Raising Of Threshold For Defence Offsets:An Appraisal

In order to provide the necessary thrust to improving the defence manufacturing environment and lend impetus to the defence acquisitions in India the Committee of Experts for Amendments to DPP 2013 Including Formulation of Policy Framework ("Committee") was formulated by the new Indian Government on assuming office in 2014 and this committee submitted its findings and recommendations to the Government on 23 July 2015. In departure from the norms of secrecy followed earlier for all such reports by Government nominated committees, this report was put in public domain by hosting it on the Ministry of Defence (MoD) website. Evidently the endeavor was to obtain maximum feedbacks from the environment. Having carried out the necessary iterations based on the feedbacks received, the Acquisition Wing of MoD fielded the revised Defence Procurement Procedure (DPP) 2016 for the approval of the Defence Acquisition Council (DAC), the apex decision-making body of the MoD on 11 January 2016.

The new DPP, less one chapter, is likely to be notified in approximately two months after incorporating certain corrections. Based on the report from a task force headed by former DRDO chief V K Aatre, the chapter on the selection of “strategic partners would be notified separately. Also, the MoD would promulgate a separate policy document on the blacklisting of foreign firms and the role of a middleman in defence deals.[i] The highlights of the new DPP are as under:

§  A new category ‘Buy Indian’, Indigenously Designed, Developed and Manufactured (IDDM) platforms, has been introduced which will be the top priority category to process defence capital procurements. This new category is further subdivided into two sub-categories

Ø   First sub – category mandating 40% domestic content for a domestic design.

Ø  The second mandating 60% local content if the design is not Indian. It is mandatory that the domestic companies eligible under this category must have majority Indian control and should be operated by an Indian national.

§   In addition to building a technology base in the country, the government through the Department of Defence Production (DDP) has proposed to fund R&D. For the ‘Make’ category, the new DPP will permit government funding up to 90 per cent of developmental costs to private companies to push research and innovation.  The 'Make' category will consist of  three sub categories:

Ø  Make-I will involve 90 percent government funding for development cost, and provision to reimburse remaining 10 percent.

Ø  Make-II is proposed to be industry funded, but with a clause that 100 percent refund will be granted for successful prototypes in case the procurement does not fructify within two years.

Ø  Make-III has been structured for MSMEs, and shall be applicable for projects with cost less than Rs 3 Crores, other provisions remaining same as for the Make-II category.

Only firms with majority stake and controlled by resident Indians will come under Make categories.[ii]

§  The new DPP has addressed the delays in acquisition process by cutting down on the existing timelines. The validity of the Acceptance of Necessity (AoN) has been brought down to six months from earlier one year, implying that the Service Headquarters will have to issue the Request for Proposal (RFP) that much faster.

§  The RFPs will comprise of enhanced performance parameters for additional capabilities over and above the essential parameters. Vendors which meet them will be provided additional credit score while evaluating their product cost.[iii]

§  Moving away from the phobia of single vendor situations, the new DPP permits accepting bids even if there is only one supplier, however a proper justification for the same will be required.[iv]

§  And lastly, the threshold for applicability of offsets has been amended from the current Rs 300 Crore to Rs 2000 Crore. Implying that only those foreign OEMs which bag contracts for over Rs 2,000 Crore will have to plough back at least 30% of the contract value into Indian enterprises as offsets. Deals with contract value less than Rs 2,000 Crore will be exempt from the offsets obligation.

An Appraisal on Raising Threshold of Offsets from Rs 300 Crore to Rs 2000 Crore

The Upside. The MoD has indeed proposed a new DPP to facilitate the capital defence procurements, making it convenient for foreign arms companies as well as encouraging the Indian private sector to take nascent steps into defence manufacturing. While raising the threshold for the applicability of the offsets, the MoD has lauded itself claiming that the same is likely to provide the much desired flexibility to foreign arms majors as the stifling offset limit has now been relaxed from the existing limit of Rs 300 Crore to Rs 2,000 Crore. Justifying the raising of the threshold value for offsets, the Raksha Mantri himself stated during the conduct of the DAC meeting that
"We currently have signed offsets worth USD 5 billion and another USD 8 to 10 billion is in pipeline. We may not be able to absorb all of this. Moreover, offsets also increase the cost of the product by 14-18 per cent”[v].

There is no denying the fact that offsets were a reason for delay in finalization of defence contracts as also at times some of the foreign OEMs stayed away from responding to Indian RFPs comprising of offset obligations, as they found the offset provisions cumbersome and at times beyond their capability to fulfill due to a plethora of reasons; inability of Indian defence industry to absorb the offsets being the prime reason quoted by these OEMs. Hence, this major policy change announced by the MoD is likely to lend the much required momentum to the capital defence acquisition in terms of more responses to the RFP by foreign OEMs, earlier fructification of contracts as also bringing down the cost of the contract, as the OEM are known to load the cost of offsets on to the cost of the main project. Another significant advantage that is expected out of this raising of threshold is that the minimum offset obligation is likely to be Rs 600 Crore. The enhanced minimum value of offsets from Rs 90 Crore to Rs 600 Crore will facilitate harnessing of certain niche technologies as part of offset obligation, which the OEMs may not have offered for the earlier lesser value offset projects.

The Downside.  The counterpoint to the above listed advantages of the change in the offset policy threshold value warrants a focus at par. World over offsets have influenced the course of weapons and equipment procurements and have accordingly impacted the growth of the global defence industry. Countries like Saudi Arabia, Brazil and Israel have had the threshold value much lower to the one in India presently and they have achieved substantial successes in their offset programs. India with Rs 300 Crore, has one of the highest threshold values world over[vi]. This implies that India ends up losing the advantage of offsets for all procurements with the value below 55 Million USD. However for a country which is aiming for ‘Make in India’ and the related development of MSMEs/ SMEs, surrendering the offset advantage by raising the threshold value further to Rs 2,000 Crore is not logical.

Of late a large number of Indian companies to include MSMEs have shown interest in the defence equipment business and have applied for industrial licences from the ministry of commerce to locally manufacture military equipment and were relying heavily on the offset provisions to further their business ventures. However, the raising of the threshold for applicability of offsets to Rs 2,000 Crore has raised the minimum value of offset obligation to Rs 600 Crore, which virtually rules out the MSMEs from being the Indian Offset Partners for the offset contracts, as an offset obligation of such high value will be beyond these enterprises. This implies that the offsets will become a domain for certain front runner major ventures like Bharat Forge Ltd, Reliance Industries Ltd, the Tata group, Larsen and Toubro Ltd, the Godrej Group, the Mahindra Group, Reliance Group and  Adani Defence Systems and Technologies Ltd, which are well entrenched in the business.

The prime aim of defence offsets was to leverage capital acquisitions to develop India’s defence industrial base (DIB) and in turn promote research and development in defence sector. Since its inception in 2005, the Indian Defence Offset Policy has undergone a number of iterations and has matured over a period of time into an extremely constructive and focused policy structured to leverage capital acquisitions to develop Indian defence industry by, fostering development of internationally competitive enterprises. An endeavour should have been made to iron out whatever hitches that still persist rather than raising the threshold to a level where most of the procurements will fall beyond the purview of the offset obligation. As per the analysis carried out by Weapons and Equipment Directorate, the capital procurement directorate for Indian Army, 52 per cent of Indian Army procurement projects are below Rs 500 Crore value[vii]. This figure is likely to increase to approx 80 to 90 per cent, if the count is for Indian Army projects with cost below Rs 2,000 Crore. This implies that Indian Army procurements would invite near to negligible offset contracts.

A caution here needs to be exercised, as the lure of the signature campaign of the present Indian Government ‘Make in India’ seems to be eclipsing the future of the Indian Defence Offset Program. While the ‘Make in India’ holds a lot of relevance in sectors other than defence, the imperatives for ‘Make in India’ in defence production has a connotation that is at complete variance to the economic advantage of this campaign. While in non defence sectors the objective of ‘Make in India’ will be purely economic, the prime objective in defence is self reliance and the economic advantage and job creation come as only related benefits . Also what needs to be understood is that the niche technologies to include designs and the source codes of defence equipment are the most closely guarded secrets and no original equipment manufacturer (OEM) will like to part with these secrets.  The ‘Make in India’ initiative is at nascent stages and the rules of its implementation are still to be laid out. The Indian offset programme on the other hand has been through a number of iterations since 2005 and has matured to quite an extent in the provisions as given in the revised DOGs of 2012. The most important issue in offsets is the provisions of safeguards against the OEM offering low end technology in the form of either multipliers in offering transfer of technology or the buyback clause.

Conclusion.  Strengthening of Defence Industrial Base (DIB) is a structured approach which involves a clear understanding of the kind of capabilities to be built up and the technologies required for the same, which is followed by in house R&D, seeking transfer of technology from foreign OEMs as part of acquisition contracts or offsets and simultaneous setting up of the infrastructure and the training of the work force The Indian Offsets Programme has catered for all the above tenets and has matured over the years and is focused at strengthening of Defence Industrial Base (DIB) to promote self reliance in defence production. Now, especially when Indian defence industry has started taking baby steps towards indigenization and the building blocks in terms of SMEs & MSMEs were relying heavily of bagging some offset contracts, denuding them of the same may not be a very appropriate step. Thus raising of threshold to a level where the offsets will be rendered inapplicable for most of the procurements needs a relook.

The author is a Senior Fellow at CLAWS. Views expressed are personal.