Is India Inc ready for defence offset leap?

Even as Aerospace is set to bag 80 per cent of India's massive defence offset market, estimated to be $10 billion by 2011, the Indian government is trying to internalise shopping and reduce defence imports of $4 billion a year

By Shahid Faridi

Defence offsets in India, introduced in 2005, will touch the $10 billion mark by 2011, says defence secretary Shekhar Dutt, of which 80 per cent will be from Aerospace—for both the civilian and the military sectors. The question is: Is India Inc ready for it?

Offset provisions will apply to capital acquisitions categorised as outright purchases from a foreign or Indian vendor, or purchases followed by licensed production in which the minimum requirement is of 30 per cent offsets in all acquisitions where the purchase exceeds $65.2 million.

V Somasundaran, joint secretary in charge of foreign exports in the ministry of defence (MoD), explained that offsets are applicable to all capital acquisitions, categorised as Buy, Outright Purchase from Foreign/Indian Vendor, or Buy and Make with Transfer of Technology (TOT), where the indicative cost in the Request for Proposal (RFP) is $65.2 million or more. Offset is also applicable, with appropriate modifications, to Buy and Buy and Make with TOT components for warship construction, where the value of individual contracts is $65.2 million or more.

There is still some ambiguity in offset guidelines, say several executives of foreign defence companies who deliberated in a Workshop on Implementation of Offsets, recently held in New Delhi, which was organised by the Confederation of Indian Industry (CII).

Somasundaran explained how some of the offset responsibilities can be discharged: it can be done through the direct purchase of export orders for defence products and components manufactured by, or services provided by, Indian defence industries—that is, state-owned defence public sector undertakings such as Hindustan Aeronautics Limited (HAL) and Bharat Electronics Limited (BEL), state-owned ordnance factories, and any private defence industry manufacturing these products or components under an industrial licence granted for such manufacture.

For the purposes of defence offset, services will mean maintenance, overhaul, upgrading, life extension, engineering, design, testing, defence- related software and quality- assurance services. Offset obligations can also be discharged by foreign direct investment in Indian defence industries for industrial infrastructure for services, co-development, joint ventures, and co-production of defence products. Foreign companies can make investments up to 26 per cent of the total capital in a joint venture in defence production. It can also be done by investing in Indian organisations engaged in research in defence research and development.

The Indian government has set up a new agency, the Defence Offsets Facilitation Agency (DOFA), under the MoD, which will assist in the implementation of the offset obligations. A senior MoD official says that the DOFA will assist potential vendors to interface with the Indian defence industry in order to identify potential offset products and projects, as well as provide requisite data and information for this purpose.

Working under the department of defence production, it will be headed by a joint secretary of the MoD and will have representatives from state-owned defence public sector undertakings, the Ordnance Factories Board, the CII, the Federation of Indian Chambers of Commerce and Industry, and ASSOCHAM, a private sector lobbying agency.

The DOFA will solicit offers of vendors who give an undertaking to meet the offset obligation in the RFP, which is binding on the vendor. Failure at any stage will disqualify the vendor from further participation in the contract. HAL will be one of the biggest beneficiaries of the offset programme, as it will create new assured business opportunities, says A K Saxena, managing director (Bangalore complex) of HAL. Besides, the offset obligations will upgrade indigenous skills and technology levels.

Some of the ongoing and near future offset programmes generated by HAL contracts include:
Boeing
Counter-trade obligation by Boeing towards purchase of two B747-40 aircraft by Air-India, with offset obligation at around $74 million. HAL's share of offset commitments is $20 million, set by Boeing.

Israel Aircraft Industries (IAI) Limited
Total offset obligation: Interactive Authoring and Display Systems (IADS) contracts for a programme that costs $33.3 million or $12 million spread over 10 years. Plus a Sea Harrier upgrade worth $3 million.

Turbomeca
HAL has been in cooperation with Turbomeca (TM), a leading manufacturer of aero, land and marine turbines, for various engine projects. Considering the cooperation in the areas of TM 333 2B2 and Shakti engines for the Advanced Light Helicopter programme, Turbomeca has got a net offset obligation to the tune of Euro 61.33 million (about $79 million).

The Indian government granted approval for the purchase for Indian Airlines of 43 aircraft from Airbus, and 68 aircraft from Boeing for Air-India. The offset landscape in the civil programme projects offset value of $360 million from 2008-2020. For Boeing, the offset value will be $1.9 billion, stretched between 2010 and 2023.

Saxena says that besides the civil programme and the programme for the purchase of 126 Multirole Medium Range Combat Aircraft (MMRCA), other Indian Air Force (IAF) proposals to be executed, and additional helicopter purchases and upgrade programmes, would lift the offset value to $2.46 billion between 2008 and 2021. The MMRCA offset, valued at around $1.96 billion, would begin around 2009-10 and end by 2018. Other IAF proposals, it is estimated, will generate an offset value of $355 million, beginning in 2008 and ending in 2015.

The naval proposals, which will include helicopters and upgrades, will generate an offset value of $150 million, beginning in 2011 and ending by 2021. The Indian defence sector was opened to private sector participation in production in 2001, but very little progress has been seen since then in terms of foreign equity participation and the setting up of new joint partnerships between Indian and foreign defence majors. What is known is that, over the years, the structure of defence weapon and equipment production will change drastically from what it is today.

There are about 5,000 companies that supply around 25 per cent of components and sub-assemblies to state-owned contractors. Of India's current defence procurement of capital items, more than 30 per cent is imported. The market size was around $6.2 billion in 2005.

A CII executive says that a 25-75 per cent reduction in defence procurement imports by 2008-09 will boost the share of domestic defence procurement in manufacturing GDP between 3.9 and 6.9 per cent. The reduction in the import content of procurement will also result in a cost saving of 30-50 per cent. India is currently one of the largest importers of defence hardware in Asia, with annual imports of around $4 billion directly from overseas markets. The Indian government is obviously trying to lower this humongous import bill in the near future.