by Manu Pubby

The inaugural ‘2+2 dialogue’ between India and the United States later this week aimed at strengthening defence ties is likely to include a discussion on the offset policy that overseas firms complain makes it tough to do business in the country. 

Although India-US defence trade has grown from nil to $15 billion, companies such as Boeing, Lockheed Martin and Textron, which execute military contracts, maintain that they are finding it difficult to adhere to India’s offset rules which mandate that at least 30% of the contract cost should be invested in the domestic industry.

While France has stumbled into a political controversy over the offset deal for the Rafale fighter jets to Reliance Defence, US companies operating in India are seeking to surmount the wall of bureaucracy over the policy that potentially impedes the government’s ‘Make in India’ plan.

Offset Offence 

Almost all companies operating in India have run into trouble over offset policy – Lockheed Martin has been fined half a million dollars for failing to meet obligations, Textron shut down its India offices after getting slapped with a stiff penalty and Boeing has been struggling to discharge offsets for the $4.7 billion deal for C-17 transporters.

Boeing is also facing a unique problem that forced it to take an extension from the defence ministry to execute offsets.

In 2011, when the aircraft deal was signed with Boeing, India saw it as an opportunity to bring in cutting edge technology to the country as part of the offsets. The Defence Research and Development Organisation (DRDO) identified the Trisonic Wind Tunnel as a desirable technology which would help in the design and development of future aircraft and unmanned aerial vehicles or UAVs. However, with the technology being restricted for export, it took discussions at the defence minister level to get clearances for the project.

In a twist, however, while the permissions from the US side came through after six years in 2017, the DRDO has not moved ahead on the project since. While 18 months have gone by after US government approved the licence, the DRDO appears to be having a rethink on the project. Although an extension has been granted to Boeing, if the project does not go through the company would be sitting on a huge offset liability that could get difficult to execute.

This particular issue is likely to come for discussion at the ministerial talks later this week, given that it ticks all the boxes on transfer of critical technology but has taken a backseat even though the funding already exists for it.

Unlimited Liability 

The ministry’s unbending approach on offsets to meet all rules in the book has left not just the US firms but also other overseas firms in a quandary. From the ministry’s side, there is no room for manoeuvre given that there have been at least three corruption cases under investigation in which the offsets route was allegedly used to route payments to corrupt individuals.

As per the rule book, the defence ministry has to approve all execution of offsets and, at the end of the contract, give an undertaking to the company freeing it of all obligations.

However, despite the offsets rule being in force since 2005, not a single major offset contract has been closed so far. This means the ministry has not yet fully audited and approved them.

Take the case of the Boeing P-8I naval aircraft, for example, which came under fire from the Comptroller and Auditor General (CAG) recently for non-compliance of offsets, among other issues.

The CAG said that the company had not met obligations worth $641 million, even as the contract was signed in 2009. However, with the ministry yet to conclude its internal audits, the offsets are still shown as outstanding, leaving a liability on the books of the arms manufacturer.

Among several issues on offsets that were taken up for discussions over the past few months between India and the US in the run-up to the 2+2 dialogue, a key point raised was that the offset guidelines place an unlimited financial liability on the company for not being able to fulfil them. The US suggested a capping of penalty at 5% on the unfulfilled obligation.

Experts suggest it is time to change the policy of fining companies for offset non-compliance and moving to a review system that can correct the process. “The US companies which have been recently penalised for non-fulfilment of offset obligations are generally very process driven and compliance-oriented,” said Karishma Maniar, associate director, Economic Laws Practice.

“Indian MoD (ministry of defence) would have strictly followed the prevailing process in levying such penalties, but maybe it’s time to review our processes to ensure our policies are coupled with ease of doing business. While India and the US are working overtime to strengthen their defence trade relationship, these hiccups could be detrimental if they lead to potential disputes,” she said.

A key problem, according to experts, is that with an indefinite liability of offsets, companies need to show in the books that they have adequate capital to pay the fine or penalty on implemented projects.

This ties down part of the capital available with companies.

Tweaks Suggested 

While India is planning to tweak its offsets policy – a draft is already doing the rounds that will include the creation of a dedicated fund approved by stock market regulator SEBI that foreign companies can invest in – the US side has suggested several changes that can streamline the process. These include electronic submission, monitoring and auditing of offset deals, extending the period of performance that is currently linked to the delivery period of the product to at least 10 years and enabling a provision to use offsets for skill development in India.

The industry feels that even the State Trading Corporation has a far better offsets monitoring mechanism and is able to process offset credits with efficiency. At present, the defence ministry takes over six months to add an Indian offset partner for such contracts, a time period that could be shrunk with an online system. 

While these tweaks could be rolled out shortly, the Indian industry is keen that the focus not be shifted away much from using these obligations to encourage manufacturing in India. For Indian companies such as TATA, which makes major components for the Apache helicopters, including the fuselage for international orders with its joint venture with Boeing as part of offset deal, these are the stepping stones to fulfilling their global ambitions.