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Analysing DAP 2020: Government Changes Offset Policy, Allows Leasing of Defence Equipment

Editor, TRANSFIN.
Sep 29, 2020 6:03 PM 5 min read
Editorial

On Monday, the Government released fresh guidelines for the procurement of defence equipment.

The new rules include many provisions to reduce acquisition costs, avoid delays and optimise the procurement process. But two changes stand out:

  1. The removal of the “offset clause”
  2. Allowing the three branches of the military to lease equipment

Here’s all you need to know...

What is the DAP?

India is a major importer of defence infrastructure. In fact, only Saudi Arabia purchases more arms and ammunition than India (as of 2019).

The top source of arms imports presently is Russia, followed by Israel, France and the US.

The Defence Acquisition Procedure (DAP) is essentially a set of guidelines that seeks to simplify and govern the defence import process.

The first DAP was promulgated in 2002, and it has been periodically revised since then (the last iteration was released in 2016).

FYI: DAP used to be called Defence Procurement Procedure (DPP). It was renamed this year. But both the terms refer to the same document.

 

What’s the Objective of the DAP?

Defence equipment doesn't come cheap. India’s underdeveloped defence manufacturing industry is not only a geopolitical Achilles’ heel but also a strain on the exchequer. In 2018-19, our defence import bill stood at ₹45,705cr ($6.2bn) - an expense the Government can do without, especially during fiscally strenuous times such as the present.

To ensure self-reliance, successive Governments have tried to boost domestic defence manufacturing. The ways to do this include some usual suspects - raising FDI limits (FYI: 74% FDI is permitted in defence under the automatic route), corporatisation of relevant entities, prohibiting imports of certain weapons etc.

Another major policy tool used to (try to) achieve defence indigenisation is the offset policy.   

 

What are Offsets?

In defence policy, “offsets” are basically additional benefits the exporter offers the importer to make their offer more competitive.

Defence deals tend to be hefty and lucrative - and therefore competitive. So, to ensure that it lands a deal with a particular Government, a defence company can offer numerous additional offerings to make their pitch more attractive. These are called offsets.

And they’re a big deal. Offsets can be worth as much as 50-100% of the original contract value.

 

What are Some Examples of Offsets?

Offsets can be direct or indirect. The former involves technological transfer (meaning, the manufacturer agrees to share the know-how of how to build military equipment). It can also include requirements to use local suppliers to manufacture the equipment.

Indirect offsets include offerings that may not have anything to do with the defence aspect of the deal per se. The exporter can promise to invest in local industries or import other goods or services. Essentially, a barter.

 

India’s Offsets Policy

Offset clauses can help in defence indigenisation (at least on paper). Requiring exporters to share knowledge on how to manufacture equipment or mandating that local suppliers are tapped ought to help India’s domestic manufacturing capabilities.

Presently, as per DAP rules, for all contracts worth more than ₹300cr ($40.7m), the foreign entities are required to spend at least 30% of the total contract value in the Indian defence industry through procurement of components, transfer of technologies or setting up of R&D facilities.

The offset requirement can vary. For the Rafale deal with France's Dassault Aviation, for example, it was 50% of the contract value.

From October 1st, however, the DAP 2020 rules will go into effect. And as per these revised guidelines, the offset clause has been removed for a “substantial” number of deals - significantly, for Government-to-Government buys, the biggest avenue for defence imports. (The offset clause will remain in place for some contracts, such as those involving competitive bidding.)

Moreover, under the new policy, whenever offsets are on the table, they would be determined by certain multipliers. And the multiplier value for offset transactions will be focused towards technology transfer instead of the value of the deal. Preference will also be given to manufacture of complete defence products over components.

 

Why Did the Government Do Away with Offsets?

One reason may be the recent report by the Comptroller and Auditor General (CAG) that criticised the policy.

The CAG told Parliament last week that there was not “a single case where the foreign vendor had transferred high technology to the Indian industry”. Reportedly, foreign vendors made various offset commitments to qualify for the main supply contract but later, “were not earnest about fulfilling these commitments”.

For example, the Rafale fighter jet deal was supposed to involve sharing information on engine technology. But this is yet to transpire.

Such criticism of the offset policy is not new. It has not yielded great results over the past decade, given that the country’s nascent defence industry was ill-equipped to absorb state-of-the-art technology that defence offsets require. At other times, international vendors reportedly discharged offsets that didn’t necessarily contribute to India’s defence manufacturing prowess, thereby defeating the very purpose of these deals.

Another reason may be that offset clauses lead to increased acquisition costs - after all, if you require a seller to make additional commitments, you’d have to cough up more in payments. In defence procurement, offsets added around 10% of overall costs. Doing away with these clauses is expected to bring down import bills.

 

The Leasing Policy

Besides distilling offset requirements, the new DAP also allows the military to lease equipment from defence companies or foreign governments. For the first time, the Armed Forces would be able to enter into contracts to lease equipment such as aircraft, land attack vehicles and unmanned aerial vehicles (UAVs).

This is expected to bring down acquisition time and costs (since leasing is a cheaper alternative to purchasing). It would also give the Air Force, Army and Navy the flexibility of procuring systems at a time of their choosing.

 

What’s “Atma Nirbhar” About DAP 2020?

Defence Minister Rajnath Singh touted the new defence procurement rules as being in tandem with the Government's Atma Nirbhar Bharat initiative.

If you consider the two major changes - revoking the offset clause and enabling leasing - this might seem contradictory. But there are other components in the new DAP, and these seek to boost domestic manufacturing.

For example, the new rules stipulate that under some categories procurement be reserved for “Indian vendors”, which are defined as companies that are owned and controlled by resident Indian citizens with FDI not more than 49%.

Along similar lines, the minimum indigenous content (IC) requirement for most projects has also been raised to 50%. If a defence platform is manufactured in India, it must have 60% Indian content.

Moreover, a new procurement category called “Buy (Global–Manufacture in India)” has been added. Under this category, manufacturers are encouraged to set up facilities in India for assembly, repair and maintenance of equipment.

 

Is DAP 2020 A Step in the Right Direction?

There is no doubt a grave need to modernise domestic defence manufacturing. Current tensions with China and Pakistan and the ongoing economic free-fall make this need all the more urgent.

Allowing leasing of equipment and liberalising the procurement process seem to be steps in the right direction.

As for offsets, the evidence suggests that they incurred auxiliary costs whilst not equipping local enterprises with any knowledge or expertise. So, it was probably reasonable to have done away with them.

At the same time, one can only hope that the new IC and make-in-India requirements will involve significant knowledge transfer. After all, it’s impossible to make India a defence manufacturing hub without procuring the technological know-how of defence manufacturing in the first place.

FIN.

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