Changes in the Offset Policy Seem Restrictive

The recently revised defence offsets policy reflects structural continuity with the past but aspires for better results than those achieved since its inception in 2005.  However the  ambiguities and uncertainties in some of the provisions neither makes things easier for future nor provide any honourable exit to those who have been struggling to discharge their offset obligation under the ongoing contracts.

The revised defence offsets policy embodied in the Defence Acquisition Procedure 2020 (DAP-2020) reflects structural continuity with the past but aspires for better results than those achieved since its inception in 2005. The changes made in the policy, however, do not seem to guarantee the intended outcome. To add to this, some of the problems faced by the foreign vendors indischarging the offset obligation remain unaddressed.

The biggest concern arises from exemption granted to certain categories of capital acquisitions contracts from the rigours of the offset policy. Since 2012, outright purchase from foreign vendors under ‘Buy (Global)’ and ‘Buy and Make’ categories exceeding Rs 300 crore entailed offset obligation of at least 30%. This threshold was raised to Rs 2,000 crore in 2016 resulting in a significant reduction in the number of contracts that entailed offset obligation. 

This scope has shrunk further with all contracts concluded on non-competitive single vendor basis being exempted from the scope of the offset policy.The exempted category includes acquisitions through inter-governmental agreements, as in the case of the 36 Rafale medium multi-role aircrafts and through the Foreign Military Sales (FMS) scheme of the US government. Both these systems account for not only a significant proportion of the acquisitions made in the recent years but are also emerging as the most successful model for outright purchase from overseas.

The MoD seems to have taken this decision on the specious grounds that the vendors ‘load’ extra cost to discharge the offset obligation which can be saved by doing away with offsets in such cases. It was known even when the policy was adopted in 2005 that discharging of offset obligation entails administrative costs, but MoD took a conscious decision to bear this cost in the larger interest of strengthening the nascent defence industry in India.

This step is significant as it indirectly disincentivises the vendors who participate in competitive bidding. It is also unfair to the countrieslike France and Israel that do not have a bespoke procedure for selling defence equipment to other countries akin to the FMS scheme, but whose companies have been participating in competitive bidding. It will not be surprising if these countries, under pressure from their defence industry, formulate schemes on the liens of the FMS or insist on contracts being negotiated by way of inter-governmental agreements.

The decision to exempt the single vendor contracts from offsets could, therefore, prove to be counterproductive. Its impact will become more and more visible when the banon import of 101 items comes into effect over the next five years commencing December 2020, thereby further reducing the number of offset-obligation-carrying contracts for outright purchase of equipment from the foreign vendors. Given this prognosis, tweaking of the multipliers (see the box below) to channelise offsets into high technology areas and the Defence Industrial Corridors may have a very limited impact.

Meanwhile, the new policy seems to have made it more difficult for the foreign vendors to discharge the offset obligation without removing the difficulties they already face. Dispensing with the ‘offset banking’ is a case in point. It was introduced in 2012 to enable the foreign vendors to earn and bank offset credits with the MoD in anticipation of their bagging a contract. These banked credits could be utilised later, to the permissible extent, to discharge a part of the offset obligation in future contracts.

Withdrawal of offset banking, instead of addressing any drawbacks that may have prompted the MoD to dispense with it, endangers the time and money invested by the foreign vendors in cultivating the Indian Offset Partners (IOPs), earning credits, and banking them for use in future. Some of these partnerships may still be in the formative stage; their future now seems uncertain.

Other changes that limit the choices hitherto available to the foreign vendors include reduction in the number of avenues available to them for discharging their offset obligation. They will no more be able to discharge a part of, or the entire, offset obligation, by investing through the non-equity route in ‘kind’ in the Indian enterprises by transferring equipment for manufacturing or maintaining the eligible defence products.

To add to this discomfiture, the practice of clubbing of multipliers has now been discontinued. It seems to imply that if, for example, a foreign vendor brings in Foreign Direct Investment (FDI) to discharge a part of his offset obligation, he will not be given any offset credit for buying eligible defence products from the investee company.

One of the most important changes is in the list of eligible defence products and technologies and deletion of services like upgradation/life extension of equipment and software development as a permissible area for discharging the offset obligation. The list of eligible products now includes full-formed products under various categories such as arms, ammunition and explosives, armoured vehicles, naval platforms, aircraft, electronic and communication equipment, and some other products like personal protective and troops comfort equipment, parachutes, forging and castings, direct energy weapon systems, and countermeasure/super-conductive equipment.

It will be a significant achievement for the Indian industry if the foreign vendors source these fully formed products from them, instead of buying their components which too is permitted under the new policy, to discharge their offset obligation. Similarly, it will be a welcome change if the foreign vendors now starttransferring the technologies enumerated in the revised lists to the Indian Offset Partners (IOPs) to earn offset credits, something they have refrained from doing in the past.

It is a bit disappointing that alongside all these changes in the policy, the procedure for discharging of the offset obligation continues to be subject to unnecessary controls by the MoD. The guidelines clearly specify the avenues through which the offset obligation can be discharged, the eligibility conditions for selection of the IOPs by the vendors, and the products and technologies that qualify for offsets.The policy also leaves the choice of avenues, IOPs, etc., to the vendors. This being the case, it is inexplicable that all offset proposals -and even changing an IOP or rephasing and restructuring of the offset implementation schedule- require prior approval of the MoD.

Considering that the Vendors are free to discharge the offset obligation so long as they do it within the laid down parameters for selection of the avenues and IOPs, etc., prior approval of the offset proposal and any subsequent change therein by the MoD is unnecessary. No vendor would submit a proposal that is non-compliant with the policy. And yet, each proposal is subjected to examination in the MoD and it is understood in many cases the proposals are found to be non-compliant. This is a reflection on the inadequacies in the text of the policy, which should have been addressed by the MoD instead of persisting with the controls.

Many other provisions entail such ambiguities and uncertainties. For example, it will not be permissible for entities other than the foreign vendor and his Tier-I sub-vendor to discharge offset obligation if it is by way of investment or technology transfer. But the guidelines do not make it clear whether this entity could be a company unrelated to the main procurement contract. Similarly, in the case of offset discharge through technology transfer it will now be permissible to claim credit based on third-party valuation, but whether this will ease the vendors’ burden or add to it will depend on the detailed procedure for valuation and the list of approved valuers, which the Department of Defence Production is yet to notify.

Such ambiguities make it difficult to discharge the offset obligation. According to a recent report of the Comptroller and Auditor General the offset claims submitted by the vendors amounted to 59% of the total obligation that should have been discharged till December 2018 against the ongoing offset contracts, of which only 48% claims were found to be acceptable after audit. This works out to a success rate of 28.38%.

These figures indicate that there was something seriously wrong both with the policy and the procedure for executing the offset contracts, for it is inconceivable that the vendors would wilfully default in discharging their offset obligation and expose themselves to penalties and loss of reputation. It is somewhat disappointing that the new policy neither makes things easier for future nor provide any honourable exit to those who have been struggling to discharge their offset obligation under the ongoing contracts.

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