First published September 2006
Offsets are formal arrangements of trade wherein a foreign supplier undertakes specified programmes with a view to compensate the buyer as regards his procurement expenditure and outflow of resources. In other words, the supplier undertakes programmes to generate benefits for the economy of the buyer country.
Application of offsets to India’s defence imports was first advocated in an exhaustive article published in the Oct-Dec 2004 issue of the Indian Defence Review titled “Offsets in Arms Trade: Need for a National Policy” . The basic thrust of the article was that India had been losing benefits worth billions of dollars by not demanding associated offsets with defence imports. It suggested formulation of a national policy and the establishment of National Offsets Mission to oversee all offset related activities.
The Government of India appreciated the requirement and took a policy decision to have a clause for compulsory offsets for all defence imports of value exceeding Rs 300 crores, equivalent to 30 per cent of the contract value. The provision was also incorporated in Defence Procurement Procedure - 2005. It appears to have been included in the new procedure at a short notice and hence was sketchy and imprecise.
Not withstanding the above, it was a praiseworthy and path-breaking policy initiative. The Indian Defence Review carried a detailed analysis of the new offset policy in its Jul-Sep 2005 issue. It highlighted certain important issues and made the following recommendations:-
•Offset threshold should be pegged at Rs 100 cr as is the practice the world over.
•Offset value should be fixed at a minimum of 100 per cent instead of 30 per cent. Extra credit should be given to vendors offering higher offsets.
•Type and nature of offsets should be decided by India as per its technological/economic needs.
•India should allocate priorities to all desired offset programmes by assigning ‘multiplier value’ to each one of them to provide vendors with incentives to offer offsets in targeted areas.
•A regime should be put in place for effective monitoring of offsets, as it not only helps in achieving the objectives spelt out in the offset contract, but also provides invaluable feedback for data storage and further refining of the policy.
After studying various models, the Ministry of Defence (MoD) decided to follow an approach of gradual, incremental and phased application of offsets. It did not want to rush in without acquiring adequate experience. Therefore, while accepting the need for a more focused and comprehensive management, it opted to keep offsets at base levels initially.
India’s Offset Policy
MoD issued detailed policy guidelines on offsets in May 2006, with the proviso that the policy would be reviewed by DAC after every two years. Main features of the current policy are as follows:-
•Scope - The policy is applicable to all purchases where indicative cost is over Rs 300 crores for ‘Buy’, ‘Buy and Make with TOT’ and ship-building. DAC may prescribe offsets higher than 30 percent for specific cases. For joint ventures where Indian firm is bidding, the foreign partner will have to discharge offset obligation.
•Defence Offset Obligation - All proposals which meet minimum offset requirement are to be treated at par. No preference is given for extra offsets offered. Offset obligation is to be completed coterminous within main contract. Offset obligation can be discharged by any of the following routes:-
•Direct purchase of or executing export orders for, defence products and services provided by Indian defence industries.
•Foreign Direct Investment (FDI) in Indian defence industries.
•FDI in Indian organisations engaged in research in defence R&D.
•Defence Offset Facilitation Agency - A Defence Offset Facilitation Agency will be established as a ‘single window’ under the Department of Defence Production. Its main functions will be -
•Facilitation of implementation of offset policy.
•Vetting offset proposals technically.
•Assisting in monitoring offset implementation.
•Rendering advice regarding areas in which offsets are preferred.
•Promotion of export of defence products and services.
•Providing advisory clarifications on policy and procedures (in consultation with the Acquisition Wing, where necessary).
•Assisting vendors in interfacing with industry for identifying potential offset products/projects.
•Solicitation of Offers -Request for Proposal (RFP) will contain provisions of offset obligations, where applicable. A vendor is required to give a simple undertaking to fulfill the obligation with his technical officer. Technical and commercial offsets are to be submitted in two separate covers to the Technical Manager by the date specified in RFP which will not be later than 3 months of submission of main offers.
•Tech Evaluation of Offset Offers -Technical Offset Offer should contain details of products, services and investment proposals indicating relative percentages and proposed Indian partners. The Technical Manager will constitute a committee to shortlist vendors whose offset offers meet parameters. Vendors are free to select Indian partners for offsets. For products which contain imported components, only the value addition in India will count towards offset obligations.
•Commercial Offset Offers - They will contain particulars specifying absolute amount of offsets with a break up of details, phasing, Indian partner etc. These will be opened with main commercial bids by the Commercial Negotiation Committee. However, offset offer will have no bearing on the determination of the lowest vendor.
•Contents of Offset Contract - Offset contract will be signed with the main contract. A vendor cannot delay execution of main contract on the plea of inability of Indian offset partner to execute offset contract.
•Vendor will submit quarterly reports to the Acquisition Manager, who may order audit by a nominated official or agency to verify.
•Vendor may request re-phasing of implementation schedule with reasons within the period of the main contract to the Acquisition Wing.
•Sanction of request for exceptional extension beyond main contract can be accorded by Defence Procurement Board. Further extension can only be given by DAC.
•A penalty equivalent to 5 percent of unfulfilled portion of obligation in a year will be imposed on the defaulter.
•Vendor failing to complete offset obligation during the period of main contract (or during the period extended) will be debarred by Acquisition Wing for future, after giving him opportunity to explain.
Offsets in Targeted Areas
Offsets can be direct or indirect. In direct offsets, the trade arrangement is related to the primary product sold. It implies that the compensatory dispensation remains confined to the main weapon system, its sub-assemblies and components. It does not transcend other economic or social activities. On the other hand, indirect offsets have a much wider scope and are not restricted to the product sold. India has decided to follow a middle path and demands offsets related to the defence industry as a whole.
The current Indian policy will not be able to derive full benefit of the potential of offsets. Offsets will neither strengthen our defence industrial base nor promote technology upgradation. Export of goods and services will, at best, provide temporary and illusory gains, as has been the experience the world over.
As per India’s policy, a vendor can fulfill his obligation by buying any product from Indian defence industry, which has been defined to include all Defence Public Sector Undertakings, Ordnance Factories and private sector firms which have been accorded the status of Raksha Udyog Ratna (none at present). Thus, it becomes a pure counter-trade arrangement, designed primarily to promote exports from the public sector. Even the procurement of mundane items such as jerseys and blankets from Ordnance Factories counts towards the discharge of stipulated offset obligation.
Some important issues have been reviewed in the following paragraphs.
Selection of Offsets
It is always for the buyer nation to decide as to what offsets to seek as they have to be in consonance with the national economic objectives, in order to fill an important technological / economic void. It is a very crucial decision and demands careful consideration as it is not the type of offset but its relevance that dictates the selection. India has abrogated that right in favour of the vendors, rendering India’s needs inconsequential.
As per India’s policy, a vendor is required to give a simple undertaking with his technical bid that it would comply with the stipulated offset requirements. He could fulfill his obligation either by direct purchase of products/services or FDI. Direct purchase of goods/services is generally considered to be the least beneficial form of offsets. In fact, it is like any common counter-purchase arrangement, i.e. a commitment by the vendor to buy (or to find a buyer for) a specific value of goods/services from the buyer nation during a specified time period.
Usually, buyer nations allocate priorities to all desired offset programmes by assigning ‘multiplier value’ to each one of them. Offset programme value (usually referred to as ‘credit value’) is determined by multiplying programme base value by its multiplier value. It is a methodology of assigning weightage to different offset programmes to provide vendors with incentives to offer offsets in targeted areas. India must adopt it immediately.