Implications of Economic Sanctions on India

30 May, 1998    ·   102

T. C. A. Srinivasa Raghavan analyses the impact of sanctions on India's economic and fiscal health is analysed by T. C. A. Srinavasa-Raghavan.

For the first time since India 's independence, a foreign country, the United States of America , has imposed economic sanctions on India . The USA took this action following India 's five nuclear tests on May 11 and May 13. Except for the US , no other country has taken the call for sanctions seriously.



Opinion in India is divided over the issue.



Some people think that India will pay a heavy economic price over the years, if not immediately. Others believe that neither immediately nor over the longer term will India pay an excessive price. Thus, everyone is agreed on one point at least, namely, that there is nothing to worry about for the next six to nine months. This is because the total value of what India will be denied by way of loans and aid as a result of the sanctions is only around one and a half billion dollars.



What about the figure of 21.4 billion dollars published by the US government? It is only an estimate of the potential cost if the full loan amounts, guarantees etc are drawn. India had no intention of doing so, which makes the financial cost in the short term quite negligible.



However, the story could be different in the long run if the controversies that have arisen following the nuclear tests and the imposition of the sanctions are not quickly resolved. But it is hard to predict the precise form in which these costs will arise.



If all goes well, they may not arise at all. But if things do go wrong, the higher costs would arise from the heightened commercial risk perceptions about India in the international financial markets. That is to say, the higher costs will work themselves through the financial markets, which may add on a risk premium to money lent to India and Indian companies.



A second way in which India could suffer is if the US government bans the sales of certain things to India by US firms. Civilian passenger aircraft are a good example of this. Air India and Indian Airlines are both in the market for a large number of aircraft. They are negotiating with Boeing, which is a US company and Airbus, which is a European one. If Boeing is prohibited from selling aircraft to India —as it was to China after the Tien An Men square massacres of 1989— India will be faced with only one option, Airbus, which could then charge whatever it liked. The same thing could happen in respect to a number of other things.



Meanwhile, the World Bank has postponed consideration of fresh loans totalling $865 million and the European Union has fallen in line by warning that it will act for postponement of multilateral assistance and withdrawal of trade privileges if India does not quickly reverse its nuclear policy. The government will point out that this has nothing to do with loan agreements signed and sealed. As a matter of fact, as there is always a considerable amount of sanctioned multilateral assistance in the pipeline, India can improve its utilisation and actually end the year with higher disbursal.



To compound the above hiccups, Standard and Poor's have also further downgraded India 's credit rating which, at BB+, is already below investment grade. An immediate consequence of this new downgrading, says the finance ministry, will that Indian firms will have to pay between $20 to $30 million more in additional interest because of the enhanced risk perception about India . Project finance deals are likely to be concluded at around 300 basis points over Libor, says a banker. This would be between 70 to 80 basis points more than at present. In some cases, the spread could go even higher. Already, there are reports that the call money rates abroad for Indian banks hardened. Soon after the US imposed sanctions, the State Bank of India had been refused overnight accommodation in New York (as it was taken to be a wholly owned government bank, which it is not). Some Indian officials, meanwhile, are arguing that the impact of the downgrading will be marginal because India is already below investment grade. Whether or not S&P has factored in the sanctions into its evaluation of Indian country risk will never be known. But it is likely that S&P has taken a long and hard look at India 's economic fundamentals and decided that lending to India could turn riskier.



The fact is that the fiscal deficit, at 6.5 per cent of GDP, is too high for comfort. And, though the RBI thinks that the current account deficit will be contained at 1.5 per cent, It fails to say that can be achieved only with lower GDP growth. The alternative assumes higher capital inflows. But that is unlikely. If anything, inflows will be lower this year. The only option, therefore, is a sharp increase in the export growth rate which, given the East Asian currency devaluations, may not happen.