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Offset dilution in defence, a flawed policy turn

Recently, the government diluted the “offset” policy in defence procurement, reportedly in response to a Comptroller and Auditor General (CAG) of India’s report tabled in Parliament last month. Many contend that the move is a setback for augmenting domestic capabilities or for realising the goal of Atmanirbhar Bharat. But why is it a setback for the goals under Atmanirbhar Bharat? The experience with the procedure in the aerospace industry since 2005 seems to offer useful lessons in redesigning defence offsets.

What is an offset policy? And how is it expected to boost domestic capabilities? What lessons can we draw from a similar system in the aerospace industry? These questions are addressed below.

Also read: Rafale vendors yet to confirm technology transfer under offsets: CAG

Offset ties up the ends

Most countries restrict trade in defence equipment and advanced technologies in order to safeguard national interest. Yet, for commercial gains and for global technological recognition, governments and firms do like to expand the trade. Negotiated bilateral sales between countries are a way out of the dilemma. Soft credit often sweetens the deals, with restrictions imposed on use, modification and resale of such equipment and technologies, to protect the proprietary knowledge and expertise embedded in them.

In such trade negotiations, the price of the product is one of the many other factors. Geopolitics and the technical knowhow involved in the equipment weigh-in considerably since the contracts are for the long term, with technological fixities. The product and technology compel buyers to stick to them for: the advantages of bulk purchase, and dependence on the supplier for spares and upgrades. In other words, there is considerable “path dependency” in such choices, rendering the decisions difficult to reverse.

Also read: Two-year residual life of 56 Mi-17s after ₹223-crore upgrade untenable: CAG

Developing country buyers often lack an industrial base and research and development (R&D) facilities (which take a long time to mature). The price and the terms of the contract often reflect the government’s relative bargaining strength and also domestic political and economic considerations.

Large buyers such as India seek to exercise their “buying power” to secure not just the lowest price. They also try to acquire the technology to upgrade domestic production and build R&D capabilities. The offset clause — used globally — is the instrument for securing these goals.

A number of changes

Initiated in 2005, the offset clause has a requirement of sourcing 30% of the value of the contract domestically; indigenisation of production in a strict time frame, and training Indian professionals in high-tech skills, for promoting domestic R&D. However, the policy has been tweaked many times since.

Also read: IAF bought uncertified engines at inflated prices in 2010: CAG

As of November 2019, as in a reply to a parliamentary question, the Defence Ministry had signed 52 offset contracts worth $12 billion via Indian offset partners, or domestic firms. The duration of these contracts extends up to 2022.

According to the recent CAG report mentioned above, between 2007 and 2018, the government reportedly signed 46 offset contracts worth ₹66,427 crore of investments. However, the realised investments were merely 8%, or worth ₹5,457 crore. Reportedly, technology transfer agreements in the offsets were not implemented, failing to accomplish the stated policy objective. We are unable to verify the claim as the government has not put in place an automatic monitoring system for offset contracts, as initially promised.

On September 28, the government has diluted this policy further. Henceforth, the offset clause will not be applicable to bilateral deals and deals with a single (monopoly) seller, to begin with.

Setback for defence

Most defence deals are bilateral (as stated above), or a single supplier deal (given the monopoly over the technology). The dilution means practically giving up the offset clause, sounding the death knell of India’s prospects for boosting defence production and technological self-reliance. The government, however, has defended the decision by claiming a cost advantage. It is a lamentable excuse for the reported policy failure. Price is but one of many factors in such deals, as explained above. The higher (upfront) cost of the agreement due to the offset clause would pay for itself by: reducing costs in the long term by indigenisation of production and the potential technology spill-overs for domestic industry. Hence, giving up the offset clause is undoubtedly a severe setback.

Shortlived in aerospace

The offset policy can, however, succeed, if it is designed and executed correctly, as a parallel episode in aerospace industry demonstrates. Despite the heft of Hindustan Aeronautics Limited, India is a lightweight in global civilian aircraft manufacturing, as the public sector giant mostly devotes itself to defence production. The much-touted National Civil Aircraft Development (NCAD) project — to come up with an indigenously designed Regional Transport Aircraft (RTA) — has remained a non-starter from day one.

However, with the introduction of the offset policy in 2005, things changed dramatically. For contracts valued at ₹300 crore or more, 30% of it will result in offsets, implemented through Indian offset partners. As aerospace imports rose rapidly, so did the exports via the offsets, by a whopping 544% in 2007, compared to the previous year. By 2014, exports increased to $6.7 billion from a paltry $62.5 million in 2005, according to the United Nations Comtrade Database. The offset clause enabled India to join the league of the world’s top 10 aerospace exporters; the only country without a major domestic aerospace firm. The success was short-lived, however. Exports plummeted after the offset clause was relaxed, primarily when the threshold for the policy was raised from the hitherto ₹300 crore to ₹2000 crore, in 2016. The offset exports fell to $1.5 billion by 2019. The 2005 policy helped promote a vibrant aerospace cluster, mostly micro, small and medium enterprises (MSMEs) around Bengaluru. The policy dilution undid success. The moral of the story is there for everyone to see.

Aiding self-reliance

Reportedly because of the CAG’s critical remarks in its latest report tabled in the Parliament, the government has virtually scrapped the defence offset policy. Thus, India has voluntarily given up a powerful instrument of bargaining to acquire scarce advanced technology — a system that large and politically ambitious nations seek to exercise. There are successful examples to draw lessons from, as the aerospace industry episode demonstrates. India needs to re-conceive or re-imagine the offset clause in defence contracts with stricter enforcement of the deals, in national interest, and in order to aim for ‘Atma Nirbhar Bharat Abhiyaan’, or a self-reliant India.

Sunil Mani is Director, Centre for Development Studies, Thiruvananthapuram. R Nagaraj is Professor (retired), Indira Gandhi Institute of Development Research, Mumbai. The views expressed are personal

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Printable version | Dec 3, 2020 4:30:04 PM | https://www.thehindu.com/opinion/lead/offset-dilution-in-defence-a-flawed-policy-turn/article32903639.ece

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