Indian Defence Review

In any highly competitive trade environment, every seller has to make his offer irresistible and more lucrative than those of others. This is the basic canon of marketing. International defence trade is no exception and offsets have come to be accepted as an integral part of all defence deals. A buyer views them as a means to recompense and defray the outflow of resources. On the other hand, a seller willingly offers offsets to grab orders. For him, it makes perfect marketing and economic sense. Additional expenditure (to fulfill offset obligations) is generally amortised by factoring it in the initial commercial quote itself. It will, therefore, be prudent to consider offsets as a natural interplay of the market forces.

National Offset Policy and Objectives

Different nations have used offsets differently to suit their specific requirements. As offsets entail billions of dollars worth of economic benefits, they are considered to be of critical importance to overall national economic endeavour and hence, are always in consonance with the national economic objectives. They fulfil an economic need or fill a technological void. Countries formulate their national offset policy with the aims that are sought to be achieved through them clearly spelt out. Offset policy and objectives vary as per the perceived needs of a nation. Different nations use offsets differently to suit their specific requirements.

Additional expenditure (to fulfill offset obligations) is generally amortised by factoring it in the initial commercial quote itself. It will, therefore, be prudent to consider offsets as a natural interplay of the market forces.

UAE policy mandates that all sellers of arms to it must generate, within a period of seven years, commercially viable products worth 60 percent of the contract value. The Swedish policy on offsets gives primary importance to the creation of long-term employment opportunities in the country. It seeks newer markets for its goods to improve balance of trade. Additionally, it also demands technology and know-how to ensure maintenance of the purchased defence equipment. Malaysia demands a mix of compensatory exports (palm oil), technology transfer and direct investment in infrastructure.

South African offset policy seeks to leverage government procurements to extract support for the development of its industry for sustainable economic growth. It has a policy of seeking three faceted offsets – about 20 percent of the contract value as direct defence oriented offsets, 45 percent as counter purchase by the seller and 35 percent as foreign investment in South Africa. The UK, on the other hand, stipulates that offsets have to be defence related, new and of equivalent technical quality. It permits both direct and indirect offsets. Although the US has no declared offset policy and its defence imports are negligible, it still demands complete transfer of technology and an assembly line to an US company.

As seen, every country has a national offset policy and defence offset policy flows from the national policy. India is perhaps the only exception. It has no national offset policy. Seeking offsets in defence deals is purely a Ministry of Defence (MoD) initiative. Understandably, the policy lacks coherence and well defined aims. As a matter of fact, the Indian policy is totally silent as regards the objectives that it wants to achieve. It appears that India has decided to demand offsets because it is in vogue and everyone else is demanding them.

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Many feel that the origin of India’s defence offset policy can be traced to the inability of the Indian defence public sector to increase exports. The MoD decided to leverage its substantial imports to promote exports. The initial policy, as announced in 2005, sought direct purchase of products, components and services by foreign vendors. It also wanted market access and creation of new markets. However, the Government soon realised that the policy was very restrictive and unrealistic. It, therefore, attempted to widen the scope of offset programmes in its policy of 2006.

Oversight and Administration of Offsets

Most countries have a central body to oversee offsets in their entirety. It could be a specially empowered central agency or a central ministry. UAE had set up an empowered Offset Group way back in 1990. It demands and negotiates offsets in varied fields like health care, ship building and other industrial activities. It also seeks joint ventures with local partners.

Every country has a national offset policy and defence offset policy flows from the national policy. India is perhaps the only exception. It has no national offset policy. Seeking offsets in defence deals is purely a Ministry of Defence (MoD) initiative.

In Belgium, Denmark, Kuwait, Netherlands and Taiwan, it is the Ministry of Economy that oversees offsets. Handling of offsets has been assigned to the Ministry of Trade/Commerce in Canada, Finland, Israel, Philippines, Thailand and Turkey. The Ministry of Defence plays an important part, albeit in conjunction with commerce and trade ministries, in countries like Australia, Germany, Greece, South Korea, New Zealand, Norway, Spain, Sweden, Switzerland and the United Kingdom.

In the US, all firms with more than 5 million dollars of offset liability are required to report to the Secretary of Commerce. The US Department of Commerce (Bureau of Industry and Security) has been tasked to submit reports to the Congress.

In India’s case, it is not a nationally co-ordinated effort. The offset policy has been conceived by MoD in isolation. That is its biggest flaw. No cognizance has been taken of national economic or technological priorities. The whole policy lacks focus and clarity.

Selection of Offset Programmes

Depending on the nature and quantum of offsets, their fulfilment may cost a seller up to 10 per cent of the indicative contract price. Some sellers defray the cost of risk involved as well. Most importing countries are aware that their demand for offsets may result in their having to pay a higher price for the equipment being bought. But they tend to overlook it in the belief that accruing benefits will validate additional cost penalty.

It, therefore, becomes essential to draw maximum economic benefits by prudent selection of offsets. It is commonly believed that it is not the size of offsets but their economic/technological relevance to the recipient company that should guide the selection. If that be so, it has to be a prerogative of the buyer nation to identify offset programmes.Strangely, India has abrogated that right in favour of vendors, rendering India’s needs inconsequential. A vendor can discharge his offset obligations simply by purchasing mundane items or sourcing defence related software from India, despite the fact that direct purchase of goods/services is generally considered to be the least beneficial form of offsets. Benefits accruing from it are temporary and limited to the duration of the contract.

Technology Transfer

Offsets have come to be regarded as an extremely potent tool to acquire technology that may not be available otherwise. Every country that strives to develop indigenous industry seeks technology to bridge the gap and use acquired technology as a take off platform for indigenous development of more advanced technologies.

That is the reason why technology transfer is considered to be the most common and best form of direct offsets.

Selection and negotiation of technology transfer requires considerable expertise as regards the level of technology on offer, its economic viability, latent cost penalty and risk of overcapacity. Additionally, technology sought should have wider application and be such that the recipient can exploit it fully by developing its other applications as well. This will provide the necessary economies of scale. The buyer nation should also match the technology sought with its capability for its smooth absorption.

India has been repeatedly declaring that it wants to develop its defence industry to reduce imports from the present level of 70 percent to 30 percent by 2010. This can be achieved only through receipt of technology to strengthen its defence industrial base and promote technology upgradation. Strangely, India has totally neglected this significant aspect and does not accept technology transfer under offset programmes. Most knowledgeable experts feel that India should have made transfer of technology to be the only acceptable form of offsets as the current Indian policy will provide only temporary and notional gains.

Fulfillment of Obligations

As per the Indian policy, offset obligation can be discharged through any of the following routes:-

As regards FDI in Indian defence industry, the Government permitted a maximum of 26 per cent FDI component in May 2001. As per the Indian policy, a foreign investor is expected to invest his resources in a venture where he has no significant control, strict capacity/product constraints, no purchase guarantee, no open access to other markets (including exports) and an unfair advantage to the local public sector. No wonder there has been a total lack of enthusiasm on the part of foreign investors to invest in the Indian defence sector. Unless India makes major changes and liberalises the policy, there is hardly any hope of attracting FDI as an offset.

India has been repeatedly declaring that it wants to develop its defence industry to reduce imports from the present level of 70 percent to 30 percent.

Coming to FDI in defence R&D, the only organisation engaged in defence R&D at present is the Government’s Defence Research and Development Organisation (DRDO). There is no entity in the Indian public or private sector which has any worthwhile defence R&D programme. Hence, the question of FDI in defence R&D does not arise, at least not in the near future.

It, therefore, emerges that the only viable route available for the fulfillment of offsets is export of goods and services from the Indian defence industry. Given the burgeoning Indian exports, seeking offsets by way of counter-purchase of goods and services does not appear prudent. India is a powerhouse as regards export of IT services. Almost all corporate giants are sourcing them from India. Given the option, they would all like to defray their offset obligations by counting IT services against it. Such offsets provide deceptive benefits as they contribute little to the generation of economic activities.

Monitoring Mechanism

Implementation of offsets is always a long drawn process. It is an accepted fact that unmonitored offsets invariably result in wasteful activity. At times, a vendor may allocate offset programmes to a number of sub-contractors. The entry of sub-contractors complicates matters as their involvement is limited to the assignments in hand. Sub-contractors remain oblivious of the fact that their indifference can affect the main contract adversely.

A properly constituted monitoring mec-hanism has to be put in place to carry out regular monitoring of the programme and apply timely corrections, where necessary. It is a highly demanding and painstaking task for two reasons. First, offsets are generally formulated in broad terms and do not lend themselves easily to numerical quantification. Methods of fulfillment of offset obligations are often left unspecified in the original agreement and are instead negotiated over the life of the contract. Secondly, lack of effective oversight mechanism and the vendors’ reluctance to share data (terming it as commercially sensitive) render the whole programme open to manipulations.Additionally, on completion, a thorough review of the whole offset programme is required to be carried out to ascertain the degree to which the stated objectives had been achieved. Weaknesses and infirmities need identification for providing corrective inputs for policy modifications.

India has failed to realise the importance of effective monitoring of offsets. The task has been assigned to the Acquisition Manager in the Acquisition Wing. Vendors are required to submit quarterly reports to him. He may obtain assistance of the Defence Offset Facilitation Agency (DOFA) and may order audit by a nominated official or agency to confirm the actual status of implementation. It is a highly inadequate and unsatisfactory arrangement. Neither the Acquisition Manager nor DOFA has the necessary expertise and wherewithal for effective monitoring.

Recommended Frame Work

India must establish a broad based National Offset Mission under the Union Commerce Ministry. In addition to functionaries from various official agencies, it should also have representatives of the Indian industry – both public and private sectors. It should perform the role of an overarching body at the national level and formulate a pragmatic national policy on offsets with clearly spelt out aims and objectives – both short term and long term.

The primary objective of Indias offset policy should be to strengthen its indigenous defence industry through infusion of technology.

The policy should prioritise areas and fields in which offsets should be sought and issue directions for apportioning weightage to direct and indirect offsets. It should fix offset thresholds for different types of procurements and issue guidelines to all Ministries for fixing offset percentages. It should also lay down a broad framework for monitoring arrangement and issue guidelines for feedback and evaluation. A national data bank should also be created.

All offset packages linked to import deals of 1000 crore rupees and more should be referred to the National Offset Mission for the grant of ‘in principle approval’. Import proposals of lesser value should be managed by respective Ministries as per the laid down policy.

In the MoD, DOFA should be the designated authority to handle all aspects of offsets. The Acquisition Wing should be left free to concentrate on its primary task of managing defence procurements. DOFA should report to the Defence Acquisition Council (DAC) through the Department of Defence Production (DDP). DAC should formulate defence-offset policy, which should flow from the national policy and identify areas for offsets with inter se priority. It should also fix offset thresholds, keeping in mind the value of the deal, level of technology and the exporting country involved. An effective implementation, monitoring and feedback mechanism should be put in place.

Conclusion

According to some estimates, India proposes to spend up to USD 100 billion on capital procurements during the next five years. As close to 70 percent of military hardware is imported, the import bill will be USD 70 billion. At the base level of 30 percent, Indian offset benefits will amount to a staggering USD 21 million. To derive full benefit, it is absolutely necessary to understand the potential and dynamics of offsets. Offsets should not be viewed in isolation as one-time agreements, but as an important and integral element of long-term national policy.

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All successful offset programmes have certain common well-defined characteristics. First, deliberate and purposeful selection is made to fulfil a pressing technological/economic need. Second, hard negotiations are carried out by experts to extract maximum benefits from offset packages. Third, detailed planning is done to facilitate smooth and co-ordinated implementation. Fourth, close supervision and continuous monitoring are carried out to apply mid-course corrections and to ensure timely completion. And finally, a mechanism for regular feed back is put in place to help modify policies and fine tune procedures.

The primary objective of India’s offset policy should be to strengthen its indigenous defence industry through infusion of technology. An effective mechanism with required infrastructure has to be developed for effective and beneficial absorption of offsets. Finally, India must ensure that the benefits accruing from offsets do not get outweighed by the cost penalty.