Indian Defence Review

Routes of the US Arms Sales

The US sells military items through two basic routes – Direct Commercial Sales and Foreign Military Sales. Though subjected to the same licencing regime, both have their distinct characteristics.

The US Government also provides equipment on lease for a period up to five years. It is always a case specific agreement, generally to meet an immediate requirement of the indenting nation till bulk procurements materialise. Additionally, stocks held in excess of the requirements of the US forces are also offered at highly reduced rates (5 to 50% of original cost) to selected countries.

Direct Commercial Sales (DCS)

These are pure commercial transactions between a buyer government and the industry. The role of the US Government is limited to the grant of licence by the Office of Defence Trade Controls of the State Department. This route facilitates open competition amongst various producers world wide. DCS route is preferred when the performance parameters of the equipment sought are materially different than the US military specifications. Parameters of the equipment sought can be determined by the buyer to suit his country’s operational requirements. The buyer may ask them to submit techno-commercial proposals for evaluation.

There are no middlemen in the FMS. The buyer nation is saved considerable effort and expenditure, as the US Government procures the item as per its well established acquisition procedure.

Transfer of technology and joint production can also form an integral part of the overall package. It is for the contracting parties to draw out terms and conditions of the deal to suit their perceived interests. Delivery of the item may be faster if it is in current production or if the company has ready stocks. In other words, the US companies are required to compete with producers from other countries to clinch deals. Buyer nations can demand and negotiate compensatory offsets as per their policy.

Foreign Military Sales (FMS)

FMS is generally known as a government-to-government deal. India bought Weapon Locating Radars through this route. This route is generally followed in respect of the items which have already been inducted in the US forces. The US Government offers similar items to foreign governments at the rate at which these items had been purchased for the US forces, albeit with additional handling charges. There are three types of FMS cases: Defined Orders are meant for specific weapon systems, Blanket Orders are to cover follow-on support and Cooperative Logistics Supply Support Arrangement enables a buyer nation to invest in the US Supply System with access to the US defence stocks.

The buyer nation forwards a Letter of Request (LOR) to the US Government. It is a comprehensive document containing information about the equipment, its planned usage and support facilities. If the request is cleared, a Letter of Offer (LOO) is sent to the requesting Government. The buying Government is required to submit a Letter of Acceptance (LOA) along with the initial advance. Every LOA includes Standard Terms and Conditions as dictated by the US laws for acceptance by the buyer. The US Government may supply the item from its own existing stocks or procure it afresh from the producer.

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There are no middlemen in the FMS. The buyer nation is saved considerable effort and expenditure, as the US Government procures the item as per its well established acquisition procedure. The quality and performance parameters are assured. Deliveries may be faster in case the equipment incorporates Government furnished material, as Government orders get priority. Since the item is already in use with its forces, the US Government is in a better position to provide logistic, training and exploitation support.

The FMS route is ideal in respect to high-tech systems, which do not require comparative trials. This route is also better for complex weapon systems as a buyer can get them fully integrated and configured.

Offsets in FMS Deals

The US Defense Offsets Disclosure Act of 1999 describes offset as ‘the entire range of industrial and commercial benefits provided to foreign governments as an inducement or condition to purchase military goods or services, including benefits such as co-production, licensed production, subcontracting, technology transfer, in-county procurement, marketing and financial assistance and joint ventures.’

The general policy of the Department of Defence with regard to offsets is that they are market distorting and inefficient. The Presidential Policy statement of April 1990 mandates 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.’

India has carried out wide-ranging reforms in its procurement organisation and procedures. The new procurement procedure ensures transparency, fair play and open competition. Offsets have been made mandatory for all deals over USD 68 million.

The US Government realises that offsets have become unavoidable in modern defence deals. Therefore, it has evolved a policy of non-intervention – it neither facilitates offsets nor obstructs their inclusion. It is for the companies to decide whether to engage in offsets or not.

This ‘hands off’ approach also extends to a policy of total non-involvement in negotiation of the offset agreement between the company and the FMS customer, and no role in judging the merits of these agreements.

Some of the major aspects of the policy have been discussed below.

Recovery of Offset Costs

Earlier, the Defense Federal Acquisition Regulation Supplement (DFARS) had permitted limited recovery by a US contractor of the ‘administrative costs to administer specific requirements of its offset agreement.’ Subsequently, in May 1995, it was clarified that US contractors could recover full cost necessary to ‘implement an offset agreement’ in connection with FMS purchases. This was necessitated because the US Government feared that the defence companies may be forced to pass the offset costs to all other customers, including the US Government, in the form of indirect overheads. The US Government’s position is that the US taxpayer should not pay any offset costs in connection with a foreign military sale.

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The Government, in 1999, replaced the term ‘offset implementation costs’ with the term ‘offset costs,’ thereby widening the sphere. It allowed a US contractor to recover all costs incurred for offset agreements with a foreign government or international organisation if the LOA is financed wholly with customer cash or repayable foreign military finance credits.

As regards FMS deals financed with funds made available on a non-repayable basis, a US defence contractor cannot recover costs incurred for offset agreements with a foreign government or international organisation.