Political power grows out of the barrel of a gun.” Thus spoke Mao-tse Tung. This quote assumes even more importance in today’s turbulent times. Having a robust defence preparedness is the cornerstone of modern diplomacy. For a country like India, given is geo-political and strategic challenges, a sub optimal focus on its defence industry will be fraught with danger. Up gradation and modernization is the need of the hour for India. Despite some remarkable progress made by India in various fields, a lack of a strong military industrial base has meant that India has been a net importer of its defence needs, bestowing upon it the dubious distinction of being the world’s largest arms importer. The root cause of this is that long-term investments made in Defence Public Sector Undertakings have not yielded a military industrial base capable of optimal and timely technology up gradation or absorption and is plagued with cost and time over runs.
With the continuous growth of the Indian economy, and its seemingly insatiable appetite for defence procurement, the Indian defence market is by far the most lucrative one for global defence firms.
Hence there exists a double jeopardy of high imports and inadequate domestic capability, which leads to a strain on the balance of payments scenario.
In a bid to address this gap, the Government of India came out with a Defence Offset Policy as part of the Defence Procurement Policy of 2005 which resulted in the Defence Offset Guidelines (DOG) of 2005. The DOG was updated from time to time and the current DOG was published in the year 2012, which came into effect w.e.f. 1st August 2012. Given the end goal of the DOG, i.e. to build up the militaryindustrial base in India, only direct offsets are allowed, through one of the prescribed routes.
The DOG stipulates a minimum 30 per cent offsets in ‘Buy (Global)’ and ‘Buy and Make with Transfer of Technology (ToT)’ contracts valued Rs 300 crore (approximately USD 50 million) or more (in the latter case the quantum of offsets of minimum 30 per cent is mandated on foreign exchange component of the contract).
In a significant departure from earlier versions of the guidelines, the current DOG has clarified that any Indian companies or their joint ventures participating in ‘Buy (Global)’ contracts are also required to provide offsets, if the product has indigenous content of less than 50 per cent by value (the value of indigenous content will be ‘determined on the basis of exchange rates prevailing on the last date for submission of the main technical bid’). However, in case the indigenous Indian content is 50 per cent or more, they are then exempted from the offset obligations.
The DOG has also expanded the modes of offset discharge by the foreign vendors. Offsets can now be claimed by the vendor through:
One of the areas of ambiguity in the DOG, and one that has been the subject of considerable debate, is- “Who qualifies as an IOP”. A bare perusal of the DPP 2013 defines IOP as:
“Indian enterprises and institutions and establishments engaged in manufacture of eligible products and/or provision of eligible services, including DRDO.”It further states that the IOP shall, “besides any other regulation in force, also comply with the guidelines/licensing requirements stipulated by theDepartment of Industrial Policy and Promotion, as applicable”
What is pertinent to note is that the DOG or the DPP have nowhere defined what is an “Indian enterprise”, “Indian institution” or “Indian establishment”
This ambiguity is exacerbated by the fact that the Comptroller and Auditor general (CAG) has taken a divergent view to the Ministry of Defence. In its report dated Nov 29, 2012, the CAG observed “…the IOP is required to comply with the guidelines /licensing requirements for the defence industry issued by the Department of Industrial Policy and Promotion (DIPP). Further, the government has allowed 100 per cent participation of private sector in the defence sector with FDI (Foreign Direct Investment) permissible upto 26 per cent. We however, noticed that some companies having more than 26 per cent of foreign holding were also accepted by the Ministry as IOPs”
On the basis of the above, the CAG observed that where a company was a subsidiary of a foreign company (with foreign shareholding in excess of the sectoral cap of 26%) then such company cannot be considered an IOP, notwithstanding the fact that such company was a company registered in India.
However, in one such instance, viz. M/s Johnson Pumps Ltd., the Ministry of defence held that, notwithstanding the fact that M/s Johnson Pumps Ltd was a subsidiary of a foreign company (M/s SPX Flow Technologies, Sweden), it is an IOP since it is a company registered under the Indian Companies Act 1956.
This view of the MoD has created an ambiguity into what constitutes an IOP and has resulted in a degree of subjectivity creeping into grant of offsets to the foreign vendor as part of their procurement from Indian sub-vendors under the contract granted by the MoD.
Further, while the DOG has been put in place to encourage private sector participation in defence manufacturing, the difference in interpretation of industrial licensing requirements and FDI limits in IOP was creating further ambiguity and was proving to be an impediment to private sector participation. Previously, the prevalent view was that and IOP, irrespective of its being in defence or non-defence sector, must have an industrial license (IL) and its FDI exposure must not exceed 26 per cent. The Defence sector is one of the few manufacturing sectors where an Industrial license is still mandatory and given that procuring this is a time consuming and cumbersome process, clarity on the requirement for an IL for even non-defence companies who want to be considered as IOP, will go a long way in improving investor sentiment. The current DOG has taken a step to shed some clarity on the issue by stating that the provisions in the DOG will be in “harmony and not in derogation of any rules and regulations stipulated” by other agencies. This may be interpreted to mean that companies in the non-defence manufacturing sector (for eg. Companies providing services under the “eligible services” category) will not be subject to IL and FDI restrictions. Such companies may be considered as sub-vendors by theforeign vendor as their IOP
Thus, while the DOG has opened up the highly lucrative and critical defence sector to private companies, lack of clarity on the concept of IOP is proving to be a hindrance to full scale participation of the Indian private sector in this industry. There is great anticipation by the Indian private sector that in the forthcoming revisions to the DPP, these ambiguities shall be suitable address by the Ministry of Defence. This will result in clarity and objectivity and give a fillip to the defence industrial base in India. This is a pressing need of the hour, and is critical for India to achieve its ambitions of becoming a global power.
www.grandmasters.in | 8 Years & Counting
www.rcls.in | 8 Years & Counting
www.itlegalsummit.com | 8 Years & Counting
www.bfls.in | 8 Years & Counting
www.maels.in | 8 Years & Counting
www.plcs.co.in | 8 Years & Counting
Copyright © 2020 Lex Witness - India's 1st Magazine on Legal & Corporate Affairs Rights of Admission Reserved
