Indirect offsets: a more realistic policy

by Ajai Shukla
Business Standard, 23rd Oct 07

Foreign defence majors are on offset overdrive, their representatives buzzing in and out of India, scrabbling to tie up partnerships with Indian companies. The deadline of 9th June looms, when companies bidding for the Rs 42,000 crore medium fighter contract must submit offsets proposals worth 50% of the contract cost, i.e. about Rs 21,000 crores. Clutching overnight bags and airline tickets to Mumbai, Pune, Bangalore, Chennai and Hyderabad, the offsets managers of the world's biggest arms corporations complain bitterly about two roadblocks that they are all running into: policy paralysis in the Ministry of Defence (MoD), and growing evidence that India's defence industry is unable to handle the deluge of foreign investment that offsets are bringing in.

While the MoD's glacial policymaking is quintessentially Indian, all developing countries that spend heavily on defence have experienced difficulties in absorbing huge offsets inflows. When the UAE --- which mandates 60% offsets, twice India's 30% --- bought large volumes of foreign weaponry in the early 1990s, the offset liabilities were in billions of dollars. Realizing that the defence industry alone could not absorb such inflows, the UAE set up an autonomous body, the UAE Offsets Group (UOG), which was tasked to canalise offsets into developing the emirates' infrastructure.

Operating under a Jordanian expert, Dr Amin Badr El-Din, the UOG emerged as an important body in developing the emirates' infrastructure. Funnelling billions of offsets dollars into the natural gas industry, the UOG masterminded the Dolphin Project, which interlinked gas fields in Qatar, UAE and Oman; there was even a proposal to build a $3.5 billion, 720-mile undersea pipeline bringing gas to India and Pakistan, a project that is now on hold.

This UAE model of coordinating, at the national level, offsets investments into fields unrelated to defence --- "indirect offsets" as they are termed --- has so far been rejected by India's MoD. One reason has been South Block's tendency to see offsets as a panacea for galvanizing its moribund defence production units, which remain tied down by ineffective goal-setting, incompetent managers, and inefficient labour that displays alacrity only in organising itself into powerful unions. A national offsets policy is also threatens to violate jealously guarded turf in more than one ministry. The MoD has its own offsets and the Ministry of Civil Aviation (MoCA) has its own. South Block has already made it clear that it will have nothing to do with the national offsets policy that is currently being drafted.

But pressure is mounting from influential bodies like the US-India Business Council (USIBC), which represents 250 of the biggest US companies that are investing in India. The USIBC has written to the MoD, suggesting that offset investments be allowed into sectors like power generation, highways, airports, ports, urban development, health and sanitation, water and high-technology.

Indian companies, industry bodies like the CII, and consultancies that work in the field of infrastructure echo this argument. Ranbir Saran Das, from Fairwood Consultants, points to the financial logic that he says will make indirect offsets inevitable. By the MoD's reckoning, defence procurements over the next five years will create offsets opportunities between Rs 50,000 to Rs 90,000 crores. This figure, of course, is not the amount that foreign vendors will be obliged to invest in India; it is merely the value of goods and services that the vendor must produce in India during the period that the parent contracts are running. Nevertheless, Das estimates that the incoming investment will create leveraged investment opportunities of anything up to 200,000 crores. He points out that the flagship infrastructure scheme, the Jawaharlal Nehru National Urban Renewal Mission (JNNURM), currently gets Rs 1,20,000 crores for a seven-year period; allowing indirect offsets could effectively double its allocation.

If the foreign vendors are proved right and Indian defence industry finds it difficult to set up the joint ventures required for the enormous offset obligations that must be met, the government will have to consider alternative offset mechanisms, including indirect offsets. Implementing these would need a ramped up management framework that could function across multiple ministries.

Instead of the woefully understaffed, single-ministry Defence Offsets Facilitation Agency (DOFA), which currently handles all offsets arising from military procurements, indirect offsets would need to be handled by a nominated nodal ministry, such as the Ministry of Commerce, which could evaluate offset proposals from the perspective of broader national requirements. This apex body could lay down priorities and then negotiate with foreign vendors to tailor the offsets package to the satisfaction of both sides. Working under its directions, the implementation of various offsets could be handled by specialised agencies; offsets in infrastructure, for example, could be coordinated by a multi-disciplinary agency like the Infrastructure Leasing and Finance Corporation (IL&FS).

The catch, of course, is that this would require the MoD and the MoCA to relinquish their control of offsets, something that both see as lucrative cash cows. While the MoD shows no sign of relenting on indirect offsets, the yet-to-be-announced decision (reported earlier in this newspaper) to allow technology transfers (ToT) to be adjusted as offsets is an implicit recognition of the need to create offset options that are easy to implement. The difficulties of setting up dozens of joint ventures with a defence industry that is far from mature cannot simply be ignored.