Summary: The draft offset guidelines 2020, with revamped features, is a bold attempt by the MoD to attract technology and investment and promote the export of major defence items. However, the guidelines could be further fine-tuned to keep the focus tight on their larger objectives. In particular, the MoD may consider further refining features pertaining to the applicability of offsets to inter-governmental agreements and foreign military sales (IGA/FMS) procurement, quantum and threshold of offsets, specific offsets through the RFP mode, banking provision, negative multiplier, methodology for value addition, the FDI cap and, more importantly, the offset management

The draft Defence Procurement Procedure 2020 (DPP-2020), released on March 20 for public comments, has made a substantial revision to the offset guidelines. The focus of the new offset guidelines is export of major defence items and investment and technology transfer. Will the new guidelines be a game-changer in the Ministry of Defence’s (MoD) efforts at building a strong arms industry, or require further fine-tuning to achieve the aforementioned objectives?

Background To Draft Offset Guidelines 2020

The draft offset guidelines come in the wake of MoD’s experience in handling over 50 offset contracts signed until now. These contracts, signed under various DPPs since 2005, are valued nearly $12 billion and likely to be fully executed by 2024. The experience of managing these contracts is likely to have weighed heavily in effecting the change in the draft guidelines. Though the MoD’s experience in handling all signed offset contracts is not available in the public domain, some idea could be formed from the key findings of a study undertaken by the Manohar Parrikar Institute for Defence Studies and Analyses (MP-IDSA) on behalf of the Department of Defence Production (DDP). As per the findings of the study, which were conveyed by the MoD to the Parliamentary Standing Committee on Defence, about 87 per cent of the offsets went to 15 Indian Offset Partners (IOPs), who in turn also benefited from repeat orders placed on them by the same offset providers. Moreover, more than 90 per cent of the offset obligations were discharged through the purchase of goods and services, with a few takers for the technology and investment which are considered more beneficial to the local industrial development. Evidently, the previous guidelines neither helped in any meaningful expansion of the defence industrial base nor the industry’s technological or infrastructural development. In other words, the previous guidelines were not fully up to the expectations of the MoD. This could be one of the main causes of change in the draft guidelines.

Notable Changes In Draft Offset Guidelines 2020

The draft has made a number of fundamental changes in the offset guidelines, including the objectives which are now much more focused on defence industrial promotion. The development of two synergistic sectors ­– the civil aerospace and internal security, which were part of the offset guidelines since DPP-2011, is no longer a core objective in the new guidelines.

Changes have also been made in the avenues for the discharge of offsets, the eligibility of IOPs to partner with foreign original equipment manufacturers (OEMs) for the fulfilment of latter’s obligations, the list of items permitted for the discharge of offsets, and the multiplier applicable in transactions under different avenues.

In comparison to the existing guidelines, the number of avenues for the discharge of offset has been reduced from six to five. The ‘investment in kind’, which was introduced in the DPP-2013, no longer remains a valid avenue. The Transfer of Technology (ToT), first permitted as an avenue in the DPP-2013, has been given a renewed focus by permitting the foreign OEMs to obtain direct credit for ToT to the Indian industry to manufacture eligible items, identifying a list of 49 technologies for acquisition by the government entities involved in design and manufacture of defence items, and modifying the list of technologies reserved for acquisition by the Defence Research and Development Organisation (DRDO).

Accepting a long-standing demand from the OEMs, the guidelines have for the first time allowed the fulfilment of offset discharge by entities other than the main offset provider and its Tier-I sub-vendors on a case-to-case basis. This is likely to enable the main offset providers to use their subsidiaries and other sister companies to fulfil offset obligations on their behalf.

The list of eligible products and services permitted for the fulfilment of offset obligations has been sharply pruned to seven major categories of defence items.4 All the services, except for maintenance and repair and overhaul (MRO) related to aircraft and helicopters, are no longer eligible for discharge of offset obligations. The pruning of the list and confining it to mostly products seems to be driven by the MoD’s desire to promote manufacturing, rather than services, in which India has developed a reasonable level of capability.

A noticeable change is the abolition of banking provision from the new guidelines. The provision, an integral part of offsets guidelines since its introduction in 2008, had allowed both pre- and post-banking by permitting vendors to claim credits for certain permitted transactions. Though the reason for scrapping the provision is not known, one plausible factor could be the MoD’s difficulty in distinguishing (especially in post-banking cases), the genuine offset-induced transactions from those undertaken as part of the OEM’s routine commercial business. Suffice it to say that since India is a major hub for software, design and engineering services, it is quite possible for the OEMs to have claimed credit for certain transactions which were not necessarily driven by the MoD’s offset policy.

From the perspective of the objectives of the draft guidelines and the MoD as a buyer, the key change in the offset guidelines pertains to the multiplier provision. The provision is a direct yet bold attempt to achieve three broad goals: to facilitate technology transfer, attract foreign direct investment, and promote export of major defence items as opposed to parts and components. The higher multipliers (two, three and four) are reserved for investment and technology transfer. For the first time, the guidelines have stipulated a negative multiplier – 0.5 – which is applicable to purchase/export of parts and components. The negative multiplier is clearly intended to discourage OEMs to resort to buying parts and components to fulfil their obligations – a practice found not so effective in furthering the domestic defence industry’s core capability.

In addition, the draft guidelines have also made a number of changes, pertaining to offset period of discharge, accountability and transparency. Like in the existing guidelines, the period of discharge is now limited to a maximum of two years beyond the period of the main procurement contract. However, the warranty period, which was earlier part of the procurement period, is delinked, reducing the offset fulfilment period to that extent. Though the reason is not provided, it may be due to the MoD’s attempt to enforce quick implementations of offsets. However, from the OEMs’ perspective, the delinking of warranty period could be a cause of concern, especially for projects which have a long gestation period.

To improve transparency and accountability, the guidelines have made a provision for online submission of offset discharge claims. This is likely to save not only time in transmitting the bulky documents from the OEMs to the concerned agencies of the MoD, but will also help in a real-time audit of the submitted claims.

For the first time, the offset guidelines have introduced a dispute settlement mechanism in the form of Independent Monitors (IM) to resolve any differences and disputes with the OEMs. The IM is expected to submit its advice in two months. The final decision on the matter, however, rests with the MoD. From the perspective of the OEMs, this provision seems unilateral as it is not in sync with the arbitration clause of the main procurement contract, which is also applicable to the offset contract.

Summing Up

The draft offset guidelines 2020, with revamped features, is a bold attempt by the MoD to attract technology and investment and promote defence exports. However, to keep the focus tight on the aforementioned objectives, the MoD may consider further refining some of the features, especially those pertaining to the applicability of offsets to IGA/FMS procurement, quantum and threshold of offsets, specific offsets through the RFP mode, banking provision, negative multiplier, methodology for value addition, the FDI cap and, more importantly, the offset management.