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Article:

Indo-Israel Defense Offset Procurement

30 August 2016

From Uncertainty to Opportunity

India–Israel relations refers to the bilateral ties between the Republic of India and the State of Israel. The two countries enjoy an extensive economic, military, and strategic relationship

India is the largest buyer of Israeli military equipment and Israel is the second-largest defense supplier to India after Russia. From 1999 to 2009, the military business between the two nations was worth around $9 billion. Military and strategic ties between the two nations extend to intelligence sharing on terrorist groups and joint military training.

India and Israel have increased co-operation in military and intelligence ventures since the establishment of diplomatic relations.

Indo-Israel bilateral ties have witnessed fluctuations in the past, but its defense relations has been steadily strengthened over the years. Anyone familiar with the Israeli defense industry is well aware of the importance of these relations and the impact of the defense offset regulations on this activity.

 

The following topics have been reviewed and discussed:

  1. Indo-Israel relations in the defense sector
  2. Structure of the Israeli defense industry
  3. Evolvement of the Indian Defense Procurement Procedures (DPP) on second rank companies in the Israeli defense industry
  4. Impact of the Indian DPP on secondary companies in the Israel defense industries
  5. Coping with the existing reality

Indo-Israel Relations and the Development of Defense Cooperation

Diplomatic relations between Israel and India were established in 1992, and since then, there has been a substantial growth in trade, economic ties and cooperation between the two countries. Annual trade between India and Israel has grown extensively, when in 2013 India became Israel's tenth-largest trade partner and import source, and the second largest trade partner in Asia.

At present, major Israeli exports to India include primarily minerals, chemicals and defense products.  The defense sector has a great impact on the volume of exports to India, and includes inter alia: industrial equipment, optical instruments and photographic equipment, measuring, testing and navigating instruments, aircraft and electronic equipment.

Bilateral trade and economic ties between Israel and India have progressed rapidly over the past years in various sectors, particularly in the defense industry, while expansion to further sub-industries, such as homeland security is also evident.  Relations between the two nations are gradually tightening, in consequence of which military cooperation has also developed, as obvious from the numerous mutual visits of ministers, and mainly the visit of the Israeli defense minister to India in February 2015.

 

The unique combination of the Indian market - which is gradually evolving as a significant economic power in global markets - the new Indian government's policy, its numerous investments in developing its defense system and military technologies, the military modernization of India's large army, all of these turn the potential offered by defense cooperation between Israel and India into an issue not to be ignored.

 

 

 

 

The Israeli Defense Industries market:

Below is a schematic description of the Israel defense industry:

Israeli Defense Industries sales amount to $10-12 billion annually, out of which some $4 billion (NIS 15 B.) are directed at the Israel defense system and $7-8 billion at exports.  More than 40% of Israeli defense exports in recent years stems from deals signed with the Indian government and army. 

 

The Israeli defense industry is comprised of three types of major companies:  “the Big 4” integration companies, assemblage and sub-system companies, and companies specializing in specific activities:

 

1.         "The Big 4":

            The Big 4 companies (Elbit, Raphael, Israel Aircraft Industries and Ta'as (Israeli Military Industries), comprise an overall (integrated) solution of defense systems for armies and governments.  These four companies are responsible for the majority of defense agreements signed in recent years with India.

 

2.         The Assemble and Sub-system companies:

            Provide sub-systems and parts to the integration companies.  This involves 60-80 companies, each generating between $2-200 million in the manufacture of electronic systems, metal parts, compounded materials etc.  What characterizes them is that in the majority of cases they are privately owned and specialize in a specific field. This mostly addresses companies which, over the years, have established excellent relations with customers, actually creating a partnership with the Big 4 integrators.

 

3.         Base of Pyramid:

            "Supplementary" companies to the ones already mentioned.  There are some 200 family companies specializing in a series of supplementary activities such as painting, processing, cutting, etc.

 

 

 

 

The Indian Market and Indian Defense Industry

The Indian Army has always been regarded as one of the largest armies worldwide.  Until the early '90s, Indian defense equipment was predominantly composed of aging Soviet military hardware and technology, from the Russian army's spillover.  India opening up its economy to the West in 1992 prompted a process of upgrading the army's military equipment and applying western technologies. 

 

Some Interesting Data about Indian Market and Indian Defense Industry

 

  • India has the second largest army in the world, comprised of some 1.1 million soldiers. The Air Force and Navy are also of a substantial size, and so is the local policing force.
  • Over the past two decades, India acquired considerable know-how in executing large and complex defense projects.
  • In recent years, India also began to develop production abilities and to provide services for defense systems that meet with international standards.
  • The Indian market is expected to become, within five years, the second largest market in Asia Pacific as far defense budgets are concerned, and the seventh in size globally by 2016.
  • In recent years, the Indian defense sector has invested large amounts of money in upgrading and developing the local industry technologically.  However, 70% of India's defense requirements are still catered for by foreign rather than domestic companies.

 

 

 

India –Defense Offset

 

Commencement – 2006

 

  •  The Indian Ministry of Defense (MoD) first published DPP regulations for defense transactions in India.
  • Pursuant to the regulations, known as "DPP 2006", any transaction                                           exceeding 3 billion rupees (approx. $50 m.) necessitates an offset procurement of 30% of its value
  • Pursuant to the regulations, each defense tender is required to designate beforehand the name of the local manufacturer with whom the international supplier works, in order to comply with offset procurement requirements.
  • The local manufacturers are known as Indian Offset Partners (IOP)
  • Pursuant to the regulations, an IOP cannot be replaced once a tender has been submitted, thus conduct vis-à-vis the Indian Defense Ministry is extremely rigid.

 

 

Note:  A company is considered to be Indian if at least 74% of corporate ownership is predominantly in the hands of resident Indians or Indian companies.  This regulation prevents foreign companies from setting up fully-owned subsidiaries in India for offset procurement purposes.

 

 

 

 

 

 

Amendment to DPP Regulations – 2009

  • In 2009, the Indian Defense Ministry issued an amendment to the DPP regulations.  The principal change between 2006 and 2009 was much clearer definitions as to what products and projects are eligible for defense offset.

 

Amendment to DPP Regulations – 2014

  • In 2014, the DPP regulations were significantly amended by adding third party DPP, enabling companies selling military equipment to India to obtain defense offset approval for equipment they purchased in India and supplied to their customers worldwide.
  • Credit multiples were added where an Indian company was a small or medium sized enterprise (MSME) or where there is transfer of technology (ToT) as part of the procurement deal.
  • Increasing the percentage of foreign ownership in a DPP-approved company from 26% to 49%.
  • Modifying the IOP designation will offer suppliers more flexibility.

 

India – a Window of Opportunities That is an Open Door

 

New Government

  • The general elections were held in India in May 2014 and a new government was formed, headed by Premier Narendra Modi.
  • The present Indian government is very supportive of trade relations with Israel and believes in Israeli technology.
  • Premier Modi announced that he expects to visit Israel this year, thus becoming the first Indian Premier to do so.

 

Make in India Project

 

  • After his election, Premier Modi launched the "Make in India" Project – aimed at increasing industrial produce in India by 12-14 % annually, thereby increasing the GDP from 16% to 25%, within 7 years.

 

Direct Impact on Israeli Defense Industries

 

  • The Indian DPP regulation (outlined above) is one of the mainstays in India, enabling the local defense industry's basis of expansion. 
  • India is considered to be one of the leading markets for the Israeli defense industry.
  • “The Big 4” - Elbit, Israel Aerospace Industries (IAI), Israel Military Industries (IMI or Ta'as) and Rafael have in recent years signed numerous projects for development in India.
  • To realize their large DPP debts, the Big 4 wish to purchase products from local manufacturers engaged in joint ventures with their authorized suppliers.
  • As far as the Israeli defense industry is concerned, these "debts", coupled with the changes in defense offset policy, open a window of opportunities for Israeli companies wishing to take part in the game.

 

 

 

 

 

 

 

 

Implications, Hardships and Opportunities as a Result of Israel-India DPP

Impact on Israeli Assemblage Companies

 

The implications of India's defense offset policy on the Big 4 integrators creates a need for intensified purchases in India – with a double result:

  • Pressure laid by the Big 4 integrators on assemblage companies to manufacture in India, while sharing technology and cooperation with a reputed Indian manufacturer for DPP purposes.
  • Massive expenditure of simple manufacturing activities relative to Indian suppliers, mainly in the area of electronic assemblies, straps and microchip processing.

 

The Opportunity

 

As a consequence of significant processes in India at present, and in view of the numerous offset commitments of the Israeli defense industries in India, there is genuine prognosis for an increase in the number of manufacturing cooperations as well as an increase in acquisitions and mergers between Indian and Israeli companies.

 

 

 

 

 

 

 

 

 

 

Getting Organized Effectively

 

This situation necessitates special organization on the part of Israeli companies in order to succeed in executing transactions:

  1. Correct definition of the business target.  Due to inability to set up a fully-  owned operation, defining targets is a must.
  2. Organized work vis-à-vis customers, the large integration companies, to ensure their support.                                             
  3. Proper choice of an Indian business partner: choosing a partner with a business vision and administrative abilities that supplement those in Israel.
  4. Proper financial planning: planning the investment income in India, paying business establishment expenses and transferring the technology to India, tax planning in Israel.
  5. Adapting the operation to the Indian DPP regulations.

How Can We Assist?

  • BDO-I2I is a subsidiary of BDO Ziv Haft Israel and has been active in the Indian market for many years.
  • Our firm's management team is comprised of senior Israeli and Indian managers located in Tel Aviv and Bangalore.
  • We provide various Israeli companies a wide range of services to maximize their success in accessing and operating within the developing and dynamic Indian market.
  • BDO-I2I has gained depth understanding and a strong network of connections with both the Israeli and the Indian markets in general and with the Defense industries in particular.
  • BDO-I2I has proven success stories in assisting Israeli companies to develop their business and activities in the Indian market

 

 

Conclusion

India is considered to be one of the leading markets for the Israeli defense industry. Defense trade volumes with India are gradually increasing.  Major contracts signed in recent years with the Big 4 on numerous development projects in India have generated defense offset debts – a fact that obligates all four integrators to place orders with local manufacturers engaged in joint ventures with Israeli enterprises. These debts, coupled with changes in defense offset policy, open a new window of opportunities for Israeli companies wishing to take part in the game.

BDO-I2I specializes and is connected with the defense industries in Israel and India.  Specializes in creating a genuine business synergy between Israeli and Indian companies, while providing the tools for succeeding by maximum adaptation to our Members goals.

Our physical presence in both countries offers our Members a substantial advantage and enables us to provide our services in a most professional, courteous and personal manner.