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Business of Offsets by Kamaljit Singh Jassal
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Business of Offsets by Kamaljit Singh Jassal

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Indian Defence Procurement, Offsets, Investment Decisions

Indian Defence Procurement, Offsets, Investment Decisions

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  • 1. 1 jassalnavy@hotmail.com BUSIENSS OF OFFSETS – INDIAN DEFENCE PROCUREMENT 1. Indian Defence Procurement has been evolving over the last two decades. Offsets in Defence were introduced in DPP 2006 (DPP- Defence Procurement Procedure). World over Offsets in Defence Procurement are considered. They vary from types and to extent while they adhere to the core principle of counter trade or offsetting the trade. 2. Why Offsets? Offsets per say are not part of the main procurement of defence item under consideration. On the contrary, it has an economy motive behind it. Buyer country opines that while buying defence item under consideration, there is not just outflow of funds (generally international trade is done in US Dollar or Euro reference) to the seller country but also jobs are created, capability and capacities created in the sellers country. This needs to be absorbed by doing the counter trade ie seller country OEM/ vendors buys some items from the host (buyer country) some items (where the host country may have the capability or otherwise invests in some capability in the host country to create additional capacities wherein the produce of such company can be bought back). This additional buying by the seller (guest) country creates some business opportunities wherein the people get employed and in international trade terms, outflow of US Dollars or Euros is offset-ed. 3. Defence Offsets. Largely, Defence Offsets in their types are defined as either Direct Offsets or Indirect Offsets. In the case of Direct Offsets, trade exchange or investments by the seller country is made into defence projects or more so into the relevant procurement under consideration. In the case of Indirect Offset, seller country may discharge its obligation by buying or making investment into a totally different field. This could be in the form of buying coconuts or fruit chocolate or spices by the seller country or it could be in the form of building schools, public toilets or highways in the buyer country. Volume of discharge of offsets, as a public policy, is enshrined in the procurement procedures. This volume ranges from 30% to 50% to 100% to 200% of the procurement costs of the main Defence item under consideration. 4. Offsets - Accumulation. Ever since the offsets were introduced, there is piling up of offsets to be discharged while the quantity discharged is less. In year 2010, it was indicated that offsets worth Rs 55 Thousand crores were pending for signed contracts while offsets worth Rs 15 thousand crores were being discharged. In 2014, volume of offsets pending to be discharged has risen to 85 thousand crores for the signed contract (MMRCA contract is not signed yet) while discharged offsets volume is around 20 thousand crores. It is assumed that another Rs 15 thousand crores offsets are being discharged. Currently, offsets discharging wing called DOMW (Defence Offsets Management Wing) is streamlining not just the approval process but also is
  • 2. 2 jassalnavy@hotmail.com looking into quality of discharging, monitoring, review etc. By 2015, after DOMW organises certain macro data on offsets, we could undertake a survey to understand the effect of offsets, quality of offsets discharged, offsets – pros & cons etc. 5. Want to Discharge Offsets. This part would be interesting for the foreign OEMs or vendors who are either planning to discharge offsets or have concluded the main contract but are in the process of discharging the offsets for the amount signed. Before we proceed any further it has to be noted that Indian MoD has stopped discharging of offsets into ‘Services’. This has been due to fallout of offsets discharging in VVIP chopper Augusta- Westland deal. In the mentioned case, as also in other offsets being proposed to MoD, valuation of offsets in Software services was becoming difficult. It is well known that certain models (say COCOMA model) do exist to value the software services in offsets but it is increasing becoming difficult to benchmark or price negotiate the offsets contract under the scheme of things. 6. As per MoD guidelines, offsets can be discharged under following:- a. Direct purchase of, or, executing export orders for, eligible products manufactured by, or services provided by Indian enterprises, i.e. Defence Public Sector Undertakings, Ordnance Factory Board and private and public sector Indian enterprises. The list of products and services eligible for discharge of offset obligations is available. b. Foreign Direct Investment in joint ventures with Indian enterprises (equity investment) for the manufacture and/or maintenance of eligible products and provision of eligible services. Such investment would be subject to the guidelines/licensing requirements stipulated by the Department of Industrial Policy and Promotion. c. Investment in ‘kind’ in terms of transfer of technology (TOT) to Indian enterprises for the manufacture and/or maintenance of eligible products and provision of eligible services. This could be through joint ventures or through the non-equity route for co-production, co- development and production or licensed production of eligible products and eligible services. The investment in kind in terms of TOT must cover all documentation, training and consultancy required for full TOT (civil infrastructure and equipment is excluded). The TOT should be provided without licence fee and there should be no restriction on domestic production, sale or export. d. Investment in ‘kind’ in Indian enterprises in terms of provision of equipment through the non-equity route for the manufacture and/or maintenance of eligible products and provision of eligible services (excluding TOT, civil infrastructure and second hand equipment). e. Provision of equipment and/or TOT to Government institutions and establishments engaged in the manufacture and/or maintenance of eligible products and provision of eligible services, including DRDO (as distinct from Indian enterprises). This will include augmenting capacity
  • 3. 3 jassalnavy@hotmail.com for Research, Design and Development, Training and Education but exclude civil infrastructure. f. Technology Acquisition by the Defence Research and Development Organization in areas of high technology. 7. Doing Business in Offsets. Clearly, for discharging offsets, an Indian Offset Partner (IOP) is required. This IOP could be in the form of private entity or a DPSU/ PSU, though other form of discharging to an organisation (R&D, Defence repair/ maintenance organisation etc) also exists. This IOP could be in the form of an independent existing business entity or a JV (Para 6(b) above refers). Selection of IOP is totally the independent decision of the foreign OEM and this decision should be done wisely as success of this selection helps in not discharging the existing offsets contract but a long term strategic dividends can be reaped out if it. Hence, it is must that seeds should be sown in this properly. At the face of it, many readers may argue that discharging of the offsets is a mandatory obligation (obviously against the will of the OEMs/ vendors) and hence why should place something more in it. It is here that professional business acumen takes over. Clearly, there is no escaping from the offsets. Either we directly buy back the items which are listed in Para 6(a) (which may be a good proposition if you can use them or market them) or the better option is to invest in offsets through IOP and enlarge the business stream and scope. 8. Strategic Offsets Investment. Strategic investment in offsets starts from the process of selection of IOP. In my tenure of examining offsets proposals, I have come across many foreign OEMs coming back for change of IOP as they found the either not co-operating or unfit in the business/ technology absorption side. Many OEMs feel that bigger business houses are too rigid for doing the business and look for more gains than a win-win situation. Most of the OEMs are happy in discharging the offsets to MSME but they are blind to their performance as in India credit rating for the MSMEs are not available. From the data available or by physical visits, foreign OEMs try to gauge the ability or performance of the MSME for being a IOP. It is as good as traditional Indian marriage wherein the boy and the girl side are less informed of who’s who or real positioning (mental/ physical etc). Like all the holy marriages, this mandated OEM-IOP offsets marriage also happens. 9. Part Manufacturing/ Services. Once if it has been planned that instead of buying back an existing product, advantage would be taken of an existing manufacturing or services capability which can be bit tweaked to manufacture the product or deliver a service of their choice, it is best bet because then not only the offsets are being delivered for the existing product but such a manufacturer could become part of the global supply chain of this equipment. It can be safely assumed that considering the low cost heads and fairly skilled technical competence of Indian manufacturers, such a product would be match winner in the global supply chain.
  • 4. 4 jassalnavy@hotmail.com 10. Issues. Many OEMs/ Vendors who come to me ask queries on larger format of the management. For them, I would say that they should note following while making their investment decisions: a. FDI. As of now, under the DIPP riles, only 26% FDI (Foreign Direct Investment) is permitted into Indian ventures. However a case exists for staking up the FDI upto 49% or more but then technology- benefit analysis have to be put up for same. b. FII. Till date, there was no limitation on the extent of investment by FIIs but soon it is going to be limited to 26% in line with FDI. c. Control. Debate is on in India as to what all constitutes control of the company. New company’s act 2013 has come out and is yet to be put to judicial scrutiny. It would be safe to say that key direct management positions like CEO, CFO, MD etc should be in the hand of Indians d. TP & Royalty. Issues of Transfer pricing where in a part manufacturing is done in India, taxes would have to be paid in India for the value addition work done in India. In the royalty case, it is admissible to pay the royalty as per contractual obligations or as listed in MoU or Articles of association. 11. There are many issues wherein smooth handling of Offsets is required. Commercial arm is just one arm while Technical issues (what kind & type), finding a suitable IOP, Monitoring & correct legal discharge of offsets call for closer scrutiny for a successful offset programme. When all such external (OEM based) parameters mesh with indigenous scenario a global supply chain & sustainable production is ensured. About the Author: Kamaljit Singh Jassal is a formal Naval Commander and Capital Acqusition expert. He retired as Joint Director from MoD/ HQ IDS after 22 yrs of service. The officer was involved in formulation of Long Term Integrated Perspective Plan [LTIPP] 2012-27, revised Offsets Policy, 12th Defence Plan, 12th Defence Manufacturing Plan etc. He has examined around 450 Capital acquisition proposals of tri-services and numerous offsets and offsets banking proposals. Currently, he is working as Country Manager with a US MNC. Detailed profile can be seen at Linkedin.

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