ISSUE V : Indian defence procurement procedure 2006 v/s 2011 – A comparative overview

Introduction

Building defence capabilities has always fared high amongst nations for self-reliance, security and to tilt the balance of power. India, like others, has been conscious of developing a strong defence base. Though it has always had (and continues to have) an increased overseas dependence for meeting its defence needs, it is no longer shying away from strongly advocating its stance on indigenization of the sector. In order to increase transparency and accountability on defence procurement policies, the Ministry of Defence (“MOD”) issued a consolidated Defence Procurement Procedure (“DPP”) in 2002. Since then, it has undergone several changes1 in line with the evolving needs. This bulletin provides a limited comparative overview of DPP 2006 and DPP 2011(which contains new additions along with the changes introduced in the interim DPP manuals). The scope is restricted to cover: (a) Capital acquisition categories; (b) Request for Proposal (“RFP”) Process (for “Buy” and “Buy and Make” categories only); and (c) Offsets.

1. DPP 2006 versus 2011

  1. Capital acquisition categories – While DPP 2006 covered three categories, DPP 2011 has a fourth dimension to the capital acquisition process, as tabled below.
DPP 2006DPP 2011
Buy – It signifies an outright purchase of the equipment. Subject to the procurement source, the classification can be “Buy (Indian)” indicating Indian vendors having minimum thirty percent (30%) indigenous content where the systems are integrated by them; or “Buy (Global)” indicating foreign as well as Indian vendors.  
Buy and Make – It connotes purchase from a foreign vendor followed by licensed production/indigenous      manufacture      in India.  
Make – Acquisitions covered herein include high technology complex systems to be designed, developed and produced indigenously.
In addition to the existing three categories, DPP 2011 has “Buy and Make (Indian) category, which is a two-tiered process and involves purchase from an Indian vendor including a Joint Venture (“JV”) or a production arrangement with Original Equipment Manufacturer (“OEM”) followed   by                  licensed production/indigenous    manufacture    in India. “Buy and Make (Indian)” ought to have at least 50% indigenous content on cost basis (cost basis means the original value of the asset and includes associated purchase costs viz. installation costs, cost of improvements, commission, sales tax, shipping less depreciation).

The introduction of the new category in the defense acquisition process is a positive step towards increasing the participation of domestic (Indian) industry. It will enable Indian defense companies to collaborate with foreign technology providers by way of technology transfers, JVs and, thus, enhance local capabilities.

  1. RFP process (“Buy” and “Buy and Make” categories only) – Barring amendment of some existing clauses and inclusion of a few new ones, as listed below, the overall RFP process2 for the said categories remains the same in both the DPP manuals.
  • Linkage to acquisition plan (Clause 9a) – Based on the Defence Planning Guidelines, the Headquarters Integrated Defence Staff aims to bring out public documents (through MOD website) outlining the technology perspective and capability road map for the next fifteen (15) years for Indian defence forces. The clause is indicative of the government’s structured approach for the benefit of defence industry players to know its long term perspective on defence procurements.
  • Transfer of Technology (“TOT”) for maintenance infrastructure3 (Clause 28) – The TOT provision to an Indian public/private entity, for providing maintenance infrastructure, is applicable for Buy (Global) category. Herein, the Indian firm is responsible for providing base repairs (third line) (i.e. depot level repairs to include repair of major assemblies, sub- assemblies and of the equipment) and the requisite spares for the equipment’s entire life cycle. Per DPP 2006, the Indian firm can be selected from a list of public or private firms specified in the RFP, viz. Defence Public Sector Undertakings (“DPSUs”), Ordnance Factory Boards (“OFB”), Raksha Udyog Ratnas or any firm selected by the Department of Defence Production. However, under DPP 2011, the Indian entity can be a domestic company incorporated under the Companies Act, 1956, including DPSUs, entities like OFB/Army  Base  Workshops/Naval  Dockyards/Base  Repair  Depots  of  Air  Force.  As  a result, RURs have been removed and the scope for selection of entities for maintenance infrastructure has been widened in DPP 2011 vis-à-vis DPP 2006.
  • Field Evaluation (Trials) (Clause 37) – Pursuant to evaluation of technical offers, the manufacturers of short listed equipments have to send equipment units/weapon systems to India  for  field  evaluation.  In  terms  of  DPP  2011  addition,  field  evaluation/No  Cost  No Commitment (“NCNC”)4 trials is not applicable for procurement cases in respect of acquisition/construction  of  ships,  submarines,  yard  craft,  tugs,  ferry  craft,  barges,  where prototype is unavailable for NCNC trials. However, technical evaluation and acceptance trials will be carried out. Further, under clause 41, any vendor who fails to produce equipment for trials by the due date is normally given a grace period of fifteen (15) days.

Under DPP 2011, an additional grace period of thirty (30) days can be obtained. All the vendors have equal opportunity to receive such grace period. If the equipment is not evaluated in the initial trials then the vendor/equipment is not considered at a later stage.

  • Contract Negotiation Committee (“CNC”)(Clause 51 (a)) – Under DPP 2011, if the lowest tenderer (L1) is unable to supply the entire quantity within the stipulated timeline, CNC has the right to divide the quantity amongst other qualified tenderers (L2, L3 and so on in that order), on the price, terms and conditions as quoted by L1. In cases where it is pre-decided to have multiple sources of supply, the ratio of splitting the supply would be pre-disclosed in the RFP.
  • Return of Commercial Offers (Clause 55 (a)) – Per DPP 2011, in cases where the validity of commercial offers submitted by vendors expires prior to staff evaluation report5, the vendors have the option to either extend the validity of the commercial offer for a specified time (in consultation with the Service Headquarters) or submit fresh commercial proposals. In case of latter, the old proposals are returned unopened by the Acquisitions Manager. However, for cases where RFP is retracted pursuant to bid submission or where a vendor unilaterally withdraws from the acquisition process or is rejected at TEC/trial/ staff evaluation stage, the Technical Manager can return the unopened offer.

Other notable changes in DPP 2011 include (i) the timeline for procurement is specified in weeks rather than in months6; (ii) a single combined performance-cum-warranty bond of 5% of contract value (valid for a period of three (3) months beyond the warranty period) instead of the earlier two separate bonds of 5% each requirement, by the seller; (iii) Exchange Rate Variation scope has been increased to include rupee contracts with Indian vendors under Buy (Global); and (iv) borrowing rate has been decreased from 9.5% to 9% for calculating the discounting rate under the Discounted Cash Flow method.

  1. Offsets – India, a late entrant, in the defence offsets space, has been steadily revising the offsets policy since its official introduction in 2005. While DPP 2006 provided better clarity and direction, the subsequent policies refined them further. The following sections set out some of the key differences between DPP 2006 and Amendment to DPP 2011 issued on August 1, 2012 (“Amendment 2012”).
  • Objective (Clause 1) – For the first time, the MOD articulated the objectives of the offset policy, viz. (i) fostering development of internationally competitive enterprises; (ii) enhancing indigenous defence R&D and design capability; (iii) encouraging development of synergistic sectors like aerospace and internal security.
  • Quantum and scope of Offsets (Clause 2)
  • Clause 2.2 – Both DPP 2006 and DPP 2011 stipulate a uniform offset of 30% of the estimated (the word used in the former being “indicative”) cost of the acquisition in “Buy (Global)” category and 30% of the foreign exchange component in “Buy and Make” category acquisitions as the minimum required offset value. Per DPP 2011, offset obligations can be discharged only for “eligible” products and services.7 For JVs between Indian companies and foreign partners bidding together, offset obligation is not applicable where the indigenous content in the product exceeds 50% (by value). If the content is below 50%, the Indian company or the JV has to fulfill offset obligations on the foreign exchange component of the contracted value.8 This means the offset obligations will have to be discharged to the extent to which the foreign partner has contributed to the product. The Indian company or JV has to submit an undertaking to fulfill the offset obligation along with the main technical bid. Failure to submit the undertaking at that stage will render the bid non-responsive and is liable to be rejected. The indigenous content (by value) is determined based on the exchange rates prevailing on the last date for submission of the main technical bid.
  • Clause 2.3 – Under DPP 2006, the Defence Acquisition Council (“DAC”), upon due deliberation, can prescribe varying offset percentages above 30% for different cases or for individual cases based on factors viz. strategic importance of the acquisition or technology, ability of Indian defence industry to absorb offset, export potential generated. Per DPP 2011, the DAC, in addition to prescribing varying percentages above 30%, can also waive the offset requirement in special cases.
  • Clause 2.5 – DPP 2011 additions provide offset provisions will not apply to procurements under the (i) Fast Track procedure9, (ii) “Option” clause where an offset obligation was not stipulated in the original contract.10
  • Avenues for discharge of Offset obligations (Clause 3) – DPP 2006 allowed only direct offsets. In contrast, DPP 2011 has widened the scope to include both direct and indirect offsets (as explained below). Further, the existing direct offset obligations clause has also been modified, as under:
DPP 2006DPP 2011
Direct Offsets
(i)        Direct purchase of, export orders for        defence        products/components manufactured by Indian defence industries i.e.(i)        The term “Indian defense industries” (italicized in column (i)) has been modified to Indian enterprises i.e. DPSUs, OFBs, private
DPSUs, OFBs and any private defence industry manufacturing under industrial license. “Services” include maintenance, overhaul, upgradation, life extension, engineering, design, testing, defence related software or quality assurance services;   (ii)     Direct foreign investment in Indian defence industries for services, co- development, JVs and co-production of defence products, and;organizations engaged in defence R&D as certified by Defence Offset Facilitation Agency (“DOFA”)11and public sector enterprises; A list of products and services eligible for discharge for offsets obligations has been provided;12   (ii) Foreign equity investment in JVs with Indian enterprises, subject to guidelines/licensing  requirements  stipulated by the Department of Industrial Policy and Promotion (“DIPP”), for the manufacture and/or maintenance of eligible products and services.
Indirect Offsets
No indirect offsets were provided for in this DPPInvestment by TOT to Indian enterprises, through JVs or non-equity route for coproduction, co-development and production or licensed production, for manufacture and maintenance of eligible products and services;   Investment by provision of equipment through non-equity route (excluding second hand equipment, TOT and civil infrastructure);   As a result, now, investment in “kind” is allowed in Indian enterprises by way of TOT or transfer of equipment. While the former can be either through the equity or non- equity route, the latter can be made only through the non-equity route. Provision of equipment and/or TOT to government institutions and establishments engaged in manufacture and/or maintenance of eligible products and services, including DRDO.   Technology acquisition by DRDO in high technology areas.13
Indian Offset Partner (IOP)14
It covered Indian defence industries or organizations. Vendor was free to select the IOP for implementing offset requirement.The scope has been increased to cover Indian                                          enterprises, institutions/establishments      engaged      in manufacture of eligible products and/or services, including DRDO. IOP has to comply    with    DIPP    guidelines/licensing requirements.    OEM/vendor/Tier-I     sub- vendor is free to select IOP provided the IOP has not been barred by the MOD from doing business.
Period of discharge
Offset obligations were co-terminus with the period of the main contract.Period extended by two years from the date of main procurement contract (which is inclusive of the warranty date). Extension is subject to vendors’ submission of an additional performance-cum-warranty bond (to be submitted six months before expiry of the main performance-cum-warranty bond) equivalent to the value of offset obligations falling beyond the period of the main contract.
Administrative agency
MOD established DOFA to act as a single window agency to oversee and assist in implementation of offsets policy.Defence Offset Management Wing (DOMW), has replaced DOFA. Unlike DOFA, it will be a powerful organization having more powers and functions viz. formulation of defence offset guidelines, post-defence offsets contract management, working in collaboration with the Acquisition Wing for smooth implementation of offset guidelines.

Further, Amendment 2012, inter alia, also contains notable additions like:

  • (i) The multiplier concept, which incentivizes investment in select areas i.e. a foreign company can claim credits for its actual offset investment. It has been restricted to two areas, firstly, micro, medium and small enterprises (“MSMEs”)15, wherein a multiplier of 1.50 is permitted and, secondly, technology acquisition by DRDO wherein higher multipliers of 2 (where technology is for Indian armed forces without any restrictions on the number of produce), 2.5 (where technology is for both military and civilian application for use in Indian market, without any restriction on the number of produce) and 3 (where the technology is offered without any restriction, with full, unfettered rights including the right to export) are allowed;
  • Extension of banking offset16 period from two to seven years;
  • Capping the overall penalties on vendor defaults at 20 % of the total offset obligations during the main procurement contract;
  • A specific provision17 harmonizing the interplay of rules between DIPP and MOD. This is definitely a welcome inclusion owing to varying positions of the government authorities. For instance, according to the internal stance of MOD, an IOP, irrespective of the  nature  of  its  activity  (defence  manufacturing/services),  ought  to  have  an  industrial license and be subject to maximum 26% Foreign Direct Investment (“FDI”) limit. On the other hand, DIPP stipulates that an Indian company is subject to industrial license and FDI restriction only if its activities come within the ambit of defence manufacturing. The addition of aforesaid clause will, perhaps, aid in reconciliation of regulations. Consequently, MOD may allow non-manufacturing entities to participate in offset programmes.

Conclusion

From DPP 2006 to DPP 2011, the Indian defence procurement procedure has evolved considerably. However, there is no denying it is a work in progress. Based on the overall industry response, vendor feedback, past experiences, international practices, the MOD is constantly trying to put together a well thought out and consolidated document for India’s defence sector. The recent changes, with its fair share of critique, have been well received and described as a step in the right direction by many. Whether the evolving policies effectively translate into building India’s defence strength is a fact that remains to be seen in the coming years.

Authored by:
Priyatha Rao

1 In 2005, 2006, 2008, 2009 and the latest in 2011.

2 This includes solicitation of offers, evaluation of technical offers by Technical Evaluation Committee (“TEC”), field evaluation, staff evaluation, oversight by Technical Oversight Committee for acquisitions above INR 3 billion, commercial negotiations by Contract Negotiation Committee, approval of Competent Financial Authority, award of contract/supply order, contract administration and post-contract management.

3 This covers production of certain spares, establishment of base repair facilities including testing facilities, provision of spares for the entire life cycle of the equipment.

4 It means the government neither bears the cost of the trials nor is it committed to buy the products after the trials. So, the buyer carries out the trial evaluation of the products on a no-cost, no-commitment basis for the MOD for capital procurements.

5 The procurement process includes various stages. Once the RFP is issued, and vendor queries are addressed, opened technical offers are sent to the TEC and the sealed commercial bids/offers to the Acquisition Manager. Pursuant to TEC report, the selected vendors have to do a field valuation based on which a staff evaluation is conducted. Therefore, it is possible that the commercial offers of vendors expire before the stage of staff evaluation.

6 The time allowed for receipt of responses to RFP has been reduced from 3 months to 3 weeks.

7 Annexure VI to Appendix D of Chapter I, Amendment 2012 contains the latest list of eligible products and services. In  all, there  are  39 group  of  products/services in  which foreign vendors can discharge  their  offset obligations.

8 Clause 5.10 of Amendment 2012.

9 This procedure is to ensure expeditious procurement for meeting urgent operational requirements foreseen as imminent, or for a situation in which a crisis emerges without prior warning. It covers acquisitions under “Buy” category and is applicable for both indigenous sources and ex-import.

10 In respect of procurements under the “Option” clause, where an offset obligation was stipulated in the original contract, the offset guidelines prevailing at the time of signing of the original contract would be applicable.

11 This was the previous entity set-up for overseeing offsets.

12 Ibid Refer footnote 7.

13 Listed in Annexure VIII to Appendix D, Amendment 2012.

14 In exceptional cases, DOMW can permit change in offset partners or offset components, provided the value of offset obligations remains unchanged.

15 MSMEs have been defined on the basis of investment levels. For manufacture of goods: (i) micro – maximum investment is INR 2.5 million, (ii) small – investment is between INR 2.5 million and INR 50 million,

(iii) medium – investment is between INR 50 million and INR 100 million. For providing services, (i) micro – maximum investment is INR 1 million, (ii) small – investment is between INR 1 million and INR 20 million,

(iii) medium – investment is between INR 20 million and INR 50 million. These limits are subject to Department of Micro, Small and Medium Enterprises notifications.

16 DPP 2008, for the first time, allowed foreign vendors to create offset programmes in anticipation of future contracts. Offset credits, thus acquired, were allowed to be banked and discharged against future contracts.. If a vendor was able to create more offsets than his obligations under a particular contract, the surplus could be banked, which remained valid for two financial years after conclusion of the said contract.

17 According to clause 8.19 of the Amendment 2012, “Defence Offset Guidelines will apply in harmony with and not in derogation of any rules and regulations stipulated by various agencies of the Government of India, including Department of Industrial Policy and Promotion, DG Foreign Trade and Ministry of Finance, etc.”

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