India’s next big scam…

by Ajai Shukla

Business Standard, 20th Apr 10

Move over artillery gun deals… stamp paper… fodder and other scams! India’s pinnacle of subterfuge will soon belong to a new hustle called offsets through which pliant Indian defence manufacturers are set to ride to riches. Setting the stage for this shakedown is a disinterested Ministry of Defence, which has artlessly authored a scamster’s delight called the Defence Offset Procedure.

To recapitulate, the MoD’s procurement regulations (currently the Defence Procurement Procedure of 2008, or DPP-2008) impose a minimum offset of 30% in all contracts worth Rs 300 crores or more. Foreign arms vendors must discharge this liability through the purchase of products or services from Indian defence companies; or through investments into the infrastructure of JVs they set up in India; or through investment into Indian R&D organisations. In all cases, the essential first step is for foreign vendors to identify an Indian partner through which offset obligations will be discharged.

Viewing this through a more cynical and realistic prism, unscrupulous foreign vendors (most of whom regard offsets as state-legitimised extortion) are starting by identifying pliable Indian partners that will happily partner them in neutering the offset requirement. The DIPP confirms that rafts of small companies, many without a track record in defence, are applying for licenses.

To get an idea of the money at stake here, a recently released CII-KPMG report estimates that India will buy foreign weaponry worth some US $100 billion (Rs 4,50,000 crores) over the next 12 years. Going by this extremely conservative estimate (actual figures could be 50% higher), Indian defence companies will have to anchor at least US $30 billion (Rs 1,35,000 crores) in offsets business by 2022. That averages out to about Rs 11,000 crores every year.

So how will the skulduggery be structured? Let’s look at a hypothetical offsets tie-up between a hypothetical foreign company --- let’s call it Shipping, Communications and Munitions International, or SCAM International --- and an equally hypothetical small Indian company called 15% Partners. Each year, SCAM International will hand the MoD an offsets compliance certificate, along with a copy of an invoice from 15% Partners, as proof that goods worth US $100 million were manufactured and shipped by the Indian company. Actually, the goods were worth only US $35 million, but both companies had quietly agreed that 15% Partners would hold the excess amount on behalf of SCAM International. The Indian company is entitled to a fee of --- you guessed it --- 15% for its services. That means 15% Partners now has effective custody of US $50 million on behalf of SCAM International.

“The implications of this are frightening”, a senior defence ministry official apprehends. “A few years down the line, all defence kickbacks will be coming through the route of offsets. Currently, there is tight control over the money that foreign companies can bring in. Now Indian offset partners will become the agents that pay out bribes. That is why so many offset deals are being tied up with small and medium companies.”

Other ingenious stings are being fashioned out of offset partnerships. One foreign company has already asked its Indian offsets partner to start paying all the expenses for its executives visiting India. The costs of tickets, hotels, meals and entertainment will all be adjusted through over-invoicing offset supplies.

Making all this feasible is the MoD’s inertia in setting up the systems needed for tightly monitoring offset transactions. Currently a small, undermanned section --- the Defence Offsets Facilitation Agency (DOFA) --- handles everything relating to offsets. A section of the MoD argues for setting up an expanded, high-power, multi-agency Defence Offsets Management Agency (DOMA) that is equipped to minutely evaluate the impending flood of offsets proposals; keep a running account of banked offsets; and interpret and clarify offsets policy. But South Block continues to shy away from framing a holistic offsets policy.

“Are you surprised that they are leaving open loopholes?” asks a senior executive from a global arms corporation. “Who do you think will benefit from the kickbacks when they pick up momentum?”

Keeping a track of offsets is even more difficult when they are executed in Information Technology and services. But the MoD has not set up any specialist organisation, or even obtained specialist advice, for monitoring these fields.

Four years after offsets were announced their purpose remains a matter of speculation. The MoD has never declared whether offsets are meant to generate employment in the defence sector through mass manufacture; or to encourage high-tech R&D through collaborative ventures; or to bring in foreign direct investment (FDI) into the defence sector. South Block will probably avow that it wants all three. In this policy vacuum, vendors will naturally structure offsets to suit themselves rather than Indian defence industry.

Within the MoD there is disquiet; many bureaucrats fear that offset scams will have the potential to end promising careers. But there is little expectation that Defence Minister Antony, with his unblemished record of policy paralysis, will allow clarity to creep in unnoticed. And so bureaucrats are passing the buck. The Department of Defence and the Department of Defence Production are each trying to make the other responsible for offsets, hoping that, when the music stops, they will not be holding the parcel.