|
The origin of defence offsets may be attributed
to the US Aircraft industry. The F-16 represents
the quintessence of defence offset transactions
as every country that procured the aircraft made
efforts to develop its aircraft industry through
one offset transaction or another. Today, while
offsets are sought by developing nations to enhance
their defence industry as well as R&D capabilities,
developed nations are using offsets for promoting
joint development projects to share the costs,
work and risks as well.
So it seems that in the foreseeable future defence
offsets are here to stay.
What are defence offsets?
According to the US Government, “Offsets
in defence trade encompass a range of industrial
compensation arrangements required by foreign
governments as a condition of the purchase of
defence articles and services from a non-domestic
source.” Offsets encompass a whole range
of activities from joint development, co-production,
license production, sub-contracting, technology
transfer, export assistance, credit assistance,
overseas training, investment in R&D, counter
trade etc.
Direct offsets are related to the system or equipment
under procurement. Countries seek co-production
or licensed production of the equipment depending
on their industrial capability. The co-production
of a hybrid version of F-16 in the form of F-2
(FSX) fighters by Japan as well as the licensed
production of F-16 by Turkey exemplifies this
route. Lesser industrialised countries require
the seller to purchase sub-systems/ parts/ components
from the buyer country for incorporating in the
equipment under sale or establishing logistic
and maintenance support systems. Malaysia’s
demand for a high value of local content amounting
to 60% as well as establishment of an extensive
sub-contractor base as part of offsets in their
procurement contracts of Armoured vehicles and
Littoral Combat ship clearly demonstrates preference
for this route.
Indirect offsets on the other hand are not related
to the system/ equipment under procurement but
could consist of any of the accepted activities
in defence and/ or any other agreed sector. The
establishment of a sugar processing complex in
Saudi Arabia, oil facilities in the UAE and setting
up of air traffic control colleges in Oman are
examples of indirect offsets.
Offsets are driven by many reasons – to
develop indigenous defence industry, leap frog
technological backwardness, create job opportunities,
enhance educational, scientific and research capabilities,
promote SMEs and try to gain access to export
markets. The predominant stated purpose is attaining
self-reliance in defence but other underlying
compulsions include overcoming sanctions or denial
regimes in times of need, reduce dependence on
foreign OEMs through in-house availability of
spares and maintenance support.
Are Offsets good or bad?
The US government describes offsets as “economically
inefficient and trade distorting” and
does not encourage offsets. Transparency International
– Defence against Corruption feels that “offsets
are big business yet they are very opaque and
receive much less transparency and attention than
they should, given their susceptibility to high
corruption risk”.
It goes on to state that offsets improperly
influence the need for a defence acquisition,
influence the finalisation of main contract in
non transparent ways and allows favours to be
repaid to corrupt personnel via the offset contracts.
Whether offsets are good or bad depends on the
industrial capability of the country and its capacity
to leverage the buying power to obtain non-existent/
deficient technologies in the defence sector.
One of the best offset packages concerns South
Korea which not only obtained co-production rights
of the F-16 aircraft, but also enabled co-development
of KTX-2 advanced trainer with help from Lockheed
Martin. However, Indonesia’s attempt of creating
an indigenous military and civilian aircraft industry
reportedly crashed in the wake of the 1997 East
Asian financial crisis, and represents the other
side.
The costs of procurement contracts involving
offsets are always higher.
The fact that vested interests may resort to
foreign imports driven more by offsets rather
than actual needs make offsets susceptible to
corrupt practices. Further, the methodology adopted/
involved in valuation of technology transfer which
relies on approximations tends to question the
effectiveness of such transactions. Finally, there
is no clear system of ensuring complete discharge
of offsets to realise the full benefit of extra
costs which puts a question mark on their efficacy.
All these factors tend to make a case against
seeking or demanding offsets.
Therefore, to derive the intended benefits from
offsets, there must be a cost benefit analysis
to check their viability and that they actually
fulfil our needs/ requirements. Then there should
be an efficient and transparent process of valuation
as well as an effective implementation strategy.
Once these are ensured, there is every chance
of such offset requirements having a positive
effect and attainment of stated objectives.
Offsets in the Indian
context
India has been practicing offsets in an indirect
manner using licensed production under transfer
of technology (ToT). The official Offset policy
has been introduced in the Indian Defence Procurement
Procedure only in 2005. Many lament the fact that
it has not really made much difference to our
indigenous efforts. In order to make offsets credible,
the policy must have an overarching aim, measurable
objectives, simple and clear guidelines which
are easy to interpret and finally state upfront
one’s requirements with each and every offset
contract.
The present policy does not have any of these
principles and leaves it entirely to the seller
to decide what to offer as offsets. This, and
an absence of implementation strategy, are the
main reasons for not achieving any significant
gains through offsets so far.
So, if we want offsets to work there is a need
to state the aim and objectives, articulate clear
and unambiguous policy guidelines, provide adequate
avenues for both sides to benefit from offset
transactions, craft a well defined implementation
strategy to direct offsets in to areas of our
interest, make provisions for building long lasting
relationships, establish single point authority
and finally ensure ways and means of seeking upfront
what are needed through offsets.
We must also learn from other countries’
experience and must not attempt to develop the
entire range of defence industry. First and foremost,
we must carry out a mapping of the defence technologies
available/ deficient in the country. Thereafter,
efforts must be made to direct investments in
terms of technology and knowhow so as to develop
the manufacturing base whose output should adequately
cater to the needs of our Armed Forces.
This should be followed up with an endeavour
to build upon the knowledge acquired through enhanced
stress on R&D so as to develop indigenous
capabilities for the future requirements. There
are only a few countries which can afford to build
everything in their own country.
So instead of attempting complete self-reliance
across the board, we must target specific areas
that are of strategic importance and make all
out attempts to develop them.
Some Policy prescriptions
India is lagging way behind all the developed
countries in terms of technologies and their application
in defence.
Therefore, taking into account that industrial
participation holds the key to developing indigenous
defence industry, we must leverage our buying
power to ensure implementation of this crucial
aspect. FDI in defence as part of offsets must
be utilised to attract foreign manufacturers to
set up JVs/ subsidiaries in India.
Many of the reputed manufacturers are averse
to setting up industries in India due to issues
of management control as well as secrecy of technologies
involved. If we want to procure defence systems/
equipment involving critical/ dual use technologies
from sources within the country then we must create
the necessary environment for the same by enhancing
the present FDI cap of 26%, waiver of taxes etc.
for a certain period, assure procurements in case
the local content exceeds a certain percentage
and allow the foreign entity to retain management
control.
This will allow for the growth of connected ancillary
industry in the form of SMEs and added benefits
of quality and reliability of the products.
The threshold/quantum is the contract value at
which offsets become applicable and the percentage
denotes the level of obligation – both of
which play an important role in the offset policy
of a country.
There are countries which have as low a threshold
as $100,000 and those whose percentage is more
than 100% of the value of the contract. India
has one of the highest thresholds at around $65
million and one of the lowest percentages of 30%.
There is certainly a need to align our requirements
with the average values which correspond to around
$10 million and 70-80% of the contract value.
Further, everyone invariably states the required
percentage of obligations that need to be discharged
through direct and indirect offsets. Incorporating
such provisions not only helps in clarity in the
entire process but would also enable development
of the defence industry and technical infrastructure
at a faster pace.
Notably, when offsets were first introduced,
they were mainly targeted at direct purchase/
providing export avenues for defence goods and
services produced by the Indian industry.
However, the Indian defence industry which consisted
of Ordnance factories and DPSUs did not offer
adequate scope for discharge of the obligations.
Increasing the number of avenues for discharging
the offset obligations would enhance the chances
of enabling a vendor meet the requirements over
a wider spectrum. The present list of goods and
services relating to defence, civil aerospace
and internal security as eligible avenues can
certainly be enhanced to cover a wider range of
offset transactions.
Further, multipliers which indicate the need/
importance of a specific offset activity need
to be introduced in the policy to give it the
necessary direction for development of the indigenous
defence capabilities.
How to make offsets work
Banking of offsets is a good tool that can be
utilised to develop the defence industry through
proper channelling and coordination. Foreign manufacturers
must be incentivised to invest in Indian industry
or R&D, even without waiting for participation
in any particular contract.
This can be achieved by enabling build-up of
offset credits and even inter-OEM trade, limiting
that though to only those participating in various
defence acquisitions. Such tradable offset credits
could be utilised by the vendors to fulfil indirect
obligations completely thereby leaving only direct
offsets to be negotiated with each procurement
contract. The attendant benefits of this provision
include conclusion of procurement contracts without
being held hostage by offset requirements as well
as complete discharge of offset obligations without
resorting to penalties.
In order to build long term relationships to
boost the Indian defence industry through offsets,
we must allow realistic timelines for implementation
of offset obligations. Discharging offset obligations
is a time consuming and tedious process for a
vendor because he has to manage constraints like
time, finding competent partners and meeting deadlines
associated with the main contract.
There is a need to decouple the requirement of
discharging the offset obligations coterminous
with the main procurement contract by providing
longer timelines which should enable both sides
to discharge and accept obligations to mutual
advantage.
Multipliers are generally used to denote the
importance assigned to a particular transaction
due to its strategic value to the buyer. It also
indicates the enhanced value of a transaction
in terms of credit to the seller in relation to
the actual investment made.
A majority of countries use multipliers to acquire
technology and give enhanced credits for investments
in R&D. This has not been practiced by India
thus far and could be utilised judiciously to
develop important areas of industry, SMEs in particular,
and to obtain deficient technologies. In order
to discourage investments in already developed
sectors, such sectors/ activities should be deleted
from the approved list at regular intervals or
multiplier values less than one should be assigned
to them.
Import of equipment/ systems entails huge expenditure
and must be justified not only by their necessity
but also through optimal exploitation across their
lifecycle.
A drawback of imports is the dependence on the
vendor for logistic and maintenance support. Therefore,
when importing weapon systems/ equipment, direct
offsets should be used for development of local
industry to ensure uninterrupted availability
of spares as well as acquiring the technical infrastructure
and know-how for maintenance purposes. Efforts
should also be made to acquire technologies and
know-how to overcome the deficiencies/ voids in
the industry/ R&D so as to avoid recurrent
imports of the same or similar systems.
Boosting Indian R&D
Even after six decades of the establishment of
DRDO as well as a myriad DPSUs and Ordnance factories
in an endeavour to accomplish the objective of
self-reliance in defence, India is nowhere close
to equipping the Armed Forces with advanced indigenous
weapon system.
Huge sums of money have been spent in their creation
and great efforts have been made to build them
up with regular doses of transfer of technology
to undertake licensed production of major weapons
as well as platforms like T-72, T-90, MiG-21,
MiG-30, Jaguar etc. However, these entities have
neither been able to master the acquired technologies
nor proved themselves capable of building upon
the inducted technologies, thereby necessitating
ToT with every major acquisition.
Worse still, there has been no attempt to audit
and check the impact of the acquired ToT on our
industrial capabilities. We could learn from the
Westland Aircraft Company of UK which entered
the helicopter field through a licensed production
agreement with Sikorsky and went on to develop
its independent design and development capability
which enabled it to produce the Lynx as well as
the EH 101 Merlin helicopter all by itself.
So, in order to ensure that ToT contributes effectively
in enhancing our self-reliance endeavours, we
must acquire the relevant know-how for the development
of our defence industry and know-why for defence
R&D with each technology transfer.
There is an urgent need to enhance the R&D
capabilities of the industry and enable wider
participation of other S&T as well as academic
institutions in addressing our defence needs.
Assigning suitable multipliers to different categories
of technology transfer so as to make them economically
attractive and participation in collaborative
research projects would give a fillip to defence
R&D across the industry as well as DRDO.
Conclusion
Offsets may be costly in the initial stages but
can be turned into profitable activities with
correct application of one’s needs. It is
inevitable that the vendor builds in his additional
costs for discharging offset obligations.
The payment of such additional costs would be
justified only when we can (i) Enhance our manufacturing
capacities/ capabilities in defence industry;
(ii) Make progress in critical areas of R&D;
(iii) Encourage innovative solutions for optimal
exploitation, maintenance and modernisation of
systems/ equipment that are in service or under
procurement; (iv) Enhance awareness of defence
technology needs and the necessity of participation
of S&T institutions/ academia in the national
interest; (v) Minimize the differential between
imports and exports; and (vi) Procure majority
of defence equipment from Indian companies or
JVs with foreign OEMs.
It must also be borne in mind that mere requirement
of offsets without proper policy guidelines, objectives,
a good implementation strategy and a responsible
organisation representing single point accountability
would be more of a liability than an asset in
our quest for self-reliance.
We cannot expect to match the capabilities of
major developed nations unless we enunciate a
comprehensive strategy that strives to develop
various disciplines/ sectors in a time-bound manner.
We must identify those areas that are strategically
important from the view of denial regimes or sanctions
in times of war and aim to develop them in our
national interests. In all other sectors we must
not waste precious resources but procure the items
from competitive sources.
In order to sustain the developed industry we
may need to establish export markets by suitable
policy guidelines as well as political arrangements.
Finally, due consideration must be given to the
huge amounts of money expected to be spent over
the next 10 years in defence imports and efforts
made to plough back as much as possible into developing
our indigenous industry.
Brazilian Defence Minister Nelson Jobim says
it well: “Whatever the final contract, it
must be closely linked to national development,
to help advance in the creation of a strong defense
industry and therefore the technological edge
we are requesting.”
That is true for India too. Cmde S Govind is
presently serving in HQ-IDS.
The views expressed here
are personal do not reflect the official position
of the Ministry of Defence or this publication.
|
