S-400: Rupee-Ruble Matrix and Other Points of Caution
Lt Gen (Dr) V K Saxena (Retd), PVSM,AVSM,VSM, Distinguished Fellow, VIF

Speaking to a select group of journalists on 22 Feb 2019 at the Aero India Show in Bengaluru, the Deputy Director of the Russian Military-Technical Cooperation Mr Anatoly said " Dollar is no longer the universal currency for trade in defence"1. The Minister was speaking in the context of the institutional arrangement being put in place by Russia and India to do a rupee-rouble transfer in paying for the S-400 deal valued at Rs 39,000 cr.

This article throws light on the above arrangement and also lists out certain points of caution in dealing with the execution of the contract for S-400 with the Russian partners.

Rupee-Rouble Matrix

As the name suggests, the rupee-rouble arrangement means that the payment for S -400 will be done by India in Indian Rupees (INR) equivalent to the value of the weapon system in roubles. Another way of doing payment is through a vehicle called ‘trade counterbalance’. In this method, Russia won't pay for the imports it undertakes from India, in terms of say, black tea, coffee beans, grapes, rice etc. equivalent to the rouble value of the S-400 system. Also, since trade counterbalance is a two-way street, Indian payments for its imports from Russia will be adjusted accordingly. By definition therefore, the trade counterbalance method avoids core currency transfer on a reciprocal basis.

The purpose of working out an arrangement to deal in national currencies through the rupee-ruble route or trade counterbalance route is to work around the US imposed financial sanctions on Moscow under the provisions of Countering America's Adversaries Through Sanctions Act (CAATSA). These sanctions prevent fund transfers for weapon purchases from Russia2 (working a way around for India by the US by proposing modified waivers under CAATSA is a separate story that is driven by the US strategic compulsions vis-a-vis India in the Indo-Pacific region given the reality of China. This is not discussed further).

The rupee-rouble exchange is nothing new. It had its foundation in the Indo-Soviet Trade Agreement signed between the two countries on 02 Dec 1953. This agreement provided that all payments between India and USSR (described in Article VII of the Agreement) may be made in Indian Rupees. It was indeed a historic Agreement since, it was for the first time in the history of International trade that a developed country agreed to open trade with an underdeveloped country after the Bretton Woods Agreement in the currency of the underdeveloped country.

This strategic help from the Soviet Union proved to be a great boost to India's industrialisation. It started by enabling India to build her first steel plant in Bhilai, and subsequently manifested in a long list of Government-to-Government (G2G) agreements providing for the inflow of Soviet defence equipment to India starting from the sixties right up to the demise of the Soviet Union in Dec 1991. In fact, the rupee never went out. It got adjusted against India's exports to the Soviet Union3.

Unfortunately, the above arrangement fell through on the rupee-rouble conversion rate which Russia, as a heir to the erstwhile Soviet Union wanted to scale up ( from the highly subsidised era of Soviet times) to the rates which now a cash-strapped and an economically weakened nation would be compelled to demand!

The current effort is to somehow visit the rupee-rouble matrix again in the changed environment of CAATSA.

To put this institutional arrangement through is strewn with multiple hurdles. At the onset, it does not cover all deals. In that, while the Indian payment liability stuck under sanctions is reported to be over $2 billion (including the repair of nuclear attack submarine INS Chakra), Mr Anatoli has stated that rupee-rouble hard currency exchange or the trade counterbalance arrangement is not a default option for all Indo-Russian defence deals. It is being uniquely looked at for the S-400 and the Very Short Range Air Defence System (VSHORADS) Igla 1S, for which the Russian exporter Rosoboronexport was declared the L1 bidder in Nov 2018 in the 9-year long VSHORAD case for the three Services4.

Talking of hurdles, India was in fact, not keen initially on the rupee-rouble arrangement because of the steadily declining value of rouble. Off late, the rouble has shown a degree of stability and traces of a bullish stance. Additionally, to bind the two currencies (rupee and rouble) into one reference scale, there will be a requirement of a mutually accepted benchmark international currency. Open sources have reported that Singapore Dollar was under consideration as a benchmark currency. Further, the banking institutions will have to be arranged which will agree to transfer such huge funds running the risk of earning the wrath of US. These will require State protection and guarantees. It was reported that Vijaya Bank and Indian Bank on the Indian side and the Sberbank from the Russian side were under consideration. While making the selection of the Banks, least exposure to US sanctions has been the criteria.

Apart from the banking institutes, there was another option being weighed, i.e., payment to non-sanctioned entities. This option was however rejected as the same would have opened up a large number of legal and audit issues5. Then there is yet another issue of national currencies being capable of handling such huge fund transfer without impact on their traction and stability.

All this and more is ‘work in progress’ at this point in time. The aim is to get around the sanctions part. Amidst the multiple options at hand, the arrangement of trade counterbalance appears to be viable option provided the seller offers a conversion rate that is closer to contemporary realities. Surely this is not 1991 and both Russia and India have moved far ahead and now face a new challenge in CAATSA.

Points of Caution - Post Contract

So much for the rupee-rouble options. The rest of the article deals with such issues that relate more closely to the Services. These refer to such post-contract aspects as will be relevant in the continued and successful exploitation of the weapon system over years and decades.

As the contract unfolds and the combat equipment starts to induct from Oct 2020 onwards, the Ministry of Defence (MoD) must ensure these points and must commit the Russians to it. These points are based on the experience of having gone through several Russian contracts and having lived through the equipment flows thereafter. These are discussed here.

Spares Support

In the past, G2G deals with the erstwhile USSR and now Russia, spares support has invariably become a casualty of inadequate pre-thought at the contract time. Experience has it that while initially the spares arrive in adequate quantity both ‘on weapon’ as also in back up spare echelons (called ZIP 1, 2 and 3), it is the later requirement of spares after the on weapon and ZIP lines are consumed that becomes an issue.

This is how the spares issue unfolds: Complex weapons like Surface-to-Air Missile (SAM) systems consume spares at a reasonably fast rate both during day-to-day exploitation as well as during routine maintenance and repairs. Resultantly, it is a matter of a 10-15 years (or even earlier) during which nearly all the spares that came initially nearly dry up leading to multiple actions of raising demands, inevitable delays in processing and the worst - huge cost escalation by the Original Equipment Manufacturers (OEMs) by as much as 100-300%. Since 15 years is just about a third of the operational life of an equipment like the S-400, spares support for the ‘entire anticipated life-cycle of the equipment’ must be catered for and Russians committed to it.

While in the earlier Soviet/Russian equipment (that came from 1970s-90s on G2G route) an unprecedented force-masseur event like the collapse of USSR happened due to which the original production lines of the weapon systems were either snapped or forced to close causing a severe drying out of spares and forcing India to go for Life-Time-Buy or LTB (which also produced a sweet little), this time around Russia may proactively put forward a clause of the likely closing down of the main production line by a certain time. If that is the case, the OEM must be tied to the clause of guaranteeing adequate quantity of spares for the life cycle of the equipment (40-50 years). Such an assurance must not be an empty one, it must be associated with a commitment at today's costs of spares plus a mutually agreed figure of year-on-year (YoY) inflation.

On Maintenance, Repair and Overhaul (MRO)

While it is assumed that for such a niche system like the S-400 bought as a one-time-package (may be with a repeat/option clause well into the future) it will neither be prudent to ask for a Transfer of Technology (ToT) nor have any intentions of make-in-India etc., it does not still negate the requirement to ask for maintenance ToT or MToT since the weapon system will essentially be operated and maintained by us.

This becomes a very complex issue as the modalities of MRO will have to be decided on a ruthless cost-benefit analysis weighing options of activities being done in India by Indian maintainers or outsourced to Russian experts at ‘now decided’ costs, equipment transiting to Russia, or a combination of all or some of the above.
There is a precedent of a several Soviet G2G equipment purchases (details not mentioned) where MRO did not get defined, the consequences were as
under:-
a. The timeline for initial and mid life overhaul slipped owing to protracted negotiations with the vendor on multiple issues:-

  • Costs of setting up facility in India including cost of doing the initial Detailed Project Report (DPR) followed by the main project;
  • Time lines;
  • Single or joint involvement;
  • Plant and spares for specialist overhaul activity;
  • In India or in Russia debate.
  • b. The time and costs were hugely escalated by OEM, leading to no decision.
    Such a thing must not get repeated for S-400 and all issues related to MToT (as applicable) as well as the MRO, must be thrashed out in all details, and more importantly, costed at today's cost plus mutually agreed figure of YoY inflation.

    Auto-Upgrade

    Another important point is auto-update. In that, our consignment of the weapon system should qualify for an auto-upgrade if the same gets done with the OEM any time over the weapon life-cycle. It is understood that the same will come at cost. But, how much, is the issue to be resolved and formalised a priori.

    Training

    Training is a huge matter. There are multiple requirements: Initial training of station chiefs, equipment crews and maintainers in Russia culminating into live firing, phase-wise training in India, training documents and reference standards for evaluation of training, use of Russian simulators, setting up of selected simulators in India, hand-holding for weapon crews and maintainers up to a point in time, etc.
    With such huge costs of the equipment paid and offsets foregone, the entire training package should actually come as gratis. But knowing the vendor, this may be hard to come by. The aim of hard-nosed negotiations must be to obtain the entire (or as much as possible) training package and a part of simulators as gratis.

    On Missiles

    Missiles is another important issue requiring detailed deliberations. At the onset, the initial consignment of the missiles as contracted for must be so phased out in time that these do not become shelf-life expired at the same time. This phasing out is very critical and is a classified operational decision (with built-in assurances for emergencies) that must be mutually agreed to and committed to writing. Another aspect in the missiles will be the requirement of technical help and knowhow in setting up of missile related infrastructure by way of missile storage sheds, missile preparation bays (if required) and missile test bays.

    Equally important will be the arrangements for missile life-extension since missile are likely to reach their shelf lives at one time or the other. How their life will be extended? What are the reference and base standards, will it be done in India or Russia, by Indian experts or Russian - all these issues must be resolved and documented.

    Safety of Equipment in Transit

    It is understood that the safety of equipment till it reaches the users hand will be of the seller. This is quoted in context of a news item that appeared in media on 21 Feb 2019, wherein it was reported that the consignment of S-400 missiles headed for China was damaged at high seas by a storm. While the Rosoboronexport has been forced to destroy the consignment of damaged missiles and is reportedly filing a lawsuit against the transporter (Baltic Trans-Port LLC), the point being made is that the buyer must get the new consignment of missiles without waiting for the litigation process to inch to a close.


    (Google Image, https://www.google.co.in/search?hl=en&biw=1366&bih=610&tbm= isch&sa=1&ei=DoByXJ7IM4y89QPygIaQBQ&q=Russia+forced+to+destroy+consignment+of+S+400+missiles+get+damaged+at+se)

    Cyber Security

    Last but not the least is the issue of cyber security. A complex and a huge weapon system like S-400 will be highly electromagnetic-intensive with high platform venerability of computer algorithms, source codes, sensor codes, guidance-loop mechanisms of interceptors, security of data transmissions, electronic security and survivability of critical battle management and command and control systems (BMC2) systems etc.

    Since the OEM has sold the same system to China as well, specific assurance on the survivability of the system against a possible cyber attack by China needs to be sought from the OEM. It is understood that the same is a tall order but so is the criticality of our platform vulnerability which cannot be compromised at any cost.

    it is assumed that certain others regulars in the Contract document (Chapter V DPP) such as advance bank guarantee, performance-cum-warranty bond, payment terms, quality issues, warranty clause, claims, taxes and duties, termination, arbitration etc would have been addressed with buyer's interests in mind

    Such are issues and such are the compulsions that surround the 39000 Cr purchase!

    References:
    1. "To bypass US sanctions, India and Russia work out rupee ruble transfer for S 400 deal," at www.the print.in. Accessed 24 Feb 2019.
    2. "India Russia consider rupee-ruble trade to avoid future sanctions..," at www.economictimes.indiatimes.com, accessed 24 Feb 2019.
    3. "Rupee-ruble controversy," at www.shodhganga.infibnet.ac.in. Accessed 24 Feb 2019.
    4. "Russia may have found a way to bypass US sanctions," at www.defensenews.in. Accessed 24Feb 2019.
    5. Ibid.

    Image Source: https://i.ytimg.com/vi/EPwcURdIbRg/maxresdefault.jpg

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