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Strategic Defence

Defence Offsets And Transfer Of Technology
By Major General Mrinal Suman, July 2011 [[email protected]]

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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.

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