DEFENCE INDIGENISATION€¦ · challenge lies in being able to fund these in these times when...

challenge lies in being able to fundthese in these times when revenuereceipts have taken a historic hit.

Defence as a strategic sector still hasa high ratio of imports vs exports. Thedefence infrastructure base in thecountry is being enhanced and is beingmade more competitive. However, thehigh capital investment and longgestation period required in the sectorrestricts the expectation of immediatereturns. Hence, while as a nation weare focussing on indigenous design,development and production, importsmay still continue for a while at least.The emergent purchases / importsbeing planned and / or already orderedare plugging a small section of the gap.If we consider the case of fighteraircraft, the additional 21 MiG-29s and12 Su-30s along with upgradation ofexisting 59 MiG-29s coupled with theplanned order for 83 LCA Tejas aircraftin the coming few years would enhancethe IAF fleet.

OFFSET OBLIGATIONSTill date, the defence sector has seen alot of foreign purchases which haveresulted in billions of dollars of offsetobligations by the vendors. Thenumbers suggest that till March 2019,MoD has reportedly signed 52 offsetcontracts worth ~$11.8bn out of whichas of 24 April 2020, only $1.6bn havebeen disposed while close to $1.2bn areeither under examination orclarifications are being sought onclaims. This leaves a huge gap of closeof $9bn worth of offset obligations thatare still pending to be discharged viathe avenues as mentioned in the DPP. A

delay in the discharge attractspenalties from the vendors.

As of date, close to $35mn inpenalties has been reportedly chargedto the foreign OEMs for violation ofdischarge of offset obligations. One ofthe reported cases is for a global leaderwhich was fined ~$500,000 after thedefence ministry was not satisfied withthe discharge of obligationsundertaken by the company in relationto the orders . Possible causes for suchdelays in meeting obligations and thesubsequent fines possibly includeamong others (1) India's capacity toabsorb offsets within the confines ofthe eligible list of goods and services indefence, civil aerospace, homelandsecurity and services segments and (2)lack of a comprehensive understandingof the India defence landscape. Thelack of a comprehensive understandingof the defence ecosystem can beplugged via a detailed exercise ofstudying the same. The more urgentrequirement is the policy angle wherethere are limited avenues for dischargeof offset obligations.

While there is merit in restrictingthe avenues to defence and alliedsegments, past experience has shownthat it is not easy to discharge offsetobligations just via this sector. Hence acase can be made that such obligationsbe allowed to be discharged in otherinfrastructure and / or socialinfrastructure based sectors via abanking set up maybe. These sectorsincluding healthcare and educationwhich provide for 100% FDI under theautomatic route making it moreconvenient for all stakeholders. Theforeign OEMs will get more avenues todischarge their offset obligationsthereby probably completing it faster.

rr NNIILLAAYYAA VVAARRMMAA AANNDD AAMMIITT DDUUGGAARR

Mostbelieve,

India's growthtrajectory thathas lost its steam

due to the COVID-19 impact, is expected toreturn to its pre-covid growth trajectory inthe next FY. There is also a universalacceptance that the best way for India togain out of this global recession is to investin its infrastructure. The infrastructure thatgoes beyond traditional infrastructure oftransport and energy but also healthcare,agriculture, irrigation, water, etc. The

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Reviving India's defence infrastructure iscritical and so is discharging its offsetobligations. More investments ininfrastructure is the only way out

Lack of understandingof the defence

ecosystem can beplugged via its detailed

study. Policy anglewhere there are limitedavenues for dischargeof offset obligations

needs urgent attention

DEFENCE INDIGENISATION

DEFENCEOFFSETS: BEYONDBORDERS

Fund that discharges the obligationthrough FDI (equity) to furtherleverages the funds. The funding canalso be used in cantonmentinfrastructure works. It is suggestedthat we target a part of the availableoffset pool, say 30%, which wouldamount to approximately $3billion(~INR 20,000 cr). This can target clearprojects like Har Ghar Jal, Irrigationworks, OFB modernization, nationalinfrastructure pipeline projects, forexample - with the priority being givento projects that are ready to disbursefunding, or in an advanced state of the

procurement process. Another optioncould be to open up specificinfrastructure sectors in the eligiblelist, and allow the foreign vendors tofind investment avenues with localpartners. While this injects INR20,000cr into the treasury as non-taxrevenue, with the current leveragingratio, this can inject INR 50,000cr intothe economy, via critical infrastructureprojects.

—TThhee aauutthhoorrss aarree CCoo--ffoouunnddeerr aanndd VViiccee PPrreessiiddeenntt ((AA&&DD))

ooff aa pprriivvaattee ccoonnssuullttiinngg ffiirrmm

The Indian ecosystem will get thedesired equity FDI and / or investmentin other relevant forms. A win-win forboth. India needs investment ininfrastructure right now and this is areadily available medium which canarguably be operationalised soonerthan any other.

From a social infrastructureperspective, on one side there are manypressing requirements which needinterventions from the Governmentand on the other there are manytechnology enabled solutions that canhelp build the ecosystem with a littleinvestment support.

INDUSTRIAL COOPERATION Referencing a case of Israel forexample. Israel's offset policy requiresa mandatory 50% offset dischargeobligation for all contracts above $5mn.For India, the same is a minimum 30%offset liability for contracts above~$300mn. However, in Israel thedischarge of such obligations is throughwhat is called as 'Industrial Co-operation' which is arguably morebroad compared to the avenues as perthe Indian DPP. Industrial Cooperationincludes R&D, know-how transfer,vocational training, purchase of Israelimade goods and Work in Israel (work,services and assembly) . To eachcountry its own. Hence given India'srequirements, it is important to takethe best practices of other countriesand weave it into the best possiblesolution for self.

In healthcare for example, theGovernment is committed toincreasing the spends from 1.4% ofGDP to 2.5% of GDP . Investments arerequired in tier 1/2/3 in the healthcaresector along with focussing onremoving bottlenecks or barriers asthese would enable in building a supplyside capacity. With the ongoingpandemic, manufacturing of APIs hasbeen taken up on a mission mode bythe Government of India as reportedlyabout 60% of its total imported APIsand intermediaries are from Chinaalone. The Government has announceda $394mn scheme to promote thedevelopment of three bulk drug parks .FDI (both equity and / or in the form ofscience & technology) in such cases andareas will assist tremendously. Indiaalready has an established pharma andhealthcare industry and the additionalFDI will only add to it. In educationsector for example, infrastructurerequirements like laboratories,

libraries, electricity requirements inschools and colleges also reportedlyhave critical gaps in terms of requisitebudget allocations . Similarly in waterrelated infrastructure, India reportedlyneeds to invest close to $270bn overthe next 5-15 years to meet its waterinfrastructure ambitions . In a nutshell,the idea being pursued here is thatwhile defence infrastructure is criticaland also urgent, there are other sectorsalso where investments are required.Hence, expanding the avenues fordischarging of defence obligations willjust give the foreign OEMs moreoptions to invest. If not for futurecontracts, an allowance to settleobligations via other avenues as a one-off case for all foreign vendors couldalso be considered.

UTILISING DEFENCE OFFSET FUNDSIn view of the current need foridentifying non-tax revenues, it isimportant to utilise the defence offsetfunds on a relatively immediate basis.Options of putting the funds to use canbe considered: a possible developmentbanking set up, or Impact Investment

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Possible causes for delays inmeeting obligations and thesubsequent fines possibly

include among others -India's capacity to absorboffsets within the confinesof the eligible list of goods

and services in defence, civilaerospace, homelandsecurity and services

segments

Lack of a comprehensiveunderstanding of the India

defence landscape.The moreurgent requirement is the

policy angle where there arelimited avenues fordischarge of offset

obligations

THE ROLE:Streamlining offset

obligations

Options of putting the fundsto use can be considered: a

possible developmentbanking set up, or Impact

Investment Fund thatdischarges the obligation

through FDI (equity) tofurther leverages the funds.

The funding can also beused in cantonmentinfrastructure works

Another option could be toopen up specific

infrastructure sectors in theeligible list, and allow the

foreign vendors to findinvestment avenues with

local partners

THE POTENTIAL:Utilising defence

offset funds