What is to be done with India’s defence offset policy!
The Economic Times, August 26, 2022

By Pradeep S. Mehta and Sandra George

Recently, the Minister of State for Defence Ajay Bhatt’s reply to John Brittas in Rajya Sabha, on the lapse in Offset Obligation, signals the need for a new outlook on India’s defence offset policy. As per the statement, vendors have lapsed on offset obligation in 21 contracts in the last five years. The lapse amounts to a whopping US$2.24bn as of 31st December 2021. Can we use this amount productively? Yes, we can, but it needs a whole of government approach. Many other countries have done it easily.

Over the years, CAG’s (Comptroller and Audit General) audit reports on the procurements indicate an under-realisation of offset benefits; zero-value additions; invalid selection of Indian Offset Partners; delay at different stages from contract to delivery; poor monitoring and supervision. Similarly, according to IDSA’s (Institute for Defence Studies and Analysis) study, one of the observations made was that the offset policy had minimal impact on the defence industry, especially in the Transfer of Technology areas.

In this scenario, it is imperative to raise this question, how effective is our offset policy? What is the global experience of offset policy? What can India learn from international offset policies? Globally, more than 130 countries have an offset policy. The lack of publicly available data on
Further, contestations over offset policy often use specific case studies to argue for or against it. First, most economists argue that offsets have a little positive impact on economic development. The second category argues it is a ‘free lunch’. The third group claims that a compound annual growth or cumulative benefit flows from the offset policy.
In this vein, perhaps, one of the criteria for analysing the success of any policy is drawing a comparison between the objectives of a policy and its outcomes. Often there are three main objectives for which any country adopts offset policy, i.e., economic development, technology transfer, and industrial benefit.

In the case of India, provisions on offset were included for the first time in Defence Procurement Procedure (DPP) 2005. Since then, the offset policy has undergone significant revisions. The latest was two years back when the Defence Acquisition Procedure 2020 (DAP 2020) was promulgated. Broadly, the evolution includes articulated objectives of offset policy; broadened avenues for the discharge of the offset obligations; streamlined applicability of offset; refined mechanisms of implementation and monitoring; flexibility for vendors to plan offset activity; and incorporation of multipliers. Despite periodic reformulation of the offset policy, it seems to have multiple shortcomings.

Conversely, it is essential to distinguish between the two poles of the offset policy, one at the objective and the other at the implementation side. As the former shapes the latter, India’s offset policy needs to rethink the policy’s objectives to facilitate innovation-based transformation. Perhaps, the offset policy needs to aim at a new National Offset Policy (NOP), which would target overall economic development and industrial benefit.

An analysis of the objectives of the offset policy of countries like Canada, Saudi Arabia, Brazil, Israel and Japan in contrast to their outcomes would be helpful here. Canada adopted its offset policy, realising an absence of a large defence industrial base. Similarly, Japanese industries post-World War were in a complete overhaul. Today, India has a similar need: predicament to harp spinoff effects from defence industrial base to other sectors.

Most of the offset models, be it Canada, Japan, Saudi Arabia, Israel, Spain or Brazil, all had similar or identical conditions when they adopted an offset policy. This is the objective of national security, which forms the core of the offset policy. They were often phrased in different notations of self-sufficiency or indigenisation in the respective country’s defence sector. Also, the objectives of offset policy in these respective countries were shaped in response to the conditions of its economy, i.e., focusing on a factor other than the defence sector requirement.

Another commonality is the significance of the relationship with the US. Canada and Japan benefited from a close relation to the US in acquiring transfer of technology through offset and emerging as a strong defence industrial base. High-income countries always benefit from technological innovation and the development of cutting-edge technology. The US is a powerhouse of innovation, especially in the defence sector. Today, Canada and Japan are strong contenders for the US in supply to Original Equipment Manufacturers. Currently, India has a robust bilateral relationship with the US, as is evident from the holding back of the CAATSA (Countering America's Adversaries Through Sanctions Act) sanctions. This situation arose because India has purchased S-400 missile defence systems from Russia. The focus of the US should be on negotiating tangible outcomes by capturing India’s strategic attention.

In addition, generating employment is a parallel theme in most countries’ offset policies, either directly or indirectly. For instance, Saudi Arabia’s offset policy was to generate highly skilled technical jobs. Boeing with Saudi Arabian General Investment Authority (SAGIA) undertook a training and education programme in the offset obligation while procuring the Peace Shield land-based air defence system. Similarly, initiatives like training and skill development can be a strong policy component for India’s offset policy, enabling the skilling of the sizeable unemployed youth. India discontinued the service sector offset post the VVIP helicopter scandal, but such an approach is headless.

Nevertheless, spinoff effects come with developments in the defence sector. It has a cross-cutting impact on diverse sectors. The boost in technological development creates a ripple effect in the civilian and synergic sectors. The story of the aerospace and automotive industries of Saudi Arabia, the automobile sector (Bullet train from F-86 Aircraft co-production), the advancement of dual-use technologies in Japan, and the electronics and aerospace industries’ progress in Spain are numerous instances of spinoff effects of offset policy-led technological advancement. The spinoff effects can be a direct flow from the offset policy or an indirect spill-over to another sector.

In this regard, channelling offsets to the country’s strong sectors like Saudi Arabia has steered its offset policy to chemical industries and Brazil’s to the aviation sector. For example, the establishment of Synthomer Middle East in Saudi Arabia came from a Joint Venture initiative between Dhahran Chemical industries and the UK’s Synthomer. This was part of the UK government and the British Aerospace System’s offset. UK’s Synthomer produced polymer dispersants for West Asia’s paints and adhesive markets. Now, Synthomer Middle East specialises in polymer business with an increase of three-fold export. Similarly, India’s IT sector is one such sector which can reap technological innovation, as there is a strong base sector in existence, in addition to being a dual-use technology.

Specifically, one will need to ensure non-concentration of offset benefits in the hands of a few vendors. One of the mechanisms can be Japan’s model of subcontracting procurement to companies that are not the primary vendors. Spain adopted a similar policy through the indirect offset category, ensuring a horizontal growth of multiple companies, deriving benefits from the same contract. Apart from these, all countries focusing on R&D in offset gradually turn to technology-led innovation.

Parallelly, an arm’s length single window management of offsets like SAGIA of Saudi Arabia, Israel’s Industrial Cooperation Authority, and Offset Management Office of Spain can be a better way forward. India’s current offset policy implementation is managed by the Defence Offset Facilitation Agency (DOFA) under the Ministry of Defence (MoD). Alas, this arrangement is not efficient for the Agency to take independent decisions. Thus we propose that the DOFA be moved to the Ministry of Commerce & Industry or Department of Economic Affairs in Finance which too conduct negotiations in the international economic arena. They would be at arm’s length from the MoD, and thus take decisions in the larger interest of the Indian economy. A good example of arms’ length in the Indian administrative structure comes into our minds which can be a good role model for DOFA as well as other similar arrangements. The Commission of Railway Safety is under the Ministry of Civil Aviation and not Railways, for obvious reasons.

Furthermore, Transfer of Technology (ToT) can be a trickle-down effect which comes with the focus on R&D. For example, Israel’s purchase of Combat Aircraft from Mc Donnell Douglas for a 100% offset package. The Transfer of Technology that came out of this offset enabled the development of Israeli Aircraft Industries, Cyclone Aviation Products, Israeli Military Industries, and TAT Aero, allowing them to be competitive in export markets. Hence, focusing on R&D will improve the economy’s ability to absorb heavy transfers and reap economic benefits. India’s R&D sector requires a major overhaul, and specifically, the defence sector needs to target R&D-led co-design and co-production of equipment. One can also look at PLI in the semiconductors area as something which can be quite cogent, or other areas which can reduce our budget burden and aid our economic development.

Moving ahead, India’s offset policy should aim to get companies to move beyond the contract-bound manufacturing under offset and diversify to other sectors. Perhaps, this can be done by reformulating specific clearly laid out policy objectives, easing up the procurement process, flexing the scope of offset to more civilian sectors, and in effect, ensuring vendors from non-lapse in offset obligation, aiming towards a National Offset Policy.

The authors work for CUTS International, a global public policy research and advocacy group.

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