In February 2018, the Ministry of Defence (MoD) informed the Standing Committee on Defence (SCoD) that in 11 of the 42 offset contracts signed till then, a final/interim penalty, totalling USD 38.19 million, had been imposed on account of shortfall in the discharge of the offset obligation by the vendors.

Based on this input, SCoD advised the MoD to ‘ensure that the penalties imposed on the defaulter vendors reasonably compensate for the losses incurred due to a shortfall in the discharge of offset obligations.’

This raises two questions

FIRST, why is it that the vendors, most of which are reputed global defence companies with vast experience in discharging offset obligations, fail to discharge the offset obligation as per the implementation schedule submitted by them?

SECOND, what ‘loss’ is suffered by the MoD on account of delay in the discharge of offset obligation by the vendors that requires to be ‘compensated’, and whether it would ensure more efficient implementation of the offset contract if this Damocles’ sword is kept hanging on their heads?

The first question is quite puzzling considering that vendors are at full liberty to choose from a basket of six possible avenues for discharging their offset obligation and also to select the Indian Offset Partners (IOPs) through which they want to discharge the offset obligation.

The avenues are arguably quite exhaustive, but the eligibility criteria for an Indian entity to be an IOP could certainly not be more liberal.

To be fair, MoD has been making efforts to make it easier for the vendors to discharge their obligation.

For example, vendors used to find it difficult to provide the details of the IOPs at the time of the signing of the offset contract, re-phase the offset implementation schedule and change the IOPs after signing the contract.

These issues have been addressed by allowing the vendors the option of furnishing the details of the IOPs a year before claiming the offset credit or even at the time of claiming the credit and by making it easier for them to re-phase the implementation schedule and change the IOPs.

It is difficult to say whether this has helped, but what can be said with a reasonable certainty is that these were not the only issues that bedevilled the foreign vendors.

Foreign vendors have been asking for several changes in the offset guidelines. One of their demands has been that they should be permitted to rope in their group companies and Tier 1 to 3 sub-vendors to discharge offset obligation on their behalf without limit.

This, and many other suggestions made by vendors, need to be considered. All these may not be acceptable to MoD, but a final decision on them cannot be allowed to hang fire.

To be sure, the problem is not limited to making changes in the offset guidelines on the basis of the suggestions made by the vendors and, for that matter, by the Indian companies which have to discharge the complementary role as IOPs.

There are several provisions in the present guidelines which are either not clear, lend themselves to varying interpretations or do not serve the objective of the offset policy.

These impact the discharge of the offset obligations in many ways, such as at the stage of formulation of the offset proposals, choice of IOPs or claiming of the offset credits by the vendors.

To give a very simple example, the existing guidelines permit vendors to let their Tier-I sub-vendors under the main procurement contract ‘to discharge offset obligations, to the extent of their work share (by value)’ on their behalf.

What the guidelines do not make clear is whether the ‘work share’ refers to the sub-vendor’s work share in the main contract or the offset contract. The answer may be clear to those vendors who have had experience of engaging with the MoD on offset matters, but the point is that there has to be textual clarity in the guidelines so that prospective vendors and IOPs do not have to struggle with the interpretation of the existing clauses. It does not require much effort to remove such ambiguities in the guidelines.

It is not only textual ambiguities that may be holding back the offset policy from achieving its true potential. Though it is not one of the stated objectives of the offset policy, it is not uncommon to come across the criticism that it has led to hardly any transfer of technology (ToT).

While the actual reasons can be identified only by engaging the vendors in a free and frank discussion, it is possible that they do not find the existing policy attractive enough to transfer technology to the IOPs.

The relevant provision in DPP 2016 says that where the discharge of offset obligations is proposed in terms of ToT to IOPs, ‘the offset credit for ToT shall be 10% of the value of (the) buyback during the period of the offset contract, to the extent of value addition in India’. How does one interpret it?

Suppose a vendor wants to transfer technology which it considers to be worth, say, USD 10 million, and buys back the products manufactured by using that technology worth USD 5 million within the period of performance of the offset contract (a tall order by any stretch of the imagination).

The offset credit the vendor can expect to earn for the transferred technology would be just USD 500,000 (10 per cent of the value of the buyback), provided the value added in India is equal to or more than this amount! This apparently not only discourages the choice of ToT as an avenue for the discharge of the offset obligation but also provides no incentive for ensuring higher levels of value addition in India or, more importantly, high-end and high-value technologies.

It needs to be recognised that no foreign vendor would willingly, or by sheer incompetence, default on the discharge of its offset obligation. For any reputed manufacturer, the reputation of the company is far more important than the penalty it may have to pay on account of default in discharging the offset obligation.

A dynamic offset policy has to include a mechanism for identifying the causes for likely delay or default on the part of vendors in discharging their obligation and removing the impediments faced by them during the course of implementation of an offset contract.

It is arguable whether the MoD suffers a ‘loss’ on account of delay in discharge of the offset obligation and, more importantly, if such a delay can be quantified and compensated by imposing financial penalties. The focus has to shift from enforcing performance of the offset contract by imposing penalties to facilitating such performance.

The MoD will do well to put in place a mechanism for regular engagement not just with the industry associations, both foreign and Indian, but with the individual stakeholders who alone can make the offset policy succeed by completing the implementation of the signed contracts.