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offsets

By Jon Grevatt, IHS Jane's Asia Pacific Defence Industry Analyst

Indonesia is set to introduce its inaugural defence offset policy from 2011 as part of wide-ranging changes to the country's defence procurement policies. The policy, which is being finalised by the Ministry of Defence (MoD), is expected to call on foreign contractors to transfer technologies to Indonesian defence companies to facilitate at least 40 per cent of a production contract to take place locally under licensed manufacturing arrangements.

The offset guidelines will be implemented by the MoD's Defence Industrial Policy Committee (KKIP) and will supplant existing ad hoc guidelines that relate to defence manufacturing and technology transfer and are based on counter-trade. The objective of the offset policy is to improve indigenous industrial capabilities, reduce dependency on imports, and create meaningful employment in a country whose economy is forecast to expand rapidly over the next decade. It will be supported by a government pledge to revitalise the state-owned defence industry over the next five years through financial support and a commitment to procure military equipment from indigenous sources whenever possible.

In a bid to shape the offset guidelines, a senior official from the MoD said Indonesia was talking to several foreign countries about their respective industrial participation and offset schemes in order to learn more about best practice. Commodore Sudi Haryono, director for technology and industry in the MoD's Directorate General of Defence Facilities, said: "With input and help from foreign countries, we will make regulations for defence offset for Indonesia's defence industry. We are now talking to other countries to get their input and to listen to their experience. I think it is important to make this [happen next year]. We want offset to build Indonesia's defence industry so we can improve."

The KKIP is headed by Defence Minister Purnomo Yusgiantoro and was created under a presidential decree earlier in 2010. Its policies are being shaped by the MoD but they are expected to form a central part of the government bid to improve defence industry capability. Officials have stated that the KKIP will focus on introducing the offset policy as well as guidelines related to promoting indigenous R&D activities, licensed production, technology acquisition and ensuring industry's access to loans from state banks.

As part of its policy-forming initiatives the MoD held a conference in Jakarta in late November, which was dedicated to raising awareness of offset and learning from the experiences of speakers from countries such as India (which is continuing to adapt its offset policy after its introduction in 2005) and Australia (which abandoned its offset policy in 2008 in favour of a participation programme that encourages growth through exports). In this conference, Yusgiantoro underlined Indonesia's need to develop its own such policies and vowed that the country's use of offset and related schemes will be expected to be utilised "in every purchase of defence equipment from abroad". He added: "The offset programme will build the capacity of [Indonesia's] domestic defence industry... The government is determined to revitalise the defence industry: it is one of the priorities of the cabinet."

Another of the speakers at the offset conference was Professor Ron Matthews, deputy director of the Institute of Defence and Strategic Studies at the S Rajaratnam School of International Studies in Singapore. Prof Matthews, a regular adviser to Southeast Asian governments on their defence industry policy initiatives, said that despite Indonesia being one of the first countries in Southeast Asian to introduce a counter-trade policy in the 1970s, the country has never documented a defence offset policy and defence production has never had any credit values associated with it.

Prof Matthews said, however, that Indonesia is now taking defence offset "very seriously" as it attempts to build the capabilities of state-owned defence companies, many of which continue to struggle financially: a result of years of under-funding, a dearth of contracts, and the lingering effects of the last economic crisis in Southeast Asia during the late 1990s. These entities are exemplified by naval shipbuilder PT Pal, which during the past year has undergone a restructuring process to turn around the company's ailing finances. This process will see more than half the company's 2,400 employees made redundant.

Prof Matthews said: "In my view, Indonesia does need a robust offset policy. At the moment, Indonesia's defence industry is withering on the vine almost. Indonesia is increasing its defence budget and procuring more equipment... [but] there is no work coming into the Indonesian defence factories. So I think that really needs to be addressed." He added that, in order to benefit from a defence offset policy, Indonesia needs to invest in modernising facilities to enable the absorption of foreign technologies. "It is not just putting an offset policy in place that is important," he said. "It is also about investing in the relevant associated infrastructure."

Indonesian defence officials, however, have indicated that they intend to do just that. Executives from PT Pal, for instance, have said that the modernisation of production facilities is regarded as a priority with funds expected to be sourced from state-owned banks. The House of Representatives' defence commission has provided firm political backing for such moves arguing that without such investment companies will struggle to not only win contracts but also support technology transfer through offset.

Securing such funds for investment has been problematic in the past decade or so while Indonesia's military modernisation ambitions have been limited by a lack of funds. But this time it's expected to be different. Indonesia remained relatively unscathed by the global financial crisis and the economy is now forecast to expand due to an increase in foreign investment, strong domestic demand and, in particular, the emergence of oil and gas deposits. Such factors prompted the International Monetary Fund to state recently that Indonesia is set to become one of the world's fastest-growing economies over the next five years. It has also prompted the Indonesian government to outline a number of ambitious procurement programmes such as additional submarines and combat fighters as well as a pledge to increase defence spending from 0.8 per cent of the GDP in 2009 to at least 1.5 per cent by 2014. Such spending plans could take the defence budget closer to the USD10 billion-mark that the government says it needs to effectively secure such a vast archipelago of more than 18,000 islands.

 

Guy Anderson, editor and lead analyst, Jane's Defence Industry

The United Arab Emirates is one of the world's true "frontier" defence markets. It is courted by Western firms seeking to offset slumping spending at home; emerging exporters like South Korea seeking to establish a foothold beyond their own borders; and Russia and China under their arms-for-energy-access strategies.

A precarious geographical position, buoyant oil revenues and strong defence expenditure growth (military funding leapt 276 per cent between 2001 and 2010)[1] make the UAE an attractive prospect. There is both the means and the rationale to continue spending on national defence.

The UAE, meanwhile, knows its value to the world market and is looking for a healthy return on its investments. It is looking to defence expenditure to help overcome two pressing problems: firstly, the twin demographic challenges of a young population in need of meaningful employment and a strong reliance on foreign labour (20.9 per cent of UAE nationals were under the age of 15 in 2008 and 73.9 per cent of those of working age were non-nationals)[2] and, secondly, continued high reliance on oil revenues (oil exports accounted for 40 per cent of GDP in 2008).[3]

It is unsurprising that the UAE overhauled its offset regime this year [2010] in order to maximise the social and economic returns on its investment in military materiel.

The reforms have created numerous challenges for foreign industry, however, and may yet backfire by alienating the very firms which the UAE is seeking to work with. Indeed, there have been reports that international defence trade associations are considering sending a jointly-signed letter to the UAE's offset bureau to vent their frustrations (there is a precedent - a similar letter on a similar subject was recently despatched to India)[4].

Read more...  

By Deba R. Mohanty

The time to unveil India's new Defence Procurement Procedure (DPP 2010), an official document on procedural aspects of defence procurement guidelines, is round the corner once again. While the MoD mandarins are engaged in giving final touches to the document by taking inputs from stakeholders from within the government as well as outside (like FICCI, CII, and others), it is time for an informed debate on what is considered as one of the most complex issues that the Indian defence sector has been facing from time to time.

Efforts to streamline the otherwise cumbersome defence procurement process have been going on especially since the Indian defence sector opened up for private participation in 2002. Consider this: the DPP has been revised six times, including an addendum officially announced in late October 2009, in the last eight years. The Defence Minister periodically reminds us that this is still an evolving document. Even though the review of DPP is to be taken up every two years as envisaged (No. 76, DPP-2008, p. 21), it appears that 'change' has become 'constant' at the cost of practicable inputs being injected into the document, where as it should have actually been other way round.

Autopsies of the previous DPPs have brought out some interesting insights. First, despite tall claims to reduce the time frame of acquisition process, the MoD has neither been able to reduce the number of stages of evaluation process (eleven in total, from laying down services quality requirements to post-contract management) nor do any thing that can entail positive impacts. Although specific timelines have been earmarked for each stage of the process, scope for delay has also been provided under special conditions which the vendors can take advantage of. The on-going acquisition process for 126 medium multi-role fighters (MMRCA) serves as a case in point.

Second, the central objectives of DPP revolve round ensuring expeditious procurement, sticking to prescribed time frame, demonstrating highest degree of accountability, transparency and fair competition (No. 2, DPP-2008, p. 1). Let's pick two key words 'transparency' and 'fair competition' from the text and pit them vis--vis available evidences. At least four major defence deals, including the multi-billion dollar 197 helicopters, have been cancelled in recent times, causing negative consequences for the ongoing military modernization programme. Official explanations often times point to 'technical reasons' in cancellation of such deals. Last two years have also witnessed close to half a dozen defence deals with a single country (read the US) through what is known as 'inter-government agreements' facilitated through Foreign Military Sales (FMS) route. At least USD 9 billion worth of weapons, including big ticket items like C-130J Hercules, P-8I maritime aircraft and the most recently agreed Javelin anti-tank guided missiles (ATGMs), have not only surpassed competitive bidding route but being purchased with little or no benefit to the Indian industry. While adequate explanations to the Indian Parliament must be treated as a norm to ensure transparency in defence acquisitions, 'fast track' or even single vendor situations in defence deals must also be explained to the Indian public and perhaps a clause to lay down norms for 'competition' must be framed to discourage 'single vendor' situation. 'Strategic considerations' (No. 73, DPP-2008, p. 21) clause at the same time must be carefully used to suit Indian interests.

Third, inclusion of new features like offsets including banking, ToT conditions, 'buy and make' (Indian) and FDI have been propagated, especially by the bureaucrats and grudgingly supported by the industry, as beneficial to the Indian industry are increasingly been proved ill-thought-out and impractical. Braggart assertion by the MoD that offsets have brought nearly Rs 8,000 crore worth of work to India with Rs 48,000 crore in pipeline are in paper only and one does not know the real value of offsets as details are beyond the reach of any analyst. ToT conditions are yet to be defined properly, forget their future worth. Buy and make procedure has thus far not benefited the Indian industry in any manner, even the Raksha Udyog Ratnas are yet to be officially announced while the DPP still has a section devoted to selection of the same (Appendix C, DPP-2008, pp 164 75)! Increase in FDI in defence from 26 to 74 as proposed by a discussion paper prepared by the DIPP, Ministry of Commerce, has found support without credible justifications from most quarters, except for FICCI which wants it to remain at 26 percent.

In sum, most of the new features seem to have been added without much homework and the results are there for all to see. Many more issues need to be debated, however, suffice to add the end note here: its time to change the 'constant' with cosmetic changes and inject pragmatic ideas instead.

The author is a Senior Fellow in Security Studies at Observer Research Foundation.

 
 

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