Sanctions could have an impact on many levels of the Indian economy.
Soon after the 11 May nuclear tests, the US, Japan, Germany and a number of other countries announced the suspension of fresh aid, besides humanitarian assistance, to India. The US sanctions are the most far-reaching and include the suspension of further export credit and guarantees from the Eximbank and OPIC, military sales, commodity assistance, and direct bilateral aid. Of these, the first one is the most important since the US is the largest investor in India, especially in the power and telecom sector with their huge demand for funds, and all US investors depend on Eximbank for credit equipment. Moreover, the law under which the US is mandated to impose sanctions against any non-nuclear country conducting tests also requires the US to oppose loans from multilateral financial institutions (MFI) such as the World Bank and Asian Development Bank.
There has been much wishful arithmetic in the Indian press on whether the US with its vote share in these organisations will be able to block loans. But now that the G-8 countries – including France and the UK, both of which had not suspended bilateral aid – have supported the cut-off of loans from the MFIs except for humanitarian purposes, the fate of loans is no longer in doubt. The only hope was that the World Bank interprets “humanitarian” broadly to let through a number of social sector and poverty-related new loans, and that is precisely what happened when the WB let through a number of such loans in the last week of June, including the Andhra Pradesh restructuring loan of USD 543 million (see Himal December 1997).
Gross aid disbursements in the Indian budget for the new financial year that just began (1998-99) are estimated at about INR 100 billion (about USD 2.4 billion) compared to total plan outlays of INR 720 billion, and plan capital expenditures of INR 280 billion (aid finances mostly capital expenditures). Thus aid provides a non-trivial share of plan expenditures, and is particularly high in some sectors such as power (one-third of central sector plan outlays). This year about 69 percent of the aid is to come from the two MFIs, about 27 percent from Japan and 3 percent from Germany.
This year’s disbursements will not be affected since they come mostly from loans already approved in past years. Ironically, what cushions the impact of the cut-off is the huge backlog or pipeline of disbursing loans that amount to about USD 18.5 million. Theoretically, India could continue to draw on the pipeline for some time to come. But this will be of little use to new projects that were about to get new loans under this and next year’s programme.
There has been a massive shift in the last couple of years of fresh commitments to certain reforming states and sectors. Thus, while the Andhra Pradesh restructuring loan has been cleared, a number of agencies in the power sector such as PowerGrid and National Thermal Power Corporation will be badly hit. The ADS was developing a huge USD 1.8 billion loan to Indian Railways over the next five years along with bilateral co-financiers (some of whom called the day after the blasts and asked to be counted out). Infrastructure generally will be badly hit.
It has been pointed out that when one takes repayments of principal and interest into account, net aid actually turns negative (by INR 8 billion this year). It was precisely to increase the level of net aid that the WB and. ADB have been stepping up their commitments of fresh aid. The World Bank was to increase its programme to USD 3.3 billion in the financial year 1997-98 that ended in June (of which only about USD 900 million worth of loans got through before the sanctions) and the ADB was expected to provide USD 1.3 billion this year. Since it does not lend to the social sectors, as it does not offer IDA-type soft loans to India, nearly all of the new ADS lending will be hit. And unless the pipeline is replenished soon, net aid flows will turn more strongly negative.
As important as the direct impact of the sanctions on aid is the indirect effect on the investment climate and the cost of non-aid sources of external borrowings. Part of the sudden worsening of sentiments is due to the lacklustre budget coming on top of the sanction-inviting blasts, as also the downgrading of India’s credit rating by Standard and Poor’. And the combined effect has been massive sales of securities by foreign institutional investors, a net outflow of portfolio investment, declining share prices, and depreciation of the rupee. While India’s foreign exchange reserves are a comfortable USD 28 billion, Moody’s has forecast a loss of reserves of USD 5 billion this year. Sentiment is unlikely to turn positive unless there is concrete progress by India and Pakistan in initiating talks, curbing the threatened arms race and addressing some of their underlying problems.
Although it is too early to show the numbers yet, direct foreign investment is also likely to suffer a sharp decline. Even existing proposals are in jeopardy. About 15,000 MW of private power projects were reaching financial closure, with power purchase agreements already finalised. About 40 percent of these projects had US promoters who were relying on Exim or OPIC loans and guarantees. (OPIC and Exim are reported by the US Commerce Department to have Indian proposals worth USD 15 billion before them, although, of course, not all of these would have materialised. However, given the commercial implications – India is the second largest overseas power market after China – these agencies will probably be the first to be exempted by Congress, should there be a softening of the sanctions).
While some of the private projects will be abandoned (cynics say many of them were not going anywhere anyway), other promoters will try to switch to European equipment suppliers and sources of export credit, including Enron for its Phase 2. (General Electric, Enron’s suppliers, have licensing agreements in Italy). However the requirements are so vast that the European export credit agencies may not be able to handle all of them. (Apart from US Exim, the two other main export credit agencies, the Japanese OECF and German KfW, are participating in the sanctions). As for commercial borrowings, they are likely to see a two to three percent add on to the existing country risk premium. This will raise the cost of the projects, a price that will be passed on to consumers through higher tariffs.
The impact of sanctions are multifarious and are still evolving. Much depends on how India decides to react and also on whether it retaliates against the “sanctioning” countries by giving preference to “non-sanctioning” countries (in further oil exploration contracts, mining and telecom leases, and in speeding up clearances). So far, the government has fallen over backwards to try to accord liberal treatment to US and Japanese investors (e.g. the rather sudden patch-up with Suzuki over Maruti). More important, the impact will depend on how long the sanctions last, which in turn depends on how soon India is seen to make progress on the non-proliferation front and improvement of relations with Pakistan.