Scrap offsets and foreign investment caps

Galvanising military modernisation requires radical changes to the procurement mindset

Sushant K Singh, head of Takshashila’s national security programme and an editor of Pragati has an op-ed in the Wall Street Journal’s Asian edition, commenting on the Indian government’s new, more-of-the-same, defence procurement policy. Excerpt:

The defense ministry in New Delhi won’t admit it, but the turn-around is not just a tacit acknowledgment of India’s limited capacity to absorb offsets, but also an indictment of the offsets policy itself. If the policy is to succeed, the foreign vendor should want to operate in a country where it actually derives commercial benefits from partnering with locals. But in India, the poor quality of the state-run defense units and ordnance factories rules them out as partners. The country simply does not also have a large enough private defense manufacturing sector that a Boeing or Lockheed could buy parts from or invest in.

The final nail in the offset coffin is India’s FDI policy. Which among the decrepit public-sector companies or near-absent private ones would Boeing choose from to invest in? Or, rather, which local manufacturer does it trust enough to share its proprietary technology with? A joint venture could be trustworthy, but because of the FDI cap, a local firm will have to put up 74% equity—no small potatoes in an industry where contracts easily total $100 million and upward. This is why over 10 years the 26% FDI regime brought in only $150,000 of investment.

If the Indian government wants to use offsets as an interim measure to bring in foreign manufacturers, it should do away with the FDI cap. Higher stakes in companies could help add value to the offsets policy: Boeing’s purchase of 34% of Aero Vodochody, a Czech firm, as an offset deal in 1998 is a good example.

The FDI regime has wrecked such opportunities. A proposal last year by India’s Ministry of Commerce to increase the FDI cap in defense manufacturing was rejected outright by the defense ministry. By both sheltering local firms from real competition and yet requiring foreigners to invest in them with offsets, the government wants the best of the old socialist way of nurturing its infant industries and the new capitalist way of acquiring foreign know-how. So far it has failed to secure either. [WSJ]

One thought on “Scrap offsets and foreign investment caps”

  1. This article may be called a good primer for the uninitiated to the topic of ‘Defence Offsets’ (henceforth DFO). However i have a few objections to the conclusions drawn here.

    Offsets began as a policy decision in the post 2nd WW era, when western Europe was being re-built and outfitted by USA for the cold war. DFOs helped W-Europe to channel its defence spending to productive national causes. The present article looks at the changes in the DFO policy of India as so many nails to the offset policy coffin. In my personal opinion the situation does not warrant such a bleak outlook. The changes may be considered to be a part of the learning curve for handling technology imports through a private sector initiative. This is an unavoidable situation for India due to the lack of a pvt sector defence capability.
    To understand the present situation on DFOs, we need to understand why it introduced in the first place.
    India is on an unprecedented expansion of its armed forces. A conservative estimate pegs India’s defence spending by 2022 to be around 100 billion dollars . With the current DFO limit being 30% of a contract value and if the above amount is assumed to be a reasonable figure then domestic manufacturers will get orders worth 21 billion dollars. However the Indian defence offset policy was undeveloped in the area of managing this massive inflow.
    To cite a few areas:
    1. The idea of multipliers was absent in the offset policy. Hence offsets pertaining to multi-functional display (MFDs) would be on par with offsets dealing with jet engines or AESA radar technology or submarine hull fabrication know-how.
    2. Identification of industries which are considered to be priorities for domestic defence industry development. An attempt was made by introducing the concept of ‘Rakhsa Udyog Ratnas’ (RURs), however the same was scuttled due to opposition by the OFBs and other DPSUs.
    3. Creation of a national offset policy with a hierarchy of requirements and a clear roadmap laid out for the duration of the Long Term Integrated Perspective Plan (LTIPP).

    The author does identify the problem of low FDI as a significant hurdle to building partnerships with foreign players. The easiest solution to this problem would be to increase the FDI limit to at least 49%. However in a deadlock as in the present situation, the Govt may follow the selective route of allowing FDI through the approval instead of an automatic route. This will not require dramatic changes to the present policy along with retaining a measure of control over foreign access to domestic industries.

    There are a number of other additions that may be made to the DFO policy including allowing offset trading and increasing the tenure for banking of DFO. However I fail to understand how the author of this article is suggesting that the ‘offset policy’ per se be dismantled due to perceived problems. This is akin to throwing the baby out with the bath water.

    Using the example of a Czech aviation firm, he seems to make a case for allowing higher FDI limits. However to make a case for the removal of offsets as a policy, the author will have to provide more inputs as well as examples to make his case. Presently he is only pointing out the inadequacies of Indian DFO policy; to prove his point he will need to argue on-
    1. The actual harm caused to the Indian private and-or public sector defence industry due to the offset policy.
    2. As a corollary, how imports of defence equipment without a DFO policy will contribute and help the DPSUs and pvt industry build capacity.
    Looking forward to your reply,
    Best wishes,
    Mike.

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