Sunday, 1 December 2013

Defence Offsets in India : The Way Forward

India has emerged as a large net importer of arms over the past decade. The year 2001 saw an opening up the defence sector to private players and allowing up to 26 per cent foreign direct investment.
India has emerged as a large net importer of arms over the past decade. The year 2001 saw an opening up the defence sector to private players and allowing up to 26 per cent foreign direct investment. In 2006, the first formal Defence Procurement Policy (DPP) was put in place. The key objective of the defence offset guidelines was to leverage capital acquisitions to develop the defence industry, improve defence research and encourage development of synergistic sectors like civil aerospace and internal security. The guidelines were last revised in August 2012 and the latest DPP-2013 came into effect on June 1.Some form of barter system has existed for centuries, but the US was the first to coin the term ‘offsets’ as an inducement to sell arms to underdeveloped friendly countries, and in return, either purchased goods or made local investments. The ground position today is that the major arms sellers of the world such as US, UK, France and Germany label such regulations as protectionist, and are not in favour of defence offsets. On the other hand, most countries have high defence offsets regulations. China has no formal offsets policy. Australia does not accept indirect (civilian) offsets, unless they bring benefits to the country’s defence industry.
In India, all contracts above $65 million require 30 per cent of offset. Indian firms and joint ventures are exempted from offset obligations provided the indigenous content is over 50 per cent. India also accepts subcontracting in outsourced services, such as engineering and defence software. Clearly, Indian offsets’ requirements are not unreasonably stringent.
Nearly 122 open defence offset contracts signed around the world between 1997 and 2010 have only partially been executed due to various issues. It is clear that offset management is very complex, as has to be managed to the satisfaction of two parties. The US, being one of the largest exporters of high technology weapons, has been vocally moderating offset policies around the world.
Offsets are a powerful marketing tool to motivate a purchase. Major defence contractors are conscious of the psychological power of offsets in democracies. What constitutes a legitimate offset, are questions still searching for answers. The physical valuation of offsets is complex. Value of parts locally sourced could be straight-forward, but cost of transfer of technology (ToT) and helping set up industrial base could be vague. Co-production and subcontracts are the best forms of direct offsets.
Offset/industrial partnership management organisations have emerged. Offset India Solutions (OIS), an Indian company, extends a partnering approach to provide customised expertise to international companies for fulfilling their offset obligations throughout its lifecycle. Offsets management itself has, thus, become an industry.
The new offset guidelines promote investment in micro, small and medium enterprises (MSMEs) by applying a multiplier factor of 3.0 to the offset calculations. It also facilitates technology acquisition from a select list, by the defence research and development organisation (DRDO). The offset discharge banking period is extended to seven years. Period of execution of offset contracts is now allowed up to two years beyond the period of main procurement contract.
Indian defence manufacturing industries’ capability to absorb offsets is still evolving. To achieve high indigenous content in high technology products is not easy. At present, the exclusion of services for purposes of value addition in India is a dampener. All this results in complex extended negotiations. One would recall the long time that Indian agencies and French aerospace company Dassault had to iron out offset issues during the MMRCA negotiations. One recent successful offsets management case is that of Pilatus Aircraft, Switzerland, setting up an electrical harness manufacturing capability, along with Bharat Electronics (BEL) in Bangalore. The electrical harnesses manufactured by BEL would be for the Pilatus global supply chain. The contract which includes an integrated ground based training system, and a comprehensive logistics support package, covers the 30 per cent offset obligation. Pilatus Aircraft entered into a contract with the Indian government last year for the supply of 75 PC-7 Mk II turboprop basic trainer aircraft for the IAF.
The companies that want to build long-term defence relations with an emerging power like India would find good offsets solutions.
A Financial Times study projects 15,000 defence contracts in the decade ending 2022, with offset obligations of $100 billion. Top five US defence contractors — Boeing, General Dynamics, Lockheed Martin, Northrop-Grumman, and Raytheon would be saddled with $ 42 billion of the obligations. Even as Indo-US defence trade reach new highs, offsets and defence FDI policies continue to act as roadblocks. Notwithstanding, US president Barack Obama reaffirmed during his recent meeting with prime minister Manmohan Singh that the US would grant India the same privileges reserved for its closest allies in respect of transfer of defence technology, co-production and co-development.
US sales of military equipment to India have grown from zero in 2008 to around $9 billion in 2013. Projects worth tens of billions are in the pipeline. India’s expectation combined with a 26 per cent cap on FDI in the defence sector limits the interest of American firms to fulfill Indian requests for high-technology defence items. Defence contractors are not only worried about intellectual property rights or the technology moving to unintended sources, but also about some of the recipients developing technologies and later becoming competitors at their expense. India has a significant manufacturing industrial base. It has, under licence, produced thousands of aircraft over five decades. It has a very successful space programme. Therefore, it should not be difficult to find local offset partners. Pilatus has recently set a good example for others to follow.

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