India s Revised Offset Guidelines DIOA / GOCA Fall 2012 Conference Brewster, Mass. Robert S. Metzger 750 Ninth Street, N.W., Ste 710 Washington, D.C. 20001 rmetzger@rjo.com www.rjo.com
Where are the markets? What is their size? Defense Defense spending has risen from $11B ($4B capital) in 2002 to $37B in 2012-13 (of which $15B is for capital items) Some project a 2011-15 spend of $54B from foreign vendors SIPRI now reports India as the world s largest arms importer; weapons imports increased by 38% from 2007-2011 Homeland Security India s homeland security expected to double to $16 billion by 2018 Civil Aviation KPMG projects domestic passenger throughput of 293M by 2020, up from 105M in 2011 and 51M in 2006 India predicted to be world s 3 d largest aviation market by 2020 Boeing in 2011 forecast a $150B market for 1,320 aircraft over 20 years Bombardier in 2012 forecasts a market of 1,300 20-149 seat aircraft 2
Access to the Defense Market Distinct markets selling to the Government of India FMS or other Inter-Governmental Agreement GOI prefers direct sales and views FMS w/ suspicion Direct Commercial Sale (DCS) under the DPP Buy Global, Buy and Make or Buy and Make (Indian) Single Stage, 2-Bid System; Lowest price ( L1 ) ordinarily winner Rule-driven; little flexibility Expensive to participate ( NCNC Trials) and often very slow The Offset Submarket 30% requirement on all sales (FMS, IGA and DCS) Contractual obligation with penalties >$4 billion of (17) signed offset contracts + $10B in pipeline Offset Primes are a real and addressable market
Behind the Statistics Fiscal restraints on new defense purchases Almost 70% of the capital budget is already committed Adjusted for Inflation and currency fluctuation, the 2012-13 capital budget is no greater than 2011-12. Induction of new systems puts pressure on revenue (O&M) budget. Pressure to reduce fiscal deficit (5.9% of GDP) will constrain spending. MMRCA and other awards constrain new capital awards Civil aviation faces many and serious challenges Absence of airports and supporting infrastructure Poor economic condition of carriers; Over-regulation and excessive taxes Essentially no current civil aeronautics industrial base Can passenger growth continue without more airports? Homeland Security Absence of central purchasing authority Uncertain priority and budget at states
DPP Offset Requirements - Introduction Since 2005 the Defence Procurement Procedure has required offsets for major defense contracts. The requirement applies to all Capital Acquisitions in the Buy (Global) and Buy and Make (Global) for acquisitions > Rs. 300 crores (~$60M). Uniform offset of 30% of acquisition cost (for Buy Global ) and 30% of foreign exchange component (for Buy and Make ). Defence Acquisition Council (DAC) has power to waive or vary. 2011 Amendments 1- expanded eligible products to include civil aviation and homeland security 2 allows Tier-1 sub-vendors to discharge offset obligations for their workshare Offsets: Commitment to compliance due at RFP response Separate Technical and Commercial Offset Proposals Offset Offer evaluated in two stages Commercial Offset Offer has no bearing on L1 selection
OEM Perspectives on India s Offset Program Foreign OEMs Advocated Change to the Program Uncertain administration and inflexible application Absorption of public sector capacity Uncertain Government support for private sector Unrealistic gestation period and inadequate banking Restricted categories of eligible products and services Excessive contractual exposure New ventures face challenges of quality FDI limits impair confidence in JVs Doubts inhibited participation in India s markets Companies questioned risk-adjusted return
Changes Advocated by Foreign OEMs Policy Expand Eligible Supplies & Services to other national objectives Increase allowable FDI > 26% for new ventures Grant credit to foreign firms using existing India aerospace subsidiaries Incentivize ToT by using multipliers earned by technology delivery Encourage use S/MEs w/ multipliers and allow banking for gestation Administration Increase staffing and increase authority of Offset Authority Improve consistency and establish cycle times for bureaucratic action Confirm vendors may rely on DOFA rulings (certainty of actions) Assure transparency through disclosure and regular reporting Implementation Cap offset contractual liability with reasonable max penalties Enable DOFA to grant relief for changed circumstances Extend period of performance for offsets and liberalize banking Allow new rules to apply to existing Offset Contracts
Revised Defence Offset Guidelines Aug. 1, 2012 Revised Guidelines answer many concerns of suppliers New methods to discharge offset obligations encourage supplier participation in DPP procurements Credit for ToT and ToE, as well as FDI, should foster achievement of indigenization objectives Multipliers for MSMEs especially important Private sector encouraged as Indian Offset Partner Extended performance period and liberalized banking Capped penalty exposure Clarified if not improved administration Potential flexibility in application
Key 2012 Changes: Purpose, Quantum & Scope Objectives now described: Fostering development of internationally competitive enterprises Augmenting capacity for R&D and Development Encouraging development of synergistic sectors (civ aero, int l sec) Scope largely unchanged: Applies to Buy (Global) and Buy & Make with Transfer of Technology ) Also applies to JV between Indian Company and foreign partner if indigenous content is less than 50% (by value) Quantum largely unchanged Remains at 30% of estimated cost of acquisition ( Buy (Global) ) or of the foreign exchange component ( Buy & Make with TOT ) Offset obligations can be varied or waived in special cases Offset obligations will not apply to Fast Track procurements
Key 2012 Changes: Avenues for Discharge Avenues for Discharge expanded to six categories Direct purchase of eligible products manufactured by, or services provided by Indian enterprises (to include DPSUs, OFs and private and public sector enterprises ) FDI in JVs with Indian enterprises (equity investment) subject to the guidelines/licensing requirements of the DIPP Investment In kind (non-equity) in terms of ToT for the manufacture or maintenance of eligible products and provision of eligible services. Must cover all documentation for full ToT without license fee or restriction Investment in kind by provision of equipment Provision of equipment and/or ToT to Government institutions (not Indian enterprises ) engaged in the manufacture or maintenance of eligible products and/or provision of eligible services. Technology Acquisition by DRDO in areas of listed high technology Foreign vendors encouraged to create offset programmes ahead of future obligations
Key 2012 Changes: Indian Offset Partner Definition improved to expand potential partners: Indian enterprises and institutions and establishments engaged in manufacture of eligible products and/or provision of eligible services, including DRDO are IOPs IOPs must comply with guidelines/licensing stipulated by the Dep t of Industrial Policy & Promotion These include FDI approval and issuance of Industrial license OEM/Tier 1 sub vendor free to select the IOP May be read to recognize need for OEMs to create partnerships with private sector as / if DPSUs are absorbed
Key 2012 Changes: Discharge of Obligations Vendor Responsibility Tier 1 sub-vendors may satisfy to extent of their work share by value Period for Discharge Now main contract period (including warranty) plus 2 years and Performance Bond Additional bond required where discharge period exceeds duration of main contract; to cover full value of undischarged obligation; For IGA purchases, e.g., FMS, OEM to furnish 5% bond Other Provisions In kind discharge by ToE subject to a 40% buyback requirement Offset credit for in kind discharge by ToT is limited to 10% of the buyback to the extent of value addition in India Banked offset credits remain valid for 7 years from acceptance Pre-approved banked offsets may discharge up to 50% of obligation Transfer of banked credits only between main vendor and Tier 1 sub
Key 2012 Changes: Value Addition; Multipliers The concept of value addition will apply only for direct purchase/export of eligible products. Value Addition will be determined by subtracting (i) value of imported components (i.e.) import content in the product and (ii) any fees/royalty paid. This may prove a major obstacle because India currently does not have indigenous capabilities sufficient to avoid reliance on imported parts TBD is when and how Value Addition will be determined. Further challenges may be presented by Foreign Exchange Rate Variation (FERV) and rupee depreciation Multipliers (1.50) awarded for MSMEs For direct purchase or eligible products or services For FDI in JV to manufacture or maintain eligible products & services For in kind ToT or ToE (subject to buyback) Multipliers ( 3.0) for DRDO Technology Acquisition DRDO s objectives present export control and technology release challenges
Key 2012 Changes: Management DOFA replaced with DOMW (Defence Offset Management Wing) DOFA was ineffective and understaffed; DOMW will be better resourced But MOD Acquisition Wing remains responsible for Offset evaluation and contract award while DOMW is responsible for administration and postcontract management Elaborate rules on roles and responsibilities presumably to balance the economic & political interests of the various MOD constituencies and the public sector enterprises Thus bureaucratic impasse or entanglement remain risks Some causes for concern OEM perspective is that faster, better and more reliable guidance is needed up front E.g., what partners qualify, whether products or services are eligible, how to value in kind ToE or ToT DOMW adds resources on oversight and enforcement but not to address formation concerns
Key 2012 Changes: Adjustments; Penalties A vendor may request re-phasing of offset obligations within the period of the offset contract. Re-phasing is not permitted beyond the applicable discharge period. Change in IOP or Offset Component In exceptional cases, DOMW may recommend change in offset partner or offset component if convinced necessary to enable the vendor to satisfy offset obligations. The overall value of offset obligations shall not be changed. High level approval is required for any change in the IOP. A 5% penalty applies for failure to fulfil annual phasing An overall cap on penalty is set at 20% of the total offset obligation but only during the main contract period. Failure to satisfy offsets risks debarment of up to 5 years.
Products & Services Eligible for Offset Discharge Defense Products, e.g., Vessels of war and special naval systems Aircraft specially designed or modified for military use Software for development, production and use of defense products Products for Inland/Coastal Security Now encompasses more maritime security items Civil Aerospace Products Includes design, development, manufacture and upgrade of all types of fixed-wing and rotary-wing aircraft and systems and components Services (related to eligible products) Maintenance, overhaul, upgrades, life-extension, engineering, design, testing services, QA and training Investment is civil infrastructure is specifically excluded
Assessment of 2012 Revisions
Net Assessment of the 2012 Revision Many positive steps Improved understanding of India s objectives & clarification of administrative responsibilities New means to discharge offset responsibilities Multipliers should motivate better small business opportunity Longer performance period and new banking rules Foreign OEMs can have higher confidence Issues of policy and administration remain Absence of focus on priority and achievable industrial results Division of authority over offsets FDI Limit of 26% remain on defense ventures Uncertainty remains as to interaction with other licensing regimes Offset program remains rule-bound New rules prospective only
SPEAKER CONTACT Counseling on India Aviation & Defense Opportunities Strategic Business Counseling Policy & Regulatory Assessment Robert S. Metzger Head of DC Office 202-777-8951 rmetzger@rjo.com Knowledge of U.S. and India Procurement Practices Assurance of FCPA Compliance + Coordination w/ India Counsel Transaction Counseling Offset Strategies & Compliance