Defence Offset Guidelines DOG

Very recently Ministry of Defence (MoD) has turned up with its newly revised Defence Offset Guidelines (DOG), with effect from August 1, 2012. This is an excellent step towards creating an effective mechanism of reverse trade and this is the first time the Ministry has put an earnest, prudent and agile step towards achieving Offset goals. The ministry has tackled its deficient and ham-fisted policy to achieve key objectives like capital acquisitions to develop Indian defence industry. Although the policy is still a baby in the cradle and requires lot of improvisation and lateral thinking to clear the ambiguity of its various provisions including a clear list of Government Institutions and Establishments on which DOG would be applicable, but the effort of MoD for clarifying existing provisions and policy objectives with much required modifications can’t be dismantled out rightly.

Objective of DOG is now clear and precise, that is, to leverage capital acquisitions to develop Indian defence industry by augmenting Research, Design and Development related to defence products and services. In parallel there shall be a development of synergistic sectors like civil aerospace and internal security.

The newly updated provision of DOG (as placed in detail under Appendix D to the Defence Procurement Procedures (DPP)) inserted multiplier up to three, to incentivize investment in Micro, Small and Medium Enterprises (MSMEs). Transfer of technology and equipment are being declared a valid gateway of offset discharge. In addition to this, steps are taken to facilitate technology acquisition within in selected list by DRDO. Further incentives are created for Offset by extending banking period up to seven years and by widening the catchment area of the DOG including list of eligible product/services for discharge of offset obligations. Revised DOG also agrees to the investment in ‘kind’”in the form of transfer of equipment (ToE) vide non-equity route. A brain child Defence Offset Monitoring Wing (DOMW) of DOG will now effectively tackle monitoring and supervision of offset programs as more teeth has been provided to this new monitoring agency.

Salient Features of DOG:

Extending Banking Period: Banking of the offset provision till now is a sleeping beauty, with no taker of the idea - as the validity period was only two-and- a- half -years, which has now been revised with a much extended period of seven years. Banking provision is although allowed in technology and equipment transfer to Indian industry, but such acquisition if done by DRDO or any government institutions/establishments will be declared void ab initio.

DOFA to DOMW: The new guidelines has set up a new agency DOMW which will monitor almost all parts of offset related requirements prime of which are to work as an repositories of the signed offset contracts, to take care of technical and commercial offset negotiation, audit offset programmes and administer penalties in case of any contravene of guidelines. DOMW will now share report to the DAC on annual basis as compliance.

Multiplier:  To incentivize investment in the domain, DOG has incorporated the idea of multipliers with a reservation that the multiplier of 3 (allowed only when a foreign company provides a listed technology without any restriction attached to it on its volume of production and sales)  is applicable only in MSMEs and in case of technology acquisition by DRDO. Although, DOG ensures that the higher multiplier is reserved for technology acquisition by DRDO only, incentive scheme for MSMEs with a multiplier of 1.5 still hold a lucrative idea.

Clarification on Scope of Offsets: DOG has clear the suspended air on the Scope of Offset by expounding that Indian company or its JVs participating in “Buy (Global)” contracts are exempted from offset obligations, in case if the product in question has indigenous content of not less than 50% percent of the value of the contract. However, DOGs stand on offsets with 30% offsets in “Buy (Global)” and “Buy and Make with Transfer of Technology” contracts up to the value of INR 300 Cr remains unmoved. 

 

Widened Area for Discharge of Offsets: DOG has now expended the horizon of OEMs for discharge of offset responsibilities by permitting investment in “kind” (which is allowed as transfer of technology or transfer of equipment for manufacture and / or maintenance of permitted line items) in Indian industry; (ii) allowing DRDO to acquire select list of high technologies; and (iii) by further expanding the number of Indian Offset Partners (IOPs).

Other measures like addition in the list of eligible products/services against which offset can be discharged, extension of the offset discharge period which is now two years and addition of categories like “Civil Aerospace Products” and Services (s) deserve accolades.

Although the revised DOG tried to placate the foreign OEMs concerns like (i) uncertainty in Govt. support for the private sector; (ii) unrealistic gestation period (iii) inadequate “banking” and (iv) restricted category of “eligible” products and services, a more determined approach to achieve the objective with translucent and pragmatic ideas is the requirement of the time to up beat the defence industrial base and to eliminate the loop holes as enlisted below.

Issues craving for practical solution:

1. DOG’s  50% indigenous requirement provision is an astronomical figure as it is well known fact that only a bunch of Indian companies can offer items/products with 50% or more indigenous content. A practical resolution to this issue will help mobilizing the DOG.
2. Exclusion of “services” from the perspective of value addition in India will put foreign companies at superior position and in comparison Indian companies will have less incentive.
3. DOMW would be now responsible for all compliance and monitoring regarding DOG but the agency is finding it difficult to manage its resource crunch and any idea of outsourcing the work of audit to a private agency will attract various compliance and policy related issues.
4. DOG, although has mentioned a list of Government Institutions and Establishments under press release but the list is not exhaustive in nature as the inclusion of word “etc.”, trigger the thought of adding more in the row.

Controversy around IOP:

What constitute an Indian Offset Partner (IOP):

Para 4.1 of the Offset Guidelines under DPP – 2013 defined the term as “Indian enterprises and institutions and establishments engaged in manufacture of eligible products and / or provision of eligible services, including DRDO.” The term like Indian enterprises and establishments used in the above statement are not explicitly defined and hence creating ambiguity whether any company incorporated in India will be eligible for IOP, irrespective of the level of FDI in the company. The quandary is realistic and remains unresolved till now as CAG and MoD have difference of opinion.  

CAG‟s stance as reported in CAG Report dated November 29, 2012

• “...the IOP is required to comply with the guidelines /licensing requirements for the defence industry issued by the Department of Industrial Policy and Promotion (DIPP). Further, the government has allowed 100 per cent participation of private sector in the defence sector with FDI (Foreign Direct Investment) permissible upto 26 per cent.” (Paragraph 2.1.4 of Chapter II of the CAG Report No. 17 of 2012-13 (Air Force and Navy)).
  Going by the aforesaid, it appears that as per the CAG,  to be an eligible IOP, a company would have to adhere to the licensing requirements prescribed for entities operating in the defence sector in India including conditions applicable to FDI in the defence sector  like the company should be  “owned and controlled”  by resident Indian citizens. However, this ownership criterion has been diluted by the recent amendment to the FDI Policy, which provides that FDI beyond 26%, may be approved in certain cases by the Cabinet Committee on Security (CCS) provided that it ensures access to modern and “state of the art” technology to the country.
   
  Who Qualifies as an Indian Offset Partner (“IOP”)?
   
  CAG has in the report identified 2 cases, wherein the firms appointed as IOPs were ineligible as IOPs on the ground that in both instances, the IOPs were subsidiaries of foreign companies. 1.M/s Thales International India- Appointed as IOP for offset contract (July 2009) for procurement of Low Level Transportable Radar (LLTR). According to the CAG, the company being a 100 per cent subsidiary of M/s Thales, Singapore and M/s Thales, Hong Kong was not eligible to be selected as IOP.
  2.M/s Wartsila India Ltd. and M/s Johnson Pumps Ltd.- Appointed as IOPs for offset contract (April 2008) for procurement of fleet tankers for the Indian Navy. Both of these are subsidiaries of foreign companies.
   
   
  Who Qualifies as an Indian Offset Partner (“IOP”)?
   
  MoD‟s response to CAG‟s report:
   

• In contrast, according to the MoD, M/s Johnson Pumps is an eligible IOP since it is a company registered under the (Indian) Companies Act, 1956 even though it is a subsidiary of a Swedish company.
• According to the CAG, the MoD‟s contention is not acceptable since the company is a subsidiary of a foreign company and therefore the ambiguity continues and remains unresolved till now; consensus should be formulated soon, before it’s too late and will start impacting the very idea of DOG.

To qualify to become an IOP there are certain basic elements to be taken care like (i) the IOP must be an Indian Enterprise, establishment or an Institution; (ii) must manufacture or provide an Eligible Product or Eligible Services respectively; (iii) should comply with GoI related guidelines; and (iv) for Defence Sector, PN 4 of 2001 series and PN 2 of 2002 series is applicable. In case if a company complies with these guidelines it will automatically be qualified for IOP.

Conclusion:  Although the latest revised DOG has given much needed oxygen to the ailing guidelines at the right time by introducing some dynamic thoughts like expansion of avenues for discharge of Offsets, provision of multiplier, extension of banking period, more agile monitoring agency and expansion of the eligible products and services list etc.. to achieve its vital socio economic objective. Much is required to strengthen the policy objective at ground level.

By: Bharwan Sanjeev Singh