Rafale Deal: Back-Up Bank Guarantees?
Deconstructing sovereign guarantee in inter-govt agreements with France, US, Russia
Much confusion has been raised post the Indian government’s admission in the Supreme Court on November 14 that there was no sovereign guarantee given by the French government to the Indian government during the signing of the Intergovernmental Agreement (IGA) on September 23, 2016 for procurement of 36 Rafale aircrafts in flyaway condition.
Some voices have opined that this is quite in line with the past IGAs signed by India with the US and Russian governments for purchase of military equipments for the Indian armed forces and there is nothing exceptional about it. What has been given instead in lieu is a ‘letter of comfort’ signed by the French Prime Minister.
A sovereign guarantee is given by one sovereign government to another sovereign government guaranteeing observance/enforcement of the terms and conditions of the contract signed under their auspices. It’s a sovereign nation’s commitment that although the deliverables are to be forthcoming from an Original Equipment Manufacturer (OEM) of their country who is a private entity, on the basis of the IGA signed, it vouches to take the responsibility to ensure fulfillment of the commitment so made in the contract, as per agreed terms and conditions. In the instance case, France was to provide this commitment to India for the deal signed by the latter with the private entity, Dassault Aviation. This hasn’t happened.
What we have is a ‘letter of comfort’, which though is not at par with a sovereign guarantee. At best it is a ‘letter of intent’ as often used in international contracts, maybe morally binding, but not legally tenable and enforceable – something akin to a betrothal. One or the other party can break away from its promise and go its own way free from any legal consequences.
For a buying nation’s commitment involving advancing funds in a long-term fabrication and manufacturing contract and with terms and conditions to provide life-time maintenance, technological upgrades, logistical support etc, it can cause concern because it gives no comfort that the successor President or Prime Minister will honour the terms.
If there are any problems, for example, the successor government may or may not honour the promise contained in the letter of comfort. On the contrary, a contract backed by bank guarantee (BG) is on an entirely different footing. The BGs being encashable, it carries the necessary assurance that the money so advanced is not lost in case of non-fulfillment of any terms and conditions of the contract.
India too signs IGAs with the US government from time to time for purchase of military hardwares under Foreign Military Sales (FMS), called the Letter of Offer and Acceptance (LOA) of the US government.
True the FMS program is US-centric, aimed and designed as a U.S. foreign policy initiative and authorized by the Arms Export Control Act (AECA). It is “managed by the Defence Security Cooperation Agency (DSCA), which functions under the United States Department of Defence (DoD) to provide financial/technical assistance, transfer of defense material, training and services to allies, and promotes military-to-military contacts.”
Apart from the US DoD, the US State Department, Commerce Department, the President and the US Congress are also involved.
While “DSCA’s mission is to advance U.S. national security and foreign policy interests by building the capacity of foreign security forces to respond to shared challenges”, there are discernible benefits for the partner nations.
In a global regime of denial – of technical and operational defence equipment – it helps buying nations to access high quality systems and platforms. The US government takes the responsibility for procurement through collaboration, transparency, integrity of business practices, and most importantly tries achieving an economy of scale in its purchases by conflating proposals from indenting parties.
The payments are made directly to a US government assigned fund agency as per the IGA signed for sourcing the purchases from American defence and aerospace companies or from the US government’s DoD stocks. These are direct purchases made from/or by the US government and with advance payments earning the standard interest rates from the date of advance payment to the retirement of bills/invoices.
The risk of such payments, if any, are covered in the IGA signed with the US government and with no need for any overweening sovereign guarantee.
Similarly, procurement from Russia are controlled and administered directly by the Russian government through the state intermediary agency, that was first set up on May 8, 1953 within the Ministry of Internal and Foreign Trade of the then USSR. While India’s long standing purchases of defence items from the erstwhile USSR held fast, it was further bolstered by Article IX of the Indo-Soviet Treaty of Peace, Friendship and Co-operation of August 9, 1971 “to take appropriate effective measures to ensure peace and the security of their countries”.
In 2000, the Russian Government formed Rosoboronexport as its sole state intermediary agency for managing all its exports and imports pertaining to defence products, technologies and services. Thus IGAs signed and purchases made from Russia are clearly on a firm government-to-government basis, and with no need for obtaining any sovereign guarantee from Russia, since no private entities are involved.
Sovereign guarantees are imperative under an IGA when a supplier is a private company and outside the control of the foreign government. It is aimed at securing the contract by the OEM’s country on behalf of this private entity through this IGA and hence the need for due backing of a sovereign guarantee.
Financially also there are ostensible advantages of sovereign guarantees for a buying nation. It whittles the cost down by eliminating the need for bank guarantees (BGs) by private companies for money advanced to them by the buying nation. Since BGs provided by the banks don’t come free, by doing away with BGs in the wake of sovereign guarantee(s), it concomitantly reduces the liability that the supplier will have to otherwise bear for obtaining the same. Given that the timelines for fabricating, manufacturing, and maintaining the defence equipments are long, this reduced cost tots up to a sizeable amount and shows up on the costing sheets.
In the case of the Rafale contract, an IGA signed between the Governments of India and France has little meaning without the backing of a sovereign guarantee by the French government.
The supply of Rafale aircrafts by French OEM Dassault Aviation will willy-nilly involve advancing a whopping sum of money through mobilization advances and milestones payments. The ‘letter of comfort’ can provide little comfort to protect India’s money and strategic interests. At best it can be treated as a straight forward contract between India and the private company Dassault Aviation, with the French government’s ‘letter of comfort’ merely showing up on Rafale’s mantelshelf.
To obviate any such risks and to firmly and fully protect public funds, Rule 172(1) of General Financial Rules 2017 (as in all its previous editions) of the Government of India is quite categorical: “While making any advance payment… adequate safeguards in the form of bank guarantee etc. should be obtained from the firm”.
With the IGA in place and the contract proclaimed to be Government-to-Government (G-to-G), the back-up bank guarantees of corresponding amounts advanced to protect taxpayers’ money, is not available to India in the Rafale case.
(Sudhanshu Mohanty is a former Controller General of Defence Accounts and also a former Financial Adviser (Defence Services) in the Ministry of Defence who retired on May 31, 2016.He is the author of several books including Babudom: Catacombs of Indian Bureaucracy and Anatomy of a Tumour: A Patient's Intimate Dialogue with the Scourge (Hay House).