OEMs Unhappy That Relaxed Indian Offset Policy Is Not Retroactive

 - July 12, 2012, 11:00 AM

Recent upgrades to India’s Defense Procurement Policy (DPP) 2011 that are to be incorporated in DPP 2012 could soon allow foreign vendors to buy from Indian companies assemblies that contain foreign content while getting credit for the entire assembly, as long as the content is paid for in rupees.

The period of time allowed for the discharge of offset obligations is also being extended by two years, up to four, and that for the banking of offsets from five to seven years. A multiplier of factor 1.5 will be permitted through a non-equity route for offset obligations relating to direct exports, foreign direct investment, transfer of technology (TOT) or investment in kind.

While the objective is to ensure establishment of a consistent, authoritative, empowered offsets agency serving as a clearinghouse and having the ability to approve or reject offset (FDI) proposals, international OEMs are not satisfied. They feel that, as the policy matures, the Indian Ministry of Defense should retroactively apply the revised offset amendments to previous iterations of the DPP, since many major contracts are bound to the terms of DPP 2006-2008.

But the government is not willing to go this route, which in effect means its largest current acquisition–the medium multi-role combat aircraft (MMRCA), now worth around $8 billion in offsets under the DPP 2006–will not reap any advantage under the new policy. A disappointed French analyst summed up the sentiment: “Imagine you were condemned to death for whatever reason,” he said, “then new legislation in your country abolishes the death penalty. Would you be happy if the new rule was not retroactive?”

However, some observers believe the Indian government is doing exactly what it set out to do–that is, to evolve the policy slowly. “Major OEMs that were quite happy to sign contracts and take the revenues now need to play ball and do it in the right spirit. My advice to our clients is to plan to comply fully with the policy today and then adapt as it changes,” John Williams, founder of Delhi-based Williams Global Advisors, told AIN.

Williams’ recommendations for making offsets more palatable include allowing offset credit for TOT with the private sector (presently applicable only to government defense firms); creating transparency in the banking process for foreign companies to easily navigate the system; and permitting civil infrastructure (for example, improvements to airfields, hangars and so on) to be eligible for defense offsets when being built for defense purposes

Offset policy guidelines were expanded last year to include civil aerospace, internal security and training. Eligible offset obligations now cover most aspects of civil aerospace, including aircraft, aero engines, aircraft components, design and engineering services. A wide range of counterterrorism weapons and services also have been included in the list of products under the internal security category.

According to the Ministry of Civil Aviation, the Indian aerospace industry needs investment of between $200 billion and $300 billion up to 2034. “The thrust now…is on modernization of airports, communication, navigation and surveillance systems for aircraft management, and facilities for maintenance repair and overhaul of aircraft and subsystems,” junior minister of defense M.M. Pallam Raju told AIN last year.

Companies continue to face challenges to get offset proposals approved, validated, discharged and measured in a timely manner, adding uncertainty and delay (and cost) to the program. The U.S. industry has been seeking certain provisions or amendments regarding clarifications to ensure certainty of action on offset questions because approved offsets sometimes are later invalidated. It has also asked the government to look at an upward revision of the FDI limit from the present 26-percent cap in the defense industry to 74 percent, even if it is granted for specific technologies on a case-by-case basis.

“The effect will spur greater investment and transfer of technology by American defense companies, resulting in increased opportunities for coproduction, joint manufacturing and offset partnerships with Indian industry. This will be particularly crucial as more [OEMs] tie up with Indian industry to meet offset obligations,” concluded the U.S.-India Business Council advocacy agenda 2012.

There remains the issue of intellectual property rights and technology safety (protection, policing and enforcement), the single most sensitive issue for OEMs. “India must learn from the successful examples of Japan, Singapore and Brazil to improve its IPR management dynamics through regulating industrial policy, greater judicial awareness and proactive participation by industry,” said Ajay Batra, president of strategic electronics, aerospace and defense division at Vittal Innovation City, an aerospace cluster near Bangalore that provides an internal compliance program on IPR protection. “The aim is to build an eco-system of trust that protects and promotes transferred technologies and a legal system that preserves IPRs.”