DPP-2008: changes in offsets and FDI policy

(Part II of a two-part series on the new procurement policy)

by Ajai Shukla

Business Standard, 9th April 08

By 15th May, the Ministry of Defence (MoD) hopes to announce the long-awaited changes to its existing procurement and offsets regulations, spelt out in the Defence Procurement Policy of 2006 (DPP-2006). The new rulebook called the DPP-2008 will govern the purchase of military equipment worth an estimated Rs 300,000 crores (US $75 billion) over the next five years. It will cover the outright purchase of military equipment; transfer of technology to Indian companies for manufacturing equipment in India; development and manufacture of goods by Indian private and public companies; and a new, more liberal, defence offsets policy.

The most anticipated changes concern the defence offsets policy, which currently mandates that any defence contract worth more than Rs 300 crores (US $73 million) will place on the vendor a “direct offset liability” of 30%, making him liable for sourcing from India, defence goods or services worth at least 30% of the contract value. DPP-2008 is expected to increase offsets to 50%, at the MoD’s discretion.

The new policy will also allow “offset banking”, which means that a foreign vendor that generates defence business in India in a particular year, can “bank” that credit and claim it as an offset against a defence contract signed subsequently. However, DPP-2008 will lay down a time period, after which the banked offsets will lapse. 

Foreign vendors, particularly the six aerospace giants competing for the Rs 42,000 crore contract for 126 multi-role fighter aircraft, have been pressing to allow the transfer of technology (ToT) to India as a part of offsets. One reason for this demand was the hope that the messy process of tying up manufacturing partnerships with Indian defence producers could be avoided by discharging offsets liabilities through ToT. But DPP-2008 does not allow ToT to be counted as an offset.

A top MoD policymaker told Business Standard, “The aim of offsets is to build up the indigenous defence industry; allowing ToT as offsets does nothing for Indian companies. Besides, you don’t get the technology that we really want. It’s best to pay for technology up-front; you can choose the exact technology that you need.”

The other major change that the MoD is still contemplating concerns the enhancement of FDI limits in defence production. The current limit, laid down by Press Note No 4 of the Department of Industrial Policy and Promotion (DIPP), is 26% FDI in Indian companies engaged in defence production. The DPP-2008 could allow the FDI limit to be raised, on a case-by-case basis, to 49%.

Business Standard has already reported on an existing application for setting up a 49%-51% joint venture between multinational BAE Systems and Mahindra Defence Systems (MDS). While the MoD has verbally said that it is open to such JVs, depending upon the level of technology being brought into India through them, a specific mention of this in the DPP-2008 is expected to ease the grant of clearances.

The MoD is also grappling with the difficult issue of setting up a single-window body that will handle the growing offsets-related workload that will flow from DPP-2008, especially the accounting of “banked” offsets. Currently a small department called the Defence Offsets Facilitation Agency (DOFA) handles all offsets-related issues. If DOFA is to continue doing so, the MoD would need to provide it additional resources.