Indian Defence Procurement, Offsets, Investment Decisions

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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

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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

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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.

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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.