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Defence Offsets:
Policy to Implementation -
How Offsets can enable Indian Industry
Knowledge Partner
FICCI
Federation of Indian Chambers of Commerce and Industry (FICCI) acknowledges the assistance
rendered in the preparation of this report by
Defence Offsets:
Policy to Implementation -
How Offsets can enable Indian Industry
Knowledge Partner
Foreword
Indian defence sector is going through an evolutionary phase since 2001 when the sector was
opened for private sector participation, hitherto reserved for the state under Industrial policy
resolution. FICCI, as the apex Industry chamber of India, has always advocated for facilitating
meaningful participation of Indian Industry, both public and private for working with Ministry Of
Defence and DRDO towards building of indigenous capabilities in the area of defence. FICCI
complements the MOD for periodically reviewing the Defence Procurement Procedure to
accelerate the defence acquisition process, usher transparency, and enhance indegenisation
towards modernization of India's armed forces.
Offset policy is globally recognized as an efficient way of building up defence Industry capability and
integrating it with global supply chain while providing self-sufficiency to Indian armed forces. It not
only helps to acquire modern defence equipments, but also gives a chance to acquire intangible
assets like technology through co-developments & co-production, besides opening up of other
valuable opportunities.
I would like to place our sincere thanks to the Religare team for preparing this knowledge paper. I
hope this report will be useful to the policy makers, thinkers and Indian industry, as a suggested
approach to the growth of the defence sector in India, particularly as they deal with issues of
defence security of India.
FICCI works closely with the government on policy issues, enhancing efficiency,
competitiveness and expanding business opportunities for industry through a range
of specialised services and global linkages. It also provides a platform for sector
specific consensus building and networking. Partnerships with countries across the
world carry forward our initiatives in inclusive development, which encompass
health, education, livelihood, governance, skill development, etc. FICCI serves as the
first port of call for Indian industry and the international business community.
www.ficci.com
In these industry sectors, Religare Strategic Advisory provides to its clients - Advisory
Services, Project Management, Investment Related services and Supply Chain
Management solutions.
www.religare.in
CONTENTS
Executive Summary 1
Introduction 3
Defence Offsets In India : 4
The Current Scenario
Key Issues : Implementation 7
Trends that are impacting the offset 14
absorption capability in India
Outlook 16
Global Offset Regimes 17
Glossary of select terms used 23
Executive Summary
The practice of nations executing counter-trade measures by demanding discharge
of offset obligations as a prerequisite to participation by foreign vendors in large
capital acquisition programmes has been well established. Infact over 100 countries
practice some form or the other of offsets. Globally as offsets become more
prevalent, so do the models for their execution and through this ever growing
complexity, countries try to channelize investments and technology to target
domestic industries while industry utilizes it as a catalyst for growth.
The relevance in the Indian context is also driven by the buying power dictated by
the geo-politics of the Indian subcontinent, as also the peculiarities of geography.
The Indian Armed Forces are destined to remain in a state of continuous conflict,
thanks to the insurgency prevalent in various parts of the country as also the
requirement of operational readiness demanded of them at all times. The Indian
defence industry is still in its infancy, struggling hard to find its feet, despite more
than 60 years of nurturing, which obviously has not been the best that the industry
could get.
Offset practice provides Indian industry with a quick route towards participation in
the global defence manufacturing and services industry. It provides the Indian
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industry with a significant opportunity to build credible capability which is not only
oriented towards domestic consumption but also positions India in the global supply
chain of foreign OEMs.
Given the Indian Industries proven track record on “Frugal Engineering” once offset
opens the window of Defence Industrial participation for Indian Industry, it will help
the Foreign OEM's improve their competitiveness in their home markets. In the
medium to long run Armed Forces and India's Defence preparness will enormously
benefit as Indian Industrial involvement will result in “Know Why” transfer creating
a Defence Industrial eco System, that can target Upgrades and Obsolesce
management issues. This will provide the Armed Forces a capability to sustain long
drawn conflicts without any issues related to serviceability/availability of
equipment or supplies.
It is a well established fact that Offsets are not freebies and the cost associated with
offsets depends on the economic conditions prevalent in the offset applying nation,
its industrial base or its capacity to absorb technology, and the various other risks
that foreign vendors need to take on as a cost onto themselves. OEMs naturally
therefore, pass on the costs of meeting the offset requirement as a part of their bid
on the main programme. Therefore, an offset implementing nation pays more for
the procurement of defence items than it would otherwise have to do if it did not
impose mandatory offset obligations. To view the offset policy as a cost centre
would result in a highly myopic view, as offsets are demanded despite the
knowledge of the costs associated with it. Therefore the implementation of the
policy needs more attention and care to align it with the national goals. In summary,
the offset policy needs to be seen as a tool that promotes the development of a
strong and vibrant domestic defence manufacturing industry that leads the global
technological cycle and is positioned strongly for the spill-over business
opportunities and benefits from other sectors as well.
02
Introduction
The Indian experience with structured defence offsets commenced in 2006 through
the introduction of offset obligations in the Defence Procurement Procedures (DPP).
These were then subsequently revised in DPP 2008 as a part of an ongoing process of
evolution.
To understand defence offsets and their context in the recent past, it is important to
recognize, note and realize the factors that impact this policy.
The prime factor that influences the offset policy is a strong need for self-reliance. It
is critical that the country provides to the Armed Forces a capability to sustain long
drawn conflicts without any issues related to serviceability / availability of
equipment or supplies. This is interlinked to the current dependence on exports and
the need to inverse the trend to create an Indian defence manufacturing industry
that can sustain the needs of our armed forces.
Linked to the above is the intent of the Government to leverage its buying power and
invite global OEMs to provide market access for products manufactured in India
thereby providing a jump-start to businesses that can comply with the stringent
defence manufacturing requirements.
03
Defence Offsets In India :
The Current Scenario
Applicability of Offset clause
• Under the current Defence Procurement Procedures, the Offset provisions are
applicable to all Capital Acquisitions categorized as 'Buy (Global)', i.e., outright
purchase from foreign / Indian vendor, or 'Buy and Make with Transfer of
Technology', i.e., purchase from foreign vendor followed by Licensed
production, where the estimated cost of the acquisition proposal is Rs. 300 crore
or more.
• The DPP also prescribes a minimum Offset obligation of 30 per cent of the
estimated cost of the acquisition in Capital Acquisition programmmes where
offset is applicable. This value of 30 per cent is only the lower benchmark and
the government reserves the right to have higher offset percentages for some
Capital Acquisitions (case in point being the MMRCA contract where an Offset
obligation of 50 per cent is stipulated)
04
Ø Direct Purchase of defence products and components manufactured by
Indian Defence Industries
05
Who is the recipient of Offset?
• It is critical to note that the current policy defines Indian Defence Industry to
include Defence Public Sector Undertakings, the Ordnance Factory Board and
private Indian defence industry.
• It is also critical to note that through other significant regulation private Indian
defence Industry is mandated to comply with the following, in order to qualify as
being a valid Indian Offset Partner:-
Ø Incorporated in India
• It may also be noted that Indian companies need to comply with Department of
Industrial Policy and Promotion (DIPP) guidelines for licence requirement for
undertaking defence manufacturing.
06
Key Issues : Implementation
The Offset policy has proven to be a bold step in the right direction by the Indian
government. However this opportunity catalyst is significantly linked to the easing of
the overall procedural constraints. For the full impact of this policy to be felt, it is
important to address key issues. We present below some of the key issues faced by
the industry in the implementation of this policy.
• Under the DPP-08, DOFA has no specified role in assisting the concerned
Acquisition Manager in monitoring the implementation of the offset contract,
the responsibility of which has now been taken over by the “Offset Monitoring
Cell” in the MoD
• The establishment of a single point of accountability for the entire offset process
is extremely critical. This is needed to ensure that one nodal agency within the
MoD be responsible for the evaluation of offset proposals as part of the
acquisition process, approving projects during implementation and approving
and banking the offset credits gained for that project.
• For DOFA Clearly Identified Funding Mechanism and requisite permanent Staff.
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• Leveraging the offset opportunity is, for the Indian industry, further complicated
by the stringent requirements of export control through SCOMET. It is
understandable that world-wide export control does play a significant role,
however for a nascent and developing defence manufacturing industry like
India's a simpler procedure will go a long way in ensuring efficient
implementation of the policy.
• In DPP 2008, a listing of the Defence goods, export of which counts towards
liquidation of offset oligation was provided. This list however has elements
which are not a part of the specific chapters dedicated to defence and aerospace
manufacturing as per ITC-HS. This creates confusion for the manufacturer. A
rationalization of the defence related products in the ITC-HS will help in enabling
the manufacturer to have a clearer picture.
• In cases where a foreign OEM and its Indian partner are bringing systems
integration to India, not having the “Deemed Export” benefit implies the
impact of Duties & Taxes on the entire product being applicable under the
current regime. In such cases, if Deemed Export benefit is not available to the
OEM, then conversely the OEM should also be entitled to reimbursement of
duties and taxes, the impact of which should reflect in L1 calculations.
08
FDI in Defence Manufacturing
• The government of India allows for 100 per cent participation of the private
sector in defence production with FDI to the extent of 26 per cent subject to
licensing from the Department of Industrial Policy and Promotion (DIPP).
• There have been significant demands from the foreign OEMs and some Indian
industrial houses to hike the permissible FDI ceiling to atleast 49%. The rationale
provided is that such a move will go a long way towards enhancing the technical
capability of the private sector in the shortest possible time frame, as foreign
OEMs will find it more rewarding in sharing technology. It is noteworthy to
mention that cumulative amount of FDI in Defence sector as of 2009 stands at a
mere $0.15 million
• In line with the above, it is also critical for the establishment of a separate fund
to provide necessary resource to public / private sector, academic and scientific
institutions to support research & development for up-gradation of different
platforms / systems and to promote innovation.
09
• The Indian industry needs technology for its global acceptability.
• It is the lack of technology with the Indian industry that is driving the Armed
Forces to look beyond our frontiers for procurement of weapon systems.
• MoD has taken a one off stance in not including Technology transfers as a valid
method of discharge of offset obligations. This needs to be corrected.
• The practice of nominations(only OFB and DPSUs) by the DDP has not borne
much fruit in the past 60years or so. May be it is time to look beyond this practice
of nominations and truly create an atmosphere for a level playing field.
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regime. It may be better for the government as well as the industry if the validity
of the banked credits were to be increased thereby incentivizing the foreign
vendor to commence offset business in India despite having little or no visible
programme exposure in the near future.
• Porposals for banking of offset credits could be more liberal than the
procurement cases as they anyway provide catalectic propulsion to the Indian
defence industry.
11
Defence SEZs
• There is a requirement for the MoD to aggressively step in and provide for
Defence SEZs.
• There are a number of private industrialists who could team-up and create
world class manufacturing capabilities in India. This needs to be encouraged in a
more systemic manner.
• Under the cover of the secrecy/holy cow status or the fear of repercussions from
a possible scam, the MoD is probably not venturing into this area.
Deemed Exports
• All transactions from offsets must be notified as “Deemed Exports” and
maximum possible export benefits be provided to them.
• The offset transactions do result in positive Foreign Exchange (FE) flows, while
the port of delivery is within India in many cases. Thus real export does not take
place, although the foreign OEM has paid for in FE.
• The Indian industry especially those located within SEZs will immensely benefit
if such status be accorded for all transactions necessitated by offsets.
SEZ Airport
• There is a requirement of an SEZ airport. This will cater for the huge number of
aviation orders that are in the pipeline.
• The foreign OEM could place his aircraft for integration in an SEZ airport and the
Indian industry could avail of all the benefits of exports for all the integration
work or supply of components and sub-systems for the target aircraft.
12
Use of Multipliers
• At present, the offset policy of India does not allow the use of multipliers, which
are a device to give additional credits for discharge of offsets in a directed
manner either through industry segments or through critical technologies.
• The use of multipliers will further help in directing the development of the
indigenous defence industry to pre-determined segments. This appears to be
less of a danger than allowing the development of defence industry that results
in India having the capability to produce small components of defence
equipment, but not be complex systems. Considering the steady pace at which
Indian offset policy has evolved, it may be prudent for the MoD to explore the
tangible benefits which multipliers can bring to Indian defence manufacturing
industry. Multipliers are required only when the priorities are clear( areas where
offsets are preferred), and the requirement is overpowering. This situation is
less likely to arise in our context and multipliers may not find the necessary
grounds to find a place in the policy. It should however be noted that globally,
countries that have adopted Multipliers in their Offset policies, have a much
lower threshold to project size and much higher offer percentages (as can be
seen from country examples letter in the report) being eligible for Offset (usually
in the range of a few million USD) thereby a wider project coverage.
13
Trends that are impacting the offset
absorption capability in India
Emergence of a tiered manufacturing structure
• Traditionally DPSUs were playing the roles of primes but with significant in-
house production capability spread across the entire production process and
little outsourcing beyond component level supplies. As a result they were
managing thousands of vendors as suppliers, each with component level
capability and very little tiering throughout the supply chain. Globally A&D
primes have reduced the number of suppliers and are increasingly having more
risk sharing partners. Indian A&D Segment too is seeing a tiered structure
emerging in the A&D supply chains and mid chain players with composite
capabilities emerging.
In view of the above, there are some traditional segments with a historic cost
advantage that are witnessing rapid growth. A prominent example is
Engineering Design where India is the preferred location for most global OEMs
to base their offshore design centers from.
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credit crunch as these businesses have low attractiveness and high risk
exposures. The development of sources of structured financing in this industry
will go a long way in sustaining the Indian industry's capability to make full use of
the offset opportunity.
Trained Manpower
• A large business opportunity as provided by the offset opportunity requires
shoring up of pools of talent to be able to create and run businesses profitably.
India has only just started witnessing an interaction between the pool of
manufacturing talent (which primarily resides in the DPSUs, DRDO and private
industry) and the users (from the armed forces). This emerging mix is providing
the right human capital framework to create businesses that can take this high
growth phase forward.
15
Outlook
The Offset opportunity is expected to bring in a large volume of business to a nascent
Indian defence manufacturing industry in the near future. Industry predicts the size
of this opportunity in the vicinity of USD 15-18 bn over the next 6 to 8 years.
A key challenge that OEMs will face in India is in finding local industry that will be able
to absorb this volume of business. Indian industry has had traditional pockets of
excellence like software and engineering design that will be key attractions for
foreign players to do business in India, it is however a balanced overall development
of Indian defence industry especially in the manufacturing segment that will not
only help position India as a prime destination for global sourcing but also help
Indian government realize the overarching objective of developing an indigenous
industrial base that addresses the needs of self-reliance.
Indian industry too is realizing that offsets are just a stepping stone to quickly
amalgamate itself into the global aerospace and defence supply chains.
A lot of ground has been covered since the structured introduction of the policy in
2006; however as the number of programmes that attract offsets increase and the
size of the obligation on global OEMs expands, Indian offset policy too will need
further refinement to enable the country create the industrial base required to
sustain the overall requirements of the defence forces.
16
Global Offset Regimes
A quick summary of some key offset regimes world-wide.
Australia
Canada
17
Greece
• Penalties : 10% of unfulfilled benefits, 1.5% penalty late fee per month
Israel
18
Italy
• Minimum Offset Required (%) : 100% target, but no less than 70%
Netherlands
• Term : Generally 5-7 years from date agreement is in effect, but not to
exceed 10
19
Poland
• Focus : Defense
20
Switzerland
Taiwan
21
Turkey
22
Glossary of select terms used
DIPP Department of Industrial Policy and Promotion
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Religare Strategic Advisory
Corporate Office:
D3, District Centre Saket
New Delhi- 110017, India
T: +91(11) 3912 5000
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www.religare.in
Vivek Pandit
Director – Defence & Aerospace
T: +91(11) 23354801, M: +91- 9811-27-3473, E : vpandit@ficci.com
L N Pradhan
Assistant Director - Defence & Aerospace
T: +91(11) 23708062, M: +91-9968-50-8504, E: lnpradhan@ficci.com
24
Federation of Indian Chambers
of Commerce and Industry
Federation House, 1, Tansen Marg D3, District Centre Saket
New Delhi - 110001, India New Delhi- 110017, India
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