Late last month, the Ministry of Defence (MoD) imposed a penalty of around Rs 8 crore (Euro one million) on the French missile manufacturer MBDA for having defaulted on its offset commitments. The company has paid the penalty but also lodged a strong protest with the MoD. The reason for the default is unknown.
As a Tier-I sub-vendor of Dassault Aviation, with which MoD signed a contract in September 2016 for the acquisition of 36 Medium Multi-Role Combat Aircraft, MBDA is shouldering a part of the overall responsibility for discharging offset obligation of approximately Rs 30,000 crore in connection with this mega deal.
The penalty was imposed as MBDA did not meet the annual target set out in the implementation schedule that forms a part of the offset contract. The legality of MoD’s action may be unquestionable, but the rationale of imposing penalties for the shortfall in achieving annual targets is debatable. Such interim defaults do not cause any harm to MoD’s interest. In this case, for example, the contract has not run its full course and MBDA can always make up for the shortfall in the subsequent years.
The media reports on this subject mentioned, needlessly and rather humiliatingly, that the penalty was imposed in keeping with the government’s resolve to tighten the screws on the defaulting firms. Such comments overlook the fact that the offset contract in question is an offshoot of the Rafale contract under which the aircraft are being supplied by Dassault Aviation in time to the satisfaction of the Indian Air Force. Is that not more important than meeting the annual offset target?
This is not the first time that a defaulting firm has been penalised. According to a March 2020 report of the Standing Committee on Defence, fines amounting to USD 38.19 million had been imposed till then in eleven offset contracts for a shortfall in achieving the annual targets. The malady is evidently more widespread than the MBDA incident suggests.
The offset contracts, whose duration coincides with the duration of the corresponding main procurement contracts, but can be extended for another two years thereafter, contain an implementation schedule that specifies the annual targets to be achieved in monetary terms. Failure to achieve the target in a particular year entails a penalty equivalent to five per cent of the value of the unfulfilled obligation, which is then rolled over to the next year.
The maximum penalty that can be imposed while the main procurement contract is running its course cannot exceed 20 per cent of the total offset obligation but there is no cap on penalty for failure to discharge the offset obligation beyond the period of the main contract. The latter condition introduces an element of uncertain liability for the vendors and arguably pushes up the price of the main contract.
In addition to the stringent monetary penalties, a vendor eventually failing to discharge the offset obligation in full can also be debarred or slapped with any other penal action as deemed fit by the MoD. While things have not gone that far till now, MoD is reported to have threatened to ban a US company last August while putting another 11 US, French, Russian and Israeli companies on a watch-list.
According to the information given by the MoD to the Standing Committee on Defence in December last, a total of 56 contracts had been signed till April 2021, entailing a cumulative offset obligation of approximately US $ 13.03 billion. These offset obligations were to be discharged between 2008 when the first offset contract was signed, and 2027, when the last of the existing contracts runs its full course.
The committee was also informed that the vendors had submitted offset discharge claims worth US $3.67 billion but claim worth US $2.16 billion only had been accepted in the audit. The remaining claims were under examination by the auditing agency. In some cases, clarifications had been sought from the vendors on the claims submitted by them.
These figures point to the sluggish pace of execution of the offset contracts and a lackadaisical system of auditing the offset claims. This should be a matter of concern, more for the MoD than for the foreign companies obligated to meet the offset targets. All these foreign vendors are reputed names in the international arms market. It is unimaginable that they would fail to meet the annual targets because of mismanagement, complacency or some other deliberate act of omission or commission. The root cause of the problem seems to lie somewhere else.
The fact that internationally renowned defence companies are struggling to meet the offset targets reflects poorly on the offset policy itself which was introduced in 2005 and has been tweaked several times since then to make it more effective without much success. It would, therefore, be reasonable to infer that either something is wrong with the offset policy and its implementation, or the companies MoD is dealing with are good only for delivering major military platforms but incapable of discharging offset obligations. The latter proposition is too implausible to merit any serious consideration.
Consequently, the introspection must start with a review of the offset guidelines which, despite the changes made in the last fifteen years, continue to be replete with dichotomous features. Take, for example, the provision that permits the vendors to decide how they want to discharge their obligation within the prescribed offset policy framework. This provision is business-friendly but it is fettered by needless bureaucratic controls.
The avenues through which the offset obligation can be discharged, Indian companies which are eligible to be Indian Offset Partners (IOPs), and the products and technologies that are eligible for offsets, are clearly defined in the guidelines. However, paradoxically, these very guidelines also require the offset proposal to be examined and approved by the MoD for reasons that are both ambiguous and unconvincing.
Not only that, MoD’s approval is required even for changing the Indian Offset Partner (IOP) or rephasing the implementation schedule. Evidently, this excessive control by the MoD has proved to be ineffective in ensuring smooth execution of the offset contracts. It is time the rationale for these controls is given a second look.
Besides being needless, this entire exercise is also opaque. Very little is known of the criteria adopted by the MoD for examination of the offset proposals and the grounds on which e these are accepted or rejected. It becomes more complicated if the proposal is to transfer technology.
There have been instances of the MoD taking a long time to examine technology transfer proposals and eventually turning them down without even assigning any reason. No wonder then that there are hardly any instances of technology transfer under the offset contracts. Ironically, MoD considers Transfer of Technology (ToT) as one of the most cherished outcomes of the offset policy and never tires of berating the foreign vendors for their failure to transfer technology.
A study carried out by Manohar Parrikar Institute for Defence Studies and Analyses in 2019 revealed that more than 90 per cent of the offset obligation was discharged through direct purchase of defence products and services and that there were hardly any instances of ToT or foreign direct investment to meet the offset commitment. It is not surprising.
The simple truth is that these are among five or six options available to the vendors for discharging the offset obligation. Since the vendors are free to choose the avenues through which they want to discharge their obligation, they cannot be blamed for choosing the easiest avenue, which is to buy eligible defence products from the IOPs, rather than opting for ToT or FDI which are bogged down in cumbersome conditions and procedures.
It would be fair to argue that there should be no slippage in meeting the annual offset implementation targets since the vendors are by and large choosing the easiest avenue for discharging their obligation. But the fact that they are defaulting despite choosing this easy option indicates that either there is something wrong with the list of defence products eligible for offset or there is some difficulty on the part of the IOPs to deliver them to the vendors to enable the latter to claim the offset credit in time. This needs examination.
There is another feature of the offset guidelines which calls for a closer look. This is related to the provision that allows the MoD to advise the vendor during the examination of the offset proposal to make changes therein to bring it ‘in conformity with the offset guidelines. This advice can potentially result in the offset proposal being changed as per the wishes of the MoD with little regard for its implementability by the vendor.
To elaborate, there seems to be a tendency to coerce the vendors to start discharging the offset obligation right from the word go, rather than leaving a large proportion of the obligation to be discharged towards the end of the contractual period. There is no inherent merit in, and there is nothing to be gained by, insisting on the early discharge of the offset obligation, especially since the offset guidelines allow the vendor the flexibility to pace the implementation of the offset contract.
Whether the issues highlighted here are genuine or not cannot be said with certainty as no systematic effort seems to have been made to identify the reasons for the default and to address those issues. This is what the MoD ought to focus on rather than deriving satisfaction from tightening the screws on the defaulting vendors and imposing fines, thus missing the trees for the woods.
(Disclaimer: The views and opinions expressed in this article are those of the author and do not necessarily reflect the official policy or position of BharatShakti.in)