Chakraview

Without offset options, India defence sector future bleak

File Photo: India’s defence minister Rajnath Singh inspecting the Vajra K9 guns manufacturing unit of L&T.

(Editor’s Note: The views are that of the author’s. For the writer’s other interests, read the credit line at the end of the article.)

By Rajiv Chib

Rajiv Chib

A resurgence of COVID-19 cases in India has forced domestic defence companies to reintroduce strict restrictions. It again threatens to increase business uncertainty and cripple manufacturing operations and supply chains of aerospace and defence industries, who have started asking their customers for extension of their delivery schedules.

Foreign companies are further postponing visits for business development or for forging fresh partnerships. Demand side shocks are perhaps some of the most visible effects of the pandemic’s impact on the Indian defence sector.

The private sector is already smarting under the monopolistic clout of the Defence Public Sector Undertakings (DPSUs), which has been seen to increase in recent times. The favouritism reaches each and every level of government organisation.

Even for the Defence Research and Development Organisation (DRDO), the nominated recipient for a platform-level Transfer or Technology (ToT) is always a DPSU, even if a private sector company is better placed in terms of infrastructure and know-how to absorb the technology and has contributed to 70 per cent in the development of the product.

The present case of providing ToT of 18 Low Level Transportable Radars (Ashwini Radar) only to state-run Bharat Electronics Limited (BEL), when two ToT partners could be chosen is an example.

Old mindsets continue to act as a major deterrent to any meaningful participation as selection of a vendor by nomination gains ground. The Defence Acquisition Procedure 2020, duly endorsed in repetitive, servile tones by representatives of industry bodies fails to encourage the private sector in any concrete way. The private sector finds themselves relegated to the role of being minor sub-contractors to DPSUs.

The preceding year saw a bulk of fast-track orders placed either on DPSUs on a nomination basis, or with foreign Original Equipment Manufacturers (OEMs) in limited quantities. Moreover, export requests from friendly countries were diverted to DPSUs, even when track records exist with the private sector.

Earlier, at least offset related orders had played a major role in sustaining the middle rung private Indian industries but now domestic companies are realising that future contracts are not getting renewed.

The increase of the offset threshold to from Rs 300 crore to Rs 2,000 crore, which is the highest amongst the present 130-odd weapon importing countries, combined with removal of offsets from Foreign Military Sales or inter-governmental agreement procurement, has possibly sent a signal to foreign OEMs, as renewal of export contracts is on the wane.

Between 2010 and 2016, India found its defence exports doubling. Increased sourcing of aircraft/marine equipment parts from India for global supplies by Airbus, Boeing, Safran, GE Aviation, Rolls-Royce, and Fincantieri had established an international competitiveness of Indian enterprises.

A number of domestic companies could position themselves successfully in different product and technology verticals. it was offset orders, which forced the global OEMs to look at Indian companies.

A large number of local companies like Titan, Samtel Avionics, Taneja Aerospace, and Godrej Aerospace became a part of global supply chains. It is difficult to digest statements, that, offsets have generated only low technology work when one sees a Dynamatic Technologies exporting A320 flap track assemblies, Maini Aerospace exporting LP turbine of Leap Engines, or TAL Manufacturing Solutions exporting composite floor beams for the Dreamliner B 787.

The period also saw foreign OEMs and lower tier suppliers like Axon Cables SAS, Thales Group, Rafaut Group, Amphenol Group, Lockheed Martin, forming manufacturing Joint Ventures (JVs) in India, with the aim of addressing the offset market. In other words, these JVs aimed at becoming Indian offset partners.

Again, between 2010 and 2016, the formation of 25 such JVs, indicates that the offset policy had definitely played a role in persuading foreign OEMs to invest in India. These entities have brought in technology, provided local employment besides giving an exposure to their sub-contractors in India.

At present, aerospace and defence OEMs are seriously considering the risks involved in production offshoring, as supply chain disruptions are on the increase. COVID-19 has exposed the low-level visibility and transparency of aerospace supply chains and options of keeping production within the home state or in near shoring locations are being debated.

As far as India is concerned, the concept of “India sourcing” was built upon the principle of execution of potential offset obligations. If the government would like to retain its aim encouraging exports and bringing in Foreign Direct Investment (FDI) in the defence sector, then it is time to bring offset obligations in the good books again.

The private sector has to be included in the goals of ‘Atmanirbhar Bharat’ (Self-reliant India) and this has to trickle down to the DRDO, Ordnance Factory Board and all the DPSUs.  Else, a misled or disincentivised private sector may reveal permanent scars, which will only be evident in the next exigency where shortages are of a different kind.

(The writer is the founder of Insighteon Consulting)

NOTEDefence.Capital is available on Telegram. Please click here to subscribe

Categories: Chakraview, Defence, Industry, Policy, Procurement, Technology

Tagged as: , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,

12 replies »

  1. We need a very sturdy defence offset & TOT policy which encourages private sector to meet critical deadlines of building complex weapon systems.

  2. A very apt and timely article by Rajeev.
    The scars on the private sector are already showing.
    Why would a foreign OEM go through the complicated and endless the Make , Buy or IDDM procedure when the GOI offers him two major incentives in the G2G route – No ToT and No offsets.
    Coupled with increasing offset threshold from Rs. 300 cr to Rs. 2000 Cr , GoI appears to have given a quiet burial to offsets in Defence procurements.
    Aatmanirbharta – what’s that?

  3. A very apt commentary on the travails of the defence industry. While the situation has been exacerbated by the COVID-19 crisis, the fact is that there already were systemic problems with the DAP and it’s offsets component.
    There are many reasons that have resulted in the poor outcome of the offsets system, the aim of which is laudable – in essence, giving a fillip to the defence industry in the country, both public and private sectors, and raising its technological threshold.
    There are three issues here. First, the offsets policy itself, and its repeated changes. Second, the actual offsets negotiated for, and the recipients of these orders. Third, the implementation of the offset obligations.
    The Policy
    The repeated policy changes apart, the raising of the bar to 2000 crores is seen as a retrograde step. Yes, there are many challenges in the offsets system but by raising the base to 2000 crores and excluding FMS and IGA deals, it implies that offsets now apply to almost no deal.
    It is true that the offsets obligations that sellers had to factor in meant that they raised their bids. However, perhaps the additional price paid was worth it, if the defence industry benefited, even if there was no major TOT. Actually, the major bane of the system has been the interminable negotiations that have resulted once an L1 bidder was announced – leading to massive delays in procurement, with the serious national risks that that entailed. These problems do not imply that the offsets system itself is wrong, though its execution certainly has been seriously flawed.
    Hence, rather than de facto doing away with the offsets system (which the new policy actually implies), perhaps the way ahead would be to improve the system.
    Firstly, the overarching L1 system needs to be urgently modified. If you start negotiating after declaring the winner, the winner is going to claim his pound of flesh. There must be an L2, and maybe an L3 too, before the negotiations are concluded, so that the lever remains with the buyer, not the seller.
    However, the point is moot unless the inordinately high base is not revised. In fact, to ensure a wider spread of orders including TOT or even simply manufacture in the country, it may be wiser to lower the limit substantially, to even lower than 300 crores. The reason is that big ticket deals are few and far between, and the high costs usually imply high technology, which any nation will try and avoid sharing. Therefore, such large deals may, in any case, not result in TOT, though they may result in increased manufacture/ assembly in the country, The much more numerous smaller deals may imply a lower level of technology, which a nation may be more willing to part with, resulting in more deals, or may at least result in manufacture orders and for a larger number of companies. This would perhaps be more useful for industry in general as the numbers of orders and companies benefiting from them would likely increase.
    The Offsets And Order Recipients
    The areas in which TOT is desired or, at least, manufacturing opportunities are helpful, need to be worked out with, in conjunction with industry, both the public and private sector, before RFPs are floated, and not left open-ended for the post L1 declaration negotiation stage. I am sure many would argue that, obviously, that is done. However, it doesn’t quite reflect on the ground.
    Next, DPSUs and private sector undertakings must be on an even footing as regards the offsets orders recipients or transfer of technology. To ensure commerce does not trump national interest, as the avowed aim of the DPSU first system aims at, there could be a separate agreement with such private sector firms, obligating them to ensure that such technology remains within the country. I suspect no vendor will begrudge a nation that. It protects their interest too.
    Implementation of Offsets
    Even in the number of offset orders that fructified between 2007 and 2016, there has been very poor implementation and verification, as brought out by the CAG.
    The one word that sums up the root cause is ‘red tape’, okay, two words. The archaic procedures that the bureaucracy seems unable to break their shackles from, lead to many aims being lost in the maze of these procedures. The fear of corruption charges has led to so many checks and balances that the basic aim gets lost in the need to show that all is above board.
    The interminable procedures that the bureaucracy is apparently wedded to simply have to be streamlined. While many offsets have been agreed upon, their implementation have been very tardy, and a distinct lack of interest seen in insisting that the sellers comply with their obligations. In cases of non-compliance, financial or other penalties has not been enforced.
    The vetting of offset claims has to be sensible and the embedded CYA system has to be cut through. If anyone feels that these convoluted checks & balances actually curb complete corruption, they are being naive. A balance between checks & balances and realism is required. Time penalties in verification of claims must be enforced. Bank guarantees need to be insisted on, and enforced in case of slippages, even if the deal is an IGA or FMS one.

  4. A very apt commentary on the travails of the defence industry. While the situation has been exacerbated by the COVID-19 crisis, the fact is that there already were systemic problems with the DAP and it’s offsets component.
    There are many reasons that have resulted in the poor outcome of the offsets system, the aim of which is laudable – in essence, giving a fillip to the defence industry in the country, both public and private sectors, and raising its technological threshold.
    There are three issues here. First, the offsets policy itself, and its repeated changes. Second, the actual offsets negotiated for, and the recipients of these orders. Third, the implementation of the offset obligations.
    The Policy
    The repeated policy changes apart, the raising of the bar to 2000 crores is seen as a retrograde step. Yes, there are many challenges in the offsets system but by raising the base to 2000 crores and excluding FMS and IGA deals, it implies that offsets now apply to almost no deal.

  5. A very apt commentary on the travails of the defence industry. While the situation has been exacerbated by the COVID-19 crisis, the fact is that there already were systemic problems with the DAP and it’s offsets component.
    There are many reasons that have resulted in the poor outcome of the offsets system, the aim of which is laudable – in essence, giving a fillip to the defence industry in the country, both public and private sectors, and raising its technological threshold.
    There are three issues here. First, the offsets policy itself, and its repeated changes. Second, the actual offsets negotiated for, and the recipients of these orders. Third, the implementation of the offset obligations.

  6. A very apt commentary on the travails of the defence industry. While the situation has been exacerbated by the COVID-19 crisis, the fact is that there already were systemic problems with the DAP and it’s offsets component.
    There are many reasons that have resulted in the poor outcome of the offsets system, the aim of which is laudable – in essence, giving a fillip to the defence industry in the country, both public and private sectors, and raising its technological threshold.

  7. A very apt commentary on the travails of the defence industry. While the situation has been exacerbated by the COVID-19 crisis, the fact is that there already were systemic problems with the DAP and it’s offsets component.

  8. A very apt commentary on the travails of the defence industry. While the situation has been exacerbated by the COVID-19 crisis, the fact is that there already were systemic problems with the DAP and it’s offsets component.
    There are many reasons that have resulted in the poor outcome of the offsets system, the aim of which is laudable – in essence, giving a fillip to the defence industry in the country, both public and private sectors, and raising its technological threshold.
    There are three issues here. First, the offsets policy itself, and its repeated changes. Second, the actual offsets negotiated for, and the recipients of these orders. Third, the implementation of the offset obligations.

  9. The Policy
    The repeated policy changes apart, the raising of the bar to 2000 crores is seen as a retrograde step. Yes, there are many challenges in the offsets system but by raising the base to 2000 crores and excluding FMS and IGA deals, it implies that offsets now apply to almost no deal.
    It is true that the offsets obligations that sellers had to factor in meant that they raised their bids. However, perhaps the additional price paid was worth it, if the defence industry benefited, even if there was no major TOT. Actually, the major bane of the system has been the interminable negotiations that have resulted once an L1 bidder was announced – leading to massive delays in procurement, with the serious national risks that that entailed. These problems do not imply that the offsets system itself is wrong, though its execution certainly has been seriously flawed.
    Hence, rather than de facto doing away with the offsets system (which the new policy actually implies), perhaps the way ahead would be to improve the system.
    Firstly, the overarching L1 system needs to be urgently modified. If you start negotiating after declaring the winner, the winner is going to claim his pound of flesh. There must be an L2, and maybe an L3 too, before the negotiations are concluded, so that the lever remains with the buyer, not the seller.
    However, the point is moot unless the inordinately high base is not revised. In fact, to ensure a wider spread of orders including TOT or even simply manufacture in the country, it may be wiser to lower the limit substantially, to even lower than 300 crores. The reason is that big ticket deals are few and far between, and the high costs usually imply high technology, which any nation will try and avoid sharing. Therefore, such large deals may, in any case, not result in TOT, though they may result in increased manufacture/ assembly in the country, The much more numerous smaller deals may imply a lower level of technology, which a nation may be more willing to part with, resulting in more deals, or may at least result in manufacture orders and for a larger number of companies. This would perhaps be more useful for industry in general as the numbers of orders and companies benefiting from them would likely increase.

  10. The Offsets And Order Recipients
    The areas in which TOT is desired or, at least, manufacturing opportunities are helpful, need to be worked out with, in conjunction with industry, both the public and private sector, before RFPs are floated, and not left open-ended for the post L1 declaration negotiation stage. I am sure many would argue that, obviously, that is done. However, it doesn’t quite reflect on the ground.
    Next, DPSUs and private sector undertakings must be on an even footing as regards the offsets orders recipients or transfer of technology. To ensure commerce does not trump national interest, as the avowed aim of the DPSU first system aims at, there could be a separate agreement with such private sector firms, obligating them to ensure that such technology remains within the country. I suspect no vendor will begrudge a nation that. It protects their interest too.
    Implementation of Offsets
    Even in the number of offset orders that fructified between 2007 and 2016, there has been very poor implementation and verification, as brought out by the CAG.
    The one word that sums up the root cause is ‘red tape’, okay, two words. The archaic procedures that the bureaucracy seems unable to break their shackles from, lead to many aims being lost in the maze of these procedures. The fear of corruption charges has led to so many checks and balances that the basic aim gets lost in the need to show that all is above board.
    The interminable procedures that the bureaucracy is apparently wedded to simply have to be streamlined. While many offsets have been agreed upon, their implementation have been very tardy, and a distinct lack of interest seen in insisting that the sellers comply with their obligations. In cases of non-compliance, financial or other penalties has not been enforced.
    The vetting of offset claims has to be sensible and the embedded CYA system has to be cut through. If anyone feels that these convoluted checks & balances actually curb complete corruption, they are being naive. A balance between checks & balances and realism is required. Time penalties in verification of claims must be enforced. Bank guarantees need to be insisted on, and enforced in case of slippages, even if the deal is an IGA or FMS one.

    P.S. Pls pardon the repetition. Involuntary

  11. Confidence building & business clarity was what the private industry was looking at. But once again after moving a few steps ahead it seems to be back to prioritizing the needs of the DPSUs and going the G2G route and thereby making offsets close to redundant.
    We need a policy that should be allowed to run and only tweak it to your advantage if the need is felt. Offsets are a good incentive especially to the second tier suppliers and will help them also grow.
    A very appropriate article by Rajeev who having been in the procurement process understands the pitfalls & the need to focus on the offset to encourage the private industry also in the Defence & Aerospace industry.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.