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Sunday, October 25, 2020

Explained: What are defence offsets? Here’ everything you need to know

Effective today, the new Defence Acquisition Procedure removes the clause for offsets for certain kinds of defence contracts. How does the offset policy work, and why has this step been taken?

Written by Krishn Kaushik | New Delhi | Updated: October 5, 2020 10:04:57 am
Defence Acquisition Procedure, DAP 2020, Defence Acquisition, Defence Ministry DAP 2020, Express ExplainedA Rafale jet at the induction ceremony at Ambala Air Force base. (Express Photo: Tashi Tobgyal)

The Defence Ministry came up with its latest Defence Acquisition Procedure 2020 (DAP 2020) on Monday, which comes into effect from Thursday, October 1. Changing a 15-year old policy, the government has decided to remove the clause for offsets if the equipment is being bought either through deals or agreements between two countries, or through an ab initio single-vendor deal.

What are defence offsets?

In simplest terms, the offset is an obligation by an international player to boost India’s domestic defence industry if India is buying defence equipment from it. Since defence contracts are costly, the government wants part of that money either to benefit the Indian industry, or to allow the country to gain in terms of technology.

The Comptroller and Auditor General (CAG), in a report submitted on September 23, defined offsets as a “mechanism generally established with the triple objectives of: (a) partially compensating for a significant outflow of a buyer country’s resources in a large purchase of foreign goods (b) facilitating induction of technology and (c) adding capacities and capabilities of domestic industry”.

An offset provision in a contract makes it obligatory on the supplier to either “reverse purchase, execute export orders or invest in local industry or in research and development” in the buyer’s domestic industry, according to CAG.

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When was the policy introduced?

Amit Cowshish, a former Financial Advisor to the Defence Ministry, who retired in 2012 and continues to be part of the Manohar Parrikar Institute for Defence Studies and Analysis, said the policy was adopted on the recommendations of the Vijay Kelkar Committee in 2005.

“The idea was that since we have been buying a lot of defence equipment from foreign countries, so that we can leverage our buying power by making them discharge offset obligations, which is the norm world over,” Cowshish said. “The first policy said that all defence procurements exceeding Rs 300 crore, estimated cost, will entail offset obligations of at least 30%, which could be increased or decreased by the DAC (Defence Acquisition Council),” Cowshish said.

The Sixth Standing Committee on Defence (2005-06) had recommended in December 2005 in its report on Defence Procurement Policy and Procedure that modalities for implementation of offset contracts should be worked out.

The first offset contract was signed in 2007.

The government stated the “objective for defence offsets” for the first time on August 1, 2012: “The key objective of the Defence Offset Policy is to leverage capital acquisitions to develop Indian defence industry by (i) fostering development of internationally competitive enterprises, (ii) augmenting capacity for Research, Design and Development related to defence products and services and (iii) encouraging development of synergistic sectors like civil aerospace, and internal security”.

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Defence Acquisition Procedure, DAP 2020, Defence Acquisition, Defence Ministry DAP 2020, Express Explained (Express Photo: Tashi Tobgyal)

How can a foreign vendor fulfil its offset obligations?

There are multiple routes. Until 2016, the vendor had to declare around the time of signing the contract the details about how it will go about it. In April 2016, the new policy amended it to allow it to provide it “either at the time of seeking offset credits or one year prior to discharge of offset obligations”.

The August 2012 Defence Ministry note mentioned these avenues

* Direct purchase of, or executing export orders for, eligible products manufactured by, or services provided by Indian enterprises

* Foreign Direct Investment in joint ventures with Indian enterprises (equity investment) for eligible products and services

* Investment in ‘kind’ in terms of transfer of technology (TOT) to Indian enterprises, through joint ventures or through the non-equity route for eligible products and services

* Investment in ‘kind’ in Indian enterprises in terms of provision of equipment through the non-equity route for manufacture and/or maintenance of products and services

* Provision of equipment and/or TOT to government institutions and establishments engaged in the manufacture and/or maintenance of eligible products, and provision of eligible services, including DRDO (as distinct from Indian enterprises).

* Technology acquisition by DRDO in areas of high technology.

Cowshish said the 2012 note also introduced offset banking and multipliers. “Banking means that in anticipation of getting a contract from the Defence Ministry, a vendor could discharge offsets and earn the credit which could be banked. Later on, if you got the contract, you could use the banked credits, subject to certain conditions.” He said.

For multipliers, Cowshish said, “if you discharge offset obligation by taking an MSME unit as an IOP (Indian Offset Partner for the foreign vendor), you get the multiplier of 1.5, which is to say if you discharge an offset obligation of Rs 100, but your IOP is an MSME unit, you will get an offset credit of Rs 150”.

The DAP 2020 has given transfer of critical technology to DRDO the highest multiplier of 4.

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Will no defence contracts have offset clauses now?

Only government-to-government agreements (G2G), ab initio single vendor contracts or inter-governmental agreements (IGA) will not have offset clauses anymore. For example, the deal to buy 36 Rafale fighter jets, signed between the Indian and French governments in 2016, was an IGA.

“Ab initio single vendor means that when you start the process you have only one vendor… There can be a situation when you start with two or three vendors and issue Request for Proposals (RFP) to them, and are left with a single vendor, which is called a resultant single vendor situation,” Cowshish said. The Defence Ministry issues the RFP to only one vendor.

IGA is an agreement between two countries, and could be an umbrella contract, under which you can go on signing individual contracts, Cowshish said. G2G is transaction specific, or an acquisition specific agreement, he said.

According to DAP 2020, all other international deals that are competitive, and have multiple vendors vying for it, will continue to have a 30% offset clause.

Defence Acquisition Procedure, DAP 2020, Defence Acquisition, Defence Ministry DAP 2020, Express Explained The induction ceremony of the newly acquired Rafale jets was held in the presence of Defence Minister Rajnath Singh and his French counterpart Florence Parly at the Ambala Air Force station in Haryana on Thursday. (Express Photo: Tashi Tobgyal)

Why was the clause removed?

Apurva Chandra, Director General of Acquisitions, said Monday that vendors would “load” extra cost in the contract to balance the costs, and doing away with the offsets can bring down the costs in such contracts.

Sources explained that there are “administrative costs” involved in discharging offset obligations, which the vendors pay.

Chandra had also mentioned recent CAG criticism.

What has the CAG said?

The CAG has been critical of the entire policy. From the first contract signed in 2007 until March 2018, CAG said, 46 offset contracts have been signed for Rs 66,427 crore. “On the whole, from 2007 till December 2018. Rs 19,223 crore worth of offsets should have been discharged. However, the claimed discharge of the offset obligation by the vendors till December 2018 was Rs 11,396 crore. This was only 59 per cent of the offsets which were due by December 2018.”

It said the relevant authority had accepted claims of only Rs 5,457 crore out of the Rs 11,396 crore and rest are either pending or rejected. “The remaining offset obligation of about Rs 55,000 crore is due to be completed by 2024”. The CAG is not very hopeful of the obligations being met by 2024. It said the audit “found that the foreign vendors made various offset commitments to qualify for the main supply contract but later, were not earnest about fulfilling these commitments”.

The CAG had not found “a single case where the foreign vendor had transferred high technology to the Indian industry”.

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