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Reviewing Defence Offset Guidelines: A Recap

Mr Amit Cowshish is a former Financial Advisor (Acquisition), Ministry of Defence and former Distinguished Fellow, Manohar Parrikar Institute for Defence Studies and Analyses, New Delhi. Click here for Detailed Profile
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  • July 17, 2014

    The Defence Offset Guidelines of 2012 have been under review for some time. The Ministry of Defence (MoD) has been absorbing the feedback from various stakeholders and will undoubtedly come out with revised guidelines that help in achieving the stated objectives of the policy rather becoming an end in itself.

    While a drastic shift in the policy is unlikely, some changes in the policy, clarity about some of the existing provisions and simplification of the procedure seem necessary to make the policy work better. Here is a quick recap of the issues that merit attention.

    Policy Issues

    There are five policy issues: one, changing the vendor-driven orientation of the policy; two, increasing the quantum of offsets from the present 30%; three, permitting offset trading; four, taking a final view on the order holding ‘services’ in abeyance; and, five permitting the Tier-I vendors to discharge offset obligation exceeding their work share.

    The first of these three requires very serious consideration. This suggestion was made even when the 2012 guidelines were being framed but for some reason did not find favour. The offsets must be buyer-demanded rather than vendor-driven.

    An enabling clause must, therefore, be included in the policy which will permit MoD to specify in the Request for Proposal (RFP) itself the area(s) in which it would expect the offset obligation to be discharged. It may not be possible to do so in every case and, in any case, a mechanism will have to be created to identify the area(s) to be specified in the RFP but an enabling provision will buy MoD the time to put that mechanism in place and make it possible to start channelizing the offsets in future without having to amend the guidelines yet again once the mechanism is in place.

    While identifying the area(s) to be specified in the RFP, a view could also be taken as regards the quantum of offsets.

    Considering the difficulty being faced presently in regard to banking of offsets and monitoring implementation of the offset contracts it may be a bit premature to permit full scale offset trading, which could also defeat the very purpose of the offset policy. This issue could, therefore, wait. However, it may be worth the while to allow group companies to discharge offset obligations to some extent, subject to proper checks and balances.

    It has been more than a year since the ‘services’ were held in abeyance. There seems to be no reason to shut the doors permanently on such services as MRO, upgradartion/life extension and software developed specifically for the equipment contracted for by MoD. A final view needs to be taken, especially in regard to pricing of the software, if that is to be permitted.

    The existing guidelines permit offset obligation to be discharged by Tier-I vendors to the extent of their work share in the offset contract. This restricts the vendor’s ability to discharge the offset obligation. Some relaxation in this regard is called for, as long as the overall responsibility continues to be that of the prime vendor.

    Besides these, there are larger issues like workability of mandatory offsets, rationale behind the multipliers and the method of determining value addition but altering these aspects would require avoidable large scale restructuring of the policy.

    Removing Ambiguities

    It was undoubtedly unintentional but the text of 2012 guidelines suffered from a few ambiguities. Three major issues that need to be clarified are as follows:

    1. The difference between ‘direct purchase of’ and ‘executing export orders for’ eligible products, as one of the avenues for discharge of the offset obligation.
    2. The quantum of offset credit a vendor would get if he buys back 40% of the product made using the equipment he brings in to discharge the offset obligation, especially keeping in view the fact that there is no incentive for a higher buy back.
    3. Eligibility as an Indian Offset Partner (IOP) of a wholly owned subsidiary or any other Indian company operating with permissible limits of FDI applicable to that sector, making items that qualify as defence products for the purpose of discharge of the offset obligation.

    Procedural Issues

    There are at least three procedural issues that caused glitches in implementation of the 2012 guidelines. The difficulty was exacerbated by MoD’s inability to resolve those issues as they arose, leaving all the issues to be sorted out at the time of the next review.

    The first issue concerns valuation of technology. As mentioned earlier, the vendor has to buy back 40% of the products to earn offset credit in case the obligation is discharged through transfer of equipment. Assuming that, subject to the buyback condition being met, the vendor gets full credit for the value of the equipment, the manner in which the cost of equipment will be determined needs to be clarified.

    This also applies to transfer of critical technologies to Defence Research & Development Organization (DRDO). Offset Guidelines provide that a Technology Acquisition Committee (TAC) will carry out the technical and financial assessment, which would include valuation of technology offered by the vendor. The precise method for carrying out this assessment needs to be prescribed for the sake of objectivity, uniformity and transparency.

    The second issue concerns simplification of the procedure for rephasing of the offset schedule, changing an IOP and altering the offset component of a contract. The first two require approval of Secretary (Defence Production) and the third that of the Defence Minister. This can be simplified by laying down guidelines to be followed for entertaining such requests and delegating the authority to Director General (Acquisition) to permit such changes.

    Changing of IOPs is seen as being not in the interest of the Indian companies. This is not a strong plea against simplifying the procedure. The IOPs can safeguard their interests through suitable provisions while entering into agreement with the vendor to prevent any future setback.

    The third issue relates to impracticality of submitting full implementation schedule at the time of submitting the offset offer. Implementation of an offset contract could typically spread over several years. It is not possible to furnish a fixed implementation schedule upfront with all attendant details. Since the vendor is anyway contractually bound to discharge the offset obligation, allowing greater flexibility in regard to implementation schedule does not carry much risk for MoD.

    Some Other Related Issues

    MoD has steadfastly rejected the demand for retrospective applicability of the changes made in the offset guidelines from time to time. There are valid reasons for this but there is no harm in permitting retrospective applicability to a limited extent, for which MoD could formulate guidelines.

    There is a view that MoD should have a system of registering the IOPs. This may not be a good idea. It will not only restrict the freedom that the vendors presently enjoy in regard to selection of IOPs but also create administrative problems for MoD.

    Despite whatever changes are made, the foreign vendors are bound to run into blind alleys while formulating offset proposals. Contract-specific problems are also bound to arise in the course of contract negotiation and implementation of each contract. A system of deciding issues as and when raised and giving time-bound written clarifications would be the key to making sure that the policy plays out as per MoD’s expectation.

    Views expressed are of the author and do not necessarily reflect the views of the IDSA or of the Government of India