Offsets for India: wasted opportunities - Broadsword by Ajai Shukla - Strategy. Economics. Defence.

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Tuesday 30 January 2007

Offsets for India: wasted opportunities

by Ajai Shukla
Business Standard: 25th April 2006

The recent contracts with Boeing and Airbus for the purchase of new airliners have aroused relief amongst harassed Indian travellers and airline companies alike. But amidst the celebrations, these deals must also be noted as squandered opportunities to bring into India vast amounts of foreign direct investment (FDI) through the medium of offsets. 

Offsets are binding arrangements, written into commercial deals with foreign suppliers like Boeing, Airbus, or Lockheed Martin, which oblige the vendor to undertake specified obligations within the buyer country that will generate benefits within its economy. These could be direct offsets, such as technology transfer, to manufacture in the buyer country components of the equipment being bought (for example, aircraft undercarriages for all Boeing airliners worldwide). Alternatively, they could be indirect offsets, such as investment into an unrelated sector ( e.g. FDI into the software industry), trading guarantees (such as the purchase of a specified amount of Basmati rice) or even an undertaking to put an astronaut from the buyer country on the next space mission launched by the vendor. 

The larger the size of an international contract, the more offsets a prospective vendor dangles in order to gain the benefits of that deal: monetary profits, strategic influence, and increased employment amongst its own workers. By that token, India, one of the world's leading arms importers and now a major buyer in the airliner market as well, should benefit from billions of dollars in offsets from the countries it buys from. But the reality is starkly different. India's offsets policy, framed last year as a part of the Defence Procurement Procedure of 2005, specifies only that vendor countries supplying more than 300 crores (about $70 million) worth of defence items to India must reciprocate with offsets worth 30 per cent of the contract value. 

In contrast, offsets of more than 100% of the deal value are accepted as normal in international arms trade and aircraft deals. The UK specifies an offset demand of minimum 100% whenever a British company signs any contracts worth over 10 million pounds ($18 million). A recent Austrian purchase of radars included offsets of 280% of the contract value. And South Africa negotiated offsets of nearly 350% for an arms package in 1999. That country demands over 100% offsets for all defence contracts: 20% in direct offsets, 45% as counter purchase by the vendor and 35% as foreign investment in South Africa. 

With a demand of just 30%, India is likely to forego staggering opportunities. Over the last three years, foreign outflow on defence has been over 30,000 crores; over the next three, it could be around 120,000 crores. That adds up to over $30 billion. The purchase of commercial airliners could account for another $15 billion. If, instead of a realistic demand for 100% offsets, India is satisfied with offsets worth just 30% of the contract amount, we will have cast aside the opportunity to marshal over $30 billion in FDI, technology investment and trade. 

But even more worrisome than lost dollars, India's offsets policy leaves it entirely to the vendor to decide what offsets to offer. This means that instead of high-technology transfers and orders in core areas like infotech and biotechnology, the vendor country could meet its offset obligations by trading in basmati rice from India. Other buyer countries consider and prioritise beforehand the offsets they need. And vendors know that the offering valuable offsets could swing the contract in their favour. 

India, on the other hand, treats offsets like a free gift from the vendor. Offsets are not even a factor in deciding the most suitable vendor for a contract. The lowest bidder automatically wins, as long as he has undertaken to provide 30 per cent offsets; offering more than that does not better his chances. After signing the contract, the vendor has 60 days to negotiate any kind of offsets with any Indian recipient company he chooses. In most cases, the offset takes the form of part manufacture of some components by an Indian defence PSU. At that stage, India has no leverage --- an apparently little desire ---for demanding another offset. 

Most developing countries lack the scientific and industrial capability to absorb high-technology transfers, information technology partnerships and the joint development of advanced systems. They have no choice but to accept offsets in the form of trade in commodities and low-tech joint manufacture. India, in contrast, can demand and smoothly absorb cutting edge technologies. New Delhi is prepared to expend diplomatic capital to bring in high technology, like the now-superseded Next Steps in Strategic Partnership (NSSP) with the United States. The lever of offsets, in contrast, lies unused. 

A national offsets policy is urgently required that lowers the threshold for mandatory offsets from 300 crores to 100 crores, to reap the benefits of the large number of contracts that are signed in that range. An inter-ministerial group, including the defence, aviation, IT, finance and commerce ministers must coordinate nationally with high-tech departments like space and atomic energy to prioritise offsets. And foreign vendors, bidding for large contracts, must be made to understand that the offsets they offer will be important considerations in deciding Indian contracts.

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