DPP-2008 on 1st August: Offset banking okayed for 2 years

(Photo: courtesy Ajai Shukla. The assembly line at HAL, Bangalore, for the Dhruv Advanced Light Helicopter)

by Ajai Shukla

Business Standard, 24th July 08

Defence Minister AK Antony has confirmed that the long wait for the new Defence Procurement Policy of 2008 (DPP-2008) will finally end on 1st August. A keenly anticipated portion of DPP-2008 is the new defence offset policy, which will immediately govern offset proposals for a Rs 47,000 crores contract for fighter aircraft and, thereafter offsets for defence purchases worth Rs 300,000 crores over the next five years.

India’s offset policy mandates that defence contracts worth more than Rs 300 crores will place on vendors a “direct offset liability” of 30%, making them liable for investing 30% of the contract value in Indian defence companies, or sourcing defence goods or services worth an equivalent amount.

The new policy, Business Standard has learned, incorporates a key request of foreign defence companies; offset banking is now permitted. Foreign vendors can accumulate offset credits for two years preceding the award of a contract. Offsets can only be banked after permission from the government, which will examine all offset banking proposals to ensure that they benefit Indian defence industry. 

This appears far short of the request from global arms corporations for a 10-year banking period. However, in the way the policy has been framed, the 2-year clearance would practically amount to far longer. As long as the vendor links the banked offsets to a government tender (a Request for Proposals, or RfP, as the MoD calls it) the banked offsets will remain alive until that contract is finalised.

A senior MoD official explains how this will be interpreted. Assume that Rs 4000 crores worth of offsets banked by a foreign vendor is lapsing on 1st January 2009. Over the next three months, i.e. before 31st March 2009, the vendor can link those Rs 4000 crores to an RfP to which that company is responding, e.g. the procurement of helicopters. Once the banked offsets get linked to the helicopter purchase, they do not lapse even if the evaluation and trials go on for another five years. In fact, if the vendor continues accumulating Rs 1000 crores worth of offsets credits each year, at the end of the 5-year period, i.e. on 1st January 2014, he will have Rs 9000 crores as banked offsets (Rs 4000 crores + Rs 5000 crores).

If that vendor wins the contract, his offsets liabilities would be immediately reduced to the extent of his banked offsets credit of Rs 9000 crores. If, however, he fails to win the contract, the entire amount would lapse, less offsets for the preceding two years, i.e. for 2013 and 2014. 

The new offsets policy also waives the current requirement for a defence production licence for Indian private defence industry doing offsets business with foreign vendors. DPP-2006, the current policy, defines offsets as the purchase of products from “Defence Public Sector Undertakings, the Ordnance Factory Board, and any private defence industry manufacturing these products or components under an industrial licence granted for such manufacture. The new policy has quietly done away with the phrase “under an industrial licence granted for such manufacture”.

While this is an important liberalisation for the private sector, it appears to clash with the current Government of India policy, promulgated by the Department of Industrial Policy & Promotion, in the Ministry of Commerce & Industry. That policy specifies, in Press Note No 4 of 2001, (which has not yet been amended) that, “The defence industry sector is opened up to 100% for Indian private sector participation with FDI permissible up to 26%, both subject to licensing.” The new DPP 2008 does not clarify how this clash will be resolved.