Defense purchases from abroad attract what is called the offset clause. Basically, the seller in deals where the total cost of acquisition exceeds Rs. 300 Crore has to invest back or purchase from the country 30-50% of the value of the deal. But it is not as simple as that.
Offset is applicable only to the foreign component of the deal. Also, the procedure for selection of Indian entities through whom the offsets are routed is not trivial.
With several big-ticket defense procurement deals such as the one to procure 126 fighter aircraft for the Indian Air Force on the anvil, the issue of offsets has attracted attention, but not enough from smaller Indian businesses, particularly on how they can participate in and benefit from the offset requirements.
This article attempts to do just that. We also analyze in detail the implications of the offset clause on the 126 fighter aircraft deal.
What are defense offsets?
Defense offsets are counter trade obligations imposed by an importing country upon the Original Equipment Manufacturer (OEM) that mandate the transfer of critical technologies and production of components (that may or may not be related to the said deal per se), as part of big defense procurement contracts. In fact, India is not the only country to have an offset clause. Some countries that have an offset clause on defense purchases do not even insist that investments in offsets be limited to defense, in a bid to develop generic technologies even in civilian businesses. India, though, obligates that offset related investments be strictly limited to defense.
| Big ticket Purchases | |||
| No of units likely to be procured | Total expected cost of acquisition (US$ billion) | Total expected offset generation (US$ billion) | |
|
AIRCRAFT |
126 |
10.8 |
4 |
| HELICOPTERS Light Utility Helicopter Attack VVIP Seahawk Anti-Submarine Warfare |
197 22 6 80 16 |
2.3 0.7 0.4 1.5 0.66 |
1.15 0.23 0.13 0.5 0.22 |
| WARSHIPS/SUBMARINES Scorpene Submarines Frigates |
6 3 |
3.4 1.7 |
1.1 0.57 |
How does the seller meet the offset obligation ?
Offset obligations maybe discharged in any one of four ways.
By a direct purchase of, or executing export orders for, defense products and components manufactured by, or services provided by Indian defense industries
By direct foreign investment in Indian defense industries
By direct foreign investment in Indian organizations engaged in research in defense R & D or
By creation of offset programs by foreign vendors in anticipation of future obligations. (For details, see box: Meeting Offset Obligations)
| The 126 aircraft MMRCA deal | |||
| Six foreign OEMs are in the fray for the US$10.8 billion Medium Multi-Role Combat Aircraft (MMRCA) deal under which the Indian Air Force (IAF) will get 126 state-of-the-art fighter jets to make up for its aging fleet, most of which has lived out its time and is due for a phase-out. The first eighteen out of the proposed 126 aircraft would be procured under the 'Buy' mode and would be fully operational on delivery. The remaining 108 would be brought in with successive degrees of indigenization, that is, technology would be successively transferred during the course of the acquisition which is likely to begin in 2014 and carry on till 2024 (see table). | |||
|
126 aircraft MMRCA deal 26 aircraft MMRCA deal Cost of Support, Spares etc: Therefore, total Cost of Acquisition (excluding cost of engines) Cost per engine (purchased separately from different vendor) Assuming the IAF settles for single engine aircraft, then, cost of 126 engines Therefore the total cost of acquisition (assuming single-engine aircraft are procured) |
 US$ 6.1 billion
|
||
|
Likely schedule of acquisition of the aircraft Year 2014-2017 2018-2019 2020 2021 2022 2023 2024 Total Teerefore amount on which offset is applicable Offset amount at 50 % |
No of aircraft
18 18 18 18 18 18 |
% of Foreign  100 80 60 40 10 10 10  8.1 billions
|
Total Cost if Acquisition of Foreign Component (US$ million)
864 648 432 108 108 108 3.4 billions |
| Six major players viz. EADS, MiG, Lockheed Martin, SAAB, Boeing and Dassault are in the fray While MiG, Lockheed Martin and SAAB have pitched in for single engine aircraft, the others hope to supply twin-engine variants. If the IAF chooses to go in for the single-engine variant, the government would have to shell out US$ 10.8 billion, out of which US$ 8 billion would go towards the foreign component, generating an offset business to the tune of US$ 4 billion.
Sources however indicate that the IAF is in favor of the twin-engine version out of stable of any one vendor and that some smart negotiating could limit the deal to about US$ 8-10 billion. Informed sources also indicate that strategic reasons might eventually force the IAF to go in for a combination of single and twin-engine aircraft, in a way that the cost of acquisition remains nearly the same. Most OEMs already have existing relationships with some Indian players, almost all of whom are understood to be lobbying hard for a share of the pie. THE BIG TICKET COMPANY-COMPANY RELATIONSHIPS: EADS (twin-engine aircraft): Samtel Display Systems (SDS), HAL, L&T, Infotech Enterprises,Tata (EADS is known to have signed MoUs with nearly 50 Indian companies) |
|||
Why are offsets important to an arms importer like India? How will offsets in general influence Indian defense industry which is still in its nascent stage?
The Indian defense industry is nascent and lacks the domain expertise or the scale to become a viable domestic supplier for the country’s growing needs for cutting edge technologies required to keep the strategic balance of power in the region. The raison’detre for offsets therefore is to stimulate growth in the Indian defense establishment, be it in R&D or production, both in the public and the private sectors. It is hoped that the business generated from the offset obligations will help government and private defense equipment manufacturers attain critical mass and this will eventually lead to domestic capabilities that may be harnessed for import substitution. Further, it could also help India tap the lucrative global defense market, thus far out of bounds barring some back-end operations that are now outsourced to Indian IT players. Business generation will also help the country develop a competitive defense export market, just as ISRO has managed to do in space exploration.
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written by Siddharth, October 25, 2009
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