An offset by definition is a provision in an import agreement (say, a defence procurement deal) between the seller (an original equipment manufacturer/OEM) and the buyer, wherein the former agrees to undertake activities that satisfy the “second objective” of the buyer.
While the primary objective of the buyer is to procure the goods and services pertaining to the ‘core transaction’, the second objective is seen as an “additional benefit” which the buyer ‘extracts’ from the seller for awarding him the ‘core transaction contract’. In other words, the buyer agrees to service the second objective for winning the main contract.
In typical defence procurement deals, offsets may take different forms. Some of these may include supply of additional goods and services in addition to the main equipment at no extra cost, supply of simulators, training equipment, packages for technical and on-the-job training, transfer of certain technology, setting up infrastructure for overhaul and refurbishment, provision of additional spare packages/ life-time guarantee of spares, buy-back clause/or offer for export to seller’s clients for the output produced by the buyer (where co-development and co-production is involved), etc.
Revised Guidelines
In 2012, the Ministry of Defence (MoD) constituted a study group under Director General Acquisition (DGA) for carrying out a comprehensive revision of the offset guidelines. The report, duly approved by the MoD, found a place in DPP 2013. (The author has had the honour of being a Service representative on the said study group.)
The difference in opinion between the acquisition wing and the Department of Defence Production (DDP) regarding the primacy position in the offset milieu came to the fore. Ultimately, a position of duality between these two in negotiating of offsets and discharge thereof, respectively found its place in the guidelines. The discussion also included many contours related to the complex issues of the transfer of technology (ToT), multipliers, offset banking credits and more. After months of debate, the guidelines emerged.
Unfortunately, even with the guidelines in place, the offsets did not get the type of traction that was expected. As of March 2016, when the new DPP was announced, some 28 offsets contracts stood signed worth $6 billion and another 43 contracts worth $ 6 billion-7 billion were in the pipeline. Over time, the OEMs found a sort of rigidity in the guidelines as regards the Indian offset partners (IOPs). Another problem was, that if the initial selection went faulty, changing of IOPs down the line became a near impossible issue.
On the home front, with the slow but steady growth of the defence private industry, the face of IOPs itself was in flux as they were mostly on a growing and learning path. In this situation, it would have been ideal if the OEMs were given the chance of firming up on the IOPs as late as possible down the procurement chain thus allowing them ample time to grow and mature.
With the above requirements showing up, the MoD came up with two amendments in the offset guidelines in 2016. Some details about these amendments have been attempted.
The vendors could now have the option to submit detailed offset proposals at a later stage, thereby allowing them to finalise a more realistic offset offer. A vendor could finalise its IOPs and offset product details either at the time of seeking offset credits or one year prior to the intended offset discharge whichever was earlier.
The amendment also provided adequate flexibility in the post-contract stage. Also a standard operating procedure was introduced allowing addressing of supplier’s requests to change the IOP or their offset component as per requirement during the period of the contract. However, the overall value of the offset obligation was to remain the same. This amendment was to apply not only to DPP 2013, but earlier DPPs as well.
The second amendment related to reducing the offset trigger for Indian companies participating in ‘Buy (Global)’ Tenders. Earlier, the Indian vendors participating in ‘Buy (Global)’ category procurements were required to discharge offset obligation on the foreign exchange component of the contract if the indigenous content (by value) in the product was less than 50 per cent. This threshold was reduced to 30 per cent – the offset obligations would not be attracted if the indigenous content in the product was 30 per cent or more. With the Indian vendors now at par with the foreign OEMs in terms of fulfilling offset obligations, this was likely to pave the way for greater participation of the Indian companies in ‘Buy (Global)’ tenders. Both the above amendments were steps in the positive direction.
Further Changes
Moving boldly ahead of the above two amendments, DPP 2016 made some fundamental changes in the applicability norms of the offsets. The most important among these was the significant enhancement in the threshold of the cost at which the offsets became applicable. In this, the Offset clause was only be attracted where the indicative cost of acquisition is Rs 2,000 crore or more. This was a sea change from the earlier limit of applicability pegged at Rs 300 crore. Second, several other fields for discharge of offsets were identified.
Another very important provision built in the new Defence offset guidelines was the waiver clause. As per this provision (Clause 2.3) the Defence Acquisition Council (DAC) could consider partial or full waiver of the offset clause (for any reason whatsoever). This optionally adaptable route was to provide an institutionalised exit route from the offset regime if conditions of operational expediency so demanded. In any case, offset was not to be applied in cases of Fast Track Procedure (FTP) and while exercising Option Clause of a previously signed Contract if the original Contract was not having any offset stipulation (Clause 2.5)
Challenges As of Now
With the “offset world” as enumerated above what are the emerging challenges? A user’s take is as under:
Colonel K.V. Kuber, a well-known expert in defence procurement, while speaking at the PHD Chambers on 14 March, gave a call for building a society of MSMEs to portray a consolidated voice. The author’s call is for a consolidated voice of IOPs. This could be a subset arrangement out of the MSME Society itself since most of the IOPs belong to the MSME class.
And finally, there is an urgent need to correct one fundamental rule: The duality of control between DGA and DG Defence Production, wherein, the former is responsible to execute the offset contract while the latter is to ensure its discharge in the run time to follow. This duality, which could not be resolved during the last study on offset guidelines sits at the base of all confusion, delay and sub-optimality is contracting and executing offset contracts.
While the permanent solution lies in evolving a new lean, mean and smart Defence Procurement Organisation (DPO), correction of the above anomaly now (without waiting for the DPO to happen) will do a lot of good to offset business in near term.
The writer is a former Director General, Corps of Army Air Defence, Indian Army; Distinguished Fellow, Vivekananda International Foundation; Member, DIPM, Senior Adviser, GOPIO, NCR Chapter and Project Director, Project Gift Hopes
Evolution of the Offset Regime
The offset regime started way back in 2005 when it found a place in the Defence Procurement Procedure (DPP) 2005. For many years following this, offsets essentially remained a non-starter on nearly all fronts.
A period of seven years of inaction and slow progress unfolded and over this period of time, it was realised that not only the offsets were not happening, the policy guidelines itself were devoid of many of the contemporary and going features in the offset domain (as were prevalent in many countries), for example, the incentives, multipliers, ToT provisions diversities in discharge fields and more.
Also, over these seven years, the Indian private defence industry gained more traction and additional muscle, inching itself closure to a state where it was ready to play the role of IOPs in a better manner. The old offset guidelines were now a mismatch to the then current realities.
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