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Indian offset policy overcoming challenges to achieve target worth USD15 billion in defence offset work over next decade.

The defence equipment held by Indian defence forces is 50% obsolete, the proportion of state-of-the-art equipment also needs to double from current 15% to 30%. This justifies the huge requirement of new systems. Ongoing projects include submarine building, advance early warning aircraft, Rafale fighters, missiles, missile shields, aerostat radars, all of which already signed for and delivery schedules have begun. The future requirement includes multi-role combat fighters, basic and intermediate jet trainer, attack helicopters, drones, infantry clothing and weapons, artillery guns, gun-mounted turrets for tanks, improved electronics and sat-nav equipment for all three services and a host of equipment to modernize the forces.


But most of its requirements are met by imports. India ranks among the top 10 countries in the world in terms of its military expenditure and import of defense equipment. It allocates about 1.8% of its GDP to defense spending, of which 36% is assigned to capital acquisitions. However, only about 35% of defense equipment is manufactured
in India. Moreover, even when defense products are manufactured domestically, there is a large import component of raw material at both the system and sub-system levels.


According to defence analysts, India – the world’s largest arms importer – is poised to spend $250 billion in the next decade to modernise its armed forces by acquiring more lethal weapons and combat jets.  Offsets is one of the mechanism that leverages india’s purchasing power for acquisition of denied technologies.


Indian MOD launched Defense offset policy  to leverage India’s huge arms import for strengthening the indigenous arms industry. Offsets was first introduced as part of Defence Procurement Procedure in 2005 and has undergone many rounds of revisions over time and its prime objective . The key objective of the Defence Offset Policy is to leverage the capital acquisitions to develop Indian defence industry by (i) fostering development of internationally competitive enterprises, (ii) augmenting capacity for Research, Design and Development related to defence products and services and (iii) encouraging development of synergistic sectors like civil aerospace, and internal security, according to Defence Offset Guidelines.


Globally there is  wide acceptance of the practice of offsets can be gauged from the fact that presently around 120-130 countries have offset requirements in some form or other, compared to some 15 countries that had such a requirement in the early seventies.  The 30% is quite less than demanded by other countries internationally. This For instance, a 2007 European Defence Agency (EDA)- sponsored study found an average offset percentage of 135 among the European countries during 2000-2006. The offset percentage was also found to be much higher for countries like Finland, Greece, Poland and Spain which demanded an average of 145 per cent during the study period. However European countries, which had traditionally high offset percentage requirements, have started lowering their demands, subject to a maximum cap of 100 per cent. On the other hand countries like Brazil, Malaysia and South Korea have progressively increased the percentage of offsets. For instance, Brazil which used have a 100 per cent offset requirement, has upped the demand to 175 per cent in the acquisition of Swedish Gripen aircraft.


Twenty-one defence offset contracts with cumulative value of USD 5.67 billion have been sealed by the defence ministry in last three years, the government said in Nov 2019. Under India’s offset policy, foreign defence entities are mandated to spend at least 30 per cent of the total contract value in India through procurement of components or setting up of research and development facilities.


However as highlighted in the successive reports of the Comptroller and Auditor General of India (CAG), India’s experience of offsets has been less than satisfactory. Two weeks after the Indian Air Force (IAF) formally inducted five of the 36 Rafale jets ordered from France under a Rs 59,000-crore deal, the country’s top auditor in Sep 2020 said that the plane’s maker Dassault Aviation and weapons-supplier MBDA have not confirmed the transfer of technology (ToT) to the Defence Research and Development Organisation (DRDO), which was part of the contract. The Comptroller and Auditor General (CAG), in a detailed report tabled in Parliament, doubted if the ToT for a key engine would even take place, and pointed out that several offset contracts built into multiple defence deals have “not yielded the desired results”. The critical observations were part of CAG’s scrutiny of the status of a raft of offset contracts — including the September 2016 Rafale deal — between 2005 and 2018.


The Indian defense offsets clause is believed to have put off international aerospace and defense majors, leading to a poor response and absence of big names from the Aero India 2017 at Bangalore. Though India is the world’s largest importer of military hardware in the last five years, according to the Stockholm International Peace Research Institute, the 30-percent offsets rider for winning big-ticket contracts appears to have unnerved top global aerospace and defense players, barring a few from Europe.


The US, which is by far the largest offset provider, has always been worried about the negative impact of offsets on its economic, industrial and technological base. Officially, the US government views offsets as “economically inefficient and trade-distorting”, and prohibits its government agencies from being directly involved in offset related activities. Media reports that the US is pushing for change in India’s offset policy for defence and the changes that the US seeks are primarily two. First, that since Indian defence firms have not yet found their roots in the global supply chain, US firms should not be penalized for delays unless a ‘willful default’ is found on their part. Second, that US companies should be able to perform offsets on behalf of the company given the contract.

Rising offset opportunity

Indigenization is only route forward as it  is cheaper to build, operate and maintain, results in building of strong defence industrial base and growth of R&D leading to strong technology innovation ecosystem. It is also insurance against denial of critical weapons and spares by foreign countries in crisis or conflicts in pursuit of their political or strategic interests. The India Defense Industry has grown from USD 21.9 billion in 2010-11 to USD 37.3 billion in 2016-17, at a CAGR of 9.25%. The civil military integration resulting from indigenization shall  result in military technologies to be applied in civilian fields, making high-tech equipment available to commercial markets, as well as military to benefit from civilian innovations. This will lead ultimately to industry move up in innovation ladder to become leading exporter.


However technology is critical element to enable indigenization as it enables design development and upgradation of defence systems. However, leading countries protect their technologies through various controls like MTCR, ITAR, EAR 99.


The offsets policy has often been criticized with experts saying that it has been inadequate in compensating for India’s huge purchasing power and also that its implementation has been woefully insufficient. It has neither proved to be a catalyst for bringing in foreign direct investment, nor been able to facilitate and promote defence exports, its key objective of the policy. They also claim that it has not led to any substantial growth of indigenous industries. Offsets have also consider to delay implementation of strategic projects. The offsets have also become new, favourite route for paying those who grease the wheels of the multibillion dollars deals.


However, after implementation of DPP 2016, the offsets are looking up. Defence procurements have started flowing in along with their offsets. The offset benefits for the country look set to reach $12-15 billion over the next 10 years, said Defence Minister Manohar Parrikar. With purchases coming through, their offsets or plough-backs to domestic industry have normalised. In the last two years, 100 per cent offset obligations were achieved compared to around 60 per cent during the earlier five years. “The quantum of offsets will increase in the coming years because deals are in the offing.” The purchase of 36 Rafale medium multi-role fighter aircraft that is currently going through cost negotiations will result in offsets that will be 50 per cent of the value of the deal.


As per the MoD, 19 contracts worth about USD 15 billion had been awarded to foreign majors such as Boeing, Lockheed Martin, etc from 2007 to 2012. 30% of these deals translate into USD 4.5 billion in offset opportunities. One of the routes to indigenization are Joint ventures with transfer of Technology (ToT). For the purpose of defence capital acquisitions, one of the methods to discharge offset obligations is Foreign Direct Investment in joint ventures with Indian enterprises


Many defence offset JVs are already underway or on the anvil in India: between HAL and SNECMA of France; Lockheed Martin (USA) and Wipro Technologies; Boeing and Tata; Thales and Samtel Group (France) with an Indian company; TCS and SAAB; L&T and DRDO; Dassault Systems (DS) and Cummins Info Sys Ltd; Wipro and GE Security (USA); Taneja Aerospace and TIDCO; HAL and CAE (Canada); SAERTEX and KEM – ROC; Sikorsky and Tata Advanced Systems; Airbus, Airspace Infrastructure Ltd and Airlogic Ltd; Wipro and CAE (Canada); BEL and Surinam Armed Forces; Rolls Royce and HAL; M&M Ltd and BAE; L&T and Cassadian; Augusta Westland and Tata Sons Ltd, and: between L&T and Europe’s EAD.


Ray Challis, Head of Sales and Marketing for UK-based Ultra Electronics, says the company has already signed an MoU with Mahindra Defense for manufacturing systems for the Indian Navy. “Ultra is a pioneer in precision control system and has a global supply chain. We are willing to bet on a 100-percent transfer of technology if need be. India has problems that we have already solved in Brazil and the US and it is our endeavor to partner with local companies here in India,” Challis told at Aero India 2017 UK Pavilion.


Former HAL chairman A.K. Saxena believes that signing a series of joint ventures is the easiest way to propel the offsets clause while Baba Kalyani, Chairman, Bharat Forge, says they need to see order books filling up, otherwise defense manufacturing will not pick up pace. “Once Make in India begins bearing fruit, we will be manufacturing six times the current scale,” he told a Make in India — Karnataka conference recently.


Rafale deal to come with 50% offset clause

The 7.87 billion euro Rafale fighter plane deal comes with a 50 per cent offset clause which means that Indian companies, big and small, will get businesses worth over 3 billion euros. “The French government has in principle under the offset commitments have agreed to provide stealth, radar and thrust vectoring for missiles technologies besides others to DRDO and domestic defence firms. The French have also agreed in principle to collaborate on the Kaveri engine which lacks the real power thrust needed to fly the Tejas. An upgraded Kaveri engine with 90 kN thrust compared to the existing 72 kN can be developed with French cooperation which can eventually be used for Tejas which currently uses an American engine.


“The offset clause of 50 per cent in the Rafale deal will provide a great opportunity for indigenous manufacturers such as us who have put in years of effort in developing world class technology within the country. This means a lot of business and job opportunities in India, sources said. They added that the offset, spread over a period of seven years, will be finalised soon.


Indian Offset policy 2016

The  DPP 2016 laid  down various categories of procurement processes namely, in priority, Buy Indian – IDDM (Indigenously Designed, Developed & Manufactured), Buy Indian, Buy & Make (Indian), Buy & Make (Global) and Buy Global. Based on the Indigenous Content, as you go down the procurement category in priority, 30% offset is applicable on the foreign exchange component. Apart from laying down the rules for foreign sellers, the government has also rejigged the DPP into three categories to encourage Make in India – Make I involves 90-percent funding of the development by government; under Make II, the government will refund 100 percent development cost in case the product is not bought, and Make III has been reserved for small and medium enterprises to give this sector a thrust.


The offset policy in defence purchases means that the seller needs to source 30 percent of the cost of any deal over Rupees 300 crore with a higher percentage involved for bigger deals. Although, Indian firms and JVs are exempted from offset obligations provided the indigenous content is over 50 per cent. According to the new guidelines, the responsibility of defence offsets is divided between two organizations: the Defence Acquisition Council (DAC) to evaluate the offset proposals and finalize the contracts whereas the DoDP is responsible for implementation of offset contracts, including monitoring the progress of the contracts. The newly established DOMW was assigned the responsibility of offset contract management.


Offsets can therefore be of two types: direct and indirect. While direct offsets are related to the system being procured and are typically in the form of co-production, subcontracting, licenced production and technology transfer, indirect offsets are unrelated to the items imported by the buyer. Such offsets usually include counter trade transactions, investment, financing activities, export related assistance, and technology transfer.


Offsets still have challenges

“There are still many things that can be done with offsets if you apply them well,” Mr. Parrrikar said. Starting with the Defence Procurement Policy 2016, many changes are taking place in Defence policies where industry role was important. The government was carefully and practically viewing the policy of banning and penalising certain vendors. The logic was to ensure that projects do not get stalled for many years, he said.

Offsets may also lead to delay in execution of strategic projects. According to reports, the defence ministry may forego the offset clause to speed up deliveries of a Russian air defence system designed to deter Pakistani fighters and provide a missile shield for major cities. India and Russia deal on the S 400 air defence system is pegged at Rs 39,000 crore. “As far as I have heard, there is no offset package for the programme. It is a strategic project and is very important for the two countries,” said Viktor N Kladov, director of international cooperation at Rostec, the Russian stateowned company that controls sales of the S 400 system. He said Russia would comply if India insisted on an offset package. But, he said, “It may delay delivery by one two years and that is why a deal with no offsets package is the best choice.”


The offsets have also become new, favourite route for paying those who grease the wheels of the multibillion dollars deals. The Indian Ministry of Defence (MoD) is taking a close look at defence offsets as a route for illegal payments to middlemen. The Ministry is taking a particularly close look at the several small Indian firms that receive offset money and then frequently cease to exist as an entity. The Agusta Westland VVIP chopper deal saw a Mohali based firm being awarded an engineering drawing contract. The offset route finds mention in a confidential Credit Suisse report that details payments made by Russian defence majors to companies associated with relatives of Sudhir Choudhrie, who’s under investigation by CBI and ED in a separate case. The Comptroller and Auditor General (CAG) had also red flagged offsets as a trouble area. In a 2013 report, CAG brought out glaring discrepancies in at least 11 of the 16 offset projects under execution.


In DPP 2016, a major policy change wherein offsets would now be applicable for those cases only where indicative cost of procurement is Rs 2000 crores or more as against Rs 300 crores till now. It is a big relief to foreign OEMs. Policy change however is not favourable to Indian Companies who would now have lesser offset related opportunities.


Study undertaken by the Manohar Parrikar Institute for Defence Studies and Analyses (MP-IDSA) on behalf of the Department of Defence Production (DDP). As per the findings of the study, which were conveyed by the MoD to the Parliamentary Standing Committee on Defence, about 87 per cent of the offsets went to 15 Indian Offset Partners (IOPs), who in turn also benefited from repeat orders placed on them by the same offset providers. Moreover, more than 90 per cent of the offset obligations were discharged through the purchase of goods and services, with a few takers for the technology and investment which are considered more beneficial to the local industrial development. Evidently, the previous guidelines neither helped in any meaningful expansion of the defence industrial base nor the industry’s technological or infrastructural development. In other words, the previous guidelines were not fully up to the expectations of the MoD. This could be one of the main causes of change in the draft guidelines.


India’s new offset Policy 2020

The Indian Ministry of Defence (MoD) has recently issued an official version of its updated defence offset guidelines in 2020. The draft offset guidelines 2020, with revamped features, is a bold attempt by the MoD to attract technology and investment and promote the export of major defence items. The focus of the new offset guidelines is export of major defence items and investment and technology transfer. Will the new guidelines be a game-changer in the Ministry of Defence’s (MoD) efforts at building a strong arms industry, or require further fine-tuning to achieve the aforementioned objectives?


Key new features in the 2020 offset guidelines include the discontinuation of offset banking provisions and the removal of civilian aerospace and homeland security as sectors in which defence offsets can be discharged. Obligations are now fully focused on “eligible products” in the defence sector. The routes through which offsets can be discharged by original equipment manufacturers (OEMs) have also been narrowed to five, compared with six in the policy it replaces. The new policy removes the ability to discharge offset through the “investment in kind in Indian enterprises in terms of the provision of equipment”.


The draft offset guidelines come in the wake of MoD’s experience in handling over 50 offset contracts signed until now. These contracts, signed under various DPPs since 2005, are valued nearly $12 billion and likely to be fully executed by 2024. The experience of managing these contracts is likely to have weighed heavily in effecting the change in the draft guidelines.


Changes have also been made in the avenues for the discharge of offsets, the eligibility of IOPs to partner with foreign original equipment manufacturers (OEMs) for the fulfilment of latter’s obligations, the list of items permitted for the discharge of offsets, and the multiplier applicable in transactions under different avenues.


However, the guidelines could be further fine-tuned to keep the focus tight on their larger objectives. In particular, the MoD may consider further refining features pertaining to the applicability of offsets to inter-governmental agreements and foreign military sales (IGA/FMS) procurement, quantum and threshold of offsets, specific offsets through the RFP mode, banking provision, negative multiplier, methodology for value addition, the FDI cap and, more importantly, the offset management


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