Will offsets bring technology to India?

Will offsets bring technology to India?

(Global Defence and Offset Review 2014)

Major General Mrinal Suman

Technology is the engine that drives the growth of a country’s industrial prowess. In the case of the defence industry, technology acquires additional criticality as modern defence systems are highly complex and technology intensive. Moreover, they suffer from rapid obsolescence. India’s failure to keep pace with technological advancements is responsible for the current dismal state of the indigenous defence industry. Self-sufficiency in defence production can never be achieved unless India masters cutting-edge technologies.

Undoubtedly, all efforts must be made to upgrade technologies through the indigenous research and development route. However, it is a very time-consuming process and reinventing the wheel is no solution. Therefore, indigenous efforts must be supplemented by importing key technologies and thereafter using them as jumping boards for developing higher levels of technologies indigenously.

There are three ways of obtaining required technology from abroad. One, by purchasing it from the willing sellers and India has been adopting this route through the ‘Buy and Make’ procedure. Under this, a limited quantity is purchased from a foreign vendor in a fully built-up condition and the bulk quantity is manufactured in India through the transfer of technology (ToT). Although India has been following this course for decades, it has failed to upgrade the Indian technological base – foreign vendors continue to provide key components and sub-assemblies to Indian manufacturers for assembling the systems. Resultantly, there is little infusion of the latest know-how.

The second option is to obtain technology by inviting foreign vendors to invest in the Indian defence industry through joint ventures. India opened the defence industry to the private sector in May 2001, allowing 26 percent Foreign Direct Investment (FDI). The policy has been a total failure as prospective foreign investors view it to be highly dissuasive in intent and content – a licensee has no control over the enterprise; he can produce only the licensed products and in the sanctioned quantity; he can neither diversify nor enhance production; the Government can give no purchase guarantee; and the licensee will have no open access to other markets including exports.

The third, and perhaps the most potent tool available to India, is to seek technology against offsets. Being the largest importer of conventional weapons in the world, India possesses enormous leverage to demand required technologies. Foreign technology majors can be coerced to transfer their cutting-edge technologies by making award of high value contracts contingent to the offer of such technologies. Attractive multipliers can be applied to key technologies to provide necessary incentive to vendors to earn higher offset credits.

The term ‘technology’ does not convey know-how in absolute terms. It denotes a package of multiple sub-technologies that go into the making of a product or a defence system.  As most defence manufacturers are systems integrators, sub-technologies belong to diverse producers.

Every technology package consists of multiple items. They fall in three broad categories. One, items with ‘complete transfer of technology’ are those for which complete expertise (engineering-manufacturing documentation to enable fabrication, assembly and test of item) is being provided by the main contractor. Two, items with ‘limited transfer of technology for maintenance support’ are those whose development and manufacture has been subcontracted by the main contractor to his vendors based on his procurement drawings/specifications. Finally, the items branded as ‘proprietary items’ and for which he declines to transfer the technology.

The Current Offsets Policy

Earlier, technology against offsets was being declined on the specious excuse that India did not have the wherewithal to price technology realistically. Interestingly, under the Defence Offset Guidelines of 2012 (DOG), technology transfer has emerged as the preferred avenue for discharging offset obligations. This can be construed as a paradigm shift in India’s approach towards offsets, changing the fundamental character of India’s defence offset policy.

As per DOG, foreign vendors can choose their Indian partners and discharge their offset obligations through any one or a combination of the following seven methods:-

a)   Direct purchase of or executing export orders for eligible products manufactured by, or services provided by Indian enterprises.

b)   FDI in joint ventures with Indian enterprises (equity investment) for the manufacture and/or maintenance of eligible products and the provision of eligible services.

c)   Investment in ‘kind’ in terms of ToT to Indian enterprises for the manufacture and/or maintenance of eligible products and provision of eligible services.

d)   Investment in ‘kind’ in Indian enterprises in terms of provision of equipment through the non-equity route for the manufacture and/or maintenance of eligible products and provision of eligible services.

e)   Provision of equipment and/or ToT to government entities engaged in the manufacture and/or maintenance of eligible products and provision of eligible services, including the Defence Research and Development Organisation (DRDO).

f)    Technology acquisition by DRDO in areas of high technology.

Hence, investment in Indian enterprises (both public and private sectors) can be made in kind in terms of ToT through  joint  ventures  or  through  the  non-equity  route  for  co-production,  co-development  and  production  or  licensed  production and/or  maintenance  of eligible  products  and  provision of eligible  services. ToT must cover all documentation, training and consultancy required. ToT has to be provided without licence fee and there can be no restriction on domestic production, sale or export.

Offset credit for ToT would be 10 percent of the value of buyback by the OEM during the period of the offset contract, to the extent of the value addition in India. The  concept  of  value  addition  will  apply  only  for  direct purchase/export  of  eligible  products. Value addition is to be determined by subtracting value of imported components and any fees/royalty paid. This provision will ensure that the technology offered is not outdated.

In addition to the above mentioned common clauses, DOG has made special provisions for the public sector and DRDO. Vendors can opt to provide equipment/ToT to government institutions and establishments engaged in the manufacture and/or maintenance of eligible products and provision of eligible services, including DRDO.  Augmentation of capacity for research, design and development; training; and education can be included.

High Technology for DRDO

This is really the key aspect of DOG. An exclusive provision has been made for DRDO to acquire technologies in ‘areas of high technology’. DRDO has made public a list of high technologies and test facilities that it seeks under offsets. The list is vast both in scope and depth. It includes sensors, nano technology, radars, fibre lasers, gunnery, solar cells, hypersonic flights, carbon fibres and pulse power network, amongst others.

Broad guidelines have been provided wherein the Directorate of Industry Interface and Technology Management (DIITM) in DRDO has been nominated to be the nodal agency for all matters related to technology acquisition. DIITM will service a multi-disciplinary Technology Acquisition Committee (TAC) of DRDO. The committee will process all technology acquisition proposals and make its recommendations regarding their viability and a fair assessment of their cost. TAC could seek the services of professional bodies, if required.

TAC may also call for a presentation and have detailed technical discussions with the vendor to understand various aspects of the proposal. Where necessary, the TAC may visit the vendors’ premises to make an assessment of the technology offered. TAC will make its recommendations based on the viability of the proposal, the technology implications, absorption capabilities and a fair assessment of the cost of technology. Recommendations of TAC will be incorporated in the report prepared by the Technical Offset Evaluation Committee while the commercial valuation will be incorporated in the report of the Contract Negotiation Committee.

If TAC in its assessment feels that the technology so indicated is already available and/or is of no further use, it may reject the proposal and intimate the same to the Technical Manager in the Acquisition Wing of MoD.

Offset credits will be assigned by the newly created Defence Offsets Management Wing (under the Department of Defence Production) after completion of the technology acquisition programme successfully, as certified by DRDO.  

Will the Policy Succeed in Getting Technologies?

Disappointingly, the procedure mentioned in the DOG is afflicted with serious infirmities that have the potential of becoming contentious and embroiling the whole procurement process in protracted controversies.

As stated above, technology acquisition by DRDO has been designated as the primary mode of getting critical technologies and vendors are allowed to fulfill up to 30 percent of their offset obligations through this avenue. This is a considerable proportion. Sadly, the policy has been framed without basic understanding of the dynamics of offsets.

To start with, the current dispensation is fraught with uncertainties. In case a vendor wishes to offer any technology to DRDO in part fulfillment of his offset obligations, he will face a number of imponderables. For the submission of definite technical and commercial offset offers, a vendor has to be confident that the offered technology would be accepted by DRDO. Further, he should know its assessed cost and the applicable multiplier. It is only then that he can calculate offset credits that he would earn.

Every technology transfer offer forms a part of the overall technical offset proposal and is submitted along with it, albeit in a separate envelope.  In case TAC rejects the technology offer due to redundancy or the indicated cost, vendor will have to rework his offset proposal afresh. The complete acquisition process will get delayed as technical evaluation cannot be started unless technical offset proposal is found to be fully compliant. Thus, procedure for the selection of high technology for receipt by DRDO is too convoluted to succeed.

It should be for the buyer nation to decide as to what technology to seek against offsets to fill a critical void. It is not the type of technology but its relevance that should dictate the selection. India has abrogated that right in favour of the vendors who are free to choose the technologies they wish to offer. The list of the technologies provided by DRDO is highly imprecise and contains open-ended descriptions of vast arrays of related technologies. Needless to say, every vendor will try to pass off low-end technologies that do not require export licenses and are cheap to implement. Thus technologies that flow to India will not be need-based.

Multiplier is a factor applied to the actual value of an offset transaction to calculate the offset credit value earned. It is a methodology of assigning weightage to different offset programmes to provide vendors with incentives to offer offsets in targeted areas. In the case of technologies, multiplier values are universally assigned on the basis of level, depth, criticality and exclusivity of the technology on offer. Unfortunately, Indian policy makers have rendered such a potent tool ineffective and purposeless by making multipliers usage-based.   

The Way Forward

Offsets cost a country considerable extra expenditure – between 10 to 20 percent of the contract value. Every foreign vendor amortises the offset expenditure by suitably factoring it in his price quote, prompting many to question whether demanding offsets makes sound business sense. Regrettably, India has failed to derive any worthwhile benefits from offsets so far. Two audit reports submitted by the Comptroller and Auditor General of India (CAG) in the recent past provide a rare glimpse of India’s offset regime. Management of the complete gamut of offset activities has been found to be highly flawed and wasteful.

Ideally, the highly powerful leverage of offsets must be exploited to procure those critical technologies that industrially-advanced countries are reluctant to sell. India should seek technologies in which it has made considerable headway but not yet mastered – commonly referred to as lacking ‘last mile connectivity’. Such technologies can be absorbed seamlessly and utilised across a number of systems.

Being the principal recipient of critical technologies, DRDO must spell out every required technology (including sub-technologies) in specific terms, prioritise them, indicate estimated cost and assign multiplier values. These aspects must be made known to all vendors well in advance to help them in the formulation of their proposals. Through a well-evolved system of multipliers, irresistible incentives should be provided to foreign vendors to offer technologies that India needs the most. Application of multipliers should be technology-based and not usage-based.

Finally, it is time MoD undertakes a fresh look at the entire offset strategy.  DOG is a highly convoluted policy documents due to the incorporation of special provisions for the public sector. It should be simplified by having a common set of provisions for both the public and the public sectors. MoD must rise above narrow extraneous considerations and recognise the fact that the private sector is a national asset and must be treated as an equal partner in our pursuit of self-reliance in defence production.*****