July 24, 2013 Source: Institute for Defence Studies and Analysis
On 23 May 2013, the Ministry of Defence (MoD) issued an Office Memorandum (OM), keeping in abeyance of ‘services’ related provisions from offset guidelines, the latest revised version of which was issued less than a year ago in August 2012. The abeyance of all services, effective from the date of issue of the OM, is applicable to all tenders or Request for Proposals (RFPs) issued after the notification of the OM, and also those tenders issued earlier but the commercial and technical bids are yet to be submitted.
The MoD’s action has created a debate among various stakeholders, particularly the Indian IT and software- related companies which see a loss of business to the tune of $10 billion as consequence of the OM. More importantly, the OM has opened up a new challenge for the MoD in articulating a revised offset policy that would take into account the current gaps in the offset guidelines while satisfying the services sector – a key stakeholder in Indian defence industry and a vital partner from the offsets point of view.
The OM comes in the wake of controversies surrounding the purchase of 12 VVIP Agusta Westland helicopters, in which allegations were made that bribes were paid through bogus software companies which merely worked as front organisations on behalf of middlemen and foreign companies. While the OM is an attempt to prevent such malpractices, it has in the process banned the entire services sector from doing offset business.
This is evident from its annexure, which has gone into every possible minute details in identifying and suspending all such paragraphs in the Defence Offset Guidelines of 2012 (DOG 2012), where the term services surfaces. Consequently, the term ‘Services” which broadly cover a range of activities including software development; software and computer based training modules; maintenance, repair and overhaul (MRO); engineering, designing and testing; quality assurance; and training has now become history till the time new orders are issued.
Interestingly, in addition to suspending the complete list of services which appear as the fourth category in the “List of the Products and Services Eligible for Discharge of Offset Obligations”, the annexure has also suspended services-related activities in other paragraphs, including the ones which had been included for the first time in the DOG 2012. Two such paragraphs relate to “vessels of war, special naval systems, equipment and accessories” and “Micro, Small and Medium Enterprises’. Any services related to the above two now stand suspended.
Since the OM talks of its validity “till such time that further instructions are issued”, one would assume that no sooner than later a revised guideline would be issued by the MoD. It is also assumed that the new guidelines would take into account the current gap in the offset policy which is biased in favour of the services sector. In comparison to the defence manufacturing sector which is subject to compulsory industrial licensing and where strict value addition principle is applicable (the latter being made more stringent in Defence Procurement Procedure 2013), the services sector is exempted from such conditions.
The services sector also gets further incentivised by the defence FDI policy which (after the 16 July 2013 meeting chaired by the Prime Minister) allows more than 26 per cent foreign equity in defence manufacturing sector on a case by case basis to be decided by the Cabinet Committee on Security (CCS), India’s highest decision making body on security matters. The CCS decision is to be influenced by the FDI proposal’s credibility in bringing in yet to be defined “modern and state of the art technology” to India. In comparison, the services sector can attract upto 100 per cent FDI without any governmental watch or regulation.
The above imbalance has led to a flurry of offset inflows into the services sector which has in fact become the most preferred area for the foreign companies to choose Indian Offset Partners (IOPs) from, for the discharge of their offset obligations. This has, however, not necessarily led to capability enhancement of the Indian services sector, particularly the companies in the IT and IT enabled Services (IT-ITeS) industry which have already reached a certain level of maturity and international reckoning. Moreover as the VVIP helicopter procurement case shows, the sector is at times vulnerable to malpractice since the government has no wherewithal to see how much real work is being done in India and by the Indian companies.
The crucial challenge for the MoD is now to limit the flow of offsets into the services sector and ensure that value addition takes place in India. On the aspects of limiting offset flows into the services sector it would be ideal for the MoD to stipulate a maximum percentage of offsets that can go into the services sector. This would not only limit the scope for malpractice, but would provide a fillip to the manufacturing sector which constitutes the core of defence industrial base.
On the aspect of value addition by the services sector, the MoD has a real challenge on hand as the services by nature are intangible. The silver lining is that the National Association of Software and Services Companies (NASSCOM), an industry association, has come forward in devising a method by which the intangibles can be measured. The MoD now needs to work with the NASSCOM and other industry players to establish a mechanism and issue the revised guidelines that would thwart bogus companies from doing business in defence.
Last but not the least the MoD also needs to seriously think about the background checking of Indian Offset Partner (IOP). Presently the foreign companies have the complete discretion in choosing the IOPs, with virtually no background checking by the MoD. It is quite surprising that the Defence Offset Management Wing (DOMW) which has otherwise a wider mandate relating offset guidelines and all matters relating to post-offset contract management does not have the authority to ensure genuiness of the IOPs. A little background checking by way of examining the IOP’s annual reports, balance sheet and all such necessary documents would however trigger a fear among the foreign companies who would be more cautious in partnering with bogus companies.
Views expressed are of the author and do not necessarily reflect the views of the IDSA or of the Government of India.