20th October 2020

Confidant Classes

A Premier Judicial Service Coaching

What are defence offsets?

The Defense Ministry presented its last defense procurement procedure of 2020 (DAP 2020) on Monday, which will take effect from Thursday, October 1.

  • By amending a 15-year policy, the government decided to remove the compensation clause if the equipment is purchased under agreements or arrangements between two countries, or under an ab initio supplier agreement only.

What are defense offsets?

  • In simpler terms, compensation is an obligation for an international player to boost India’s national defense industry if India purchases defense equipment from it.
  • With defense contracts expensive, the government wants some of that money to either benefit Indian industry or allow the country to benefit from the technology.
  • The Comptroller and Auditor General (CAG), in a report presented on September 23, defined remuneration as a “mechanism generally put in place with the threefold objective of: (a) partially compensating for a significant outflow of resources from a purchasing country in a large purchase of foreign products (b) facilitating the introduction of technology and (c) strengthening the capacities and capacities of the domestic industry ”.
  • An offsetting provision in a contract requires the supplier to “cancel the purchase, fulfill export orders or invest in local industry or research and development” in the buyer’s domestic industry, according to CAG .

When was the policy introduced?

  • Amit Cowshish, a former Defense Ministry financial adviser, who retired in 2012 and continues to be part of the Manohar Parrikar Institute for Defense Studies and Analysis, said the policy was adopted on the recommendations of the Vijay Kelkar committee in 2005.

“The idea was that since we buy a lot of defense equipment from foreign countries, we can harness our purchasing power by taxing it to meet compensation obligations, which is the norm around the world.”

Cowshish said.

“The first policy says that all defense acquisitions exceeding Rs 300 crore, the estimated cost, will involve compensation obligations of at least 30%, which could increase or decrease the DAC (Defense Acquisition Council),”

Cowshish said.
  • In December 2005, the Sixth Standing Defense Committee (2005-2006) recommended in its report on defense procurement policy and procedure that modalities be established for the implementation of compensation contracts.

The first offsets contract was signed in 2007

  • The government declared the “defense compensation target” for the first time on August 1, 2012: “The main objective of defense compensation policy is to leverage capital acquisitions to develop the defense industry. Defense of India by (i) promoting the development of internationally competitive enterprises, (ii) increasing research, design and development capabilities related to defense products and services and (iii) promoting development synergistic sectors such as civil aerospace and internal security ”.

How can a foreign supplier meet its compensation obligations?

  • There are several routes. Until 2016, the supplier had to declare at the time of signing the contract the details of how it will do so.
  • In April 2016, the new policy amended it to allow you to provide it “either at the time of the offset credit request or one year before the offset obligations are met.
  • The August 2012 Defense Ministry note mentioned these routes.
  • Direct purchase or fulfillment of export orders for qualified products manufactured or services provided by Indian companies.
  • Foreign direct investment in joint ventures with Indian companies (equity investment) for eligible products and services.
  • In-kind investment in terms of technology transfer (TOT) to Indian companies, through joint ventures or non-participatory channels for eligible products and services.
  • Investment in “kind” in Indian companies concerning the supply of equipment by non-participatory means for the manufacture and / or maintenance of products and services
  • Supply of equipment and / or TOT to government institutions and establishments engaged in the manufacture and / or maintenance of eligible products and provision of eligible services including DRDO (unlike Indian companies).
  • Acquisition of technology by DRDO in high technology fields.
  • Cowshish said the 2012 note also introduced bank and clearing multipliers. “Banking means that while waiting to get a contract from the Department of Defense, a seller can ditch the offsets and get credit that could be deposited. Later, if you have obtained the contract, you will be able to use the credits in the bank, under certain conditions. ” He said.
  • For multipliers, says Cowshish, “if you meet the compensation obligation by taking an MSME unit as IOP (Indian clearing partner for foreign provider), you get the multiplier of 1.5, that is – Let’s say if you meet a compensation obligation of Rs 100, but your IOP is an MSME unit, you will get a compensation credit of Rs 150 ”.
  • DAP 2020 gave the critical technology transfer to DRDO the highest multiplier of 4.

Will no defense contract now have compensation clauses?

  • Only government-to-government (G2G) agreements, single-source ab initio contracts, or intergovernmental agreements (IGA) will no longer have offset clauses.
  • For example, the purchase agreement for 36 Rafale fighter jets, signed between the governments of India and France in 2016, was an IGA.

“Ab initio a single vendor means that when you start the process, you only have one vendor … There may be a situation where you start with two or three vendors and send them a Request for Proposal (RFP), and end with a single vendor, resulting in a single vendor situation, ”

said Cowshish.
  • The Department of Defense issues the RFP to a single vendor.
  • The IGA is an agreement between two countries and could be a framework contract, under which individual contracts can continue to be signed, Cowshish said.
  • G2G is a specific transaction or a specific acquisition agreement, he said.
  • Under DAP 2020, all other international offers that are competitive and competing with multiple providers will continue to have a 30% offset clause.

Why was the article removed?

  • Apurva Chandra, general manager of acquisitions, said on Monday that suppliers would “charge” additional costs on the contract to balance the costs and that the elimination of offsets could reduce the costs of those contracts.
  • The sources explained that the fulfillment of the compensation obligations entails an “administrative fee” paid by the sellers.
  • Chandra had also mentioned recent criticism of the CAG.

What did the CAG say?

  • The ACG criticized the entire policy. From the first contract signed in 2007 to March 2018, CAG said, 46 compensation contracts were signed for Rs 66,427 crore.
  • “Overall from 2007 to December 2018. Rs 19,223 crore should have been released in compensation. However, the claimed exemption from sellers’ compensation obligation as of December 2018 was Rs 11,396 crore. This only represented 59% of the compensation owed in December 2018. “
  • It said that the competent authority had accepted claims of only Rs 5,457 crore over Rs 11,396 crore and the rest are pending or rejected. “The remaining clearing obligation of approximately Rs 55 billion should be completed by 2024.”
  • The ACG is not very optimistic about meeting the obligations by 2024. It said the audit “found that foreign suppliers have made various compensation commitments to qualify for the main supply contract, but then they have not decided to fulfill those commitments. ”.
  • The ACG found “no case in which the foreign supplier transferred high technology to the Indian industry.”
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