Offsets gather momentum: time to go from banking to trading

by Ajai Shukla

Business Standard, 25th Nov 09

With India’s defence offset policy finally taking off, Prime Minister Manmohan Singh’s call for increased Indo-US collaboration in defence production portends well for offset-based foreign investment. A foreign boost to India’s moribund defence industry has been a government priority since 2005, when the Defence Offset Policy first mandated a 30% plough back into Indian defence industry of every foreign defence sale worth more than Rs 300 crores.

That the policy is beginning to yield results is evident from figures released last week by the MoD. Since 2007, when offsets took effect, foreign vendors have tied up production agreements worth Rs 8000 crores, almost entirely with domestic aerospace manufacturers. But, given that India’s foreign defence purchases currently generate an offset liability of about Rs 15,000 crores annually, this is only a beginning.

The success of India’s defence offset policy should not be measured in agreements signed, or goods manufactured. An offset policy is successful only in so far as it generates long-term industrial partnerships, which function even after the vendor has discharged his offset liabilities. For this the partnership must benefit both vendor and buyer. The challenge for India is to develop the domestic defence industry, both public and private sector, to create an eco-system of potential partners for foreign vendors. This is not difficult; India’s auto component manufacturers have already demonstrated domestic capabilities in high-tech manufacture and cutting-edge R&D. These are precisely the qualities that global arms corporations seek in offset partners in India.

Where mutual benefits are not available, arms vendors simply treat offsets as an imposition, a cost of doing business. They fulfil their offset obligations superficially and add the costs to their bill. That this is happening in India’s civil aviation sector (where, as in defence, vendors are liable for offsets) was evident from what former Civil Aviation Secretary, Ajay Prasad, told a gathering in Delhi last week. Revealing that Kingfisher Airlines had paid US $50 million less than Indian Airlines for similar Airbus aircraft, Mr Prasad explained that was because offsets were mandatory in the purchases by the government carrier. Evidently, the costs of those offsets were added on to Indian Airlines’ bill.

Such subterfuge can be minimised through responsive policymaking, creating benefits for India’s defence economy without unduly taxing vendors. The MoD’s first offset policy, promulgated in the Defence Procurement Policy of 2005 (DPP-2005), has gradually evolved, mainly at the instance of Indian and foreign defence suppliers. The most far-reaching change is the introduction of “offset banking” last year, allowing vendors to accumulate offset credits towards a future liability. But South Block has been less than responsive in the justifiable demand for “offset trading”, which would allow accumulated credits to be sold by vendors who may not have a use for them at that time.

As foreign vendors struggle to find offset partners for their mounting offset liabilities, there is a rising clamour --- particularly from US companies --- for allowing “indirect offsets”, or the discharge of offset obligations through investment in non-defence fields like infrastructure, health, housing, etc. The MoD, focused on building up domestic defence industry, considers “indirect offsets” a potential turf infringement. But unless a well-conceived policy and regulatory framework is created for handling billions of dollars of offsets liabilities each year, New Delhi may have to allow some of that money to spill over into non-defence fields.