by G Mohan Kumar (Former Defence Secretary)

The recent review report of the CAG on defence offsets highlights the inability of the ministry of defence (MoD) to leverage its huge buying power to enable the domestic defence industry to acquire cutting edge technologies, which are so critical for achieving self-reliance. It also points to the fact that the costs the country has had to incur in making offsets a part of high-value defence contracts have given the country poor returns. The defence offset policy seeks to leverage capital acquisitions to develop the Indian defence industry.

Offsets are applicable when the estimated cost of acquisition is Rs 2,000 crore or more (Rs 300 crore till 2015). It requires foreign and Indian vendors of certain category to buy components from Indian manufacturers or invest in Indian enterprises in the form of equity or transfer of technology (ToT) or equipment, provide equipment or ToT to government institutions or establishments or to DRDO to the extent of 30% of the estimated contract value. Offsets have to be discharged annually during the contract period with extension up to two years. The CAG found that out of the offsets worth Rs 19,223 crore due for discharge by 2018, only 59% (Rs 11,396 crore) had been discharged, leaving a large gap of 41%. Only half of these discharged claims have been finally accepted by the MoD, leaving a large gap of nearly Rs 6,000 crore. The rate of annual discharge was a measly Rs 1,300 crore, making one wonder as to the fate of offsets worth Rs 55,000 crore to be discharged by 2024. These bleak figures are indicative of a host of problems that plague offsets management and the consequent deprivation of the domestic defence industry of great opportunities to acquire technologies. Only when we see the great strides a country like South Korea has made in its defence industry utilising offsets do we realise what India has lost by unprofessional management of offsets.

Although some leading Indian companies have benefited from offsets and are able to manufacture for some well known US companies like Boeing and Lockheed Martin, the profile of the products supplied does not inspire confidence in the efficacy of offsets in accessing cutting edge technology. The manufacturing portfolio includes empennage for aircraft, fuselages, crowns, tail-cones, ramp, pylons, gun bay doors for helicopters, and the like, which, from the suppliers’ point of view, are ‘safe’ components, which do not involve cutting edge technology. This is confirmed by the CAG’s report, according which there is no instance of any foreign vendor having transferred high technology. There are no instance of offsets being instrumental in transferring knowhow for critical systems like avionics, jet engine technology or even communications. The effort of the DRDO in acquiring some key technologies from French companies for its long-forgotten Kaveri engine utilising the huge Rafale offsets has not yet borne fruit.

Offsets are not free lunch given by the vendors. They are generally regarded as an unwelcome appendage of the main contract. It is well known that the vendors pad their bids by 10-15 % if they have an offset obligation. Therefore if offsets are not discharged at all or discharged partially, there is double jeopardy—of losing both money and production capability in the country. India’s huge buying power as one of the largest importers of defence equipment in the world is often wasted by our dismal failure to leverage this buying power to seek cutting edge technology. The way China has arm-twisted western investors to part with technology as a price for doing business with it is well known.

Apart from procedural rigidities, the administration of offsets at the MoD is at best a book-keeping exercise with the sole objective of tallying the figures reported by the vendor with the contract. The MoD simply does not have a system to actively oversee domestic manufacturing resulting from offsets. It does not have a strategy or road map for capability building using offsets by pro-actively engaging with the private sector and the vendors. There is simply no manpower available with the MoD to do this. Above all, the MoD’s defence acquisition system is altogether devoid of credible machinery to convert huge defence buying to an engine of growth for the domestic private industry as the bureaucracy has no stomach for working with the private industry, which is considered a near taboo.

Even the punitive provisions of the offset contracts are not stringent enough. A defaulting vendor can get away with a paltry penalty of 5% of the annual offset value subject to a cap of 20% of the offset obligations of the entire contact. It is necessary to lay down a fresh vision for offsets and make stringent punitive provision for failure to discharge offset obligations. The penalties have to be increased substantially to ensure that the vendor cannot afford to treat offsets in a cavalier manner. Offset policy on defence electronics where India has considerable strength needs to be re-imagined. The armed forces have to play a pivotal role. A comprehensive review of the entire policy is necessary to make offsets function as the prime mover of defence manufacturing in the country unless the present thrust on self-reliance makes offsets themselves redundant.