July 6, 1998

Sanctions are softer than expected and definitions are becoming clearer, but India finds that its best bet is still good economics.

By Sudeep Chakravarti

When it comes to sanctions, the words come easily. Finance Minister Yashwant Sinha still insists that sanctions imposed by the US "doesn't mean the world will come crashing down". India's Executive Director to the International Monetary Fund M.R. Sivaraman is a quote-of-the-year contender, with a raffish line about Moody's Investor Service recently downgrading Indian long-term debt on a visit last week to Mumbai. "Moody's sometime gets moody," he wisecracked, gently rubbishing the New York-based agency. Finance Secretary Montek Singh Ahluwalia added to his Moody repertoire at the Euromoney conference in Delhi last week. "Moody's has been wrong before. I hope it is wrong again."

They are all about a hair's breadth away -- the US and Moody's included -- from being wrong or right. Because it depends on who is doing the evaluating. It also depends on how well Indian policy-makers play out the game, and how well they tackle the grey area between perception and reality, where the only thing that's right is what others can do for you and what is wrong is what others are trying to do to you.

The good news is that in the twilight zone of sanctions where rhetoric holds as great a sway as reason, what exactly the curbs and related moves mean is increasingly becoming clearer, in both how they will impact and how they can be controlled. The bad news is more than a year old but as fresh as a can of worms: the general confidence in India's economy and the ability of its political masters to do anything about it is close to abysmal.

India, as numerous economists, businessmen and FII punters have pointed out, is reeling from a multiple whammy. Lacklustre economic performance for two years in a row, the pulling out of money by FIIs and the falling value of the rupee against the US dollar have more to do with perception of South East Asian style panic, more than signs of real economic instability than sanctions, but it's all getting mixed up in one bag. There's a Government that is riven with dissent three months into its term, with more policy talk than action. And, finally, the perceived impact of economic sanctions. "Generally, in spite of a lot of policy statements, this Government gives the impression of either not knowing what it wants to do or not being strong enough to stick to something once it has gone ahead with a plan of action," says Prasenjit K. Basu, vice-president and co-head, Asian economics, with Credit Suisse First Boston, in Singapore. "The Moody's downgrade was really like rubbing salt into a wound."

That must hurt because if there is one thing that the Government has gone ahead with and stuck to -- though nowhere near enough -- is to try and contain the fallout of sanctions. And it's showing. What was earlier pitched as a $21 billion-plus scarestimate provided by the Press Office of the White House on May 13, the day India conducted its last of five nuclear tests, is now, according to estimates provided by the same Government, more like $4 billion for this calendar year. This includes delayed loans which, in any case, start being funnelled into the economy over the next three-five years.

An indication of what gets hit and what stays unhurt was provided particularly in the case of multilateral loans. On June 18, in Washington D.C. -- a day before an executive order signed by President Bill Clinton formalising the sanctions was issued -- at a briefing at the State Department (see box), Under-Secretary of Treasury David Lipton mentioned that under "basic human needs", he expects that loans "in these categories such as education, maternal and child health, water and sewage, low-income housing, rural development will go forward".

This means that while several projects funded by the World Bank, for instance, in the infrastructure area in power, roads and ports -- over $1 billion worth of projects have been stalled already, affecting a transmission project loan to the Power Grid Corporation and another for energy efficiency to IREDA -- about half the 60 projects, for which preliminary proposal and negotiation work are going on, will stay on track. These include health projects in Andhra Pradesh, Central projects involving malaria, HIV, developing state health systems, water supply projects in Chennai, Hyderabad and Haryana. "The point is that the definition is really an argument," says an Indian official close to the negotiations. "In the give-and-take that typically characterises this situation, what constitutes a 'basic human need' can be really, really flexible."

The built-in ambiguity, though, is the overriding reason for so much indecision with sanctions. This leads Andhra Pradesh Chief Minister N. Chandrababu Naidu to publicly worry that all multilateral loans to his state will be nixed because of G-8 led delays. It makes West Bengal finance minister reassure members of the Assembly that at least a dozen projects in the pipeline for funding by agencies like Japan's OECF, the World Bank and adb, totalling almost Rs 10,000 crore, were already cleared.

Even with greater clarity, what is still vague is the term of the sanctions themselves. They remain in effect until the US Congress passes a legislation to lift them, there are no specified criteria for India to meet for sanctions to be removed or "actions which India could take that would lead to an automatic removal of sanctions". So it's open to interpretation, political whimsy and constant negotiation. Some US sanctions remain against China eight years after the Tiananmen Square incident; the economic relationship between the two countries has only grown to the extent that China enjoys a $60 billion trade surplus with the US.

An executive order is expected to be issued any day for banking, which is expected to find ways of limiting the definition of sanctions relating to US banks' lending to the Indian Government.That will be the last move, officially from the US, as far as boosting or killing positive perception towards India. This is a major outstanding issue that still remains unclear: can US banks lend to Indian psus or not? Can they hold government gilts as they are supposed to under the Indian law, through statutory liquidity ratio requirements or not? Can US investment companies hold and trade in shares of PSUs or not?

Whatever clarity has emerged is because of the sustained discussions pitched to as high a level as possible in both governments. It began just days after May 13, when a select group of representatives from think tanks, the Ministry of External Affairs, business associations and the Prime Minister's Office met to plan India's worst case scenario retaliation -- the idea was, and is, to assume the worst and work backwards to prevent it from happening -- against the US. The one-page paper that emerged from it just listed out a few points: freeze all multilateral loan repayments; withdraw permission to US banks to operate in India; cancel PSU and government purchases of US goods and services, tap alternative domestic and foreign sources and urge the private sector to do the same. It also suggested, among other things, that the Indian Government shouldn't be bound by any assurances previously given for use of any US equipment or technology.

Alongside this extreme plan was one that has already paid off in spades, one to cajole and convince the US administration that money talks loudest, and if US businesses are hampered or prevented from doing business or selling products in India, then it affects jobs in the US. This is exactly the line taken with Japan which froze about $1 billion in yen denominated loans. The hook here is to try and turn the Japanese tide towards India by giving management control to Suzuki Motor in Maruti Udyog, clearing Japanese projects -- the same tactic being used for US and European companies.

While on-the-record support from Japanese businesses is hard to come by -- it works differently there -- US support has been more vocal. CII President Rajesh Shah has a file full of letters from top corporations, mostly with business interests in India. "We have specifically used Phase II at Dabhol to point out the problems with the embargo," Kenneth Lay, chairman and CEO of Enron Corp, wrote about his company's pitch to the US Congress and administration. "In as much as US Export/Import Bank financing will not be available for that project now, the equipment for the project will be sourced outside of the US. It should not in any way slow down or impair the progress on that project but will certainly reduce US exports to India and US jobs."

Pepsico, through Louise Finnerty, its vice-president, international government affairs, mentions that the company is encouraging the US government "to take a balanced approach and not lose sight of the economic partnership ... it is important to continue this dialogue between the two business communities of our countries during this sensitive time". Ford's Vice-Chairman W. Wayne Booker's biggest highlight was a set of five words, "... focus on India's economic reforms".

This will ultimately decide how the sanctions game plays out. Even now, Moody's downgrading of India's long-term debt is being seen as somewhat over the top. "But the fact is that they exist and they are important," says an overseas analyst, requesting anonymity; he recently came away from a meeting with Finance Secretary Ahluwalia with the impression of having spoken to a man who spoke exceedingly well but "without really having a clue about how to solve India's massive perception and political economy mess".

This, despite the past three months recording the biggest flurry of policy announcements or action -- for export and import, stock markets, power, oil exploration, foreign investment, divestment in public-sector undertakings, among numerous other areas -- since wholesale delicensing in 1991. A lot of it has to do with what Moody's correctly describes as "fractious politics" which is affecting policy-making -- even Prime Minister Atal Bihari Vajpayee has been driven to announce a cell to devise a time-bound "action plan" to turn negative investor sentiment around. The believe-in-India marketing roadshows will help. But there's nothing like a little concrete, cohesive action to cut the flavour of sanctions.

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