Thursday, July 31, 2008

Reform of the defence offset policy

I am one of those die hard fans of companies like PWC (Price Waterhouse Coopers). Though I do criticise them at times; by and large I am a great fan of many an international consultant. They really bring lot of value add to the discussions on the table.

Look at today’s article by Dhiraj Mathur on India’s defence offset policy – a subject which we are interested in and have covered earlier also in our blogs.

He discusses with cogent reasons as to why the FDI cap in defence production (currently at 26%) makes no sense. While I recommend reading the full article at least once (do so here), let us look at some excerpts:

The government is scheduled to announce a new (and delayed) defence procurement policy (DPP 2008) in the next couple of days. From Indian industry’s perspective, the defence offset policy is a key element of the DPP. The existing version (DPP 2006) stipulates that 30% (or more) of the value of a defence purchase from a foreign vendor for a contract exceeding Rs 300 crore has to be ploughed back into the country via a defence offset obligation. Broadly, this obligation can be fulfilled by one of several methods — purchase from or exports on behalf of Indian defence industries of good or services produced or supplied by them, foreign direct investment (FDI) into Indian defence industries, investments in defence R&D etc.

The Indian government has launched a $100 billion capital investment plan over the 2007-12 period. The annual budget for the year 2008-09 is set at $26.4 billion.

The existing FDI policy restricts foreign equity in the manufacture of defence equipment to 26%. If one were to assume that approximately $10 billion of the offset obligation would be discharged through investment in manufacturing, the existing policy would require a domestic equity contribution of almost about $30 billion (Rs 1,20,000 crore). Since the offset policy requires that the obligation be discharged during the tenure of the defence equipment supply agreement, this quantum of domestic equity would need to be raised over a 2-5 year period in the defence sector alone, a target that seems quite impossible to achieve. Second and equally important, original equipment manufacturers (OEMs) aggressively guard their intellectual property and would be loathe providing cutting edge technology to a joint venture in which they own only 26% equity.

There is no economic or strategic rationale for this cap on foreign equity. For those who say that defence is a strategic sector in which we cannot have 100% foreign equity, I have only this to say — for the last 50 years, we have been buying equipment from companies that have no assets or even operations in India and over which we have no control. What great security threat would a company pose that would be incorporated in India, be subject to Indian laws and regulations with physical assets in India? The cap of 26% on the FDI thus works against fully exploiting the potential benefits of the offset policy.