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Desirable Changes in Offset Guidelines

The Offset procedure has been revised several times over the past decade but it is questionable if the offset procedure has actually achieved the objectives that were set out for it. The author dwells upon as to how to derive the best value....

The procedures for implementing offset provisions was promulgated vide MoD ID No. 81 / Director (Acq) / 06 dated 10 May 2006 and included in Defence Procurement Procedure (DPP). The key objective of the Defence Offset Policy is to leverage capital acquisitions to develop Indian defence industry by:

•    Fostering development of internationally competitive enterprises.
•    Augmenting capacity for Research, Design and Development related to defence products and services.
•    Encouraging development of synergistic sectors like civil aerospace and internal security.

With the release of Offset Guidelines effective from 01 Aug 2012 the offset obligations can be discharged directly by any combination of methods  and applicable to all RFP issued post 01 Aug 2012. The offset obligations forms an integral part in Part - I of RFP and, subsequently, of the contract. Offset conditions as specified in the RFP are binding unless agreed by MoD during subsequent deliberation. Thus, offset obligations will be governed by the DPP version under which the RFP has been issued.

The total value of the defence offsets contracted till now in the last few years is valued around $ 4.8 billons. The Indian Air Force (IAF) has signed contracts worth approximately $3.615 billion (Rs 19884.7 crores), the Indian Navy (IN) worth $843.73 Million (Rs 4636.5 crores) and the Indian Army (IA) worth $24 Million (Rs 132 crores). IAF procurements have generated 80% of all offsets, with IN procurements accounting for the other 15% whereas IA procurements have yielded 5% so far. The data compiled from various sources indicate that the spread of contracts signed so far is - PSU about 40 percent, SME about 27 percent and rest 33 percent with the big private sector. These aspects are represented in the figures below.

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Share by Mode of Offset Discharge
The activity wise spread is Manufacturing 55 percent, Design 19 percent, Software 8.5 percent, Engineering Services 14 percent and Services 3.5 percent. The Aerospace segments has maximum offset. The major areas of offset realisation are:

•    Sub contracts involving supply of fuselage, cabins, Radom, tail cone, data link etc (56%)
•    Engineering projects & project management (5%)
•    Overhaul and repair facilities (15%)
•    Simulators and training facilities (17%)
•    Ground Handling/Support Equipment (7%)

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Some of the significant observations are that the major chunk of the planned offsets is in the aerospace sector; the remaining covers the manufacture of naval systems and others. The investment into R&D has been negligible till now and the OEMs have preferred private companies to the public sector, despite DPSUs having a strong hold on defence production.

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In addition, contracts worth about $ 21 billion are at Commercial Negotiation Committee (CNC) stage. There is over 44 offset contracts (with global armament firms who have bagged or about to clinch the deals) worth over Rs 50,000 crore under or due for negotiation. More than 35 Indian companies, both in public and private sector would derive offset business benefits.

Offset Deals in the Pipeline
Details of certain equipment under procurement/ up gradation are given in the table to highlight the offset projections.

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Matrix for Success
The Offset procedure has been revised several times over the past decade but it is questionable if the offset procedure has actually achieved the objectives that were set out for it.

The basic matrix for the success of Offsets in the Indian context is to see a visible improvement in national capability in terms of skill development along with the national capacity in terms of productivity, quality and delivery schedules to merge with the global supply chain. As can be seen so far most offsets are “Built to Print” or “Local Purchase in India” items that is more of the same thing. Also such jobs are already executable from the available industry pool and hence no real additional capacity or capability has been created. There are, of course, exceptions where major investments have been made for bringing Indian industry into the aero structure global supply chain and these have been successful. So, unless “Built to Specifications” items begin to take up most of the order books there is really no skill enhancement.

Offsets must remain the sole responsibility of the OEM alone. So long as the offset requirements are clearly and unequivocally complied with details such as participating partners and vendors, respective work share etc are inconsequential and do not add any value to creating robust business or industry in India and are counterproductive to the stated objective simply because they do not provide the scale that can support sustainable business operations.

Between the period from 1 Jan 2008 to March 2014, 28% offsets should have been discharged; however only 15% offsets have been discharged. This indicates the implementation is not on the expected lines. In 2013, a committee was formed to recommend suitable changes in the Offset guidelines, however, outcome is long awaited. There is need to ponder over, what needs to be done or what are the desirable changes which would put the offset implementation on track?

Services still held in abeyance
"Services" were recognized as a valid means of discharging offset obligations. It was, therefore, highlighted in the agenda for the DPP 2005, with emphasis on services placed in the Detailed Guidelines for Discharge of Offsets in DPP 2006.  The list of services was further expanded in DPP 2011 to accurately reflect the whole range of activities performed under "services".

The MoD released an office memorandum on 23 May 2013 that entailed holding in abeyance, until further orders, portion of the offset guidelines that related to "services" being an eligible mode of discharging the offset obligation. The orders are applicable to all Requests for Proposal (RFPs) issued on or after the date of the memorandum. These orders also stand for RFPs that have already been issued but have time for the submission of their technical and commercial bids. The MoD has cautioned vendors to consider the provisions of this memorandum while formulating their response to RFPs. The above quoted order needs to be withdrawn.

Retrospective applicability
The offset obligations are governed by the DPP version under which the RFP has been issued. The offset process has been refined over period of time and the current  policy needs to be made applicable to all ongoing cases retrospectively.
IOP and Workshare.

In present context the vendor is expected to provide details pertaining to IOP wise work share, specific products and supporting documents indicating eligibility of IOPs in addition to conformity with other clauses in the offset guidelines soon after RFP response stage. This adds to burden and additional cost to all vendors.  The selected vendor can provide the same to DOMW soon after the main contract is signed. DOMW can establish eligibility of IOP, product and offset discharge avenue along with other compliance issues and if found ineligible on any count, penalty will be imposed by treating the transactions as invalid.

Offset Contract Amendment
Any request of change of IOP and offset component  etc are put up to Defence Minister through normal channel for approval. Such changes could be  delegated to the Secretary, (Defence Production) as the approving authority. He could approve the same based on the recommendation of the Collegiate Committee on Offsets.

IOP Clarification
The IOP guidelines with regards to Foreign holding on some of the domain such as Civil Aerospace, Security, Services are not limited to 49% and were putting the defence manufacturing IOP at a disadvantage on offset contract placement, where 49% limit is binding. In some cases fully owned subsidiaries of foreign companies/nationals were eligible theoretically.  Hence forth such companies should  not  be considered for participating in offsets. IOP must be owned and controlled by Indian persons only.

Offset obligations spread and time frame
MoD may prescribe a fixed quantum of offset discharges with the passage of period of performance to ensure even distribution to the extent possible and also insert individual work share in the offset discharge period.

Re-phasing of Offset
Instances of vendor attempting to seek frequent re-phasing to cover an anticipated shortfall have been in past. MoD may consider counterbalance the benefits accruing to vendor on account or re-phasing as and when sought by them.

Buyer Nominated Equipment  under offsets
The DPP-2013 is silent about conditions for the admissibility or otherwise of Buyer Nominated Equipment/Customer Specified Equipment (BNE/CSE) for the purpose of discharge of offsets. MoD may approve acceptance of offset credit claims of OEM for sourcing of BNE through IOP.

Conclusion
The offset guidelines may derive best value if MoD streamlines the offset related activities for faster and better management of offsets. The activities should be mutually beneficial across the spectrum. For capability and capacity building approach, the aim should be to avoid complexity & introduce simplicity and this may be achieved by reducing the complexity of conditions, intricate sub conditions and difficult formulae. This would mean that once the offset requirements have been communicated to the Vendor, the execution options are left to the DOMW and OEM on a “best effort” basis.

Reduce the infructuous work on both the Vendor and Buyers side, and therefore offset proposals must only be sought from the L1 vendor though “undertaking” to fulfill offsets requirements would need to be provided by all participating vendors. The same approach is needed for any revision for the sake of uniformity and faster conclusion of offset contract/amendments to offset contracts.

Maj Gen Dr. Bhupinder Yadav (Retd.)

Maj Gen Dr. Bhupinder Yadav (Retd.)

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