A new defence ministry rule could slam the door shut on contracts worth billions of dollars between software companies and global arms manufacturers. Worried by the prospect, information technology firms are lobbying with the government to limit the damage that could be caused by the rule, which was introduced in May.

Ostensibly, the new rule was conceived after a defence procurement scandal allegedly involved funnelling kickbacks through fake contracts with software companies. Investigators in Italy and India claim that nearly Rs 400 crore in bribes were routed through IDS Infotech and Aeromatrix under the pretext of mandatory contracts that foreign defence suppliers must award to Indian firms. The main deal involved the Indian purchase of $600 million (Rs 3,600 crore) worth of AgustaWestland helicopters from a subsidiary of Italian company Finmeccanica.

"We fully understand the government's concerns that there is a need to track value addition in software because services are by nature intangible," said Som Mittal, the president of software industry grouping Nasscom. "We are working with the authorities to set up processes to track value-addition within software and services." On May 23, the defence ministry issued a memo holding all services-related offset in abeyance.

The defence ministry memo prevented companies from counting research and design, software testing and training as part of their offset requirement. The memo is apparently also aimed at promoting the indigenous Indian defence industry. It applies not just to software but all services.

The Indian IT industry could feel the pain severely because of tepid demand in its major markets — the US and Europe. "It's going to have a huge impact on Indian IT and engineering companies. Providing software and engineering services is really where India has made significant progress in the research and development value chain," said Dhiraj Mathur, executive director at consultancy Pricewaterhouse-Coopers. Mathur, who considered the memo a "bad idea" and "overkill", said it will take out the high end of the value chain from work that is eligible to be counted as a mandatory offset contract.

According to offset rules, any foreign company winning a defence contract over $60 million must spend at least 30 per cent of the contract value in procuring services or supplies from India as a means of encouraging transfer of critical technology to the country's fledgling defence sector. For companies such as Wipro, Tata Consultancy Services, HCL Technologies, Infotech Enterprises and Rolta, this represents an opportunity of about $10 billion (Rs 60,000 crore) this year, according Deloitte. It is forecast to increase to $18 billion by 2020.

While the controversial memo places all services-related offsets in abeyance, IT services companies said they have been assured that it affects only select contracts and not future deals. "Our understanding is that only contracts signed in 2011 will be in abeyance, and that contracts signed this year will not be affected," said BVR Mohan Reddy, chief executive officer at Hyderabad-based Infotech Enterprises, whose clients include Boeing.

Infotech is in talks with Dassault to become a technology partner for engineering, defencerelated business processes and IT services. The French company's Rafale jet has been chosen as the frontline combat aircraft for Indian Air Force. Reddy, who said Nasscom executives met defence ministry officials to present their case, hoped the issue would be resolved "in the next few months". Mittal, the president of Nasscom, declined comment on the meeting.

Defence ministry officials did not answer phone calls and emailed requests for views. Reddy said the ministry is looking at ways to monitor and value services that form part of the offset contracts. "Currently, firms only need to give an invoice. But they (the ministry) are looking at asking companies to provide more documentation of the work done. So you have to back up the invoice with proof of work."

A senior executive at HCL Technologies said the new regulation would have a negative impact on dealmaking. "In this kind of market, every bit counts."

Source : TOI