Insighteon Consulting, a pioneer consulting firm in aerospace and defence, ran an interactive war-game on 23 and 24 February 2022, with the aim of ascertaining the reasons behind its failure to fulfil offset obligations leading to frequent imposition of penalties. For the uninitiated, defence offsets are arrangements in which the purchasing government of the importing country obliges the supplying company of the exporting country to reinvest some proportion of the contract in the importing country. It came to the conclusion that the offset programs which have not performed are typically those which are too ambitious or those where external factors played a role in offset discharge e.g. foreign governments, the three services, use of buyer nominated equipment as offsets, the Covid-19 pandemic, etc. Non-performance has also been linked to lack of flexibility /ambiguity in policies, which resulted in differing perceptions.
Offset contracts estimated at 13.03 billion USD (BUSD) have been signed and are expected to be implemented by the Year 2027. Only 3 BUSD have been accepted in audit till date and a penalty amounting to USD 100 million has been levied on various suppliers for shortfall in achieving the proposed targets. Presently, one out of every two contracts has either been penalised or is under the threat of penalisation.
The analysts predicted that in case status quo is maintained, the cases of penalisation are going to see an exponential increase in the next five years, even though fresh offset contracts are not expected to be signed. They were of the firm opinion that in a conflicted approach with offsets, there are no winners – everybody loses.
“The war-game studied the processes followed over the last decade and got an impression that the parties do not consider each other as partners and allies. Negotiations are on the basis of a “win-lose” mandate, and no trust-based, long-term relationship benefiting both parties was observed. “An offset/industrial cooperation relationship should be treated as a partnership, where success hinges on good communication, transparency, openness, trust, and a timely revert on quantum of obligations approved/disapproved with feedback,” said Rajiv Chib, Co-Founder, Insighteon Consulting.
The analysts also observed that possibly the need of risk aversion has led to an unintended outcome of inducing a safe approach in the implementation phase of the policy, with delayed decision-making whenever confronted with routine grey areas. Long-winded procedures and inordinate focus on paperwork have stifled verification of claims/rephasing proposals/change of IOP proposals/banking proposals. The resultant delayed decision, though not quantifiable, has contributed to a reduced time period available for offset discharge and imposition of penalty.
It was felt that there is a need to document negotiations at all times by both the parties. The discussion and interpretation of negotiations was considered important for the purpose of resolving a dispute arising during the performance of the contract. “The written document will be of assistance to avoid either problems of interpretation or changes in perception,” Rajiv added.
It was also felt by the analysts that as India is one of the few countries which does not count the quality of an offset package as a bid evaluation criteria for assessing competing tenders, this probably has played a role in the quality of offsets received.
The penalisations in the recent past pertain mainly to contracts governed by DPP 2008, with a few contracts governed by DPP 2005/2006 and DPP 2013. For contracts signed before the issue of offset guidelines of 01 August 2012, the analysts judged that in such cases, penalties levied are restricted to the duration of contract leading to a number of stalemate situations. The analysts noted that this is one of the main reasons why more than 50 offset contracts are still open out of the 56 contracts signed.
The analysts were, therefore, unanimous in their opinion that in legacy stalemate situations, the suppliers of the Ministry of Defence (MoD) should be given a second chance to fulfil their obligations. Besides a perception that each incoming offset obligation has a 1:1 dollar value, thus somehow causing a loss to the exchequer, needs to be removed, in order to pave the way to a solution. It was thus recommended that this second chance be provided under a new regulation/ broad policy framework, where the Original Equipment Manufacturer (OEM) be allowed to fulfil offset obligations, governed by the provisions indicated in offset procedures of any of the Defence Procurement Procedures (DPPs) or Defence Acquisition Procedure (DAPs) published till date.
The analysts also opined that to facilitate the “second chance”, MoD may create an Empowered Dispute Resolution Body (EDRB), led by a senior bureaucrat or a senior industry professional. The objective of EDRB will be to close all existing stalemate situations by the best possible outcome. The EDRB may be assisted by three to five persons drawn from MoD and industry, both public and private with diverse backgrounds. It can be responsible for calling fresh proposals from foreign OEMs and examine each case on its merits and within the ambit of DPPs/DAPs issued till date. It will fix a duration in consultation with the OEMs. Lastly, the EDRB will finalise the revised offset contracts with OEMs and get the same ratified by the DAC/approving body in MoD. Contracts which are not in stalemate situations, may continue to be managed by Defence Offsets Management Wing (DOMW) as before.