Changes in Defence Offsets and Their Implications

The DPP 2020 draft released by the Defence Ministry in March 2020 has recommended some newfangled offset guidelines. However, successful implementation of these proposed changes would require incorporating them along with the existing guidelines in a faultless and flawless manner coupled with improving the monitoring system for the discharge of offset obligations by the OEMs, thereby achieving its objective in making the country self reliant.

The Defence Procurement Procedure 2020 (DPP) draft released by the Ministry of Defence (MoD) in March 2020 recommended key amendments with the focus on the development of robust indigenous Defence Industrial base (DIB), thereby making India self reliant in defence which holds vital importance for both strategic and economic reasons for any country. One of the major amendments by the MoD in the draft DPP 2020 is the proposed newfangled offset guidelines which holds major concern for the Industry and also for the foreign Original Equipment manufacturers (OEMs) discharging offset obligations under previous and current DPPs.

A total of 52 number of offset contracts entered as on March 2020 with 19 foreign defence contractors with estimated worth of these defence offsets amounts to be around USD 11.80 Billion approximately. These offset contracts are under different stages of implementations by the foreign OEMs. Further, as per the Defence Ministry, the total amount of offsets disposed/discharged as on March 2020 stands to USD 1606.22 Million. Refer Fig.

Given the current and future quantum of offset obligations coupled with the fact that the offset policy is instrumental in fostering the participation of Indian firms in global value chain it indeed becomes imperative to understand the modified Defence Offset guidelines in the draft DPP 2020 and the implications they would have in procurement in future. At a glance, it seems that the Defence Ministry has taken into consideration several aspects of Defence Offsets this time and simplified and clarified some of the offset framework such as flexibility in selecting offset partners, ownership model of offset partners, indigenous content requirements and so on. It has proposed the following amendments to the offset framework under the DPP 20:

Removal of Offset Banking: Offset Banking has been removed from the offset framework/guidelines under the DPP 20 draft. Furthermore, no condition with regards to the handling of banked credits for future procurement has been provided. Consequently, vendors with banked credits possibly will not be able to make use of the same for discharging their obligations for RFP/tenders issued under the DPP.

The abolishment of Offset Banking does not seem to be an encouraging approach as it appears that foreign OEMs will feel dissuaded to set up large scale investment/sourcing from India only to comply with a one time barred obligation. Noteworthy, offset banking was a key driver for foreign OEMs to invest and source from India and also provided business/investment opportunities to the Indian industry, while, banking of credits gave a continuous order book to Indian companies resultantly meeting economies of scale. In addition, at present there is no clarity on what happens with the banking credits as well as awaiting banking applications that have already been handed out to the OEMs. However, on the positive side, this is most likely to prevent OEMs/vendors and their Tier-1 companies from claiming offset credits for the transactions undertaken as a part of their regular business.

No Offsets in case of IGA/FMS contracts: The DPP 2020 aims at exempting offset applicability on procurement contracts through Inter-Governmental Agreements (IGAs)/Foreign Military Sales (FMS) route.

This does not go in sync with the Government’s continuance declarations on self-reliance and indigenisation as taking this route will reduce the offset related opportunities available to the Indian defence companies, especially the SMEs/MSMEs. Further, this will also make the country dependent on the importer/supplier country till the defence equipment is in service since most of the items sourced through FMS/IGAs relate mainly to high-end equipment and platforms, while also making the country strategically vulnerable to technology denial regimes and sanctions imposed by these suppliers. It needs to be highlighted here that in last 5 years most of the procurements of major equipments have been through FMS/G2G or IGA route.

Enhanced Multipliers for Discharge of Offsets: There have been changes in the avenues of offset discharge as described in Draft DPP 2020 allowing the Indian industry to receive technologies for which the Foreign Original Equipment manufacturers (OEMs) will be entitled to receive direct credit. Under the previous DPPs, only transactions with DRDO and small suppliers were eligible for multipliers. Further, higher multipliers have been proposed for procurement from private Companies (MSMEs)/DPSUs/OFB and DRDO and units established in Defence Industrial Corridors to give emphasis on export of products rather than components. Refer Table for the provision of multipliers for discharge of Offset obligations changed:-

These multipliers will create a major positive impact for Foreign OEMs who can now expect considerably higher credits for the same quantum of investment. Further, the enhanced multipliers for investments and ToT would be highly beneficial for the domestic defence industry in the long-term as it aims at giving preference to complete defence products over components which in turn will likely facilitate greater participation of Indian Industry and develop robust defence industrial base. However, it is worth highlighting here that the higher technologies are reserved for the Government entities such as DRDO, DPSUs and OFB. Also, it does not seem to be a right move in reducing multiplier of 0.5x on components as this will act as an obstacle for foreign OEMs in discharging offsets as they will now have to focus on building and exporting products rather than components which will be a difficult task for them.

Revised List of ‘Eligible Products’ and ‘Services’ for Discharge of Offsets – List of ‘Eligible Products’ for discharge of offsets have been considerably reduced and majorly focuses on defence products while all coastal security or inland security and civil aerospace products have been removed.. Further, it seems that ‘Services’ shall no longer be eligible for offset discharge except for MRO services catering to helicopters and aircrafts as there is no defining/mentioning of ‘Services’ for discharge of offsets in the DPP 2020 draft.

Considering the above mentioned changes in the list of eligible product and services, it can be said that the Government has overlooked the fact that trimming down the list of eligible products/services could be an unnecessary hurdle for both Indian companies as well as the foreign OEMs who have already made substantial capital investment in this sphere. Further, with parts/components/sub-assemblies no longer being the part of the revised list and moreover attracting only 0.5x multiplier (as mentioned in previous point), it will become a daunting task for the foreign OEMs to fulfil offset obligations and they would need to vigilantly assess the feasibility of discharging offsets through direct purchase under the revised list. Further, it needs mentioning that most of the products in the revised list cater to whole of the defence hardware/platforms such as Aircrafts/Helicopters, Naval Vessels, Tanks/ICVs etc. However, considering limited capability and facilities with Indian companies for such products, the foreign OEMs would now be requiring assessment of availability and capacity of potential Indian suppliers and related timelines to ensure fulfilment of their obligations making it a bit difficult for the foreign OEMs.

Reduced Period for Discharge of Offsets: The DPP 2020 proposes to exclude the period of warranty from the duration of the main contract. Previously, under DPP 2016, in order to calculate the period of discharge for offsets the period of warranty was included within the period of main contract. In other words, this clearly meant that the period for discharge of offset obligations was fixed as the duration of the main contract and with a grace period of two additional years. Furthermore, the period of the main contract was also considered to include the warranty period provided therein, which provided the foreign OEMs with more time period to discharge their obligations.

Thus, this change does not seem to be good enough as factoring the product supplied may considerably impact the time available to the foreign OEMs for discharging their offset obligations and would need to be factored accordingly.

Changes in Transfer of Technology (ToT) and Non-Equity Investment Routes for Discharge of Offsets: Magnified viability of Transfer of Technology (ToT) and non-equity investment as means for discharge of offsets has been proposed in the DPP 2020. Previously, grant of offset credits for ToT was subject to repurchase clause, while, the offset claims for non-equity investment were also limited to a certain percentage of repurchase. Also, under DPP 2020 draft, the non-equity route is proposed to be blended with the equity route, making full offset credits available to OEMs subject to verification. Similar groundwork has also been issued for the ToT route.

These changes will help in reducing time and cost timelines required to discharge offsets under these routes. Moreover, OEMs will be freed of repurchase situation which act as an additional cost of fulfilling offset obligations.

Discharge of Offset Obligation by Subsidiaries: Draft DPP 2020 permits discharge of offsets (for a few avenues) through entities other than vendor/Tier-I sub vendor for investments/ToT on case to case basis. Previously, under DPP 2016, only Vendor/Tier-1 sub-vendors were permitted to discharge the offset obligations.

Procedural Reforms: The DPP 2020 draft proposes certain procedural changes to simplify the offset process. Some of these are mentioned below:

  • To streamline the offset process for granting offsets credits to vendors, the bi-annual reporting mechanism under the earlier offset provisions has been eliminated. Flexibility to provide details of products and Indian Offset Partners (IOPs) at later stage even after signing of contract.
  • To bring greater transparency and accountability, post contract activities are envisaged online through offset portal.
  • Real-time disposal of offset discharge claims. OEMs/vendors can now approach the MoD at any time for claiming offset credits, subject to prescribed documentation and compliances, and such credits would be granted on rolling basis.
  • Timelines for disposal of offset claims/disputes have been clearly stated. The discharge of offset obligations would be determined on yearly basis as per the phasing plan submitted at the time of the bid.

Looking Forward

For more than a decade, offsets have been an important component of procurement from foreign OEMs. The policy has had limited success so far despite several changes made over the years. The latest changes in the offset guidelines in the draft DPP 2020 seems to be having been a mixed baggage of positives and negatives to the defence market and we can only hope that it achieves its target in developing a self reliant nation. As though while, many provisions have been included to encourage both the domestic industry as well as foreign defence companies to ‘Make in India’ in the defence sector, however, few changes impact offsets significantly in not so positive manner such as no offsets in case of IGA/FMS cases as with major defence deals have been through these routes since last few years thus will lead to reduction of offsets significantly.

While it is known that the Offsets come at a cost and the results/returns yielded so far have not been as per what they were expected to bring. It would be reasonable expectations to review some provisions by MoD after the input received from various stakeholders in the final version of DPP-2020. Lastly, successful implementation of these proposed changes would require incorporating them in a faultless and flawless manner along with the existing guidelines coupled with improving the monitoring system for the discharge of offset obligation by the OEMs will ultimately lead to the successful implementation of the offsets, thereby achieving its objective in making the country self reliant looking at the bigger picture, incorporating the proposed changes in a flawless manner with the existing guidelines coupled with improving the monitoring system for the discharge of offset obligation by the OEMs will be essential in ultimately successful implementation of the proposed changes.

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