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India’s Defence Offset Policy 2008

Laxman Kumar Behera was Research Fellow at Manohar Parrikar Institute for Defence Studies and Analyses, New Delhi. Click here for detailed profile.
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  • August 19, 2008

    The Ministry of Defence (MoD) recently issued a new set of rules for the procurement of arms, ammunition and other defence related products and services. The rule book, known as Defence Procurement Procedure 2008 (DPP 2008), has revised, among others, the offset policy that was first promulgated in 2005 and subsequently revised in 2006. The revised offset policy which retains the earlier minimum 30 per cent offset requirements in defence imports of Rs. 300 crore or more has added a provision of offset banking, besides enlisting a number of categories of defence products.

    Under the banking provision, foreign vendors are allowed to accumulate credits for discharging their future offset obligations. The provision allows two ways for accumulation: one, through prior investment in the Indian defence sector; and, two, by generating excess credits from the ongoing offset projects. In other words, the banking provision allows foreign vendors prior as well as continuous opportunities in Indian defence industry, to discharge their future offset obligations.

    However, the validity of parked credit, which at present is fixed for a maximum period of two and a half years, seems to be too less to make the provision attractive for foreign companies. Countries such as Denmark allow five years for banking purposes. The logic behind such longer provision is to allow foreign companies to complete long drawn defence contracts and at the same time accumulate credits for using in future contracts. If a concerned foreign company fails to win a particular contract, there is still hope of utilising those parked credits because of the longer validity period. In India where the objective of offsets is to enhance domestic industrial capability through foreign participation, a short two and a half years validity period may not provide adequate incentive to overseas companies, to invest in India’s long-term defence projects.

    The banking provision provides freedom of full utilisation of parked credits irrespective of its desirability. As an illustration, if a foreign vendor accumulates credits by executing export orders for, say, military clothes in excess of its mandated obligations, it is technically eligible to get the approval of the MoD for parking the excess credits. Besides, such parked credits are to be treated on par with banked credits arising out of the fresh investments by any other vendor. As there are no laid down provisions of accepting or rejecting the proposal, the element of subjectivity may create a situation where a vendor may wish to continue to engage in a particular activity without contributing much to the domestic industrial capability. To avoid such a situation, the MoD could lay out procedures for selecting banking proposals, on their merits, rather than playing into the designs of foreign vendors.

    As far as attracting investment through banking provision is concerned, DPP 2008 has remained silent on the existing foreign direct investment (FDI) policy that allows up to 26 per cent foreign participation in the Indian defence sector. Since the policy was proclaimed in 2001, there has not been a single case of FDI coming through. The disinterest shown by foreign companies is due primarily to the lack of control in any ventures where they would like to invest. Since the problem lies in FDI policy, it is doubtful if the investment component of the banking provision would succeed without first addressing the basic problem in FDI policy.

    The new offset policy has however tried to avoid the earlier confusion regarding what constitutes defence products, by enlisting 13 categories of products that make up the total defence industrial output. Henceforth, any Indian company – especially in the private sector – that produces any of the listed items is eligible to be part of the domestic defence industry. From the point of view of offsets, the list would help domestic companies, engaged in production of these items in formulating their offset strategies, including tie-ups with major vendors, both domestic and overseas. The listed items would also help foreign vendors in identifying Indian partners producing these items, for the purpose of discharging their offset obligations. However, the defence industrial licensing policy, formulated by the Department of Industrial Policy and Promotion (DIPP), does not complement the merits of the new provision of the offset policy. The licensing policy requires that all companies producing all types of defence items must require a license. Hence, a foreign vendor’s freedom to choose an Indian partner is restricted to those companies that have already received licenses or are most likely to obtain it. Similarly, an Indian company cannot formulate its offset strategies unless it is sure about getting a licence for its products. In other words, the existing licensing policy is an obstacle in the expansion of domestic industry and freedom of market operations.

    Though the new offset guidelines aim at strengthening participation of foreign companies in Indian industry and creating an atmosphere conducive for private sector participation, it does not seem to carry enough thrust to achieve its objectives. Given that India’s main interest is to attract foreign investment to enhance the domestic industrial capability, the new offset policy needs to be complemented by a favourable atmosphere, involving a longer banking period and liberal FDI and licensing policies.