Monitoring Fulfillment of Offset Obligations

Monitoring Fulfillment of Offset Obligations

Major General Mrinal Suman, AVSM, VSM, PhD

The World Trade Organisation considers offsets to be detrimental to free trade practices and prohibits its signatories from imposing, seeking or considering offsets for government procurement transactions. Yet, the world is witnessing an exponential increase in the quantum and scope of offset obligations in world commerce, especially defence deals. Whatever be the positives and negatives of offsets, they have become an integral part of the international arms trade and are accepted as a corollary to natural interplay of the market forces. Earlier, arms exporters dictated terms by inflating prices and imposing stringent usage conditions. With shrinking defence budgets after the end of the Cold War, it is a buyers’ market at the present. Now all importing nations impose offset obligations on the sellers, with the objective of redirecting part of outflow of resources back into their own economies for national industrial growth. India is no exception.

To derive full benefit, it is absolutely necessary to understand the dynamics of offsets. It is universally accepted that real value of an offset depends primarily on its appropriate selection, meticulous planning and diligent monitoring. Ill-conceived, poorly planned and indifferently monitored offset programmes invariably prove to be highly wasteful and uneconomical for their value. It is also a well established fact that most offset programmes rarely achieve their objectives, the primary reason for this failing being indifferent monitoring. For example, offsets received against South Africa’s USD 4.8 billion Strategic Arms Procurement Package of 1999 were designed to generate 65,000 jobs. Subsequent studies showed that just a fraction of the above number was achieved. Thus, the said offset programme was unsuccessful in achieving the designated objective. Lack of close oversight is considered to be the main cause for the failure.

Despite the fact that offsets carry enormous financial ramifications and are susceptible to dishonest manipulations in execution, Indian policy makers have failed to grasp the criticality of keeping a close eye on their implementation. Monitoring of offsets has been treated in a highly cavalier and slapdash manner. As will be seen shortly, the Indian offset policy contains no guidelines and measuring norms to ascertain diligent compliance by foreign vendors.

The Current Indian Policy

Acquisition Managers in the Acquisition Wing are the nodal authority to monitor implementation of offsets pertaining to their respective services. As per Defence Procurement Procedure–2006, one of the functions assigned to the Defence Offset Facilitation Agency (DOFA) is to assist the Acquisition Manager concerned in monitoring tasks. Subsequently, Defence Procurement Procedure–2008 set up an Offset Monitoring Cell (OMC), headed by a Director in the Department of Defence Production, for the same purpose. In other words, Acquisition Manager is to be assisted both by DOFA and OMC in monitoring functions, without spelling out division of their respective responsibilities. The whole policy is obscure, imprecise and muddled. Worse, both DOFA and OMC are devoid of necessary competence and wherewithal. Both are typical bureaucratic offices with two or three officials manning tables.   

A foreign vendor can, giving reasons, request re-phasing of his offset schedule within the period of the main contract. Director General Acquisition may allow the request if the reasons are considered justified. Any request on exceptional grounds for extension of the period of the offset contract beyond the period of the main contract has to be examined by the Acquisition Wing and placed before the Defence Procurement Board for decision. Requests for any further extensions are required to be decided by the Defence Acquisition Council. Interestingly, DOFA has been tasked to assist the Acquisition Wing in examining all such requests while OMC has been assigned no role in the above deliberations.  

As regards the monitoring procedure, foreign vendors are required to submit quarterly progress reports on the implementation of their offset programmes to the Acquisition Manager concerned in the specified format. In case considered necessary, an audit by a nominated official/agency may be conducted to confirm the actual status of implementation. If a vendor fails to fulfill the offset obligation in a particular year, a penalty of 5 percent of the value of the unperformed offset obligation is levied. The said penalty is either paid by the defaulting vendor or recovered from his bank guarantee of the main contract, subject to replenishment, or deducted from the amount payable under the main contract. Further, the unfulfilled offset value is carried forward to the subsequent year.

In case a vendor fails to fulfill his full offset obligations during the period of the main contract, or during the period duly extended, he becomes liable to be disqualified for participation in future defence contracts. Disqualification is decided by the Acquisition Wing after giving a fair opportunity to the vendor to explain the reasons for his failure. Any differences or disputes are to be settled through discussions. The decision of the Acquisition Wing is to be considered final. As regards arbitration, provisions of the main contract apply to the offset contract as well.

Twin Facets of Monitoring

As seen above, the Indian approach to offset monitoring is limited to asking vendors to submit periodic progress reports. Due to sheer ignorance, India has trivialised a matter of enormous economic significance to routine ‘inspector raj’ practice – ask for periodic reports, verify on ground when in doubt, compile them to attest compliance and consign them to files. Since the Acquisition Wing possesses no resources for physical verification on ground, it accepts whatever the vendors claim. Worse, vendors’ reports are limited in scope and indicate percentage of ground progress alone. It is a highly unreliable, simplistic and shallow way of handling a crucial issue.

Monitoring of offsets has two principal aspects, as follows:-

a)    Oversight and Corrective Functions  

It must be remembered that offsets are not sought just because others are demanding them – they do not operate in a purposeless vacuum. Every offset programme should have a predetermined objective assigned to it. The objective could be to boost exports, create local jobs, find new markets or upgrade indigenous technology. Success or failure of any offset programme is solely decided on the basis of extent to which it realises its designated objective. Therefore, ensuring achievement of the assigned objectives has to be the primary purpose of monitoring. Everything else is of causative essence and value.

As all offset contracts run in tandem and co-terminus with the corresponding main contracts, slippages in offset implementation schedule can jeopardise progress of the main contract as well. It has to be guarded against at all costs. Thus, it is imperative that progress of offset programmes is kept under close and regular oversight. It is only then that timely corrective measures to remove impediments can be initiated.  This implies that the monitoring agency should have adequate authority to take required decisions.

Since no two offset programmes can be similar, detailed evaluation criteria and appraisal mechanism have to be evolved for each programme. In case the offset contract includes provisions for incentives and penalties, methodology of their determination has also to be worked out well in advance. 

b)    Feedback and Review Functions

India is new to the world of offsets and its policy is still evolving. Experience gained from each programme should be made use of to streamline the policy further with regular feedback providing vital inputs. Further, detailed appraisal must be carried out after the completion of every offset programme to ascertain the degree of achievement of the stated objectives. Review must help identify weaknesses and infirmities both in the policy and the execution. Thereafter, necessary lessons should be drawn for initiating curative changes for future programmes.  An effective and constructive system of feedback and review helps in formulating a policy with focus on targeted areas for realising full potential of offsets.

Recommended Dispensation

It is apparent that the current offset monitoring regime is grossly inadequate and languid. While addressing a seminar in New Delhi in February 2010, Secretary (Defence Production) Raj Kumar Singh admitted that monitoring of the implementation of defence offsets deals was fuzzy. Stressing the need for close oversight, he promised setting up of a monitoring mechanism on implementation of the offsets obligation by vendors.  Over six months have passed but nothing has been promulgated so far.

MoD needs to pay emergent attention to the following three critical aspects of the Indian offset system:- 

a)    Drafting of Offset Contract

Poorly drafted offset contracts lend themselves to multiple interpretations, resulting in rancorous squabbles and resultant delays. Despite the fact that offsets carry enormous financial encumbrance, inadequate attention is paid to finalising their contracts. Most MoD functionaries have little understanding of the dynamics of offsets and the cost penalties involved. They consider offsets to be free add-ons and equate them with free Christmas gifts that are offered by household-appliance sellers. Therefore, MoD is satisfied with whatever vendors offer.

It will not be out of place to mention here that India has abrogated the right to choose offset programmes to vendors, rendering its own needs inconsequential. Therefore, little attention is paid to the drafting of offset contracts.

MoD is also aware that the public interest remains focused on the main contract under which military equipment is being procured. As long as the main contract runs smoothly, it expects no uproar. Since cost of offsets remains hidden, offset programmes are never subjected to public scrutiny, MoD functionaries remain secure in their belief that non-fulfillment of offset obligations would never be held against them. Therefore, they find no reason to ‘waste’ time in scripting offset contracts.  Additionally, in the absence of required expertise, MoD displays a distinct penchant for treating offset contracts in a lackadaisical and dismissive manner. Foreign vendors are quick to spot this weakness and exploit small print to their advantage. It is time that this deficiency is made up and offset contracts are drafted with due diligence with monitoring mechanism unambiguously spelt out.   

b)    Performance Audit by Independent Agency

Monitoring of offsets is a multi-dimensional and long-duration task. It requires special skills and capabilities. Every offset programme needs a unique matrix, assigning values to different criteria for collation. Complexities get compounded when dealing with programmes that relate to the export of services as their fair quantification and evaluation tends to become subjective. Similarly, programmes that have wider economic and social ramifications are difficult to compute.

Performance audit should be done by an independent expert agency, preferably under the Ministry of Commerce. There are two reasons for this. One, as MoD negotiates and signs offset deals, it becomes a contracting party. It is always better that discharge of contractual obligations is overseen by an independent entity. It enhances probity and increases credibility of the mechanism. Two, MoD possesses none of the skills required for effective monitoring. DOFA and OMC are ad-hoc cells that are  totally bereft of any competence to perform complex monitoring functions. On the other hand, considerable expertise exists with many agencies under the Commerce Ministry that are performing analogous functions at present. Furthermore, their professional and knowledgeable feedback would prove invaluable in streamlining the policy further.

c)    Transparency

Transparency is the key to effective monitoring. Although a certain degree of secrecy is essential for all defence contracts, the same cannot be said of offset contracts. Offset contracts are akin to normal commercial deals. They warrant no secrecy at all and must be fully in public domain. Keeping offset contracts under wraps is the surest way of perpetuating a regime of corruption and wrong-doings.

It needs to be reiterated here that India does not seek technology against offsets. It wants to export defence goods/services or invite FDI in defence sector and defence R&D. None of these fields have any security implications. Further, as there are no licencing stipulations in place, over 2000 companies of all sizes have become eligible to be Indian offset partners. Most undesirably, MoD continues to be highly secretive and releases negligible information about the offset programmes and their progress, raising doubts about the system’s uprightness.

In view of the above, India must make all offset contracts public along with their respective monitoring criteria. Thereafter, periodic progress reports showing actual ground position should be posted on its website. Delays, if any, should be unambiguously spelt out. Deficiencies and corrective measures taken should also be made known to all. Public declaration of imposition of penalties and award of incentives would make all companies vigilant and conscious of their commitments. At the end of every offset programme, fully collated data should be published indicating the degree of achievement of the laid-down objectives.

The Way Forward

According to Transparency International, offsets are most susceptible to corruption and sleaze. It exhorts all governments to increase transparency of the whole process and institute effective mechanisms for their greater monitoring. It recommends inclusion of specifics of monitoring in all contracts upfront. In India’s case, monitoring acquires added importance due to the fact that India has abrogated the right to select offset programmes to the vendors. India is thus totally dependent on the diligence, sincerity and truthfulness of the foreign vendors. 

Further, India has allowed offset banking, i.e. foreign vendors can amass offset credits through approved programmes in anticipation of winning contracts at a later date. Such banked credits can be discharged against future offset obligations. As offset programmes for banking purposes are unrelated to any main contract, they function in a vacuity and remain totally unmonitored. Such programmes can be exceedingly deceptive and are highly vulnerable to manipulation. Therefore, close oversight, both for quality and quantity, is essential.

It has been seen that major defence vendors are highly conscious of their reputation. Any default in offset implementation schedule, if made public, would dent their standing the world over. Resultant loss of credibility is the biggest deterrent that forces them to deliver. Transparency is thus a leverage that every buying nation must exploit to ensure compliance of offset commitments. Regrettably, India has failed to appreciate the power of transparency. Not a single offset contract has been made public to date. MoD continues to resort to its old subterfuge of citing security concerns to hide its own deficiencies and infirmities of the system, harming India’s interests in the process.

It needs to be recalled here that offsets do not come for free. Buyer has to suffer a cost penalty that varies between 10 to 20 percent of the contract value. Regular monitoring not only helps mid-course corrections, it also facilitates value-for-money audits. Such audits serve two purposes. First, they reveal degree of achievement of the designated objectives. Secondly and more importantly, they apprise whether the accruing benefits justify the cost penalty suffered.  
   

India’s lax monitoring regime extends an open invitation to a wily foreign vendor and his unscrupulous Indian partner to connive to shortchange the country. They can easily enter into an unholy nexus to submit inflated progress reports and claim offset credits. In the absence of a credible verification mechanism, MoD has to accept their reports at their face value.  Resultantly, instead of benefitting from offsets, India would end up suffering additional outflow of resources. Unless corrective steps are taken immediately and a suitable monitoring mechanism is put in place, India is bound to rue its apathy and indifference. Worse, unmonitored offset programmes will inevitably degenerate into cesspools of inefficiency and corruption.