PREVIEW DEFEXPO 2008: Offsets provide a new momentum - Broadsword by Ajai Shukla - Strategy. Economics. Defence.

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Friday 15 February 2008

PREVIEW DEFEXPO 2008: Offsets provide a new momentum

Business Standard,
16th February 08

The sheer spending power of India’s Ministry of Defence (MoD) --- Rs 300,000 crores or US $75 billion over the next five years --- would be enough to attract global arms corporations to any defence exhibition held in this country. But this week, an additional factor will be packing in the international majors at Defexpo India 2008: the need to quickly conform to the MoD’s offsets policy, which was announced in September 2006. 

The offsets policy, spelt out in the Defence Procurement Policy of 2006 (DPP-2006) stipulates that any defence contract worth more than Rs 300 crores (US $73 million) will trigger a “direct offset liability” of 30%, making the vendor responsible for sourcing from India, defence equipment or services worth at least 30% of the contract value. Any vendor bidding Rs 300 crores or more for a defence contract must also submit an “offsets proposal”, elaborating how the vendor proposes to meet his 30% offsets liability. This offsets obligation has set off, amongst foreign arms vendors, an almost frenetic search for Indian companies they can partner; this search will enliven the coming exhibition.

The sums involved are astronomical, which means that each foreign vendor will need multiple Indian partners to meet offsets obligations. The MoD estimates that offsets will generate approximately Rs 40,000 crores (US $10 billion) worth of business for India’s defence industry over the next five years. Just one forthcoming purchase, the acquisition of 126 Multi-Role Combat Aircraft (MRCA) for about Rs 42,000 crores, will generate offsets worth Rs 12,600 crores. Other purchases in the pipeline include artillery guns for over Rs 10,000 crores, 317 light utility helicopters for Rs 4000 crores, 12 VIP transportation helicopters for Rs 1000 crores, mid-life upgrades for 52 Mirage-2000 fighters for Rs 8000 crores, and 12 heavy lift helicopters for Rs 2500 crores. The Indian Navy is shopping for up to 30 Long Range Maritime Patrol (LRMP) aircraft, and 16 Anti-Submarine Warfare (ASW) helicopters to replace its antiquated Sea King fleet. 

To meet offsets liabilities that will arise from these purchases, prospective vendors signed a plethora of Memoranda of Understanding (MoUs) with Indian companies during the Aero India 2007 exhibition in Bangalore last February. At Defexpo 2008, there will be negotiations to translate those MoUs into actual production. While DPSUs like Hindustan Aeronautics Limited (HAL), the only integrated aircraft producer in India, will be major beneficiaries of offsets business, foreign producers are keen on partnerships with private sector companies, which they feel would be more flexible and responsive. 

But the process of forming partnerships faces a policy black hole, with the MoD promising, but not yet delivering, on important amendments to the offsets policy. MoD officials have privately assured vendors that the MoD will permit “offsets banking”. This would allow vendors to go ahead with setting up partnerships with Indian companies, with the assurance that offsets generated would be credited towards future defence contracts. The MoD has also promised that it will allow foreign vendors to credit technology transfers to Indian manufacturers as offsets. But on both these issues, a formal announcement is still awaited.

The delay, say top MoD officials, stems from Defence Minister AK Antony’s reluctance to announce piecemeal changes to the Defence Offsets Policy, which was formalised just a year and a half ago. The MoD has indicated over the last year that the policy changes will be announced before 31st March 2008. Officials within the MoD say that it will not happen before that date; it may take even longer. 

The MoD is still to establish a fully-equipped department which can handle the enormous workload that will arise from offsets. Presently a small cell, called the Defence Offsets Facilitation Agency (DOFA), under a joint secretary, grapples with the formidable task of policymaking, evaluating offsets proposals, and liaison with foreign vendors and Indian defence manufacturers. Once offsets partnerships are up and running, DOFA will also have to keep account of the fulfilment of offsets obligations, function as an “offsets bank” to keep a track of offsets that can be carried forward, and to interpret policy and provide clarifications.

DOFA, in its present form, would be overwhelmed by this workload. The MoD is considering transforming DOFA into an expanded, multiple-agency Defence Offsets Management Agency (DOMA), which will be equipped with the policy managers, legal personnel, accountants, and the technology and production specialists that will be required for handling the entire gamut of offsets. But there is reluctance within the MoD to move quickly towards establishing a large and powerful agency like DOMA, when the offsets policy itself is in a preliminary stage. An influential stream of opinion within the MoD would like to wait and see whether the offsets policy is even viable; they would rather see DOFA continuing in its present form until offsets are successfully implemented. But putting off the expansion of DOFA for a year will only reduce the MoD’s ability to get offsets up and running.

The evolution of offsets policy and the constitution of DOMA are being watched keenly by foreign vendors, as well as by private Indian defence industry. The private sector, in fact, has lobbied actively for a role in DOMA; the MoD has refused that request. But with so much money at stake, global defence industry has its eyes focused on the MoD, waiting for the policy announcements that could open the floodgates for offsets.

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