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Arms Trade Offset: Global Trend and ‘Best’ Practices

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  • March 21, 2014
    Fellows' Seminar

    Chairperson: Shri V. K. Misra
    Discussants: Shri A. K. Ghosh and Shri Amit Cowshish

    Dr Laxman Kumar Behera’s presentation on “Arms Trade Offset: Global Trend and ‘Best’ Practices” was broadly divided into two parts. While in the first part of his presentation Dr Behera explained about the volumes, trends, and emerging issues of global offsets. In the second part he dealt with important aspects of best international practices in arms trade offset policies. Primarily, Dr Behera surveyed the offset policies of six countries: South Korea, Turkey, Canada, Israel, Malaysia and UAE which not only have had a declared policy on offsets but have also undertaken periodic revisions based on the experience gained over a period of time. He also referred to Indian offset policy to highlight its convergence and divergence with the policies of those six countries.

    He said that given the lack of comprehensive official data on arm trade offsets, the statistics provided by the US Commerce Department’s the Bureau of Industry and Security (BIS) remains the only official source for any meaningful analysis. According to Behera, the BIS data is not only defence specific, but also captures value of offsets and its percentage share in US’ total arms export, and offset transaction by type (direct and indirect) and category (co-production, licensed production, technology transfer etc.). It is however restricted to the US companies which are mandated to report to the US government on any defence export which entails an offset requirement exceeding $5.0 million.

    Citing the 17th BIS report, Dr Behera said, during 1993-2011, 53 US defence companies signed 830 offset-related defence export contracts with 47 countries. The value of associated offsets was $83.73 billion, representing 68.28 per cent of total arms export value of $122.67 billion. In 2011 alone, nine US companies signed 59 offset-related defence agreements valued $10.76 billion with 27 countries. The offset value of these contracts was $5.48 billion. Importantly, among all the offset categories reported by the US companies, three categories – purchases, subcontracting and technology transfer – stood out as the most preferred offset transactions. Between 1993 and 2011, they together represented 81.1 per cent by credit value. However, the persistent decline in offset percentage post 2003-2005 raises questions about the use of offset.

    In the second part of his presentation, Dr Behera elaborated international best practices in arms trade offsets by touching upon key issues: threshold, percentage, and multiplier in the offsets; value addition; principle of additionality and causality; offset obligations on domestic enterprises; channelling offsets; establishing long-term relationship through offsets; offset swapping; banking and offset trading; implementation and monitoring, etc.

    He said that except for Canada, India has the highest threshold limit. This means, unlike most other countries which demand offsets in contracts valued as low as $5-15 million, Indian industry cannot benefit from such smaller contracts unless the contract value reaches $55 million. India has also the lowest offset percentage requirement among the listed countries.

    Many countries apply the principle of value addition for the purpose of estimating the true value of offset credit which can be claimed by the foreign vendors. The value-addition principle ensures that the foreign vendors get their due offset credit for the local content they are able to achieve in the buying country. In India, he said, value addition is determined by subtracting value of imported components i.e. import content in the product and any fees or royalty paid from the final purchase or export price of the eligible products. It is however to be noted that unlike Canada which applies the value addition principle for both products and services, Indian policy is only restricted to the products.

    He said that many countries including India allow investment as one of the means for discharge of supplier’s offset obligations. However, few countries bother to see if such investment, for which the foreign vendors earn offset credits, is having any real impact on the exception. The UAE’s revised offset policy brought out in 2010 has incorporated a hybrid model for calculation of offset credit that virtually puts onus on the foreign suppliers to ensure that a part of the offset inflows brings real benefits to the UAE economy. On offset policy at the national level, the presenter said that some countries including India operate offset policy in the narrow prism of defence procurement only. However, South Korea and Israel are among those countries whose offset policy is applicable at the national level for both defence and civil procurement.

    In the conclusion, Dr Behera said that the role of offsets in arms trade is going to stay for the foreseeable period. Given the shrinking military spending in advanced arms manufacturing countries and the simultaneous increase in defence expenditure by big arms importing countries in Asia and other parts of the world, offsets would play an ever increasing role in the international arms trade. Particularly, in a buyers dominating global armament market, countries, which have declared offsets policy, would try to improvise their existing policies to maximise their arms import.

    Moreover, he reflected that India being one of the biggest arms importers in the world, and having a declared offset policy since 2005, it is vital that its policy is not only dynamic and but takes into account some of the fundamental practices followed by other countries. Presently, however, the Indian offset policy, despite having gone through several rounds of revisions still remains a conservative one and lacks some of the fundamental principles adopted by others. Given that offset has a cost premium loaded into the main contract, he suggested, it is high time Indian policy makers take a serious look at the policy.

    Shri A. K. Ghosh, former Finance Advisor, Defence Services, observed that the conclusion of the paper is not clearly reflecting in both parts of the paper. The author needs to clearly explain why there is a declining trend in the global markets for the offsets? The author also pointed out that India has highest threshold limit as well as the lowest offset percentage requirement. This aspect needs to be relooked, because India is having a non-aggressive offset policy whereas China is very aggressive in its offset policy. So there is framework or no framework, China will follow an aggressive offset policy. In this context, the paper shows a very conservative perspective. Shri Ghose was of the view that the proposal for establishing a long-term offset policy is very crucial. Israel is a case which looks for establishing such a long term relationship. However, building institutional capability is the key for this on which the author can write forcefully.

    Shri Amit Cowshish, former Financial Advisor (Acquisition), Ministry of Defence, said that though the paper does speak about international practices in arms trade offsets, but it does not speak about which one is the best practices. It needs to analyze which one is the best practice and why. South Korea’s practice is appreciated but it is not considered as the best practice and many countries are not following this model. Why other countries practices are not considered as the best practice also need explanation. The value of the paper could be enhanced if it expounds in overall where India stands and how effectively it’s offset policy work. The author also spoke about various fundamental lacunas but the author first needs to explain what those fundamentals are. In fact, the fundamentals are basic features of many countries policy. The author should thus describe which fundamental practices are missing from Indian side. With respect to the management of the offsets, the author talked about the loopholes in the implementation and monitoring side which requires greater attention.

    Major Points of Discussion and Suggestions:

    • Why there is a declining trend in the global markets for the offsets? What are the main reasons for this?
    • India’s policy for offset came in 2006, but that does not mean that it did not have such policy before?
    • Any policy works in a particular ecosystem. The UAE does not have its eco-system. So what are the ecosystems of various countries under study?
    • The author has given data up to the year 2011. SIPRI annual reports can be used to update the data in the paper.
    • The author has given some good recommendations for India, but a fair amount of work should be done to justify those recommendations.
    • India is very defensive in its offset policy and its offset contracts reflect what it expects.
    • It is a good paper on the arms trade offsets and could be a base paper for further research.

    Chairperson’s Remarks: Shri V.K. Mishra, former Financial Adviser (Defence Services), highlighting the significance of the paper as well as Indian offset policy and its various challenges, said that it was expected to have some kind of a transformative impact, given the major gaps not only in the technology but in infrastructure, maintenance, and manufacturing capability. So all in all it was envisioned to provide a fillip to the Indian defence industrialization process. So far much has not happened in this regard. Shri Mishra pointed out that there is misconception that it drags on the acquisition process and tends to unwarranted costs. However, it should not be seen that way. In fact, he said, the offset policy makers had hope that any offsets investment in flow would bring some amount of attractive returns on the investments by the OEMs. Then only it could be sustained. So it will also help in achieving long term relationship with those OEMs and India’s offset partners. These were the expectations. However, the experience has shown with the kind of guidelines India has with regard to foreign direct investments some worthwhile investments are there. There are also aspects of joint venture guidelines which require much greater clarity. Therefore, the progress on this front is very much slow in terms of worthwhile JV entities. There is need to move another level where there would have to be priority defined in terms of the each of the request for proposals (RfP’s) that are issued. Thus, there is a whole range of concerns whether it is technology, maintenance preparation in overhaul, infrastructure facility. He concluded the seminar by thanking all the participants for their valuable contributions and making it a success.

    Report prepared by Dr Saroj Bishoyi, Researcher, IDSA