|P. C. Tripathi
New Delhi: In 2008, India earned the dubious distinction of becoming largest arms importer in world. With rising defense budget and need for modernization of military, the import surge is likely to continue. To reduce reliance on defense imports and promote indigenization, government came up with the defense procurement procedures (DPP) in 2005. That was further reviewed in 2012 and is again under review as per defense minister’s recent statement post chopper scam hitting the UPA2 government.
Offset agreement in DPP is primarily a tool to promote self-reliance in defense production and augment the technological base of the country through transfer of technology and fostering of indigenous research and development of high-technology industries.
An offset agreement is a stipulation made between a foreign supplier and a company which requires the supplier to purchase a certain amount of goods from that country in exchange for a contract. Offset agreements can be direct or indirect, depending on what raw materials the country may have. These agreements are often required in order to award a foreign contract to a large company producing valuable goods. India’s current defense offset policy envisages an offset clause amounting to minimum of 30% value in any contract that is valued at Rs 300 crore or more.
A direct offset requires that the supplier has to procure from the contracting country something that is directly related to the product supplied. For example, if a foreign company selling aircraft to India buys aluminum used for airframes from an Indian defense company, it will be treated as direct offset. In indirect offset, the product bought from the contracting country may not be related directly to what is supplied. Mere exports from contracting country to neutralize foreign exchange component equivalent to the offset value will suffice.
Initially the task of enforcing offset policy was entrusted to the Defense Offset Facilitation Agency(DOFA). With revised guidelines since 1 August 2012, DOFA has been re-invented into Defense Offset Monitoring Wing ( DOMW) with enhanced powers of facilitation and enforcement under Defense Acquisition Council (DAC) in the ministry of Defense. The revised defense offset guidelines (DOG) also introduced multipliers up to a factor of 3 to encourage investments in Micro, Small and Medium Enterprises(MSMEs) and assist Defense Research and development Organization (DRDO) in rapid technology acquisition and absorption. Transfer of Technology (ToT) and equipments will now qualify for offset obligation discharge with facility to carry over offset credits up to seven years. The list for products and services eligible for offset has been further expanded. Foreign vendors can discharge their offset obligations up to two years beyond the period of main contract.
The indicative list of priorities to be met through an offset policy can be as under:
• Acquisition and development of state –of-the-art technologies.
• Acquisition and development of manufacturing competence to create world class defense production industry
• Export of defense industrial products, sub-systems, engineering design and testing services.
For all good intentions, the policy suffers from severe lacunae and militates against the core policy objectives of indigenization and technology acquisition. The lofty pronouncements on encouraging public-private-partnership(PPP) in defense production is still merely a slogan as ministry avoids it for ‘security consideration’ and makes it virtually impossible to obtain requests for proposal (RPF) by Indian private sector companies. Private sector has little market access to defense sector as the ‘Buy India’ program favors only Defense PSUs and Ordnance factories. ‘Buy India’ program is merely an euphemism for canalization of imports through defense PSUs. That suits very well politico-civil-military bureaucracy nexus which will be loath to forego such a lucrative source of income that defense purchases are! That’s why current defense procurement procedures implicitly encourage imports through many policy hurdles such as inverted import duty structure( components and sub-systems attract higher import duty than finished systems), lack of foreign exchange rate protection to Indian private companies. Though exchange rate protection is allowed to defense PSUs and foreign vendors. Even payments through L/C( Letter of Credit) which are extended to Defense PSUs and foreign vendors are denied to Indian private sector companies. Besides the above, the offset requirement for Indian companies is 50% against 30% to foreign vendors under ‘Buy Global’ category.
The offset policy in its current form favors services over manufacturing on account of differential value addition norms. The central goal of offset policy should be to encourage high-tech manufacturing by encouraging foreign vendors to assist local partners in absorbing technology and encourage innovation. Foreign vendors can through transfer of technology and equipment alone can notionally meet their offset obligations as their values will be subjectively determined hence prone to heavy inflation. That also opens the route for foreign vendors to dump outdated equipments and technologies to meet their offset obligations. It’s also not clear at what stage foreign vendors can claim offset in the equipment and technology they transfer.
The most distressing aspect of the defense offset policy is it has been carved without comprehending its relationship with the larger manufacturing and industrial policy of country. Its link to industrial licensing and FDI in defense industry is tenuous at best. Without raising the current FDI limit of 26% in defense industries to 75% or at least 49%, the offset policy will function merely as a canalization route for India’s burgeoning imports without any long-term benefit to her manufacturing base. The domestic pressure groups such as FICCI are opposed to raising FDI limit in defense industries to the detriment of national interest and in damage to their own interests as they will merely be seen as rent seekers by compelling foreign vendors to hold minority stakes in Indian companies. A smartly carved out defense offset policy can be a great catalyst for promoting a national high-tech manufacturing base where we see a proliferation of Indian SMEs as global suppliers for systems and sub-systems for both defense and civilian industries. This also requires India to clarify its non-existent defense export policy and firmly link it to existing foreign trade policy. One immediate amendment to defense offset rules that would galvanize the Indian SMEs towards defense manufacturing is to categorize offset obligations as ‘Deemed Exports’ under the foreign trade policy(FTP) of India.
To conclude, the defense offset policy in current form upsets the policy instincts more than it offsets India’s vision of a high-tech manufacturing economy to absorb its vast number of skilled youth seeking employment in Indian factories of tomorrow.
(The author is director of Institute of International Trade and Security. Email: firstname.lastname@example.org)