The concept of offset, as understood in the defence sector, primarily aims to benefit a buyer over and above the procurement of the defence product from a foreign supplier. Historically, most developing countries have always had provisions of offset in their defence procurement policies. Such procurements involve a substantial amount of public money and offsets allow for repatriation of some of these monies (through sub-contracting or other indirect means) back into the economy of the purchasing country through discharge of offset obligations by the seller.
While offsets policies may have various objectives–helping the domestic industry with works contracts (thus creating jobs) and to absorb complicated technology into the country remains the primary objective of most nations. Similarly, primary objective of India’s offset policy, since it’s introduction in 2005, has been to reduce imports and promote self-reliance in defence manufacturing. However, 13 years later, India continues to be a highly import-dependent nation for its military equipment requirements.
When considering the factors for the limited traction on offsets, it can be argued that the issue has not been with the policy making, but the implementation. To be sure, the Government of India has frequently tweaked and revised offsets policies to address industry’s concerns and accordingly, has given a boost to MSME sector, introduced change norms of changing Indian offset partners (IOP), increasing FDI limits to 49%, clearly defining the value addition norms, among many others similar initiatives which have been welcomed by all the stakeholders. Despite all these measures, the fundamental bottleneck has been the lack of modern technology possessed by our DPSUs, Indian private companies and MSMEs, which essentially restricts companies from effectively applying the transferred technology to their own manufacturing processes and, as a result, restricts the ability of foreign original equipment manufacturer (OEMs) from effectively discharging their offsets through this method, in a cost-effective manner.
Additionally, regulatory and operational challenges in India add to the headwinds faced by foreign OEMs while implementing offsets .
While countries such as Israel, Japan, Spain have had a very fruitful implementation of their offsets policies, a ‘one size fits all’ approach may not work for any country and certainly not for India. The country has different challenges and we need to find a balance between what we can offer to the foreigner manufacturers and what we would like to get in return.
To this end, the government of India has proposed draft amendments to the offsets policy which are a significant departure from the traditional ways of detailing offsets and are discussed below.
‘Out-of-the-box thinking’ proposal by the government of India
The government has introduced, in May 2018, a draft amendment to its offset guidelines which provides additional ways in which the foreign OEMs can discharge their obligations and at even higher multipliers. Besides the traditional forms of direct and indirect offset discharge avenues, this amendment also provides for investment in defence industry corridors, which will enable the setting up of defence production facilities, as well as SEBI regulated funds which can be used for the discharge of offset obligations, at high multipliers.
Investment in equity in a defence company
The policy proposes to open up any investment in equity in defence sector by a foreign OEM as an avenue for discharge of obligations. While entering JVs has been one of favourite means for foreign OEMs to invest in technology transfer and creation of capacity in the country, a recent data point quoted by minister of state for defence stated that since year 2000, only $5.13 million worth of FDI has been received under 41 proposals for FDI/JVs that are approved. This clearly reflects the preference foreign OEMs have to form JVs, but the actual investment under the JVs is paltry implying no technology transfer or capability creation. However, this new avenue for discharge of offsets acts an added incentive to increase the actual inflow of FDI, provided other operational requirements can be ironed out. If the government proposal of increasing the FDI limits for defence to 74% is indeed approved, this will be the most attractive avenue for discharge of offsets in a long-term perspective.
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