What India needs in a defence offsets policy: Greater technology transfer and thrust on localisation

India is the world’s largest defence importer and has steadily held this position for the previous 5 years.

By Muqbil Ahmar

Defence Minister Manohar Parrikar recently said that defence procurement from SMEs will register growth of 6 percent this year over the previous year. “Last year, procurement reached 9 percent, and in the current year, it will reach 15 percent. As the volumes increase from Rs 40,000 crore in 2014, to Rs 52,000 crore in the current year, there is more scope for SMEs. It was unheard before,” he said. In addition, the Ministry of Defence (MoD) also aims at 7 percent indigenisation by the year 2027.

There is a context to the statement. India is the world’s largest defence importer and has steadily held this position for the previous 5 years. It is also the sixth biggest defence spender internationally and the second largest spender in Asia. There has also been consistent criticism of India’s defence offsets policy and the lack of participation of the local industry in the defence sector. For the realisation of key government initiatives such as Make in India, there is need for a robust offsets policy—one that would aid the flourishing of the local defence enterprises.

India’s defence offsets policy

In order to leverage India’s huge defence import and bolster the local arms industry, the Ministry of Defence (MoD) has in place an offsets policy, which lays down the ground rules for the implementation of offset agreements—arrangements in which the seller of a defence product or service agrees to buy products or services from its client as an inducement. These agreements are legal trade practices in the aerospace and military industries. The offsets policy was made part of the Defence Procurement Procedure (DPP) in 2005 for the first time and has seen several changes since then. It permits foreign vendors to realise their offset obligations through a blend of two key provisions: Foreign Direct Investment (FDI) in Indian companies and purchase of certain products/services from qualified Indian enterprises.

Criticism of India’s defence offsets policy

The offsets policy has often been the target of criticism, with experts saying that it has been inadequate in compensating for India’s huge purchasing power and also that its implementation has been woefully insufficient. They also claim that it has not led to any substantial growth of indigenous industries. The criticism is not without reason.

The Comptroller and Auditor General of India (CAG), the body entrusted with auditing the implementation of the offsets arrangements and which has audited several offset contracts, has been unforgiving in its assessment of the policy and its implementation. In a report submitted to Parliament in November 2012, it pinpointed a number of weaknesses in the policy, including zero value addition, equipment transfer, invalid selection of the Indian Offset Partner (IOP), and a weak monitoring mechanism.

Moreover, the Defence Procurement Policy (DPP) 2016 has elevated the offset threshold limit to Rs. 2,000 crore (around US$ 305 million) from Rs. 300 crore. No reasons have been given for the hike. Industry experts believe that it may have stemmed from the ministry’s difficulty in executing the existing offset contracts. Whatever might be the case, the hike is flawed on two main accounts: (a) it goes against global practices followed by other countries and (b) it is self-defeating for initiatives such as ‘Make in India’. According to global practices, offset threshold is as low as USD 5–15 million in several countries such as Australia, Brazil, and Israel. Furthermore, states usually tend to lower the threshold overtime as they gain in experience.

The increase in the threshold limit means that a smaller number of arms import contracts would now be qualified for offsets. This translates into a setback for indigenous enterprises, specifically local manufacturers of components that have been exploiting the existing policy for boosting their own exports. In the process, enterprises have been able to set up their own capabilities and bolster initiatives such as ‘Make in India’. Although, the DPP has a clear emphasis on “Make in India” and self-reliance, with the introduction of a new category of procurement and increased localisation in the existing categories, the hike in the offsets threshold limit negates the thrust on indigenisation.

“The biggest weakness of the policy is the freedom given to foreign companies to choose offsets they want to deliver. Obviously, they have so far chosen offsets, which do not add to the capability enhancement of the local industry. The policy should clearly focus on technology acquisition and high quality and sustainable manufacturing work for the industry, which would go a long way in strengthening the indigenous capability", said Laxman Kumar Behera, author of the book Indian Defence Industry: An Agenda for Making in India and a research fellow at the MoD-funded think-tank Institute for Defence Studies and Analyses (IDSA).

India can learn from Japan and Brazil

The Japanese vision has been fairly simple: there can’t be real security unless the nation is self-sufficient with respect to technology and arms production. This has been coupled with the belief that the absorption of defence technology and the creation of indigenous arms production capacity will have significant spill-over effects on the growth of civilian commercial technologies, eventually making Japan an industrial and technological superpower.

During the post-World War II period, Japan used its relationship with the USA to develop its local defence sector. Its industrial policy too has been based on technology transfer from the West—first emulating the techniques and eventually overtaking them. This principle has been key to Japan’s quick, resilient and diversified industrialisation. In fact, a major source of the technology inflows into Japan came from defence offsets.

According to defence expert Anuradha Mitra, more than 90 percent of Japan’s requirements for military products are now met within the country. There have been a number of important developments in the aerospace sector. For the F1 fighter there was a Japanese fire control design; for the T4 intermediate jet trainer the fuselage and engine were developed in Japan; 80 per cent of the materials and systems for the P3-C Orion are sourced from within the country; the FS-X advanced fighter bomber has been built indigenously with Mitsubishi as the prime contractor in collaboration with General Dynamics (later Lockheed Martin).

Similarly, Brazil always viewed the growth of arms industry as a significant long-term goal. The Brazilian government has been able to leverage its defence buys to get state-of-the-art military technology from outside through licensed production and joint ventures.

“Technology transfer has always been a key requisite in all Brazilian arms procurements. The state has also been willing to invest a good deal of resources in the indigenous projects. Embraer Corporation, the Brazilian aeronautics major proved to be leader in the absorption and indigenisation of technologies. In the early 1970s, Embraer had a technology transfer agreement with Piper of the USA for manufacture of the Piper Seneca light aero-planes. In 1975, when 49 F-5 aircraft were purchased by Brazil from Northrop of the US, Embraer was involved in the manufacture of several fuselage components,” explains Mitra.

India’s defence industry is largely public sector

The Indian defence sector is largely dominated by public sector units (PSUs) and ordnance factories, which together make up approximately 90 percent of the indigenous defence manufacturing output.

There is an urgent need for a vibrant SME sector in the defence sector. According to a survey conducted by Deskera, an IT firm working in the SME sector, 65 percent SMEs want a greater role in the defence sector. Greater indigenisation will not only make India self-reliant in the defence sector, it will also help in creating huge employment opportunities for young engineers, operators and the labour force in general.

Although 100 percent localisation could be the ideal aim in a strategic industry such as defence, it is  not achievable because of globalisation of the supply chains and issues related to economies of scale. Right now, even 15 percent indigenous content promised for this year looks like a long shot.

The author is Senior Editor, Deskera (Run Your Business). 

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