IDSA COMMENT

The New Defence Offset Guidelines: Challenges Ahead

November 30, 2012

It has been four months since the new Defence Offset Guidelines came into force on August 1, 2012. The interest generated by the promulgation of the guidelines seems to be ebbing without achieving anything, which is not a good sign. A number of very pertinent questions have been raised by defence analysts and the industry. It is not clear who will address these questions. An opportunity to display commitment to pave the way for smooth implementation of the new guidelines is being missed by the Ministry of Defence by not addressing the questions already raised in various seminars and the media. A Defence Offset Management Wing (DOMW) has been set up under the new guidelines. Though it is not a specifically stated function of this wing to address issues arising from interpretation and implementation of the guidelines, it would not be unreasonable to assume that this responsibility will indeed be discharged by none other than the DOMW, which is responsible for, among other things, formulation of the defence offset guidelines. The anxiety about various provisions of the new guidelines can easily be put to rest by posting clarifications on the Frequently Asked Questions (FAQ) page of the DOMW website. Such dynamism in responding to the concerns of the stake holders would establish the government’s commitment to the objectives of the offset policy.

This, in fact, is the biggest challenge before the Ministry of Defence. The Defence Offset Facilitation Agency (DOFA), which was the precursor of DOMW, received a lot of flak during its short life for inaction and unresponsiveness. Surely, there are lessons to be learnt from the past experience. The objectives of DOMW are to:

  1. foster the development of internationally competitive enterprises,
  2. augment the capacity for research, design & development related to defence products and services, and
  3. encourage the development of synergetic sectors such as aerospace and internal security.

DOMW needs to develop a strategy to achieve these objectives, which would require it to assume a pro-active leadership role. The strategy should ideally be prepared in consultation with the services, industry and think tanks. This must then be posted on the DOMW website not just for the sake of transparency but to provide a framework within which the prospective foreign original equipment manufacturers (OEMs) and the Indian Offset Partners (IOPs) could chalk out their business plans. It might be painful to adopt this pro-active approach but it must be done by the DOMW to avoid falling into the humdrum of participating in technical and commercial evaluation of offset proposals, monitoring the discharge of offset obligations and assisting vendors in interfacing with the Indian industry. This cannot be achieved unless serious thought is given to capacity building within the DOMW and working through a network of advisors and consultants.

The first step that the DOMW must take is to convert its rather staid website into a veritable encyclopaedia on Indian defence offsets, dispelling all the misgivings frequently expressed at seminars and in the print media, which creates unwarranted negativity about the offset policy. Much of this negativity arises from the criticism of the first guidelines issued in 2005. It is generally believed that those guidelines only resulted in the defence public sector being the biggest beneficiary and the offset programmes being discharged in non-manufacturing areas, which does not strengthen the industrial base. This does not seem to be entirely correct. The first offset contract, related to the procurement of Medium Power Radars (MPRs) from Israel, was signed in 2007 under the 2005 guidelines. This contract was not with a defence Public Sector Undertaking. It was followed by three contracts in 2008, seven in 2009, three in 2010, two in 2011 and another two in 2012 so far. In a number of these offset contracts, the foreign OEMs have tied up with Indian companies in the private sector and more than 75 per cent of these contracts relate to design and manufacturing. These facts, put together by non-officials, indicate that the 2005 guidelines were, after all, not such a big flop as it is often made out to be. It will lend authenticity to this view if the information about the offset contracts is posted by the DOMW on its website.

While official disclosure of information and statistics related to the offset programmes on a regular basis would help clear the air and create a positive atmosphere, it is more important to address a number of issues that have already been raised about various aspects of the new guidelines. A few of these relate to policy, while others relate to implementation of the guidelines. It would enhance the acceptability of the new guidelines if the policy issues are clarified by the DOMW by way of a communiqué posted on its website. The issues related to the interpretation and implementation of some of the provisions must also be considered by the ministry immediately and necessary action taken to amend the guidelines, where necessary, and to clarify other issues, which do not warrant any amendment to the existing guidelines, and post the clarifications on its website. There is also a need to explain the rationale of some of the provisions. For example, it needs to be explained why pre-approved banked offset credits will be considered for discharge of offset obligations subject to a maximum of 50 per cent of the total offset obligation under each procurement contract.

While on the subject of the DOMW website, it is tempting to point out that its home page prompts you to log on but when you click the button you are prompted to enter the log in id and password without making it clear how to register yourself in the first place. Such issues need to be addressed immediately.

The challenges that lie ahead do not relate only to capacity building and management of the website. There are some other substantive policy related issues that need to be addressed. The new policy guidelines address practically all the issues that have been raised since the first set of guidelines was issued in 2005, with the possible exception of offset trading, which is apparently a conscious decision taken by the government. (It would help if the reasons why offset trading has not been introduced are also made known by the ministry.) What, however, seems to have got overlooked is that there is no provision in the guidelines that allows selection of the specific area in which the Ministry of Defence might want the offset obligation to be discharged in the context of a specific procurement proposal. There should be an enabling provision in the guidelines that makes it possible for the Ministry of Defence to decide and indicate in the Request For Proposal (RFP) itself the area(s) in which offsets must be offered by the OEM in a particular acquisition programme. This would help channel the offsets into specific areas where these are needed to achieve the objectives of the policy. This is just one example of a number of substantive issues that call for immediate attention.

Experience shows that a number of doubts arise while reading the fine print of the policy. DOMW would do well to institute a mechanism to give some kind of advance ruling on such doubts, which should also be posted on the website for general information and later incorporated in the guidelines, as and when these are revised. This will go a long way in ensuring smooth implementation of the guidelines.

There are concerns about the capacity of the Indian industry to absorb the offsets. There are also a number of issues concerning foreign direct investment, taxation, level-playing field between the private and public sectors, licensing, export and intellectual property rights, which have a bearing on the success of not just the offset policy but also the objective of self-reliance in defence. It is not clear in whose domain these issues fall but these could act as irritants in smooth implementation of the offset guidelines. The Ministry of Defence would do well to take them up and formulate a policy that addresses all these concerns. It has to assume the leadership role and provide some kind of a single-window service to the defence industry to steer the offsets in a direction that helps achieve the objective of modernisation of the armed forces through self-reliance. The challenge before the industry, especially the Micro Small and Medium Enterprises (MSMEs), would be to articulate their problems in a dispassionate manner, free from emotionalism and rhetoric, and pursue the matter with the government with greater determination than has been the case so far. There is a challenge before the defence Public Sector Undertakings also, which is to increase not just the extent, but also the content, of outsourcing, freeing up their capacities for the core manufacturing or system integration functions. There is a need to explore the possibility of the existing government and public sector facilities being used by the private sector under the government-owned-company-operated model to facilitate discharge of offset obligations by the vendors.

The Defence Offset Policy is here to stay. The progress so far may have been slow but it has been steady. There are tremendous opportunities for foreign companies and the Indian industry, both in the private and public sectors, to do business but the Ministry of Defence cannot rest on its laurels. The system would have to respond to address the issues related to the new guidelines that have already been raised by defence analysts and the industry, as also the problems that might arise in future, and provide quick answers to such problems. This has been a problem in the past. A formal forum could be set up by the ministry for regular interaction involving the DOMW, OEMs and the Indian industry to solve the problems as soon as they arise. The new guidelines provide a robust framework within which all the issues that have been raised since the new guidelines were issued in August 2012 as well as those that might crop up in future can be addressed by issuing supplementary instructions and clarifications, rather than having to drastically overhaul the guidelines. Much would depend on the responsiveness on the part of the Ministry of Defence in dealing with the issues comprehensively and innovatively.