A key financial tool that encourages indigenous manufacture in the defence sector was removed in the new Defence Acquisition Procedure (DAP), 2020. Henceforth, in the case of Government-to-Government (G2G) or Inter-Government Agreements (IGA) or ab-initio single vendor situations, the vendor would not have to discharge any offset obligation.

That India has the dubious distinction of being the world’s second-biggest importer of military hardware, only behind Saudi Arabia, is well known. To neutralise this, the defence offset policy, first made in 2005, introduced an ‘offset’ clause for foreign companies that won defence deals. They would need to invest a part of the contract value in the country, thereby developing skills, bringing in technology and generating employment in India. The offset obligation was meant to boost India’s domestic defence industry and help the country gain in terms of technology.

Since the last 15 years, this offset policy partially compensated for the huge outflow of India’s resources, facilitated induction of technology and added capabilities and capacities to domestic industry whenever the foreign supplier made reverse purchases of Indian goods, invested in local industry or in India’s R&D. This is not unique to India, most defence buyers the world over leverage their buying power by contracting a vendor to discharge offset obligations to augment the purchasing country’s capacity for research, design and development of military products and services and even of aerospace and internal security industries.

The foreign vendor has multiple avenues to fulfil his offset obligations. The supplier may directly buy eligible products or services from an Indian enterprise, bring in FDI in joint ventures with Indian enterprises, invest in providing transfer of technology (TOT) to Indian enterprises, or assist in technology acquisition by the Defence Research and Development Organisation (DRDO) in areas of high technology. The Defence Procurement Procedure also provides for offset banking and multipliers. The vendor could bank “offset credits” or take an MSME unit as an “Indian Offset Partner” and get his credit multiplied by 1.5 times or even up to four times where DRDO is the beneficiary.

So, why did the government remove this obligation for G2G, IGA and single vendor categories? The government belatedly discovered that vendors would load the contract with an extra cost to pay for the offset obligation. Further, “administrative costs” had to be incurred in implementing the offset obligations. Furthermore, the CAG has criticized the failure to implement the offset policy. Apparently only 59% of the offset obligations had been discharged by the target dates, and there was little hope of other obligations being met by the contracted date. Apparently, foreign vendors made offset commitments to qualify for the supply contract but were never really earnest about fulfilling their commitments.

Offsets are, unfortunately, made for controversy – they allegedly distort trade, are non-transparent and riddled with corruption. Nevertheless, they are increasingly adopted in defence purchases. The offset clause in the contract for the 36 Rafale fighter jets, an IGA, for example, was signed between the Indian and French governments in 2016, with 50% of contract value to be offset and executed by the French company Dassault Aviation and its partners. Political controversy arose over their choice of the main Indian Offset Partner and the non-transparent arrangements for the discharge of offset obligations. Waivers with respect to arbitration and access to books of accounts of the industrial suppliers were sanctioned at the highest level. Obligations were heavily loaded on to the last two years of a seven-year period. 

Despite these concessions, Dassault Aviation and missile-maker MBDA have not progressed on transfer of technology to DRDO under the offset clause. Of the new technologies desired by DRDO and to be obtained from the firms under the offset obligations, the vendors did not agree to transfer a majority of them, claiming that they were not within the vendor’s core competence.

A country with a huge military hardware requirement needs offset policies to empower the Indian domestic industry and through the “Make in India” initiative, to turn India’s defence production clusters into global manufacturing hubs. If offset clauses result in controversy or the vendor is lax, or an auditor criticises the performance of the policy, the logical solution for defence ministry mandarins is to demonstrate intellectual heft, universalise credit multipliers, give additional incentives for offset discharge, even use the Ministry of External Affairs to convince the foreign government concerned to make G2G concessions. It is very naïve to remove the offset clause itself and expect a vendor to reduce costs! Hopefully, this will not be a prelude to further dilutions of offset obligations for other categories of defence deals as well.

An offset clause serves the purposes of boosting India’s defence manufacturing ecosystem, providing technological inputs and contributing to uplifting the country’s private defence industry, DRDO, defence PSUs and the Ordnance Factories. Isn’t this critical to ushering in Atmanirbhar Bharat?