For foreign vendors, by foreign vendors

by Ajai Shukla

Business Standard, 7th Aug 12

The defence ministry’s (MoD’s) revised offset guidelines, which came into effect on August 1^st, replace seven years of shifty-eyed policy that raised more questions than answers and slowed the already snail-like pace of defence procurement. The new guidelines suggest that the MoD has listened with at least one ear to a chorus of suggestions from foreign and Indian stakeholders alike. The new rules allow transfer of technology (ToT); introduce multipliers to direct offsets towards MSMEs and the DRDO; allow vendors to discharge their offset liabilities over longer periods; and limit some penalties on vendors who fail to discharge offset obligations.

In forthrightly addressing some of these difficult issues, and in specifying a threefold aim for offsets --- nurturing internationally competitive enterprises; augmenting defence R&D; and developing civil aerospace and internal security --- the policy does well, even if the aim ends up covering too many bases. Another welcome step is the formulation of a Defence Offsets Management Wing (DOMW) under the Department of Defence Production (DDP), which has been made responsible for the post-contract management of all offsets.

But in key respects the new policy falls as short as its predecessors. While pleasing key stakeholders, particularly foreign arms vendors, it has deviated entirely from the aims that the Kelkar Committee --- the intellectual fountainhead of defence offsets --- had envisioned. Offsets were meant to be “direct”, that is connected directly with the equipment with which they were linked. If an offset liability arose from India’s purchase of a transport aircraft, the vendor was to discharge that liability by producing 30% of that aircraft’s components through Indian Offset Partners (IOPs). Over time, and over several offset contracts, India’s aerospace industry would develop into a technologically enabled eco-system that would support indigenous development of the next generation of aircraft (or shipping, or guns, or tanks, as the case might be).

But “direct” offsets were undermined from the start. The Defence Procurement Policy of 2005 (DPP-2005) and its successor, DPP-2006, permitted vendors to discharge their offset obligations anywhere in the defence sector. Then DPP-2008 did away with the requirement for the Indian offset partner to have a defence production licence. Finally DPP-2011 expanded offsets to the civil aviation and internal security sectors.

South Block was carrying out these dilutions under pressure from global arms vendors, who came together to present the MoD with briefings, memoranda and documents detailing “international best practices” that made out a systematic case against offsets. This was hardly surprising. Foreign vendors find it cumbersome to deviate from an established vendor base and production line, and to start buying 30% of a weapons system from an entirely new set of suppliers. Developing these new vendors comes with a cost, usually about 5% of the total contract cost. And so a sophisticated whisper campaign from the vendor camp began putting out the notion that direct offsets carry a heavy price that is naturally passed on to the buyer.

The vendors also deployed a second argument, which is actually the same argument packaged differently! They allege, “Indian industry is not capable of absorbing the heavy flow of offsets.” This goes without saying! If Indian defence industry were that developed, there would be no need for an offset policy. Developing offset partners and providing them with the capabilities is what the foreign vendor must be prepared to do, and for what the Indian government is paying a 5% premium.

The global vendors’ next objection is that Indian defence industry is so primitive that it simply isn’t possible to develop offset partners to the level where they can dovetail into an international supply chain. But that argument is hard to sustain when the Indian automotive parts industry has dovetailed so successfully into international supply chains.

Sadly, the MoD’s Acquisition Wing bought into these arguments from the outset, egged on by the armed forces. They have regarded offsets as a hurdle to quick procurement, and have used the arguments trotted out by the foreign arms lobbies to effectively scupper direct offsets. Instead, as Lockheed Martin was allowed to do in its offset contract linked to the C-130J aircraft sale, rules were flagrantly violated to permit the company to supply training simulators as offsets.

Offsets were never meant to be conduits for the supply of training simulators, or maintenance infrastructure, or even technology. Defence contracts worldwide provide for crew training, and for the maintenance, spares and overhaul of the weapon system being bought. Nor is there a need for technology to be obtained as an offset. As is evident from India’s insistence on advanced radar technology as a pre-requisite for vendors to participate in its recent multi-billion dollar fighter aircraft tender, high technology is best obtained as a part of the main contract.

Instead, offsets should be used directly to create manufacturing capabilities within the country, and thus creating the infrastructure that is needed to back India’s ambitious weapons programmes like the DRDO’s nuclear submarine and missile programmes; and HAL’s helicopter and fifth generation fighter programmes. Direct offsets also raise technological awareness levels, provide employment and increase exports. Offsets can create customers for Indian defence products. The MoD must snap out of the thrall of the arms lobbies and write policy for the country’s rising defence industry.