Over the past years, CAG (Chief Comptroller and Chief Auditor) audit reports on procurement indicate under-realization of offset benefits; additions with zero value; wrong choice of Indian offset partners; delay at various stages from contract to delivery; poor control and oversight. Similarly, according to an IDSA (Institute for Defense Research and Analysis) study, one of the observations made was that offset policies had minimal impact on the defense industry, especially in technology transfer.
In this scenario, the question needs to be asked, how effective is our offset policy? What is the world experience of offset policy? What can India learn from international offset policy? Worldwide, more than 130 countries have offset policies. The lack of publicly available data on defense procurement makes it difficult to formulate a definitive answer about the effectiveness of offsetting policies as success or failure. For example, in the offset policy of India, details including the name of the Indian Offset Partner (IOP) and its percentage share in the contract are not publicly available.
In addition, debates over offset policy often use specific case studies to argue for or against it. First, most economists argue that offsets have little positive effect on economic development. The second category claims to be “free lunch”. The third group argues that cumulative annual growth or cumulative benefit results from compensation policies.
In this vein, perhaps one of the criteria for analyzing the success of any policy is to compare the goals of the policy and its results. There are often three main goals for which any country adopts a compensatory policy, ie economic development, technology transfer and industrial gain.
In the case of India, set-off provisions were first included in the 2005 Defense Procurement Procedure (DPP). Since then, the offset policy has undergone significant changes. The last was two years ago when the Defense Procurement Procedure 2020 (DAP 2020) was made public. In general, the evolution includes well-articulated offset policy goals; enhanced opportunities to fulfill compensatory obligations; simplified applicability of offset; proven implementation and monitoring mechanisms; flexibility for suppliers in planning offset activities; and the inclusion of multipliers. Despite periodic reformulations of the offset policy, it seems to have many shortcomings.
Conversely, it is important to distinguish between two poles of compensation policy: one from the side of the goal, and the other from the side of implementation. As the former shapes the latter, India’s offset policy needs to rethink policy objectives to promote innovation-driven transformation. Perhaps the offset policy should be targeted at the new National Offset Policy (NOP), which would target overall economic development and industrial benefits.
Here, an analysis of the offset policy goals of countries such as Canada, Saudi Arabia, Brazil, Israel and Japan, in comparison with their results, would be useful. Canada adopted its offset policy, realizing the lack of a major defense industrial base. Similarly, Japanese industry underwent a complete restructuring after the World War. Today, India has a similar need: the predicament of spillover from the defense industrial base to other sectors.
Most offset models, be it Canada, Japan, Saudi Arabia, Israel, Spain or Brazil, had similar or identical conditions when adopting an offset policy. This is the national security goal that forms the basis of offset policy. They were often formulated in different terms of self-sufficiency or indigenous people in the defense sector of the respective country. In addition, the goals of offset policy in these countries were formed in accordance with the conditions of their economy, i.e., focusing on a factor different from the needs of the defense sector.
Another common feature is the importance of relations with the United States. Canada and Japan have benefited from a close relationship with the US in acquiring technology transfer through netting and becoming a strong defense industry base. High-income countries always benefit from technological innovation and the development of advanced technologies. The US is a powerhouse of innovation, especially in the defense sector. Today, Canada and Japan are serious contenders for US supplies to original equipment manufacturers. India currently has a strong bilateral relationship with the US as evidenced by the containment of CAATSA (Countering America’s Adversaries Through Sanctions Act) sanctions. This situation arose due to the fact that India purchased S-400 missile defense systems from Russia. The focus of the US should be negotiating tangible results by attracting the strategic attention of India.
In addition, job creation is a parallel theme in most countries’ offset policies, either directly or indirectly. For example, Saudi Arabia’s compensatory policy was to create highly skilled technical jobs. Boeing has partnered with the Saudi Arabian General Investment Authority (SAGIA) to conduct a training and education program as part of the compensatory obligation to procure the Peace Shield Ground Air Defense System. Similarly, initiatives such as training and skills development can be an important component of compensation policy in India, allowing a significant proportion of unemployed youth to improve their skills. India stopped compensation for the services sector after the VVIP helicopter scandal, but such an approach is foolhardy.
However, side effects are associated with the development of the defense sector. It has a cross-cutting impact on various industries. The acceleration of technological development creates a ripple effect in the civilian and synergistic sectors. The history of Saudi Arabia’s aerospace and automotive industry, the automotive sector (bullet train from the F-86 aircraft co-production), the development of dual-use technology in Japan, and the progress of the electronics and aerospace industry in Spain are numerous. cases of side effects of policy-based technological progress. Spillovers can be a direct stream from compensation policies or an indirect spillover to another sector.
In this regard, the direction of offsets to strong sectors of the country, such as Saudi Arabia, has directed its offset policy to the chemical industry, and Brazil’s to the aviation sector. For example, the creation of Synthomer Middle East in Saudi Arabia was the result of a joint venture between Dhahran Chemical Industries and British Synthomer. This was part of the UK Government and British Aerospace System compensation. The British company Synthomer produced polymeric dispersants for the West Asian paint and adhesive markets. Now Synthomer Middle East specializes in polymer business with a threefold increase in exports. Similarly, India’s IT sector is one such sector that can reap the benefits of technological innovation as there is a strong base sector in addition to being a dual-use technology.
In particular, it will be necessary to ensure that offsetting benefits are not concentrated in the hands of a few sellers. One mechanism could be the Japanese model of subcontracting purchases from companies that are not major suppliers. Spain has adopted a similar policy through the category of indirect reimbursement, enabling horizontal growth for multiple companies benefiting from the same contract. In addition, all offset R&D countries are gradually moving towards technological innovation.
In parallel, a more efficient way forward could be centralized management of offset operations such as Saudi Arabia’s SAGIA, Israel’s Industrial Cooperation Authority and Spain’s Office of Offset Management. The current implementation of compensation policy in India is administered by the Defense Compensation Facilitation Agency (DOFA) under the Ministry of Defense (MoD). Alas, such a scheme does not allow the Agency to make independent decisions. Thus, we propose to transfer DOFA to the Ministry of Trade and Industry or the Department of Economics and Finance, which also negotiates in the international economic arena. They will be at arm’s length from the MoD and thus make decisions in the interests of the Indian economy. We can think of a good example of distancing in the Indian administrative structure, which could be a good role model for DOFA as well as other similar mechanisms. The Railway Safety Commission is understandably under the jurisdiction of the Ministry of Civil Aviation and not of the railways.
In addition, technology transfer (ToT) can be a trickle down effect when the focus is on research and development. For example, Israel’s purchase of Combat Aircraft from Mc Donnell Douglas with 100% compensation. The transfer of technology resulting from this shift enabled the development of Israel Aircraft Industries, Cyclone Aviation Products, Israel Military Industries and TAT Aero, allowing them to be competitive in export markets. Thus, focusing on R&D will increase the ability of the economy to absorb large transfers and generate economic benefits. India’s R&D sector is in need of a major overhaul, and the defense sector in particular should focus on R&D-led co-design and co-manufacturing of equipment. One can also view the PLI in semiconductors as something quite compelling, or in other areas that can reduce our budgetary burden and help our economic development.
Moving forward, India’s offset policy should aim to force companies to move beyond offset contract manufacturing and diversify into other sectors. Perhaps this can be done by reformulating specific clearly stated policy objectives, simplifying the procurement process, expanding the scope of compensation to more civilian sectors, and essentially guaranteeing suppliers default on compensation, aiming for national netting. Politics.
The authors work for CUTS International, an international research and advocacy group.