Moment of truth for defence offsets

By Ajai Shukla

Business Standard, 14th Dec 10

Tomorrow the MoD’s apex procurement body, the Defence Acquisition Council, will consider and possibly dilute India’s defence offset policy. The proposed changes --- especially the “liberalization” of defence offsets into fields like civil aviation and homeland security --- would nullify the very rationale of a defence offset policy, which is to direct foreign money and know-how into India’s nascent defence industry by leveraging our position as a major buyer in the global arms bazaar.

Global arms corporations quite predictably resist investing in another countries’ defence industries: this builds up potential competitors; involves the painstaking and commercially risky task of identifying local partners; it transfers jobs overseas; defence remains a highly regulated field; and there are obvious strategic reasons as well. And so global arms corporations have a persuasive counter-argument that portrays offsets as unscrupulous commercial arm-twisting, which is counterproductive since it yields jobs only in the short term, with the costs borne by the buyer since the vendors load them onto the basic contract.

Foreign vendors selling weaponry to India have constructed an even more pernicious argument: that our defence industry is incapable of absorbing the vast offsets that will arise from arms purchases over the next five years. With a CII-Deloitte report in June projecting that the MoD will spend Rs 3,60,000 crore (US$ 80 billion) on the capital purchase of weaponry by 2015, India’s defence industry would be required to absorb at least Rs 108,000 crore (US$ 24 billion) worth of offsets. Therefore, suggest these vendors helpfully, the buyer should “liberalise” the policy by permitting offsets in easy fields like infrastructure, homeland security, healthcare, etc, where investment is attractive.

These self-serving arguments are, worryingly, being swallowed by the MoD, which is forgetting that it fire-walled the defence offset policy from the national offsets policy (which covers non-military procurements like civil airliners, nuclear plants, etc) expressly to jump-start Indian defence industry. To now allow vendors to discharge offset liabilities in non-defence spheres would be a turnaround that reeks of capitulation before foreign pressure groups.

Instead, the MoD must remind global arms vendors that, by participating in Indian defence tenders, they have explicitly accepted the obligation to meet our defence offset requirements. This places on vendors the responsibility to build the capacities of their local offset partners, if necessary by transferring the technology needed to develop Indian suppliers into viable links in their global supply chain.

Any difficulty that foreign vendors are encountering in finding Indian partners stems from a lazy reluctance to reach above the low-hanging fruit --- defence PSUs like Hindustan Aeronautics Ltd; Bharat Electronics; and large private corporates like L&T, and the Tata Group, which are already flush with offset offers --- and instead identify partners from amongst the many small and medium scale industries that have emerged over the last decade. The Indian defence landscape has an entire ecosystem of defence firms with impressive technological skills and entrepreneurial talent, many of them concentrated around hubs like Hyderabad, Bangalore, Pune, Chennai and Delhi. So far largely untapped, these provide partnership opportunities to global defence corporations that will endure long after their offset requirements are met.

Much of the government’s muddle-headedness on these issues stems from the absence of a clearly articulated aim for the defence offset policy. Consequently, Indian pressure groups lobby self-servingly: the DRDO pushes offsets for obtaining the 18 technologies that it has listed as key priorities; the IT industry as an opportunity to develop defence software; and low-tech manufacturing companies as an easy source of massive orders for low-end, labour-intensive, repeat manufacture.

To direct offsets into IT or repeat manufacture is wasteful, since these sectors will anyway attract foreign investment based on commercial logic. Nor should offsets be wasted on high technology, which is best prised out of vendors by leveraging the power of major contracts in competitive tendering. India’s US $10 billion multi-role fighter tender, in which the MoD has stipulated --- and vendors have accepted --- the transfer of heavily guarded AESA radar technology, provides the ideal model for obtaining technology.

Instead, offsets must have the clearly stated aim of furthering the defence minister’s oft-enunciated objective of indigenising at least 70% of our defence equipment needs. The MoD must abandon its timid, hands-off approach towards offsets and direct vendors towards carefully identified Indian companies with demonstrated technological skills in key areas. Offset partnerships with global giants would allow such companies to bridge technology gaps and --- by becoming a part of the vendor’s global supply chain --- scale up and generate the financial muscle needed for serious R&D.

For this, the MoD must empower and staff its Defence Offsets Facilitation Agency (DOFA), so that it can map Indian defence industry, creating a capability and technology matrix that can be matched with prospective platform development requirements. Offsets could then be directed to fill the gaps. This would involve an enormous MoD mind shift from its current approach towards offsets where a man-and-a-dog DOFA plays passing-the-offsets-parcel with an equally reluctant Acquisitions Wing, both hoping that when the music stops the other will be left holding the responsibility for offsets.

The need for an activist and empowered DOFA has been understood by industry, if not by the MoD. The CII and FICCI had earlier pledged Rs 25 lakhs each to set up a DOFA secretariat at Pragati Maidan, which could monitor and account for the tens of thousands of crores worth of offsets that lay ahead. But, with trust in short supply, the MoD felt that the companies that would benefit from offsets should not have any role in accounting for them; and the corporates felt, “why should we do the babus’ job for them?” It is time to come together to galvanise India’s defence industry.