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Offset Policy in Defence Procurement: Recent Developments

To ensure flow of benefits to the domestic industry either by way of transfer of technology to the buyer country or in the form of investments or an obligation on the supplier/vendor to promote local manufacturing, many countries impose conditions of offset while entering into significant defence contracts with suppliers. Following the same rationale, India too adopted an offset policy in 2005. Revised over the years on various counts, the current offset policy (“Offset Policy”) is contained in the Defence Procurement Procedure (“DPP”) 2013.

With a view to boost the domestic defence industry, the Government has since 2015 introduced certain critical amendments to the Offset Policy. A snapshot of the same is given below:

(i)            Enabling more realistic offset offers and flexibility to suppliers: Due to the time lag between submission of technical offset offers, finalization and subsequent implementation of the offset contracts, many suppliers face difficulties in providing upfront specific description of products, work share, yearly discharge schedule and supporting documents to establish eligibility of the Indian Offset Partners (“IOPs”). To address this issue both at pre-contract and post-contract stage, the Ministry of Defence (“MoD”) introduced the following amendments to the Offset Policy:

  • Pre-Contract Stage: The vendors now have the option, to submit detailed offset proposals at a later stage, thereby allowing them to finalize a more realistic offset offer. The vendor can finalize its IOPs and offset product details either at the time of seeking offset credits or 1 year prior to the intended offset discharge through the IOP.[1]

However, if the vendor has chosen to submit the required documents at the time of seeking offset credits and if at such point, the IOP, product or offset discharge avenue is found ineligible, then penalty will be imposed by treating the transaction as invalid. Similarly when documents are submitted 1 year prior to offset discharge, the final decision regarding the admissibility of the proposal will be intimated by the Government within a period of three months of submission of the complete documents and the proposal if found ineligible, the vendor incurs the risk of re-phasing with consequent enhancement of 5% in obligations, in case the annual commitments change due to such inability.

  • Post-Contract Stage: Providing significant flexibility to the supplier, enabling provisions have also been provided at the post-contract stage for change in IOP/ offset component and re-phasing within the performance period, and a standard operating procedure (for processing offset contract amendment proposals) has been introduced allowing addressing of supplier’s requests to change the IOP or their offset component as per requirement during the period of the contract. The overall value of the offset obligation will however remain the same.[2]

(ii)           Wider applicability of Exchange Rate Variation: Exchange Rate Variation (ERV) has been made applicable for Rupee contracts with Indian vendors based on RFPs issued under all categories of capital acquisitions where there is an import content. However, ERV clause will not be applicable to contracts where the delivery period is less than 1 year and the rate of exchange is within the band of +/- 2.5%.[3]

(iii)          Reinstatement of Services: In response to a demand from the industry, and in line with the recommendations made by the Dhirendra Committee (as discussed below) most of the ‘Services’ (kept in abeyance since May 2013 in the wake of the Agusta-Westland Deal) were reinstated, in December 2015, as an eligible avenue for offset discharge, as follows[4]:

  • Maintenance, repair and overhaul; upgradation/life extension; and research and development services (from government recognized R & D facilities) have been reinstated.
  • Engineering, design and testing; and software development services, have been reinstated with capping at 20% of the total offset obligation and prescribing of a random audit
  • Quality assurance; and training services still continue to be under abeyance.

(iv)          Reduced offset trigger for Indian companies participating in ‘Buy (Global)’ Tenders:

  • Indian vendors participating in ‘Buy (Global)’ category procurements, were required to discharge offset obligation on the foreign exchange component of the contract, if the indigenous content (by value) in the product was less than 50%.
  • This threshold has now been reduced to 30%. Offset obligations will not be attracted if the indigenous content in the product is 30% or more.  If it is less than 30%, then the offset obligations are to be fulfilled to the tune of 30% less the indigenous content percentage.
  • With the Indian vendors now brought at par with the foreign Original Equipment Manufacturers (OEMs) in terms of fulfilling offset obligations, this is likely to pave the way for greater participation of the Indian companies in ‘Buy (Global)’ tenders.

(v)           Increase in contract cost thresholdRecent press reports indicate that the Defence Acquisition Council (“DAC”), in its meeting on January 11, 2016 which was held to discuss the proposed changes to DPP 2013, has approved increasing of the current contract cost threshold for applying offset obligations from Rs. 300 Crores to Rs. 2000 crores.

(vi)          Proposed DPP 2016 – New Offset PolicyA Committee of Experts, under the chairmanship of former Home Secretary Dhirendra Singh, was set up in 2015 (“Committee”), for reviewing the DPP-2013 (and the Offset Policy contained therein) primarily to evolve a policy framework to facilitate ‘Make in India’ in defence manufacturing, suggest amendments to remove bottlenecks in the procurement process and to simplify/rationalize various aspects of defence procurement. As per recent press reports, it appears that most of the recommendations of the Committee have been approved by DAC and incorporated in the draft of the proposed DPP 2016 which is expected to be out soon.

The Offset Policy seems to be evolving in response to feedback and the needs of the industry as well as experience gained by the Government during its implementation phase. It also highlights the Government’s efforts to enable the domestic defence industry to benefit from the Offset Policy, which had so far failed to be as effective and productive as initially envisaged by the Government. However, the devil is in the details and with the new DPP 2016 (and a DPP Manual 2016) expected to be released soon, it remains to be seen how the proposed policy changes recommended by the Committee are going to be reflected legislatively.

(The author of this article, Ms. Seema Jhingan (Partner, LexCounsel Law Offices), will be speaking on ‘Updates on Defence Offsets’ at a Conference on ‘Opportunities in Defence Opportunities in Defence: Trends and Outlook, Issues and Challenges’ on March 15, 2016[5]where she will be providing further insights and information on the Offset Policy and the dynamics involved. For further details on the conference log on to http://indiainfrastructure.com/confpdf/brochure-opportunities-in-defence-march2016.pdf). 

Endnotes

1 MoD Order ID No. 1(6)/D(Acq)/13-Vol.II dated 05.08.2015 amending Para 8.2 of Appendix D to Chapter 1 of the DPP 2013

2 MoD Order ID No. 1(6)/D (Acq)/13 – Vol. – II dated 11.12.2015.

3 Earlier, ERV was applicable for ‘Buy (Global)’ category and not ‘Buy (Indian)’ except for Defence Public Sector Undertakings (DPSUs) in ab-initio single vendor cases or when  nominated by Production Agency. Please refer MoD Order ID No. 1(6)/D (Acq)/13 – Vol. – II dated 19.08.2015.

4 Please refer to MoD Order ID No. DOMW/OP/GEN/03/2015/01 dated 7.12.2015 reinstated services as an eligible avenue for offset discharge.

5A conference on ‘Opportunities in Defence: Trends and Outlook, Issues and Challenges’, is being organized by India Infrastructure Publishing, publisher of Indian Infrastructuremagazine, proposed to be held on March 15, 2016 at The Grand, Nelson Mandela Road, Vasant Kunj – Phase II -New Delhi 110 070.