A lot of players have already made significant investment in this space, and the same is on the drawing board strategy for a large number of other industry participants. It is in the interest of the sector and its long-term growth that MoD reconsiders the impact of a dwindling offset market on the Indian industry.

With a more inward-looking DAP 2020 based on the cornerstone of indigenisation, GoI seems to be phasing out offsets.

With the three-day Aero India 2021 on in Bangalore from February 3, the discussion about India’s defence prowess has been brought to the fore of public conversation once again. Offsets have always been a key tool of the defence policy. Through it, an original equipment manufacturer (OEM) is obligated to invest a certain percentage of the contract (upwards of 30%) into India towards exports, R&D, or manufacturing.

Since offset has been one of the most ambitious but controversial topics in defence policy, it was expected that the offset policy under the Defence Acquisition Procedure 2020 (DAP 2020) would bring in much-needed changes in guidelines. Rationalisation of offset policy was a reasonable expectation from DAP 2020. Considering DAP 2020 is likely to administer contracts with an aggregate value close to $60-70 billion of capital procurement, a workable offset procedure was all the more relevant.

Through DAP 2020, an exemption from offsets has been extended to all procurement contracts which have been from the beginning single vendor cases (SVCs), including government-to-government (G-to-G) contracts. Therefore, all ab-initio SVCs -- those not just covered under inter-governmental agreements (IGAs) but also under direct contracts with OEMs shall no longer be subject to offset regulations.

This development is likely to have a substantial impact on future offset requirements that majorly emanated from G-to-G contracts. If one were to size future offsets in India on the basis of DAP 2020, one would definitely chart a downward trajectory. The reduction is further heightened by the fact that future Indian tendering shall have an indigenous content (IC) requirement instead of an offset requirement as DAP 2020 shifts its focus to indigenisation.

Where technology is proposed to be transferred for discharging offsets, a third-party valuation from recognised and certified valuation firms shall be submitted, and the quantum of offset credits granted to OEMs be based on such valuation. This is a good move. Earlier, many OEMs struggled to estimate the accurate value of offsets under the earlier methodology (10% mechanism based on subsequent sourcing).

Given the past experience, however, on valuation related issues around transfer of technology (ToT), one can only hope that this shall not be marred by delays and disputes over valuation.

Earlier policies restricted offset discharge only to specified legal entity of the OEM and its Tier 1 on the platform. DAP 2020 permits ‘entities other vendor/Tier 1 sub vendor’ to discharge offset obligations on behalf of the OEM in selected avenues of offset discharge. This shall allow the OEM to leverage entities beyond itself and Tier 1 vendors to discharge offsets in India.

With a more inward-looking DAP 2020 based on the cornerstone of indigenisation, GoI seems to be phasing out offsets. This is evident in the significantly reduced scope of offset applicability. Even in cases where offsets are triggered, the avenues for discharging them have been reduced. GoI has introduced various deterrents, such as the abolition of services and exclusion of civil aviation and homeland security products for generation of offsets in future contracts. Importantly, these changes are prospective and pending offset obligations through the 52 offset contracts signed by the ministry of defence (MoD) till date shall continue to be governed by the old offset policy. Offsets of about $9.79 billion fall under this category.

Offset banking, a key driver for Tier-1 vendors/OEMs to invest and source from India, has been abolished as well. Banking of credits yielded a perpetual order book to Indian companies resultantly meeting economies of scale. With the abolishment of offset banking, Tier-1 vendors/OEMs seem to be disincentivised to set up large-scale investment or sourcing from India, only to comply with a one-time and time-barred obligation.

A lot of players have already made significant investment in this space, and the same is on the drawing board strategy for a large number of other industry participants. It is in the interest of the sector and its long-term growth that MoD reconsiders the impact of a dwindling offset market on the Indian industry.