Offset dilution in defence, a flawed policy turn(The Hindu)

Mains Paper 2: Governance 
Prelims level: Make in India 
Mains level: Government policies and interventions for development in various sectors

Context:

• Recently, the government diluted the “offset” policy in defence procurement, reportedly in response to a Comptroller and Auditor General (CAG) of India’s report tabled in Parliament last month.
• Many contend that the move is a setback for augmenting domestic capabilities or for realising the goal of Atmanirbhar Bharat. But why is it a setback for the goals under Atmanirbhar Bharat?
• The experience with the procedure in the aerospace industry since 2005 seems to offer useful lessons in redesigning defence offsets.
• What is an offset policy? And how is it expected to boost domestic capabilities?
• What lessons can we draw from a similar system in the aerospace industry? These questions are addressed below.

Offset ties up the ends:

• Most countries restrict trade in defence equipment and advanced technologies in order to safeguard national interest.
• Yet, for commercial gains and for global technological recognition, governments and firms do like to expand the trade.
• Negotiated bilateral sales between countries are a way out of the dilemma.
• Soft credit often sweetens the deals, with restrictions imposed on use, modification and resale of such equipment and technologies, to protect the proprietary knowledge and expertise embedded in them.
• In such trade negotiations, the price of the product is one of the many other factors.
• Geopolitics and the technical knowhow involved in the equipment weigh-in considerably since the contracts are for the long term, with technological fixities.
• The product and technology compel buyers to stick to them for: the advantages of bulk purchase, and dependence on the supplier for spares and upgrades.
• In other words, there is considerable “path dependency” in such choices, rendering the decisions difficult to reverse. 

Lacking research and development:

• Developing country buyers often lack an industrial base and research and development facilities (which take a long time to mature).
• The price and the terms of the contract often reflect the government’s relative bargaining strength and also domestic political and economic considerations.
• Large buyers such as India seek to exercise their “buying power” to secure not just the lowest price.
• They also try to acquire the technology to upgrade domestic production and build research and development capabilities.
• The offset clause — used globally — is the instrument for securing these goals.

 A number of changes:

• Initiated in 2005, the offset clause has a requirement of sourcing 30% of the value of the contract domestically.
• a) Also, indigenisation of production in a strict time frame, and training Indian professionals in high-tech skills, for promoting domestic R&D.
• However, the policy has been tweaked many times since.
• As of November 2019, as in a reply to a parliamentary question, the Defence Ministry had signed 52 offset contracts worth $12 billion via Indian offset partners, or domestic firms.
• The duration of these contracts extends up to 2022.
• According to the recent CAG report mentioned above, between 2007 and 2018, the government reportedly signed 46 offset contracts worth ?66,427 crore of investments.
• However, the realised investments were merely 8%, or worth ?5,457 crore.
• Reportedly, technology transfer agreements in the offsets were not implemented, failing to accomplish the stated policy objective.
• We are unable to verify the claim as the government has not put in place an automatic monitoring system for offset contracts, as initially promised.
• On September 28, the government has diluted this policy further.
• Henceforth, the offset clause will not be applicable to bilateral deals and deals with a single (monopoly) seller, to begin with.

Setback for defence:

• Most defence deals are bilateral (as stated above), or a single supplier deal (given the monopoly over the technology).
• The dilution means practically giving up the offset clause, sounding the death knell of India’s prospects for boosting defence production and technological self-reliance.
• The government, however, has defended the decision by claiming a cost advantage.
• It is a lamentableexcuse for the reported policy failure. Price is but one of many factors in such deals, as explained above.
• The higher (upfront) cost of the agreement due to the offset clause would pay for itself by: reducing costs in the long term by indigenisation of production and the potential technology spill-overs for domestic industry.
• Hence, giving up the offset clause is undoubtedly a severe setback.

 Short-lived in aerospace:

• The offset policy can, however, succeed, if it is designed and executed correctly, as a parallel episode in aerospace industry demonstrates.
• Despite the heft of Hindustan Aeronautics Limited, India is a lightweight in global civilian aircraft manufacturing, as the public sector giant mostly devotes itself to defence production.
• The much-touted National Civil Aircraft Development (NCAD) project — to come up with an indigenously designed Regional Transport Aircraft (RTA) — has remained a non-starter from day one.
• However, with the introduction of the offset policy in 2005, things changed dramatically.
• For contracts valued at ?300 crore or more, 30% of it will result in offsets, implemented through Indian offset partners.
• As aerospace imports rose rapidly, so did the exports via the offsets, by a whopping 544% in 2007, compared to the previous year.
• By 2014, exports increased to $6.7 billion from a paltry $62.5 million in 2005, according to the United Nations Comtrade Database.
• The offset clause enabled India to join the league of the world’s top 10 aerospace exporters; the only country without a major domestic aerospace firm.
• The success was short-lived, however.
• Exports plummetedafter the offset clause was relaxed, primarily when the threshold for the policy was raised from the hitherto ?300 crore to ?2000 crore, in 2016.
• The offset exports fell to $1.5 billion by 2019. The 2005 policy helped promote a vibrant aerospace cluster, mostly micro, small and medium enterprises (MSMEs) around Bengaluru.
• The policy dilution undid success. The moral of the story is there for everyone to see.

Aiding self-reliance:

• Reportedly because of the CAG’s critical remarks in its latest report tabled in the Parliament, the government has virtually scrapped the defence offset policy.
• Thus, India has voluntarily given up a powerful instrument of bargaining to acquire scarce advanced technology — a system that large and politically ambitious nations seek to exercise.

Conclusion: 

• There are successful examples to draw lessons from, as the aerospace industry episode demonstrates.
• India needs to re-conceive or re-imagine the offset clause in defence contracts with stricter enforcement of the deals, in national interest, and in order to aim for ‘Atma Nirbhar Bharat Abhiyaan’, or a self-reliant India.

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Prelims Questions:

Q.1)With reference to the system-based automatic caution-listing of exporters, consider the following statements:
1. The Reserve Bank has decided to discontinue the system-based automatic caution-listing of exporters.
2. As part of automation of the Export Data Processing and Monitoring System, the 'Caution/De-caution Listing' of exporters was automated in 2016.
Which of the statements given above is/are correct?
(a) 1 only
(b) 2 only
(c) Both 1 and 2
(d) Neither 1 nor 2
Answer: C

Mains Questions:

Q.1)What is an offset policy? How is it expected to boost domestic capabilities?