MoD flouts offset rules; favours foreign vendors

The first P8 Neptune LRMR aircraft built by Boeing for the US Navy. The offsets for India's $2.1 billion purchase of 8 Neptune aircraft does not bear scrutiny

by Ajai Shukla

Business Standard, 1st Sept 11

Whistleblowers in the defence ministry (MoD) have briefed Business Standard about the ministry’s flagrant violation of rules in almost every recent offset contract. Some of these striking offset irregularities relate to contracts for upgrading the IAF’s MiG-29 fighters by RAC MiG of Russia; the purchase of C-17 Globemaster III transport aircraft and P8I Neptune long-range maritime reconnaissance (LRMR) aircraft from US giant, Boeing; and the procurement of AW-101 helicopters, from Anglo-Italian company, Agusta Westland, for VVIP’s including the prime minister.

MoD officials say that rules are being flouted with impunity because of a nexus between global arms vendors and the MoD’s Acquisition Wing (which procures arms for the military). Both would like India’s arms purchases to proceed unhindered. For the vendors profits are at stake and the Acquisition Wing must meet procurement targets. Both see the strict implementation of offset rules as an inconvenient hurdle to procurement; for vendors, it also adds to the cost. And so, the vendors submit token offset proposals and the Acquisition Wing clears those without too many questions.

Offsets were intended to boost Indian defence industry by requiring vendors that supply defence equipment worth Rs 300 crore or more to source 30% of the contract value in defence products from India. But an examination of recent offset contracts points to violations of both the letter and spirit of offsets. Consider the following:

1. Russian company, RAC MiG, won a $964 million contract to upgrade India’s fleet of sixty-nine MiG-29 fighters, incurring an offset liability of $289 million (30% of the contract value). Six MiG-29s were to be upgraded in Russia and the remaining in India, for which MiG charged hefty licence fees in the contract. But MoD officials reveal that the Acquisition Wing permitted RAC MiG to also claim the licence fee as an offset.

RAC MiG was also irregularly allowed to claim the cost of training IAF personnel as an offset. Training costs can now be claimed as offsets, but this was not permitted in the rules under which the contract was signed. Asked for a reaction, the MoD has not responded.

2. The Boeing Company, signed a $2.1 billion deal to supply eight P8I Neptune Long Range Maritime Reconnaissance (LRMR) aircraft to the Indian Navy. The MoD decided that ultra-secret electronics --- e.g. Identification Friend or Foe (IFF) system, which differentiates friendly from hostile targets --- would be procured from Bharat Electronics Ltd and Electronics Corporation of India Ltd. This was done to keep US components out of these sensitive systems. But the Acquisition Wing then permitted Boeing to claim their cost as an offset, as if it had indigenised them.

Furthermore, Boeing is being allowed to claim the cost of Transfer of Technology (ToT) as a P8I offset even though ToT is ineligible for offsets.

Asked for their response, Boeing replied, “Boeing does not comment on specific offset proposals and we will have to refer you to the MoD on your queries. We continue to engage with our customers on optimal offset solutions that offer India the right technological capability for a strengthened aerospace industry.” The MoD did not respond to a request for their comments.

3. The Boeing Company has also benefited enormously, say MoD officials, from the Acquisition Wing’s “sweetheart clearance” of half a billion dollars worth of offsets arising from the IAF’s purchase of ten C-17 Globemaster III transporters for $4.1 billion. The Acquisition Wing has okayed Boeing’s proposal to supply the DRDO a “tri-sonic wind tunnel”, which can develop wind speeds of Mach 3.7 (one Mach = the speed of sound). Indian industry sources point out that this is vintage technology, with the US having built a tri-sonic wind tunnel in the 1950s. Indian company, L&T, has recently built a Mach 12 wind tunnel for the Indian Space Research Organisation (ISRO).

The Acquisition Wing has also allowed Boeing offset credit for a super-expensive “high-altitude jet engine testing facility” for the DRDO, which has just one engine under development. Having finished high-altitude testing in Russia of its unsuccessful Kaveri engine, the DRDO is now developing a jet engine with French company, Snecma, which already has its own high-altitude testing facilities. But now, after the Acquisition Wing cleared these offsets, the DRDO will get an old toy in new wrapping and Boeing will get offset credit worth dozens of millions of dollars.

4. Agusta Westland AW-101 VVIP helicopters. This high profile $800 million (Rs 3700 crore) purchase of twelve AW-101 VVIP helicopters from Agusta Westland has violated multiple provisions of the Defence Procurement Procedure, according to MoD officials. The DPP does not permit the purchase of civilian aircraft, but the PMO pushed the MoD into the purchase, arguing that the IAF flies the helicopters. No relaxation was sought under para 75 of the DPP.

The offsets for the VVIP helicopter deal are especially irregular, say MoD officials. They include indirect offsets (i.e. non-defence expenses), and ineligible offsets, such as the expenses of holding project committee meetings. The MoD has ignored a request for comments.

MoD officials say that a Comptroller and Auditor General (CAG) audit would reveal that thousands of crore have already been lost in offsets that violate the ministry’s own rules and guidelines. So far, the CAG has never audited offsets, even though the MoD revealed in 2009 that Rs 8000 crore worth of offsets had already been finalised. That will rise to Rs 30,000 crore this year, assuming that Rs 35,000 crore are spent each year on foreign arms.

Foreign vendors have resisted offsets, ever since they were first imposed in the DPP of 2005. They have argued, in multiple presentations to the MoD, that Indian industry is incapable of manufacturing defence equipment in the quantities needed; and that tough offset conditions would stall India’s military modernisation programme. The MoD has responded by incrementally diluting offset norms. The latest DPP-2011 has permitted vendors to discharge offsets in the non-defence areas of civil aerospace, internal security and training.

Business Standard had reported last December on the MoD’s violation of defence offset rules, while okaying Lockheed Martin Corporation’s US $275 million (Rs 1266 crore) offset proposal, which related to the purchase of six C-130J Super Hercules transport aircraft. Neither the MoD, nor Lockheed Martin, denied that report; but that contract still stands.

(Tomorrow: MoD set to dilute offset requirements further)