Minister of State Ajay Bhatt’s reply in Parliament last month on the state of defence offsets gave us a glimpse into the mess that these contracts are in when it comes to imbibing modern technology and mark up India’s defence production capabilities.

The minister said there are 21 offset contracts in which the vendors have defaulted/non-performed offset obligation during the last five years amounting to $2.24 billion till 31 December 2021. He also said that penalties amounting to $43.14 million have been imposed against defaulters/non-performing vendors in 16 cases.

Bhatt added that during the last five years, offset claims worth $2.64 billion have been submitted in 47 contracts till 31 December 2021.

This reply is a shocker because it means that a significant amount of 57 offset contracts signed have resulted in penalties with the number expected to rise, as per sources in the defence and security establishment.

Moreover, penalties have been imposed on major defence companies. Sources say these include Lockheed Martin during the work related to C-130J Hercules aircraft, Safran (France) during a Mirage aircraft upgrade project and the acquisition of Rafale aircraft, Dassault Aviation (France) during a Mirage upgrade project, Thales (France) during a Mirage upgrade project and rocket-related efforts with Hindustan Aeronautics Limited (HAL), European consortium MBDA for an effort involving MICA missiles for the Mirage-2000H and during the Rafael acquisition, Rosoboronexport (Russia) for contracts related to Kamov Ka-28 helicopter upgrades, MiG-29 fighter jet upgrades and Mi-17 helicopters. Even Israel Aerospace Industries have faced penalties for contracts involving Harop and Heron drones.

India adopted the Defence Offset Policy for capital purchases above Rs 300 crore made through imports in 2005. Foreign vendors were required to invest at least 30 per cent of the value of the purchase. The first offset contract was signed in 2007 with a total of 57 contracts signed since then. Offset contracts estimated at $13.52 billion have been signed and are expected to be implemented by 2033.

A Difficult Time Lies Ahead

Experts, speaking off the record, argue that the cases of penalisation are going to see an exponential increase in the next five years, even though fresh offset contracts are not expected to be signed.

India is one of the few countries that does not count the quality of an offset package as a bid evaluation criteria for assessing competing tenders, and this could have played a role in the quality of offsets received.

A recent wargame by Delhi-based Insighteon Consulting noted that for contracts signed before the issue of offset guidelines of 1 August 2012, penalties levied are restricted to the duration of contract and therefore stalemate situations are inevitable, with long periods of inaction from either side.

It also noted that more than 50 contracts are still open out of the 57 offset contracts signed.

The Comptroller and Auditor General (CAG) had in 2020 lashed out at the practice, saying foreign vendors often make offset commitments to win contracts but dilly-dally later on. The CAG had cited as an example a proposal from Dassault Aviation and MBDA that was struck as part of the Rafale deal.

The CAG had noted that from 2005 to March 2018, 46 offset contracts had been signed with foreign vendors that were together valued at Rs 66,427 crore. According to the auditor, by December 2018, Rs 19,223 crore worth of offsets should have been discharged by the vendors, but only claims worth Rs 11,396 crore, or 59 per cent, were submitted.

“Further, only 48 per cent (Rs 5,457 crore) of these offset claims submitted by the vendors were accepted by the ministry. The rest were largely rejected as they were not compliant to the contractual conditions and the Defence Procurement Procedure,” the CAG noted.

The offset in the Rafale deal was a surprise to the French as well. They argued that this was a government-to-government deal and has not been applicable in any of the deals done earlier. Given that the original tender for fighters had a 50 per cent offset clause, the Indian government insisted on the same for off-the-shelf purchase.

Need A Dispute Resolution Body

The Modi government has done away with offsets in future government-to-government deals, such as the Rafale deal that was signed in 2016.

More steps need to be taken to ensure that existing contracts are fulfilled to the liking of all parties including the defence ministry.

With a likely increase in the quantum of unfulfilled obligations in the coming years, priority should be given to such possible cases.

Rajiv Chib, founder of Insighteon Consulting, said that in legacy stalemate situations, the suppliers of the MoD should be given a second chance to fulfil their obligations.

It was also recommended that this second chance be provided under a new regulation/broad policy framework, where the Original Equipment Manufacturers (OEM) be allowed to fulfil offset obligations, governed by the provisions indicated in offset procedures of any of the defence procurement procedures published till now.

And for this, the defence ministry may create an Empowered Dispute Resolution Body (EDRB), led by a senior bureaucrat or a senior industry professional with representatives from the forces as well as the industry.

The objective of EDRB will be to close all existing stalemate situations by the best possible outcome, which could include calling for fresh proposals and clearing them through the approving body in the defence ministry – Defence Acquisition Council.