Aligning the Defence Offsets to International Benchmarks

Defence offsets like barter are a variant of counter trade, both can occur only on double coincidence of wants. Though the history of barter is almost as old as history of economic activity, defence offsets are comparatively very recent phenomena. They became popular in the mid-seventies, in what is now also referred to as the Deal of the Century. In 1975, a consortium of four European countries comprising Belgium, Denmark, the Netherlands and Norway decided between the F-16 and French Mirage F1 on the basis of the offset package. The consortium procured from the US, 348 aircrafts worth USD 2.8 billion, and in exchange obtained industrial participation in the production of the F-16. The share in production was fixed at 40% of the consortium’s order, 15% of value of orders by third countries and 10% of the value of the F-16 purchased by the US Air Force[i]. The popularity of offsets in defence rose steadily thereafter. From around 20 nations about two decades ago, this practice has now been now adopted by more than 130 nations, and offset practices of as many as 75 countries are documented in ‘The Offset Guidelines Quarterly Bulletin’[ii].

In comparison, the Indian offset policy is relatively younger. Our offset journey began in 2005, a little too hesitantly, with a non-obligatory policy of 30 percent offsets in contracts valued above Rupees 300 crores, under ‘buy’ and ‘buy and make’ categories. In 2006, offsets became mandatory and Defence Offsets Facilitation Wing was established. In 2008, a list of products which qualify for discharge of offsets obligations was published and offset credit banking became possible for a period of two years. In the amendment of 2012, the objectives of the offsets policy were first articulated and these included - (i) fostering development of internationally competitive enterprises, (ii) enhancing indigenous defence R&D and design capability, and, (iii) encouraging development of synergetic sectors like aerospace and internal security. The list of eligible sectors has since expanded to include 27 categories, period of offset banking has now been extended to seven years, and multipliers have been introduced for choosing MSMEs as Indian Offset Partners, or for transferring technology to DRDO, and for transfer of dual use technology. A Defence Offsets Management Wing has come into existence for offsets contract management. 

The pace at which the offset policy has shaped itself in the last nine years is quite extraordinary when compared to the general pace of policy change in the country. However, the offsets policy has remained rather too conservative in comparison to the practices followed by other nations. The article attempts to benchmark five facets of our offset policy with the rest of the world.

• Firstly, our threshold import value of Rupees 300 Crores or USD 48 Million dollars at today’s exchange rate is way above the world average. Average offset threshold for 20 nations, mostly developed, is approximately USD Seven million[iii]. Israel for example has a threshold of USD 0.1 million, and that too when its maximum transactions are with the US, who in principle is against offsets. Australia, Austria, Brazil, Denmark, Hungary, Lithuania, Romania, Slovenia and Slovakia have thresholds which range between USD 0.16 to 5 Million USD.
• Secondly, our offset requirement is 30%. Average global requirement works out to around 90% based on a sample of 25 nations[iv]. According to the European Defence Agency the offset percentage required by EU Member States on an average was at 135% between 2000 and 2006[v].  During 1993-2011, 53 US defence companies signed 830 offset-related defence export contracts with 47 countries. The value of associated offsets was $83.73 billion, representing 68.28 per cent of total arms export value of $122.67 billion[vi].
• Thirdly, our policy has seen a shift from direct to indirect offsets.  Direct offsets are related to the defence equipment or service acquired while the indirect offsets are not linked to the imported product. The choice ranges from strategic independence to simple economic return. It is therefore natural that direct offsets are preferred over indirect offsets. Direct offsets represent 40% of total offsets in Europe, while indirect defence offsets account for 35%, and indirect civilian offset come at 25%[vii].
• Fourthly, while we use a multiplier of 1.5 to promote MSMEs and a multiplier of 2-3 for technology acquisition, in the global arms market they are used rather aggressively to pursue interests other than economic development. Multiplier of 6 is not uncommon and in fact in some cases they go as high as 10. Apparently, nations are willing to pay the price for acquiring strategic independence.
• Lastly, the quality of the offset offer has no bearing on selection of the vendor in our case, but for most nations it contributes significantly towards vendor selection.

It clearly emerges from above that the internationals arms market is a buyer’s market and that is the raison d'être of offsets. This is perhaps best explained in the words of Lockheed Martin Vice President, "It's part of the price of international business, if we couldn't offer them an acceptable package of offsets, they wouldn't be buying an American airplane. It's that simple." However, in our case, offsets are being processed with a rather conservative mindset. What else can explain the fact that the offset threshold of the world’s largest arms importer is almost 500 times higher than Israel? Why does the largest arms importer get satisfied with just 30% offsets, when the US defence agreements include offsets contract amounting to 68% of the export value and the European nations absorb offsets to the tune of 200% of the arms purchase value.

The reason for our conservative approach may stem from our lack of confidence in the rigid and inflexible procurement procedure that we follow. But halfhearted utilization of offsets will only add to procurement costs. It is now very widely acknowledged that there is an economic cost to offsets. In a survey in the UK, it was concluded that purchases with offsets do cost more than off-the shelf purchase. In a study in Belgium, it was estimated that the nation pays between 20-30 per cent in increased costs in connection with “offsets tied to its military procurement." Therefore, while we pay the costs by asking for offsets, we do not benefit as much as others do from invoking them.

It is time the offset policy is reviewed and aligned to global benchmarks. It is also time to absorb procurement best practices to make the most of the opportunities that can be exploited to build indigenous capabilities.