a relook. If China has earmarked $25 billion for defence R&D, India too has to come closer. Increased FDI could largely take care of induction of funds. Foreign firms welcome the thrust on higher indigenous content. It is much cheaper to manufacture in India. Asia also happens to be the main market. India is a lucrative low-cost manufacturing and engineering service base affords significant opportunities to both domestic and international players. Investments in India will assure a minimum level of orders and India could actually be made an export hub. India needs investments and the West requires markets. It could be a win-win situation for all.

‘Wetting the feet a bit and testing the waters’ is relevant. India has a vast pool of engineers and a genius for adaptability. The innovative skills are recognised world over. In the recent Forbes list, five Indian companies were in the first 50 for innovativeness. Indian entrepreneurship skills are respected the world over. Our manufacturing costs are low. Many Fortune 500 companies and major aerospace players have set up shop in India using Indian IT and engineering services. They have established captive R&D units and are also collaborating with our centres of learning. Hindustan Aeronautics Limited (HAL) is the aviation monolith and its privatisation would change how India does aviation business. It will also allow easier Offsets.

India can ill-afford indecision and delay, given the potential threat from nuclear-armed rivals…

Sixty years and four major battle engagements later, India’s defence aviation technology story is one of unacceptable failures. Prime Minister Modi has been making concerted efforts to invigorate the defence production and self-reliance. 61 critical technologies have already been identified especially materials and components that can be used across a broad range of systems that India badly needs for developing higher technological capabilities. India would need to establish technology transfer paradigms and issue clear policy directives to all DPSUs. Indian defence technology is thus at the crossroads.

The West woos us while the East engages us vigorously. France, Israel, Russia, UK and USA are closely involved in India and our interactions need to be focused towards self-reliance and transfer of technology. A span of technologies can be adopted and adapted to become industrially and militarily Indian. Dynamics of defence technology can best be resolved through a Military Industrial Commission. The Defence Acquisition Council, the DG Acquisition, the Vice/Deputy Chiefs could be part of it. This should include DRDO, DPSUs, Industry associations and Private and Public sector companies. It could be tiered suitably for policy, planning, review and oversight.

A nationally synergised effort is needed which must also explore obtaining specific technologies through the offset route. India can ill-afford indecision and delay, given the potential threat from nuclear-armed rivals – a rising China and an unstable Pakistan – and a region facing uncertainty as US forces pull out of Afghanistan. Time to act is now.

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The views expressed are of the author and do not necessarily represent the opinions or policies of the Indian Defence Review.

About the Author

Air Marshal Anil Chopra

Air Marshal Anil Chopra, commanded a Mirage Squadron, two operational air bases and the IAF’s Flight Test Centre ASTE

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