The Defence Procurement Procedure, 2016, (DPP) recognises the need to ensure that procurement is undertaken in a manner that takes India closer to the goal of developing a world-class domestic defence and aerospace industry. However, the offset requirements under the DPP are not helping it achieve this goal. The recent Rafale controversy is the symptom of a larger underlying problem in decision-making, transparency and consistency of public policy.

Let’s start by looking at the offsets guidelines in the DPP. Put simply, offsets are a portion of a contracted price with a foreign supplier that must be re-invested in the Indian defence sector, or against which the government can purchase technology. Some good intentions inform the DPP and its offsets regime, such as the need for public-private partnership, encouraging startups and direct investment, and flexibility for foreign suppliers. However, when it comes to the details, things look different.

Under Indian law, government procurement is treated as distribution of largesse by the state and, hence, must be fair, transparent and equitable—there can be no favouritism or nepotism in the award of public contracts. Offsets, however, operate in a strange netherworld. On the one hand, they are financed by Indian taxpayers, but on the other, award of contracts by foreign suppliers are not subject to public procurement safeguards. The DPP even seems to indicate that the foreign supplier has complete discretion on choice of the Indian offset partner (IOP). Assuming this is true, it would result in a moral hazard at the outset and, by extension, would permit the Indian government to avoid public procurement rules when taxpayer money is routed through a foreign supplier towards “offsets".

While this was the government’s argument during the Rafale controversy, it would be disingenuous for the government to require foreign suppliers to have IOPs and yet not have a say in the choice of offset partner or its investments. If this were true, the offset regime would be inherently open to abuse by the foreign supplier.

Government procurement is treated as distribution of largesse by the state and must be fair-

The DPP covers for this by providing the government with extensive control over selection of the offset partner. For instance, it has the power to bar any entity from becoming an offset partner. The government also retains the power to evaluate offset proposals received in response to procurement tenders and conclude offset contracts. The DPP also provides that all offset proposals will be approved by the Union minister of defence, regardless of their value. During the period of the contract, any change in the Indian offset partner also requires government approval.

Therefore, it is unlikely that the government of India has nothing to do with the selection of Indian offset partners. Neither would this be desirable. If the intention is to create a free, open and competitive market, and yet at the same time, ensure that Indian taxpayers aren’t taken for a ride, are the offset guidelines satisfactory?

They aren’t. First, defence procurement should be subject to transparent processes that ensure that Indian companies, big and small, compete on a level playing field. The selection of a large (and failing) conglomerate with no prior experience, as is the case with Rafale, would not have been possible if the government had directly procured under a sophisticated award process. If it is not possible or desirable under a direct procurement regime, it is difficult to argue that it is desirable under an offsets regime.

Second, while the procurement policy recognizes the need for domestic private partnership, it does not mandate a fair and diverse procurement process for offsets. Given the large contract values involved, this makes it likely that foreign suppliers will partner with just one or two large industrial groups to discharge their offset obligations.

Third, the definition of IOP is flawed. IOPs are defined as Indian enterprises engaged in making eligible products and/or services. If the objective is to build a domestic defence sector, the focus should instead be on direct investments. In other sectors where India has succeeded, foreign technology and know-how has followed investments, irrespective of ownership. “Indian" ownership does not necessarily contribute to the growth of a sector, as much as investments within Indian shores. Focussing on investments will ensure that companies of all sizes, including foreign companies who wish to manufacture in India, are permitted to grow and flourish. For this, regulations that restrict foreign investments in the defence sector require a dose of reform.

More importantly, transparency is essential in procurement contracts. While national security arguments may withstand scrutiny in outright sales (regarding, say, specifications and customization) or where specific components or technology transfer are involved, they do not stand scrutiny in relation to offsets. In the interest of fairness, foreign suppliers should be free to invest in India, yet at the same time, offset investments/procurement must be subject to safeguards along the lines of those that govern public procurement, because after all, they are expending public funds.

Without substantive reforms in the DPP, there are likely to be more controversies and perceptions of crony capitalism. What is worse, the substantial amount of taxpayer’s money meant for the development of an indigenous defence sector might not find its way back.

Suhas Baliga heads Innove Law, a law firm specializing in foreign investment in India.

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