Exchange Rate Variation in Defence Contracts

For the second time in less than a month, the Ministry of Defence (MoD) has amended the Defence Procurement Procedure (DPP) 2013. Close on the heels of the 5th August tweaking of the offset guidelines, the amendment of 19 August extends the provision of exchange rate variation (ERV) to Indian vendors under all the procurement categories of capital acquisition.

So far, the ERV provision had been applicable to Indian Rupee (INR) contracts with Indian vendors in Buy (Global) cases only. With the new amendment in place, Indian vendors now stand to benefit since they mostly participate in procurement programmes under categories other than Buy (Global).

Defence Public Sector Undertakings (DPSUs) have all along been slightly better off, as the ERV clause had been applicable to them even in Buy (Indian) cases. This was, however, limited to cases in which they were either the ‘ab-initio single vendor’ or had been nominated as the production agency by MoD. They also, therefore, stand to gain from the EVR amendment.

Whether hastened by the steep climb of the value of the USD vis-a-vis the INR or an acceptance of a long standing demand of the Indian private sector, the amendment has not come a day too soon.

Indian vendors are heavily dependent on import of raw material, components, aggregates and other services for manufacturing/assembling defence equipment. While they have to pay for these in foreign currency, their contracts with the MoD are normally on fixed cost, denominated in INR. Indeed, the vendors are expected to take into account the likely fluctuation in the exchange rate across the period during which they are required to import material and aggregates for manufacturing/assembling of the equipment and quote their price accordingly. But these calculations can go haywire if the fluctuation during the period when they are sourcing the material from abroad is beyond what had been factored in by them at the time of making the commercial offer.

In 2013, the dollar-rupee exchange rate rose from a monthly average of INR 54.24 in January to an average of 63.79 in September. The monthly average for August 2015 is INR 65.02 to one USD. One can imagine the travail of vendors who have ongoing contracts with long delivery schedules that are based on prices quoted by them before 2013 which, in turn, would have been predicated on anticipated normal fluctuation in the exchange rate in the coming years. What was witnessed in 2013 could certainly not have been anticipated.

The 19th August amendment takes care of such travails by providing that the indigenous and import components, as also various currencies in which payments will need to be made by vendors for the imported component of their contract, must be determined in advance so that these become the reference points for working out any additional payment that may need to be made to, or recovery to be effected from, them if the exchange rate fluctuates either way beyond a specified band on the date of transaction between a vendor and its foreign supplier.

The ERV clause is not applicable to every transaction, though. According to the 19th August amendment, it is not applicable if the delivery period is less than one year or the exchange rate variation is within the “plus or minus 2.5 per cent” band. Apart from this, according to the existing guidelines on protection of ERV given in the Annexure to Appendix F of the RFP format in DPP 2013, which continue to be applicable, ERV clause is not applicable in those cases also where the delivery period for the imported content is re-fixed or extended, unless the reasons for delivery period extension are attributable to the buyer.

The stipulation that ERV will not be applicable if the delivery period is re-fixed, unless the reasons for that are attributable to the buyer, could become a source of distasteful disputes between MoD and the vendors unless it is ensured that there are no infirmities in the contract which might give rise to such disputes and due care is taken at the time of re-fixing the schedule.

There is a need to re-examine the existing guidelines on what kind of information should be sought from the vendors at the time of tendering for inclusion in the contract and the documents to be submitted by the vendors in support of their claim to prevent disputes and possible misuse of the ERV clause. Those handling ERV claims in the paying offices might also need greater specialization to handle such claims by the vendors and to raise the claims on behalf of the MoD.

The 19th August amendment has been approved for inclusion in DPP 2013 and comes into force with immediate effect. However, this does not seem to imply that it will be applicable to the already signed ongoing contracts also, which could be a dampener.
It is hard to understand why it took the MoD so long to take this step. ERV is permissible as per the existing government policy on purchase of goods. All that was needed was the courage to extend these provisions to defence contracts. Such courage will stand MoD in good stead when it comes to taking decisions on the wide-ranging recommendations of the experts’ committee on amendment to DPP, which is eagerly awaited by vendors.

Views expressed are of the author and do not necessarily reflect the views of the IDSA or of the Government of India