Now, Defuse

IN May 13, the day the US and Japan announced economic sanctions and aid freeze in reaction to the Indian nuclear tests, it was business as usual in India. Cola giants Coke and Pepsi were locked in a court battle on employee-poaching. Southern Electric Utilities, the largest power company in the US, was meeting central government bureaucrats to propose a 1,000-MW project in Orissa. In the US, Motorola announced a $3.5-million investment in a world-class design centre in Gurgaon outside Delhi. On receiving the news of the sweeping sanctions, which also implied that billions of dollars in aid from the World Bank, India’s largest patron, might be threatened, New Delhi arched its eyebrows just a little.

Even as protests and aid cutoff threats are pouring in from other nations, the corridors of the government are cool. US National Security Advisor Sandy Berger told reporters "it was a fairly expensive decision for India", but India declared that economic sanctions announced so far would not have any far-reaching impact, at least nothing that cannot be tackled. The budget is being tailored to factor in the financial flows that may dry up, core sector projects are being cleared fast, fears of a run on the rupee have been ignored. Indian industry has shrugged off any long-term impact of the sanctions. Said CII president Rajesh Shah: "The normal course of business, foreign investment, trade and economic ties would continue as before." Added Amit Mitra, FICCI secretary-general: "Sanctions do not achieve anything. Anyway, those imposed by the US are only soft sanctions."

Too good to be true? Can we really believe this? That the fourth highest aid getter in the world with the average Indian getting $2 per head, is not bothered by sanctions? That a country which gets 22 per cent of its gross national product from debt and uses only 339 kwh of electric power per person, compared to 11,571 kwh by the average American, can afford to pitch its might against global investors like the US, Japan and Germany? Before we can answer that, we have to take stock of exactly what we face.

What do all the sanctions add up to?

The global wrath has indeed been strong. Japan has cancelled 3.5 billion yen in grants ($26 million), suspended all new loans and refused to host the stock-taking meet of the International Development Forum. Germany has frozen DM 300 million of fresh aid, Denmark limited aid at the current level of $28 million and scrapped a plan to double aid by 2002, Sweden cancelled a new $119-million three-year aid pact, Australia stopped all non-humanitarian aid and defence links, and Canada, Netherlands and Norway are in different stages of aid cut moves. But the harshest of all are the sanctions imposed by the White House.

Under a first-time invoking of an amendment to the Nuclear Proliferation Prevention Act of 1994 by Senator John Glenn (also the first-ever American astronaut), President Clinton has declared a cut-off of US financial assistance to India except humanitarian and food aid, an end to the export of certain defence and high technology material, halt to military aid and to US credit and credit guarantees except for the purchase of food, and opposition to international financial institutions’ loans. A White House press statement on May 14 estimated that the sanctions, taking into account pending and potential proposals, would amount to a damage of $20.7 billion but said the final figure was subject to "legal determinations as to the precise scope of the sanctions".

The threat may not be as big as it is made out. New Delhi, especially, has taken this estimate with a large pinch of salt. It says the actual damage could be only $1.14 billion. The military impact of the sanctions would be negligible, as also of aid cancellation. USAID has shut shop in India (last year it gave $112 million), thus affecting the Ahmedabad municipal bonds issue and a stock-market development plan. Some trade is certain to be affected, especially capital goods imports. The US is India’s largest trading partner and investor. 1997 imports from the US was $7.7 billion, led by aircraft and parts, machinery, fertilisers, scrap metal and computer hardware, while exports were $7.3 billion. As for loans from US banks to the Indian government, implying public sector units, banks are still to ascertain the legalities of the situation.

 But there are two areas of concern. For one, the impact of the sanctions would be borne by American companies, who form the largest chunk of potential and existing investors in India. Marshall Bouton, executive vice-president of the New York-based Asia Society, said: "We’ll see a rapid slowing to a halt within months of new commitments across the board." US Commerce Secretary William Daley warned: "The Department of Commerce has $10 billion worth of projects in the pipeline that we would be advocating. Those may come to a grinding halt."

Next, take the case of the guarantees given by Overseas Private Investment Corp and the US Export-Import Bank on funds commitments by US firms in large projects. OPIC, which sells political risk insurance and financing to US firms, had provided $330 million in 1996, while US Exim offers vendor credit for 15-16 years at concessional terms. US firms will now have to go in for more expensive credit, raising the cost of these projects. Some 20 power companies, totalling an installed capacity of 15,000 MW, were expecting $4 billion from US banks, and may now pass on the additional cost to the Indian customer.

India will be able to get by without the aids that have been cut off. But where it will hurt is in the slowing down, cancellation or hiked project costs of infrastructure projects like power and telecom, projects that the economy sorely needs to get on-stream as quickly and in as large numbers as possible

Will World Bank loans stop?

World Bank India Director Edwin R. Lim says no. Loans, Lim told reporters on May 15, will touch $3 billion in ’98. "As on April, we have $14.5 billion loans approved for ongoing projects, some $8 billion of which has yet to be disbursed. But there’ll be no disruption in the disbursement as this is a legal contract between the donor and the donee and do not involve political risks." However, he declined to speculate on the future of four pending proposals: a $450 million powergrid loan for Andhra, a $130 million renewable energy project, $275 million for Haryana roads and $130 million for UP agriculture. The first three were to go for vote this month but Bank officials in Washington hinted the agenda could change.

Bank officials say that opposition from major shareholders had in the past encouraged the Bank to postpone such decisions. "These events are so rare that our president and our board would have to contemplate on," says Javad Khalilzadeh-Shirazi, Bank regional manager for East Asia and the Pacific. But, feels one financial analyst: "The question is whether the US will be as tough as they were against loans to Vietnam, or will Washington ask its director to oppose a loan citing the sanction law, but let other members come to their own decisions? The board could then approve the loan."

That’s something the weekend G-8 meeting at Birmingham ought to decide. It has ruled out any imposition of collective sanctions but is yet to take a clear stand on backing the US at other fora. Japan, which has imposed more worrying aid halt to India, has backed the US. But with the current division in G-8, the US, despite its largest share of 17.6 per cent, cannot hope to muster the 50.1 per cent required to veto a loan approval.

The real thorn in India’s side could be Japan, the highest bilateral aid donor to India and the largest contributor to the Asian Development Bank. Lack of Japanese grants will surely jeopardise several projects awaiting funds from the Overseas Economic Cooperation Fund as will cancellation of loans from ADB, which has a big exposure in the roads and port sector, affecting some $500 million worth of expressway and port projects. As for the other countries, the economic damage is expected to be low. Says Michael Ashfield of the India Research Group in London: "There’s no reason why tests should make a difference to business investments. It didn’t happen with the US, but we might find that some people are not happy accepting exports from India."

The other big worry is developmental aid, money that’s used for projects like primary health and education. Germany and Denmark, for instance, are liberal donors to poverty alleviation programmes and leprosy-related work. But most of the aid is sourced from the World Bank, UN agencies and voluntary groups independent of their national governments. Says Alok Mukhopadhyay, executive director, VHAI: "The total aid is 1.8 per cent of the GDP, which won’t be very difficult to mobilise."

What about India’s credit rating?

Despite euphoria among India-lovers and NRIs, experts say the long-term economic impact of the sanctions could be much more. One reason is the absence of credit guarantees which stimulate investment decisions. Says Dr Sumit Ganguly, professor, City University of New York: "These sanctions could limit India from getting high technology, plus they could also hurt foreign investments in India." Asks Jairam Ramesh, joint secretary, Congress: "What have we achieved? We won’t get better market access or technology anyway."

 Secondly, the political risk premium on loans to India has already gone up by a whopping 8 per cent, raising borrowing costs sharply. Downgrading by the New York-based Moody’s (current rating BAA3) and Standard & Poor’s (BB+) is quite likely. Kristen Lindow, vice-president and senior credit officer at Moody’s, says India can’t afford to cut the inflow of foreign aid as private credit is costlier, hinting that Moody’s is tilting toward downgrading. Says S&P’s chief India expert Joydeep Mukherjee: "What will be the impact on (India’s) access to external capital? The less access to money, the worse it will be."

And the rupee?

That the sanctions had hit the currency market more than the stockmarkets became clear on May 14, when the rupee crashed through the psychologically important Rs 40 mark to bottom out at an all-time low of Rs 40.77 to a dollar. And business is scared of a possible freeze on bank finance for export-import.

Though sanctions don’t affect transaction between two private entities, corporates, banks and most forex dealers have been madly buying up dollars. On the first two days, the State Bank of India moved in at critical moments to keep the rupee stable. But on the third day, all hell broke loose while RBI and SBI watched. Says K.N. Dey, senior vice-president, Mecklai Financial & Commercial Services: "Till late afternoon, there was no seller of dollars. The fact that there was no gesture from the RBI added to the panic and increased the loss of faith in the domestic currency." It was only late in the afternoon that SBI hauled the rupee back to Rs 40.55.

That could have been deliberate. Post Southeast Asia, it is being increasingly felt that the rupee needs to be devalued further to maintain India’s export competitiveness. "The RBI may use this opportunity to let the rupee find its correct level," probably at Rs 41. But not beyond. Says K.R. Bharat, managing director, Credit Suisse First Boston: "The government may tinker around with the rupee to depreciate it slightly more than Rs 40.50 level, but I doubt it’ll let panic dictate the market." Adds an RBI official: "There is a large corpus of foreign currency deposits with domestic banks and nothing to worry about." But the future of the rupee in the next few months will hinge on India’s stand on the CTBT.

Analysts assert that India does have an element of cushion to withstand the sanctions, which many see as a mini economic war waged by the US against India, because it is equipped to fight off a run on the rupee with a low external debt and $26-billion forex reserves. "From the macro point of view, the economy doesn’t look very vulnerable to a payment crisis or a currency attack," says Yilmaz Akyuz of the UN Conference on Trade and Development.

What happens to the stockmarket?

In the first two days after the Pokhran blast, the BSE Sensex dropped by 239 points (around 6 per cent). Near-hysteria set in when, on the afternoon of the second day, news of the two later tests flashed. Says Bhadresh Modi, the man in charge of funds at GIC Asset Management: "People were on tenterhooks and the repeat tests triggered off panic selling."

But the day after Clinton announced the sanctions, the Sensex rebounded by 115. Says Arun Kejriwal of Woodstock Securities: "This sudden new direction of the market is being prompted by the depreciating rupee and the attractive valuations." That is, stocks were cheap, and cheaper still if you were looking at it in dollar terms. Plus, big boy Unit Trust of India (uTI), perhaps under New Delhi’s instructions, muscled in with Rs 200 crore and bought like it was boomtime again.

Even foreign institutional investors (FIIs) showed cautious optimism. Feels U.R. Bhatt, chief investment officer with Jardine Fleming India Asset Management: "The markets might dip in spurts, but I guess overall the stock exchanges will remain unaffected by the sanctions. Within a week, even the volatility should reduce." Others strongly feel that the US and India will come to some kind of compromise, despite the current tough talk. "Even if India agrees to certain aspects of CTBT, the problems should substantially reduce," opines Bharat. Says a Morgan Stanley strategy note: "At the moment there seems to be nothing hitting trade in a major way though infrastructure projects are likely to get delayed further."

 In the meanwhile, strong rumours have swept the market about various impending government policies to boost the indices. Most punters have also assumed that government institutions like UTI, LIC and GIC would put their entire might into maintaining the Sensex levels. There’s also the feeling that with Southeast Asian markets still in disarray, global investors have no choice but to concentrate their Asian portfolios on India. Jon Connor, fund manager with Hong Kong-based Geomatrix Fund Management Company, told

The Wall Street Journal: "We are more than likely to increase (our exposure on India) than reduce it. India is the cleanest of the dirty shirts in Asia." And John Stainsby of Lloyd George Management says: "We like India because we like Indian companies, and I can’t see how (the nuclear tests) are going to affect them."

 Summing up the sentiments of many, K.R. Bharat told Outlook: "It’s a great opportunity for the country to railroad the economic reforms. The government could initiate steps to make foreign direct investment lucrative enough to nullify the effect of the sanctions. It could also bring in several policy-level legislations that would open up the economy on an exponential scale. That Pokhran II occurred just on the eve of the Union budget should give all of us a lot of hope." Let’s hope he’s right.

Will US business interests be hurt bad enough for Clinton to back off?

This is the crucial question, and the denouement of the current crisis hinges on this issue. The government is banking on US business interests getting hurt seriously, leading to pressure on the US government to soften its demand that India sign the CTBT unconditionally. Like any other US government, the Clinton Administration’s first priority is US business interests.

The US position is made more difficult by the fact that countries like Britain and France have refused to impose sanctions on India. Consider simply the $2 billion aircraft supply contract that the Seattle-based Boeing Company has been negotiating with Air India for two years now, a deal that could finally grow to over $15 billion in the next decade. Boeing’s only competitor is the European consortium Airbus Industrie. To service the Air India contract, Boeing needs credit guarantees from the US Exim Bank. These will not come now, as long as the sanctions are in force. Airbus is not bound by any sanctions, and will get the entire order with Boeing watching helplessly. And the removal of US Exim Bank guarantees will hike costs for all US-backed infrastructure projects.

THE $2-B BOEING CONTRACT MAY GO TO AIRBUS.

As of now, US corporations are still figuring out the effects of the sanctions on their business prospects. But Enron sources admitted that funds for the second phase of the Dabhol project have not been tied up yet and costs will rise.

US private investment proposals worth $11.5 billion have been approved by the Indian government till now. The companies include at least 13 of the 20 largest American corporations. Meanwhile, the government is moving fast to dangle juicier carrots before investors by hurrying through a slew of approvals. The day after the first tests, Housing and Urban Development Minister Ram Jethmalani announced the opening up of the housing sector to foreign investment. Three days later, the Ministry of Steel and Mines approved the mining licence for US-based mining giant Phelps Dodge for prospecting for copper and allied minerals in Bihar, and also to set up a 100 per cent subsidiary.

The same day, power minister P.R. Kumaramangalam announced that the government would soon be signing the counter-guarantees for the Ispat Group-promoted Bhadrawati, Hinduja-promoted Vizag and US-based CMS-promoted Neyveli power projects, for a total investment worth Rs 8,500 crore. He also said that the government was committed to counter-guarantee another US power project by Cogentrix. Simultaneously, the Civil Aviation Ministry informed Boeing that it would very soon be taking a decision on the aircraft deal. The message to these US companies is clear.

The question is whether the Indian government can pull off what China pulled off in the wake of the sanctions imposed on it after the Tiananmen Square massacres in 1989. China tailored its policies to attract huge investment and not only neutralised the effects of the sanctions, but spurred faster GDP growth rates.