Private firms respond to MoD offset proposals

Support for investment fund, larger private sector role for identifying projects

By Ajai Shukla

Business Standard, 14th May 18

By Tuesday, defence production stakeholders must respond to new draft proposals for the defence offsets policy, which the ministry of defence (MoD) issued last month.

The defence offsets policy, which the Kelkar Committee first proposed in 2005 and which was formalised that year, binds foreign original equipment manufacturers (OEMs) that win Indian contracts to plough back money into Indian defence industry. The Defence Procurement Procedure of 2005 (DPP-2005) required all OEMs winning defence contracts worth over Rs 300 crore to invest at least 30 per cent of the contract value into “direct offsets”, i.e. into production in India related to that contract. 

Since 2005, the offset policy has been repeatedly tweaked and liberalised. Important changes include: permitting offsets to be discharged through civil aerospace and internal security, besides defence; disallowing and then re-allowing offsets through “services”; and promulgating “multipliers” that grant enhanced offset credits for investments in MSMEs (micro, small and medium enterprises) and high-technology projects. 

In August 2015, fresh offset guidelines permitted OEMs flexibility in choosing and changing Indian Offset Partners (IOPs) and projects. In 2016, the threshold at which offsets liabilities kicked in was enhanced from Rs 300 crore to Rs 2,000 crore.

Yet, with neither OEMs nor the MoD satisfied with how offsets have delivered, the MoD has now proposed bold new offset initiatives. These include, first, allowing offsets through creating defence manufacturing infrastructure --- such as testing laboratories, ranges and skill centres; through sponsoring projects that generate high-technology; and through transferring critical technologies that do not exist in India.

Multipliers between two-to-five have been proposed for these, with higher multipliers allocated to investments in the recently-announced defence industry corridors in Tamil Nadu or Uttar Pradesh. A multiplier of three means an investment of $100 million would gain offset credits of $300 million.

Secondly, the MoD proposed to allow OEMs to discharge offsets through equity investment in manufacturing units for defence, aerospace or internal security. Such an investment, made in a defence manufacturing corridor, would be eligible for a multiplier of four, while investment into any other area would obtain a multiplier of three.

Finally, the MoD’s draft guidelines propose allowing offsets to be discharged through investment in “MoD registered, professionally managed, SEBI (Securities and Exchange Board of India) regulated funds dedicated for development of start-ups and MSMEs of defence, aerospace and internal security related enterprises in the country.” Such investments would be eligible for a multiplier of three.

Private industry reactions, most of which have already been fed-back to the MoD, express incomprehension about why identifying defence infrastructure projects, technology projects and critical technologies eligible under offsets are to be identified by “a collegium” that only comprises “SHQs (service headquarters), DRDO (Defence R&D Organisation) DPSU (defence public sector undertakings), OFB (Ordnance Factor Board) [and the] DDP (Department of Defence Production).” Private industry says that, as equal stakeholders, they must participate in identifying eligible projects.

Private firms have also questioned the clause that restricts offset credits only to the capital investment an OEM makes in a production project, but the “products/services arising out of the investment by the vendor shall not be eligible for offset discharge.”

Private firms point out that production value is the final goal, and should be the most important metric for offset eligibility. “Disallowing offsets for production value would mean that an OEM who invests in a joint venture (JV) that produces nothing would get the same offsets credits as an OEM that is highly successful in producing defence equipment for the domestic and export market.

There are strong private sector views about the proposed defence investment funds, especially given that the MoD’s Technology Development Fund, proposed by the Rama Rao Committee in 2011, has received only a luke-warm endorsement from the MSMEs it was meant to benefit.

“Given that offsets are not being fully discharged, establishing such a fund through offsets would not take away from anything. Instead, investment would come into India and another channel created for funding MSMEs and start-ups”, says the chief of a large defence firm.

Others point out that leaving the regulation of the fund to SEBI, rather than to the MoD, is an excellent step. “There should be professional management of the fund, and oversight of the funds investment activities should be through the quarterly reports that SEBI mandates. Excessive MoD interference would be a death blow”, says a chief executive.

On April 11, the MoD announced the establishment of the first such fund. Details are still awaited.

MSMEs, however, which were meant to be the prime beneficiaries of offsets, argue that the bulk of offsets have thus far been discharged through “build to print” manufacture of defence and aerospace components and sub-systems in Indian factories. They say this method must continue to derive the maximum offset benefits.

Driving home their point, they say that maximum production value, and the most employment creation, has taken place through “build to print” manufacture.