India’s Offsets for Innovation

By Sarah Watson —

Working with defense contractors to develop India's renewable energy capacity could be a more efficient use of offsets than outdated technology. Source: Brahmakumaris Photo Gallery, used under a creative commons license.

Working with defense contractors to develop India’s renewable energy capacity could be a more efficient use of offsets than outdated technology. Source: Brahmakumaris Photo Gallery, used under a creative commons license.

The policy India uses to govern defense offsets — domestic investments in India required of foreign defense vendors — is in limbo. Despite reports over a year ago that the Ministry of Defence (MoD) was on the verge of unveiling a new offsets policy that marked a break with the past, the new Defence Procurement Policy was released without an offsets chapter. India has a valuable opportunity to realign its offsets procedure to derive maximum benefit for the country, not just its defense manufacturing base. Widening the aperture for defense offsets could help India achieve its goals in other areas, including its drive to transform into an innovation-driven knowledge economy.

Defense Minister Manohar Parrikar apparently prefers a switch to a simplified “directed offsets” policy, that, according to its description in the press, would mark a departure from the current approach. India already requires “direct offsets”: defense manufacturers can only get credit for offsets spent to boost India’s defense industry. Under the new policy, however, instead of allowing defense contractors to choose how to spend their offsets through a number of eligible channels, the government would dictate to suppliers how offsets will be fulfilled (so-called “directed offsets”). Most frequently, MoD will require that the contractor invest at least 30 percent of the value of a contract in building or improving a designated defense manufacturing facility in India.

This policy risks exacerbating the problems that have plagued India’s offsets program since its exception. Most important among these is the immense backlog of offset commitments. As the Singh Committee noted, between the commencement of the offset program in 2008 and March 2014 India signed offset contracts worth $4.87 billion. Yet as of January 2015 vendors had claimed only $921 million in fulfilled obligations, and only $20-25 million in claims had received final approval.

Forcing foreign defense manufacturers to make direct investments in India’s defense manufacturing base will not change foreign companies’ reluctance (and probable refusal) to transfer truly cutting-edge technology to investment targets in which they are minority partners. The resulting manufacturing facilities are thus unlikely to be state-of-the-art plants able to take on the burden of India’s defense manufacturing needs. It will also expose foreign manufacturers to all the risks and difficulties of doing business in India. Vendors will surely bake the costs of compliance into their bids, resulting in more expensive contracts for India with little obvious benefit. Even now, offsets come at a high price: Minister Parrikar told reporters in January 2016 that India’s offset requirements push up the price of a contract by 14-18 percent.

There is an alternative to doubling-down on the conviction that offsets are only desirable when they result in direct transfers of technology or immediate improvements to India’s defense industrial base. A more flexible program would allow vendors and the government to work together to identify an offset proposal that maximized value for India, whether it was defense-related or not, and avoid the extended wrangling that characterizes many purchase negotiations. As India’s Policy Commission, or Niti Aayog, observed, companies have diverse capabilities that can help India develop its capacities over a wide range of sectors. Particularly appropriate would be funding and co-operating research laboratories to perform basic research in defense-relevant areas; offering guidance and seed funding to Indian technology start-ups whose products have defense or internal security implications; and non-core area tech transfer in areas of interest to India, like renewable energy.

India would not be the only country to expand its definition of an offset. Canada, which requires that bidders compete on the basis of their “Value Proposition” for Canada, makes investment in innovation and research and development (R&D) a key goal and awards additional points when companies partner with (as opposed to just investing in) Canadian universities. Malaysia, which requires offsets in all government procurement, not just defense, makes sustainable long-term partnerships with suppliers a key part of its offset strategy and requires that offsets be beneficial to both the government and the supplier. Malaysia thus has a strong focus on collaborative efforts in R&D and capability development. The United Kingdom has moved away from traditional offsets entirely in favor of an industrial engagement policy that seeks to work in cooperation with foreign suppliers. Even Turkey, which has historically pursued a strongly autarkic offset policy, is mulling a switch to more flexible approach that will give greater weight to investment in civil sectors such as energy and health. Like India, Turkey has a large backlog of unfulfilled offset proposals.

India has rejected innovative proposals in the past. During the course of negotiations over India’s purchase of the Dassault Rafale fighter aircraft, subcontractor Thales, which contributes the plane’s electronic systems, apparently proposed discharging up to 50 percent of its offsets obligation through the development of three cities as part of India’s “Smart Cities” program. Indian officials rejected the suggestion. The proposal might have been perceived as a boondoggle. Yet Thales, which has significant capacities in homeland security and cyber security, could have been an excellent partner for a terrorism-plagued city like Mumbai, or have offered world-class solutions to protecting the Indian government’s critical networks.

As a report by the United Kingdom’s Royal United Services Institute pointed out, a country that does not invest in research and development will remain dependent on imports; tech transferred under offsets agreements will soon be out of date. India’s MoD has hinted that it has some openness to innovation offsets with the possible creation of a “skill development” pathway under the new policy. The offsets policy, when it is eventually released, needs to reflect equal emphasis on long-term development and short-term gains.

Ms. Sarah Watson is an associate fellow with the Wadhwani Chair in U.S.-India Policy Studies at CSIS. Follow her on twitter @SWatson_CSIS.

Sarah Watson

Sarah Watson

Sarah Watson is an associate fellow with the Wadhwani Chair in U.S.-India Policy Studies at CSIS.


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