India’s Defence Offset Policy – A comprehensive analysis

The policy requires foreign vendors to plough back at least 30 percent of the contract value in the Indian defence sector to discharge their offset obligation.

India’s Defence Offset Policy – A comprehensive analysis

By Amit Cowshish

Seventeen years after it was adopted by the Ministry of Defence (MoD) with much enthusiasm, India’s defence offset policy is mired in criticism for its failure to produce the intended results.

The policy requires foreign vendors to plough back at least 30 percent of the contract value in the Indian defence sector to discharge their offset obligation. The terms and conditions and the procedure that governs conclusion and execution, of the offset contracts, as well as the system of contract management, are too convoluted, notwithstanding the Defence Ministry’s claim of having simplified them over the years.

Nothing proves this better than the recurring inability of the vendors -all of them globally renowned defence companies- to meet the annual targets for discharging their obligation.

According to the information given by the Minister of State for Defence Ajay Bhatt, in the written response to a question in Lok Sabha on August 5, as many as 15 companies ‘have missed the first deadline set for implementation of their defence offset commitment’.

The minister did not disclose more details because of the information being ‘sensitive and strategic’ in nature. Consequently, one is left guessing whether the ‘first deadline’ refers to the annual deadlines within the original period of performance (PoP) of the offset contract or to the outer deadline for discharging the entire contractual commitments at the end of the PoP.

The ambiguity in the information given by Bhatt notwithstanding, the possibility that some contracts have reached -or are about to reach- a dead end because of the vendor’s inability to discharge the entire offset obligation during the PoP of the contract cannot be ruled out. In any case, the fact is that the foreign vendors are unable to fulfil their contractual commitments.

Bhatt also disclosed in his reply that, of $6.83 billion worth of offset obligations due to be discharged till August 1, 2022, the vendors had submitted offset claims only worth $5.58 billion or 82.13% of their cumulative contractual commitment. The actual value of offsets discharged may, however, be less than $5.58 billion as all offset claims are not found to be admissible after audit.

The macro picture is not very different. According to a recent report of the Standing Committee on Defence, a total of 57 offset contracts had been signed by the MoD till March 2022, involving approximate offset obligation of $13.52 billion to be discharged between 2008 and 2033. Of this, the offset obligation due as on January 17, 2022 amounted to $6.8 billion but the vendors had submitted offset claims amounting to $4.59 billion, and after audit claims worth $3.37 billion only had been ‘disposed of’.

These statistics are not the only reason why the offset policy has faced so much flak. One major criticism has been the inability of the policy to attract technology through the offset route. A study carried out by MP-Institute for Defence Studies and Analyses in 2019 to assess the impact of offsets on the Indian defence industry had revealed that more than 90% of offset obligation was discharged by the vendors through direct purchase of products and services from the Indian companies and, more to the point, there were hardly any instances of the vendors opting to transfer technology or bring in foreign direct investment for discharging their offset obligation.

The study also highlighted that about 87% of the offset obligation had been discharged through 15 Indian Offset Partners (IOPs). The top 5 of these 15 IOPs received 51.76% and the top 10 as much as 76.11% of the offset business, indicating that the direct benefit of offsets was restricted to a few big defence companies in India.

Some of this criticism is unfair. The Defence Ministry may have expected transfer of technology through the offset route, but it was just one of the five or six ways in which the vendors were allowed to discharge their offset obligation. No wonder then that they chose to adopt the easier and less complicated ways like direct purchase of eligible defence products from the Indian companies to discharge their obligation.

Likewise, while the direct benefit may have accrued to only a handful of big Indian companies, it is evident as the downstream smaller companies have also benefited from the policy because of outsourcing of a substantial proportion of work by the main IOPs to them.

Even so, there is no denying that the policy is beset with problems and the outcome is arguably lacklustre. This is because the policy is quite convoluted. It is marked by excessive and needless controls, unrealistic expectations from the vendors, inflexibility in contract management, and bureaucratic arrogance.

To illustrate, the policy gives freedom to the vendors to choose the IOPs and the avenues – out of five or six prescribed in the manual – through which they want to discharge the offset obligation. It places no restrictions on the vendors to set the annual targets for discharging the obligation within the PoP of the contract. However, what the policy gives with one hand, it takes away with the other, as all these choices are subject to approval by the MoD.

There are reports of the MoD prevailing upon the vendors against their wishes and better judgment to discharge the obligation in the initial years of the PoP, rather than allowing them to decide on the timetable for execution of the offset contract. The bureaucratic arrogance is also evident from the comment one often hears that the vendors are not serious in discharging the obligation. Little do the offset managers realise that contractual default is something that is looked down upon in the corporate world.

Frankly, too much energy is being expended in making the policy work. Considering that all single source procurements through intergovernmental agreements or the Foreign Military Sales programme of the US government, which have emerged in the recent years as the favoured mode of direct purchase of equipment from abroad, are now exempt from the offset obligation, it’s time to reconsider the efficacy and utility of continuing with the policy.

The MoD should assign the responsibility to carry out an objective review of the offset policy to the Defence Accounts Department, which has been mandated by the ministry last month to conduct Performance and Efficiency audit of various organisations, policies and activities, which would include offsets.

The author is Former Financial Advisor (Acquisition), Ministry of Defence. 

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