Despite the Hype, the Defence Offset Policy Hasn't Really Worked for India

Foreign suppliers find India’s offset guidelines too complicated to comply with.

New Delhi: ‘Offset’ has become a buzzword in India’s defence manufacturing industry in recent years, as the government steps up arms purchases to maintain the balance of conventional military power in the region. But despite that, the country is struggling to reap the intended benefits of the policy.

The reason for this is that foreign suppliers find India’s offset guidelines too complicated to comply with. The repeated changes in offset guidelines do not seem to have helped the matter either.

The offset policy, introduced in 2005, mandates foreign suppliers to spend at least 30% of the contract value in India. It was first revised in 2006 and then again in 2011 and in 2016. Another round of tweaking is currently underway.

A defence equipment manufacturer told The Wire that offset norms are revised even before the industry adjusts to them.

But on the other hand, countries like Spain, Japan and Brazil have used offset policies to build credible local defence manufacturing capabilities. For example, Brazil’s Embraer aircraft manufacturing programme is globally cited as a successful experiment in offset policy implementation.

Indian defence manufacturers lack the technological prowess needed to benefit from the offset policy. They are not able to effectively use transferred technology in their own manufacturing processes. It is no surprise, then, that foreign suppliers find themselves struggling to fulfil their offset commitments in a cost-effective manner, and so outsource only low-end manufacturing and machining jobs to private and public sector companies in India.

According to industry sources, the real problem lies in implementation, not in the policy. Regulatory and operational bottlenecks further complicate challenges for foreign arms suppliers.

Civil aerospace, internal security brought under offset policy

The Ministry of Defence introduced the offset policy following recommendations from a panel headed by former finance secretary Vijay Kelkar. The panel was tasked with suggesting measures to involve private players in defence equipment manufacturing under a public-private partnership model.

After several rounds of revision, civil aerospace and internal security deals have also been brought under the offset policy. The offset limit has now been increased from Rs 300 crore to Rs 2,000 crore.

The policy now allows the private sector to compete in the production of surveillance vessels, such as inshore and offshore patrol vessels, with defence shipyards. This has provided a level playing field for private players in the shipbuilding sector.

The policy change has injected price competition into the market and also led to an improvement in the timely delivery of contracted supplies.

However, private players are yet to play a big role in the production of helicopters, trainers and transport aircrafts.

The offset policy envisions leveraging  big-ticket purchases in the defence space to cajole original equipment manufacturers into giving outsourcing orders, transferring technologies to Indian companies and investing here. The objective is to create a strong local ecosystem for defence manufacturing, and step up exports.

A total of 12 offset contracts were concluded between 2005 and 2012, with a value of $1.5 billion. Subsequently, ten more contracts were concluded between 2013 and 2016, with a combined value of nearly $1.5 billion.

Defence sector fails to attract FDI

India’s dream of becoming a defence manufacturing hub is far from fulfilled, despite vigorous marketing by the government. The sector attracted a paltry sum of Rs 56 lakh as foreign direct investment (FDI) between October 2014 and September 2016, according to a reply given by minister of state for defence Rao Inderjit Singh in parliament recently.

The picture was even more dismal in 2015-16, with the sector attracting only Rs 8 lakh till September, as per data available with the Department of Industrial Policy and Promotion.

India’s offset policy, which many feel originated from the defence public sector’s inability to increase exports, lacks coherence and well-defined aims. It is totally silent on what it wants to achieve, say defence experts.

The defence ministry decided to use its substantial imports to promote exports. The initial policy, as announced in 2005, sought the direct purchase of products, components and services by foreign vendors. It was also aimed at creating both market access and new new markets. However, it soon dawned on the government that the policy was restrictive and unrealistic. It therefore initiated an exercise in 2006 to widen the scope of the policy.

According to defence experts, India’s ‘one size fits all’ policy approach has not yielded the desired results. This is why even 14 years after implementation of the offset policy, India heavily relies on imports to meet hardware requirements of its military, experts said.

India’s arms imports increased by 24% between 2008 and 2012, and then again at the same rate between 2013 and  2017, according to data released by global think-tank Stockholm International Peace Research Institute recently.

As many as 130 countries have offset policies in place, but their formats are different

Globally, there are more than 130 countries with offset policies, but they follow different formats. For example, the UAE’s offset policy stipulates that all suppliers of arms must develop commercially viable products worth at least 60% of the contract within a period of seven years.

Malaysia seeks opportunities for compensatory exports, technology transfer and direct investment in infrastructure.

South Africa demands nearly 20% of the contract value as direct defence-oriented offsets, 45% as counter purchase by the seller and 35% as foreign investment.

The UK insists on defence-related, new and of equivalent technical quality offsets. Both direct and indirect offsets are permitted by the country.

A new round of amendments underway

The defence ministry recently amended the offset policy to provide more opportunities for foreign arms suppliers to invest a percentage of the value of a military hardware deal in India.

Foreign suppliers of aerospace- and internal security-related hardware will be allowed to fulfil their offset obligations by investing in defence-related infrastructure projects such as setting up testing labs and skill centres. Foreign suppliers will also be allowed to fulfil their offset obligations by sharing “specified critical technology”.

These projects will be implemented through an agency to be identified by the government, which could be a public sector entity, the Defence Research and Development Organisation or a Special Purpose Vehicle to be set up with or without industry participation.

The government has allowed foreign suppliers to invest in a SEBI-regulated fund to meet their offset obligations. Experts said the proposed policy will drastically change how companies such as Boeing, Airbus and Dassault will spend an estimated $14 billion in India by 2028.

France offers to revive Kaveri engine project as part of Rafale offset programme

France has offered to help India revive the unsuccessful Kaveri engine project for the indigenous Tejas aircraft and a host of other high-end collaborations as part of the offsets in the 7.87 billion euro Rafale fighter plane deal.

Under the agreement, the French side has made a 30% offset commitment for military aerospace research and development programmes, and the balance 20% for manufacturing Rafale components in India.

The offsets will be carried out by French companies Safran, Thales, MBDA and Dassault, all part of the Rafale project.

The government has planned defence purchases of $250 billion to modernise the Indian military. Offset expenditure for these relatively less hi-tech purchases would be 50% of the contract. With Indian defence manufacturing companies lacking technological depth to benefit from offset programmes, how contracts worth $125 billion will be implemented is unclear.

Anil Ambani-promoted Reliance Defence has said that it has bagged offset contract of Rs 30,000 crore for the Rs 1 lakh crore-lifecycle cost contract signed by the defence ministry with France’s Dassault Aviation for Rafale jets.

But on the other hand, defence minister Nirmala Sitharaman has said that the government has not yet decided on an offset programme for the deal.

The contradictory statements of Reliance Defence and Sitharaman have given rise to the suspicion that the defence ministry is not maintaining records of offset contracts.