On assuming office in 2014, the Government, with a view to provide the necessary thrust to the defence manufacturing sector, as also to lend impetus to defence acquisitions in India, set up a Committee of Experts for Amendments to DPP 2013 Including Formulation of Policy Framework (“Committee”). The said Committee, submitted its findings and recommendations to the Government on 23 July 2015. For the first time, this report was placed in the public domain, to obtain views from the stakeholders in all spheres including the industry. This endeavour resulted in the much required iterations based on the views received from the environment. Thereafter, on 11 January 2016, the Acquisition Wing of the MoD fielded the revised Defence Procurement Procedure (DPP) 2016 for the approval of the Defence Acquisition Council (DAC), the apex decisionmaking body of the MoD
DPP 2016 less one chapter is likely to be commissioned in April 2016 after incorporating certain amendments. The chapter on the selection of “strategic partners would be notified separately, based on the report from a task force headed by former DRDO chief V K Aatre. MoD also plans to promulgate a separate policy document on the blacklisting of foreign firms and the role of a middleman in defence deals.
The new DPP stipulates that only those firms with majority domestic stake and controlled by resident Indians will come under Make categories. ’Buy Indian’, Indigenously Designed, Developed and Manufactured (IDDM) platforms, has been included in the categories and will be accorded top priority for all defence capital procurements. This category has been further subdivided into two subcategories:
• Sub category I stipulates 40% domestic content for a domestic design.
• Sub category II stipulates 60% local content if the design is not Indian. It is obligatory for the domestic companies eligible under this category to have Indian control and be operated by an Indian national only. In order to provide the thrust towards building a technology base in the country, the government has proposed to fund Research & Development (R&D) efforts by the industry. In case of ‘Make’ category, the new DPP has a provision in which the government through Department of Defence Production (DDP) will be funding up to 90 percent of developmental costs to private companies. For the purpose of funding, the ‘Make’ category has been further subdivided into three sub categories:
• Make-I. This has a provision of 90 percent government funding for development cost, as also a provision to reimburse balance 10 percent.
• Make-II. It has a provision for industry funding, however with a clause of 100 percent refund for a successful prototypes in case the procurement is not effected within a time period of two years. • Make-III. This has been formulated specifically for the MSMEs. It shall be valid for projects with value less than Rs 3 crore, with no change in the remaining provisions as applicable for the Make-II category.
To address concerns arising out of delays in acquisition, the new DPP has proposed cutting down of the existing timelines. The Acceptance of Necessity (AoN) has been proposed to be valid for only six months from earlier validity of one year, implying that the Services will have to expedite the issue of the Request for Proposal (RFP). It has been proposed to include enhanced performance parameters for additional capabilities besides the essential parameters as part of RFPs. While evaluating their product cost, additional credit score will be provided to the vendors who meet these parameters.
Today, with expertise and related monopoly blurring the borders between nations and the fact that single vendor situations are going to be the norm in future, the new DPP proposes accepting of the bids even when there is only one supplier. A proper justification to the approving authority will however be mandated for the same.
Last but not the least, the applicability threshold for defence offsets has been proposed to be raised from the existing Rs 300 crore to Rs 2000 crore. This implies that only those foreign Original Equipment Manufacturers (OEMs) who bag defence contracts with cost of over Rs 2,000 crore will be subject to offsets clause and thus will have to plough back 30 percent of the contract value into Indian enterprises. The contracts with value less than Rs 2,000 crore will thus be exempt from the offsets clause. This has both a positive and a negative spill over.
It will lend impetus to capital defence procurements by making it suitable for overseas defence manufacturing companies as also the Indian defence manufacturing sector in taking promising though initial steps into defence manufacturing in India. It has also provided the much desired flexibility to foreign OEMs. On this issue, the Raksha Mantri stated,”We currently have signed offsets worth USD 5 billion and another USD 8 to 10 billion is in the pipeline. We may not be able to absorb all of this. Moreover, offsets also increase the cost of the product by 14-18 per cent”
Offsets remain one of the prime reasons for delay in fructification of defence procurement contracts. Also, at times, some foreign manufacturers do not respond when offsets form part of the RFP, as they find them unmanageable and at times, due to a plethora of reasons, beyond their capability to fulfil. We can look forward to greater participation by foreign OEMs, completion of contracts in a shorter time frame as well as reduction in costs. The last factor is due to the fact that the cost of offsets are loaded on to the contract of the main project. The raising of the threshold for offsets to Rs 2000 crore will invite the minimum offset obligation of Rs 600 crore. This implies that Indian policy makers, with this increased capital value of the offsets, can demand a higher technology transfer of niche technologies as part of the offset obligation, which may not have been available in the earlier minimum capital value of the offset threshold, which mandated only Rs 90 crore for projects of value of Rs 300 crore.
An analysis by Weapons and Equipment Directorate, the capital procurement directorate for Indian Army, shows that 52 per cent of Indian Army procurement projects are below Rs Projects costs of Rs 2000 crore and more cover only 10 to 20 percent of Army procurements. This means that Indian Army procurements would invite near to negligible offset contracts. It is true that the Indian defence offsets policy, which has been in vogue since 2005, suffers from certain glitches. However, since its inception, the policy has seen a number of iterations and has matured into a stabilised policy with a mandate to leverage capital acquisitions to develop India’s defence industrial base (DIB) and in turn promote research and development in defence sector. The answer should hence lie in finding answers to existing glitches, rather than denying the offset provisions by conveniently raising the threshold of offsets to a level where most of the procurement cases fall beyond the purview of the offset obligation.
Across the world, offsets have influenced the course of weapons and equipment procurements and have accordingly impacted the growth of the global defence industry. Countries like Saudi Arabia, Brazil and Israel have achieved substantial success through offsets, despite having lower threshold values. With a high threshold value, India may well end up losing this advantage, which in turn could adversely impact the ‘Make in India’ initiative. Also, with the raising of the threshold value to Rs 2000 crore, the MSME sector is virtually ruled out of defence offsets, as the obligation of Rs 600 crore as beyond such enterprises, and will be restricted to the larger players only such as Bharat Forge Ltd, Reliance Industries Ltd, the Tata group, Larsen and Toubro Ltd, the Godrej Group, the Mahindra Group, Reliance Group andAdani Defence Systems and Technologies Ltd, which are well entrenched in the business
A caveat also need to be put on the Government’s ambitious ‘Make in India’ campaign. This holds great salience in the non-defence sector, where the objective is purely economic. In the defence sector, the objective is self reliance, with economic advantage and job creation coming as a subsidiary benefit. Also, what needs to be understood is that niche technologies, to include designs and the source codes of defence equipment are the most closely guarded secrets and no OEM will like to part with these secrets. While the ‘Make in India’ initiative is at nascent stages and the rules of its implementation are still to be laid out, the Indian offset programme has been through a number of iterations since 2005 and has matured to quite an extent. The most important issue in offsets is the provisions of safeguards against the OEM offering low end technology in the form of either multipliers in offering transfer of technology or the buyback clause.
Points to Ponder
Strengthening of Defence Industrial Base is a structured approach which involves a clear understanding of capabilities and technologies, the requirement of in house R&D, seeking transfer of technology from foreign OEMs as part of acquisition contracts or offsets and simultaneous setting up of the infrastructure for training the work force.In this context, the pros and cons of raising the threshold levels need reexamination, to provide the best output to the Indian defence Sector.
The author is a Senior Fellow at CLAWS. Views expressed are personal.