Indian defence offset policy has played a major role in the growth of the defence industry
Maj. Gen. (Dr) Rambir Mann (retd)
Nations with a weak defence industrial base (DIB) often seek to enhance the international competitiveness of their DIB by encouraging foreign suppliers to place work with domestic manufacturers through offsets. The learning and scale economies that accrue are important for unit production costs, to achieve international competitiveness and once established, may not need further protection.
Offsets can also assist the importing nation in improved security of supply due to creation of indigenous supply as well as reduced life cycle support costs compared with the provision of such services by the original supplier. They are also perceived to have had many effects on the development of a country’s defence industry including employment, technology development, supply-chain development, skill improvement, sub-contractor development and marketing. Countries worldwide view offsets as means to acquire competence to build their defence industries. In fact, some countries are known to have used offsets to develop the skills and capacity to design, manufacture, develop, integrate and maintain equipment.
Due to information asymmetries in the defence sector, foreign companies are sometimes not aware of subcontractors in the domestic defence market that are capable of supplying components to the foreign company. In requiring local content or assemblies, importing governments reduce these informational barriers and achieve an efficient outcome by forcing foreign commercial organisations to look out for local suppliers, thus overcoming information asymmetries. Thus, even if most of the offset contracts are related to supply of components and subassemblies, the local industry gains by way of introduction of modern machinery and manufacturing processes, quality control etc.
India adopted defence offsets as a tool for development of the indigenous defence industrial base in 2005 and the first offset contract was signed only in 2007. Since then, India has signed 57 contracts worth USD 13.3 billion under different Defence Procurement Procedures (DPPs). Of these offset claims worth more than USD 8.6 billion have been made and USD 6.0 billion have been audited and disposed of.
As per reports a number of these contracts are still open, with defaults in 21 contracts worth USD 2.24 billion and penalties worth USD 43.14 million imposed. Some of the offset contracts are to continue up to 2033 and are likely to result in further defaults and penalties, as the pending offset contracts come up. These defaults and penalties have been mainly due to earlier contracts signed under previous editions of the defence offset policy; the Defence Offsets Management Wing (DOMW) continues to struggle with legacy offset contracts signed when DOFA/ DOMW was still on the learning curve. Administration of defence offset contracts has seen a marked improvement as not only are offsets now being monitored and processed digitally with minimum delay, but clarifications and requests being received from original equipment manufacturers (OEMs) are being addressed without delay. This is evident from the notable improvement in the offset claims disposed off and reduced number of pending requests and clarifications sought by OEMs.
Table 1: Defence Offset Data
Indian Offsets
There is a large body of criticism directed towards the Indian defence offset by defence analysts, Comptroller and Auditor General of India (CAG) and retired officials. It has been repeatedly pointed out that not only have Indian defence offsets failed to meet the aims and objectives for which they were introduced but have in fact adversely impacted rapport with global arms manufacturers due to levy of penalties, poor administration and inefficiencies. In some cases, allegations of corruption have also been made.
A study conducted by the Institute for Defence Studies and Analyses (IDSA) in 2019 revealed that more than 90 per cent of offset obligations were discharged through direct purchase of products and services from Indian companies, with hardly any instance of technology transfer or foreign direct investment. There has therefore been reducing emphasis on defence offsets in Indian capital procurement in recent years, with manifold increase in the threshold value of defence contracts when offsets would be applicable, and exemption of offsets in single vendor contracts or inter government agreements. Further, with increased emphasis on procurement from indigenous sources, capital procurement contracts with foreign OEMs where offsets would be applicable, would greatly reduce. There is, however, a need to re-examine our offset journey, in light of the current trends in the Indian defence industrial base, and compare it with global offset experiences, to identify whether trends match. This will help us correctly conclude whether Indian defence offsets have indeed failed.
Takeaways from Global Studies
An analysis of global defence offsets indicates that there are key factors by which offsets are measured, and success is finally evidenced by the sustained reduction of arm imports and increase in exports. An analysis of Stockholm International Peace Research Institute (SIPRI) data shows that Brazil showed a marked improvement of defence exports to the UK and France in the Eighties and Nineties, following introduction of defence offsets in Brazilian policy. Similarly, Turkey’s defence imports fell while exports multiplied manifold from 1970, when defence offsets were first introduced. Israel also benefitted from the US supplied defence offsets from 1982 onwards after offsets were introduced and is today amongst the top 10 arms exporters globally. However, this is an outcome of progress on the undermentioned key factors to collate which a robust and responsive system of industry data collection is essential to arrive at a definitive conclusion. Let’s understand these factors:
- Skill and Capacity Enhancement
- Value Chain Creation: Local supply chain or value chain creation is an indicator of offset success. The supply chain is also signified by the export of components to the OEMs through buy-back or post offset extended contracts, as a signal of product quality.
- Integration into Global Supply Chains: Export is a key indicator of offset success when the objective is to improve competitiveness of the industry. It is the net effect of improvement in all other factors.
- Forging Long-term Partnerships: JVs and businesses generated through defence offsets can only be termed a success if they enable forging of long-term partnerships with foreign firms and continued business generation beyond the term of the subject offset contract.
- Employment: Employment created in the buyer nation is one of the variables to measure the impact of offsets. Indicators used for this are the numbers of jobs created by offsets, the quality of those jobs and the numbers of jobs maintained by offsets.
- Reduction in Imports of Defence Equipment: The positive impact of defence offsets on the defence industrial base will manifest directly on the indigenous production of frontline defence technology and equipment, thereby reducing the import of defence equipment from foreign vendors.
- Defence Technology: Transfer of Technology (Know-why) is the key to success of defence offsets and effective technology absorption and its seeding will automatically create value, generate employment and enable integration with global supply chains, besides forging long term relations and enabling skill and capacity enhancement.
- Research and Development: Defence offsets can be leveraged to encourage the foreign OEM to establish R&D centres in niche areas and centres of excellence with Indian academia.
Indian Defence Industry
OEMs executing defence offsets in India can select Indian Offset Partners (IOPs); in fact, they have preferred the Indian private sector as bulk of the offset contracts have gone to them.
Coincidently, the Indian private sector has also been the key participant in the rising Indian defence exports though most of the private sector’s exports are in the form of parts, components, assemblies, and sub-assemblies. The trend of Indian imports and exports clearly indicate a reduction of imports and increase of exports coinciding with the period when offsets contracts commenced.
In the intensely competitive arms market, rising arms exports indicate several positive developments for a nation’s arms industry. These include increased global competitiveness, improved product quality and reliability as importing countries are willing to purchase its products, enhanced technological capabilities, economies of scale as higher production volumes reduce costs, making products more competitive, strengthened industry partnerships and collaborations with foreign companies and job creation and skill development.
Table 2: Progress Of Indian Defence Exports
The offset policy has fostered the growth of Indian companies that have become key players in the defence sector. For instance, around 87 per cent of offset obligations were discharged through just 15 IOPs, with the top five receiving about 51.76 per cent of the total offset business. This concentration has helped these companies scale up their operations and capabilities and has facilitated the development of robust supply chains within India. Major IOPs often outsource components and services to smaller local firms, thereby enhancing their capabilities and integrating them into the larger defence supply chain. This ripple effect helps smaller enterprises gain access to new markets and technologies.
The policy has provided opportunities for Micro, Small, and Medium Enterprises (MSMEs) to participate in defence production. Over USD 8.5 billion worth of offsets have been executed by OEMs in India. These have brought employment, exports, quality control, new manufacturing processes etc to the Indian defence industries including MSMEs. The table below shows the increasing capacity of the Indian defence industry. As can be seen, the private sector has emerged as a key player.
Table 3: Indian Defence Production Data
The Indian defence offset policy forced foreign OEMs to look for Indian industry partners, thereby gaining knowledge of the affordable talent available and the existing capabilities of Indian defence industry. Offsets have therefore enabled Indian industry to overcome entry barriers, enhanced their credibility to become valued partners in global supply chains of OEMs and provided access to global markets, thereby contributing to the growth of India’s defence industry. This has been a key contribution of Indian defence offsets as foreign OEMs are now engaged in the Indian defence industry in a major way and have enhanced the credibility of Indian companies.
The Indian defence industry has seen a record number of JVs, partnerships and collaborations, enabling them to work together on global projects, capacity building by way of infrastructure, developing skilled workforce, adopting global quality and process standards, ensuring their products meet international requirements enabling them to export products and services to foreign OEMs. For instance, the collaboration between Hindustan Aeronautics Limited (HAL) and Boeing to manufacture components for the AH-64 Apache helicopters represents a successful instance of technology transfer and local production.
Similarly, defence offsets have also enabled companies such as Tata Advanced Systems, Mahindra Defence Systems, Reliance Defence & Engineering Limited and many others to emerge as key players, engaged in various projects ranging from ships, aerospace and land systems. The offset policy has not only encouraged foreign investments but has also fostered innovation within the domestic industry. This growth in defence production shown above from 2016 onwards also coincides with the period when maximum defence offset contracts were in execution by foreign OEMs in India. It would therefore be fair to conclude that the Indian defence offset experience has also been similar to other nations such as Turkey, Brazil and Israel where defence offsets have positively impacted their defence industries. While the Indian government has carried out a lot of reforms in the defence industrial sector, which have also no doubt contributed to the current progress of the Indian defence industry, the role of defence offsets cannot be ignored.
Future Recommendations
An analysis of the trend of capital acquisitions by armed forces in Table 4 below, along-with the defence production figures in Table 3 indicate that though there has been a quantum jump in Indian defence production over the years, it still does not meet the needs of the armed forces, especially in the case of frontline weapon systems.
The foreseeable regional and global security situation also will require Indian armed forces to continue modernisation and capacity building. Similarly, while showing a declining trend, the import bill continues to be significant at Rs 500 billion in 2022. India should not waste this opportunity to build its defence industrial capability through offsets. The earlier parts of this article have shown that Indian defence offsets have delivered. While not much can be done about offset contracts that have already been signed, with our current knowledge and experience of offsets, ministry of defence (MoD) is well poised to extract maximum benefits and avoid the pitfalls of the past.
It is strongly recommended that all future capital acquisition contracts must invoke the offset clause, with a reduction of the threshold from Rs 2,000 crore to Rs 1,000 crore. Further, introduction of new categories of offsets, such as those focused on robotics and autonomous systems, directed energy, hyper sonics, artificial intelligence, augmented and virtual reality, big data, semiconductors, and cybersecurity, reflecting a forward-looking approach to modern warfare is strongly recommended.
Table 4: Capital Acquisition by Armed Forces (Domestic and Foreign)
With Indian defence exports registering a quantum jump, it is just a matter of time that importing nations will start demanding defence offsets from Indian firms. Much as we would like offsets to disappear, they are here to stay, if not in receiving offsets, India would need to provide offsets.
Conclusion
The participation of IOPs in global defence supply chains has significantly transformed the landscape of India’s defence industry. This transformation is largely driven by the Indian defence offset policy, as a result, IOPs have increasingly become integral players in international defence collaborations, enhancing their capabilities and competitiveness. These collaborations not only bring in substantial foreign investment but also facilitate the transfer of high-end technologies and skills to local industries. Such initiatives have positioned Indian companies as viable suppliers within global supply chains, allowing them to participate in projects that were previously beyond their reach.
Furthermore, the emphasis on indigenisation has encouraged IOPs to innovate and develop niche technologies, such as drones and advanced communication systems. The involvement of small and medium enterprises (SMEs) in these supply chains has also been significant as they often contribute specialised capabilities that complement larger defence contractors. As IOPs continue to expand their roles within international defence networks, they not only enhance India’s strategic autonomy but also contribute to economic growth through job creation and technological advancement.