Rafale Deal Delay and Defence Offsets – Here is a fix

One reason the Indian purchase of 36 Rafale in a deal worth about $8 billion has not yet been signed is because India wants 50% offset and France is not agreeable to that. Meanwhile, Egypt purchased 24 Rafale in February of this year and by July, Egypt had already taken delivery of the first 3 Rafale. So clearly, India needs to move more quickly in signing the purchase agreement and to start taking delivery to help the Indian Air Force which desperately needs the 36 Rafale and perhaps at least 36 more after that.

But the issue of offsets is not just about cost, there are other issues that the vendor has to consider and as a result the current defense offset policy is not only causing uncertainty in pricing, it is also significantly delaying defense purchases by India. For example, see the article in The Economic Times on 16 Sep, 2015 which reported that proposed changes to the Defense Procurement Procedures (DPP) include “At the time of signing of the main contract, the OEM should furnish a Master Offset Plan to indicate qualified IOPs, products and services in broad detail and tranches of discharge by value, year-wise”. In other words, the defense offset means that a vendor who wants to sell defense equipment to the Indian government has to identify an “Indian Offset Partner” in India in order to invest the offset money in a joint venture with that partner. This Master Offset Plan is submitted to the Defense Offset Management Wing “DOMW” for approval.

So in the Rafale purchase, this means that Dassault has to invest 50% i.e. $4 billion in India in partnership with an Indian company. Maybe Dassault finds that difficult to do because in the last few months, they initially refused to agree to the 50% offset, then they agreed to the offset but said the price per Rafale would go up, and the reason is simple, they are reducing their risk by increasing the price of each Rafale. But if you will ask the Indian Air Force they will tell you that the Rafale purchase is so important that maybe the Indian government should consider making it easier for Dassault to meet the 50% offset requirement. Dassault wants to sell Rafale at a reasonable price and maybe they don`t have the time or inclination to find an Indian partner to meet the offset requirement. So instead if Dassault raises the price of each Rafale, India will lose money. So what can the Indian government do to help Dassault and other vendors meet the offset requirements without getting involved in Indian politics, and without raising the price they are asking ?

Maybe the answer is that India should set up an “India offset fund” to be managed by the Reserve Bank of India. It will be a Rupee fund, and only the foreign companies such as Dassault who sell defense equipment to India will be invested in this fund. The way the India offset fund would work is quite simple. France will not have to bother about finding an Indian partner or writing a Master Offset Plan, all that France would have to do is negotiate a price for the sale of Rafale to India. Suppose that the agreed price is $8 billion, then once the deal is signed, India would give half that money to Dassault in Euros, but would invest the other half in the India offset fund in Rupees. So the net result now is that France has invested $4 billion in India in a Rupee denominated fund. Suppose India guarantees a 5% dividend per year and allows the principal to be withdrawn after 20 years, then India has basically obtained a 20 year loan of $4 billion at 5% simple interest, in return for placing a $8 billion order from France, which seems like a good deal.

The problem with such an approach is that the risk is all on the Indian side. The whole point of the DPP was to engage foreign vendors to invest in partnerships with Indian companies and thereby share the risk of the venture going bad. In the current DPP system, if an Indian partner is not able to deliver results, then the foreign vendor will lose money and so there is incentive for the foreign vendor to provide key technology to ensure that the partnership is profitable and thus India benefits. This is an admirable goal if it actually works, however in reality, what is actually happening is that foreign vendors factor in the risk by asking for more money up front, so India does not seem to be gaining anything at all, either technologically or financially. That is why an “India offset fund” is a better alternative for everybody i.e. for the vendor and for India. In other words the onus will be on India to deliver success, which is the way it should be.

Now, the “India offset fund” would have to be a real fund with an actual investment in Rupees and complete transparency, because the last thing that India needs is for the “India offset fund” to become no more than a promisory note, an IOU from the Indian government, that would be a recipe for disaster 20 years down the road. So assuming that India sets up an “India offset fund” with real investment of money, the next question is who will administer the fund. Right now, the Defense Offset Management Wing “DOMW” is the agency which grants approval of the Master Offset Plan. So the DOMW is already entrusted with ensuring that the defense offsets benefit India. So the DOMW is the obvious choice to administer the India offset fund. So the DOMW can invest the money in two ways. Initially the DOMW can partner with banks to provide short term consumer loans which will have the effect of boosting the Indian economy.

Meanwhile, Indian companies who can find a foreign partner will submit a proposal to the DOMW for funding. Ideally these projects should be in the national interest, such as infrastructure i.e. building regional airports, toll roads, providing high speed internet to homes and businesses, nuclear energy installations, high speed rail, but as time goes by, these should include strategic technologies, such as building jet engines under license, avionics software, radar technology, missile technology, submarine technology, drones, space based surveillance technology etc. So essentially India needs to embrace the idea that the technologies that you want to invest in may have nothing at all to do with the military equipment that you want to buy.

Think of it like this, Dassault knows how to make a superlative combat aircraft by combining technologies for hundreds of vendors, and it is willing to sell you those combat aircraft at a reasonable price. But if you ask Dassault to form investment partnerships with Indian companies to manufacture defence equipment in India, they may not have any clue as to how to make that happen, so it may be an unreasonable request which is doomed to fail. If you want to build jet engines under license, then you need to partner with General Electric, but Dassault cannot possibly help you make that happen, so why ask Dassault to do something that you know they cannot do ? Much better to let Dassault invest $4 billion in “India offset fund” and allow Indian companies such as TATA to seek a partnership with General Electric to manufacture jet engines using that money.

Lastly, I would point out that India really needs to understand that time is money. When India is unable to complete defence purchases on time, then India loses a lot more in strategic value than the money that you were trying to save, so an “India offset fund” would help you complete your defence purchases on time. Then India needs to attract partnerships from other companies to manufacture in India. So for example India can buy military aircraft from Dassault or Boeing but then you can use the offset money to attract partnerships with General Electric or an Israeli avionics company or to get help from Saab to develop LCA Mark II or to pay Russia to build nuclear energy facilities all over India. The opportunities are limitless, but only if you use the “India offset fund” to apportion money to obtain maximum strategic value.