Controlling The Economic Fallout

With the Budget a fortnight away, the government goes into overdrive in the aftermath of Pokhran 1998

May 13, 9.30 am: Its a little over a fortnight to the Union Budget and Indias top financial bureaucrats are in a huddle in finance minister Yashwant Sinhas room. But they arent number-crunching for the budget. Instead, theyre struggling to contain the fall-out of Indias nuclear test explosions at Pokhran the day before.

As the congratulations poured in and euphoria reached fever pitch, the finance mandarins talks turned to cold numbers. How would India cope with US sanctions? Would the balance of payments stand up to possible withdrawals by foreign institutional investors? Would foreign direct investment suffer? After all, the US is still by far the biggest foreign investor in India.

May 13, 11.15 am: The scene shifts to South Block, where Prime Minister Vajpayee has summoned officials for a quick debrief on the economy. They go over the vulnerable sectors where the economy could be hit. But the officials are still hopeful and maintain that the country can tide over the crisis.

Less than an hour later two more mushroom clouds broke on the economic horizon. Once again, Sinhas A-team and other senior officials went into another huddle. With sanctions already on the cards, would a second round of international retribution follow? Sinha, himself, was in constant touch with the Ministry of External Affairs and eager to get the latest diplomatic feedback.

6.30 pm: Prime Minister Vajpayees strategy team go into a another huddle in South Block. By now a strategic gameplan is emerging. First, India will bank on American investors to lobby against sanctions. Secondly, with the budget so close, the government had been served an opportunity (just like the BOP crisis did in June 1991) to signal the next big round of economic reforms what better way to assuage foreign investors whove been rattled by Indias nuclear pretensions.

By Thursday the fallout had begun. A Reuters story from Washington said that US sanctions would hit $ 20.7 billion of aid. Almost immediately the rupee went into a spin. By evening, it had hit a new low of Rs 40.85.

By now the corporate world was also counting the financial cost of going nuclear. The biggest speculation centred around the US Exim Bank which gives credit and guarantees for giant projects. Sanctions have come just as the Exim Bank has stepped up exposures to companies doing business with India. The US Exim Bank financed around $1.5 billion in import deals last year. Another $6 billion was in the pipeline involving projects in power, telecom, aviation, cement and steel.

In fact, the US Exim Bank has signed a flurry of MOUs in the last few months. In December it agreed to finance imports worth around $ 700 million for Mangalore Power Company, Escotel Mobile Communications and Hughes Network Systems. The Escotel deal (for buying equipment from Lucent Technologies) was its first private telecom sector transaction and was hailed as a trendsetter.

The worst hit by an Exim Bank pullout will be the power sector where most big projects are still struggling to reach financial closure. At risk are a string of projects by companies including Enron, AES Corporation, Cogentrix Energy ST-CMS and ABB Energy Ventures. One private sector consultant reckons that the Mangalore Power Projects future looks uncertain. There will be a need to examine existing financial arrangements for projects which are financed by lenders who are affected by the sanctions, says Harry Dhaul, director general Independent Power Producers Association of India.

The jinxed Dabhol Power Project could also face fresh hurdles. Enron had an US Exim Bank credit for $ 298 million for Dabhol I. Now Dabhol II is likely to be stalled. A ban on credit from the US Exim Bank and Japans Overseas Economic Cooperation Fund will make financing for our pending projects that much harder. But it is too early to say that it will cause irretrievable damage, says an Enron spokesman.

Does the power sector have many options? They can go to a third country, other than the US or Japan, to part-finance a deal, but the interest costs will be prohibitive, says an analyst at HSBC Investment Banking.

Then theres the small question of what will happen if the US tries to block loans to India from the ADB and the World Bank. This will be critical in a year when loan sanctions were slated to hit a record $ 3 billion. Also, several loan negotiations a $ 1 billion loan to Andhra Pradesh and $ 750 million in for roads are at an advanced stage.

The Americans dont actually have the voting power to stop loans. But they could request a re-scheduling of the loan meeting so some projects will not be cleared in this fiscal year. But its important to remember that the Americans dont have the strength to block loans. It needs a 51 per cent controlling vote to stop loans. The G-8 countries together can muster up about 45.35 per cent at the World Bank board.

US opposition, if successfully orchestrated, could be a stumbling block at the International Monetary Fund. Fund officials say that the US on its own with an 18 per cent share of the vote cannot block a loan. The US has tried unsuccessfully once before to stop loans to India in 1981.

Annual loan assistance has in the recent past ebbed (at the level of $3 billion) and the country actually sees a net outflow. The countrys debt-servicing on past loan assistance exceed aid inflows into the country. At the end of February, less of principal and interest payments there was a net ouflow of Rs 1,925 crore in the fiscal year 1997-98. In the same period (April-February) in 1996-97, the net outflow was Rs 1,688 crore.

If Japanese aid stops that would worsen the picture. The outflow would increase and put more pressure on the balance of payments. All the more so, because export performance in the current year, may not even match the 2.6 per cent growth recorded in 1997-98.

Theres worse: industrial growth is likely to pick up and this will lead to an increase in imports. If this is not offset by a commensurate rise in invisibles, pressure on the rupee would be inevitable. Further, the country has to also discharge upto $10 billion in debt-servicing payments in 1998-99.

The cost of external borrowings, which has been climbing even since the south-east Asian crisis, is also expected to go up. The finance ministry believes that the increase in spreads would settle down to about 10 basis points, even though in the immediate period they have gone up by as much as 100 basis points.

In other fields too, its hard to tell what will happen next. The countrys disinvestment programme could be hit if American investment banks are required to stay out. For finance minister Yashwant Sinha this could be disastrous, as disinvestment was a key strategy for raising money.

In this air of uncertainty, the government has a two-fold strategy. A diplomatic offensive will aim to contain the fallout. And the government is expected to unveil a fresh burst of economic reforms to woo the foreign investor anew. Its a high stakes gamble, and India must play its cards right.