The force of sanctions

Punitive sanctions under U.S. non-proliferation laws are being imposed for the first time ever, against India. But the precise extent to which India will be affected is as yet unclear.

WITH the United States leading the field in imposing sanctions on India under the Nuclear Proliferation Prevention Act of 1994 following the nuclear tests at Pokhran, the various provisions of the Act will be up for interpretation for the first time since it came into force.

The Act, better known as the Glenn Amendment (to the Arms Export Control Act), seeks to impose stiff penalties on, among others, any non-nuclear weapon state that detonates a nuclear device at any time after its passage into law. With the U.S. administration invoking the law for the first time, questions on the force of the economic sanctions imposed under it have cropped up. What, for instance, is the precise quantum of financial flows that is at risk? Do they cover only fresh investments or include disbursement of any undisbursed amounts? To what extent are non-bank financial intermediaries affected under the Act? These are some of the technical-legal questions that are being raised.

The NPPA has a number of prohibitions covering a wide variety of entities (see box). But by far the most important element in the list of "don'ts", the section that prohibits U.S. banks from making any loans or providing any credits, is likely to be the most contentious. It does not spell out whether the term "loan" or "credit" includes in its scope "investments". If it excludes "investments" from its scope, U.S. banks can get around the sanctions by structuring the loan as an investment in an underlying security. Thus, instead of granting a straight loan, the bank may subscribe to a negotiable paper issued by the borrower; the end result will still be the same.

The Act is also silent on whether the ban applies to branches of U.S. banks that are located in the country that faces sanctions. Going by the spirit of the legislation, the ban should apply equally to operations of a branch of the bank owned by an entity in the U.S. In the event, an investment in Government paper by a branch of a U.S. bank under the host country's banking liquididty norms may appear to violate this law. Non-observance of the liquidity stipulation of the host country may, however, entail the cancellation of the banking licence.

The law is also out of touch with the current reality of banking industry in the U.S. The world in general, and the U.S. in particular, is moving towards "one-stop financial supermarkets" which offer everything from loans to investment advisory services. While the NPPA seeks to bar banks from extending financial assistance to a country that has violated U.S. nuclear non-proliferation laws, it is silent on entities that are composite business interests. After the merger of Citicorp, which owns Citibank, with Travellers Group, which has interests in insurance and mutual funds, the composite entity is neither a bank nor an insurance company. The question now is: how will the law operate in respect of these outfits?

Quite apart from the operations of composite entities, the NPPA is silent on lending/investment operations of pension funds and mutual funds. Some of them may have exposure to Government securities of a country that has violated U.S. nuclear non-proliferation laws. It is not clear if they will be seen to have violated this law.

ESTIMATES of the likely financial fallout for India consequent on the imposition of U.S. sanctions vary. One such reported estimate placed the impact of sanctions on India at $20.7 billion. A news agency report, however, quoted unnamed officials in the Union Ministry of Finance as saying that this figure is vastly exaggerated. In their opinion, the impact would be of the order of $ 1.1 billion only.

At the core of the assessment is the implication of the prohibition of investment guarantees by government agencies. One such agency is the Overseas Private Investment Corporation (OPIC). The law mandates the denial of investment guarantees to U.S. investors who wish to invest in the country that is facing sanctions - in this case India. To the extent that direct investments into India ride on the strength of OPIC guarantees, there is a potential problem for the Indian economy. In a worst-case scenario, OPIC's refusal to underwrite investment losses could mean cessation of work on all ongoing projects involving U.S. companies, including those where some monies may already have been commited. This may possibly amount to about $10 billion, although figures released by the Industry Ministry in its Annual Report 1996-97 speak of a sum of Rs.24,694 crores as of November 1996, which translates into about $7 billion (at the then prevailing rate of exchange).

But is the assumption of total cessation of all projects realistic? Such an assumption presupposes that all investments by U.S. companies are covered by appropriate investment guarantees. In fact, investments are often committed by U.S. companies without the security of a guarantee cover. Investments in Vietnam, for instance, were not covered by OPIC guarantees until March 1998 when an agreement to this effect was reached by the respective governments. But that did not deter Ford Motors of the U.S. from committing hundreds of millions of dollars in its venture in Vietnam. China is another example of a country where U.S. enterprises have signed business deals - from nuclear power equipments to automobiles - without the security of OPIC guarantees.

Denial of investment protection will have real bite only if U.S. businesses suspend fresh investments in projects where they have already committed financial and managerial resources. But this is an extremely difficult decision to take. However, once U.S. businesses decide to pull out, it may not be too difficult to do so. By and large, the order of resources actually brought in against a project is not very large in relation to its total size.

According to the Industry Ministry's Annual Report 1996-97, of the Rs.244 billions in U.S. investments approved between August 1991 and November 1996, the actual inflow up till December 1995 was a mere Rs.16 billions, or less than eight per cent. Although the official data are somewhat dated, the position of actual utilisation in relation to U.S. $10 billion worth of investment proposals sanctioned till 1997 is unlikely to have changed dramatically.

On the other hand, for those U.S. companies that have already laid out a significant sum of money, exiting from India at this stage may not be easy. Take, for example, the Ford joint venture project for manufacture of automobiles. The company is reported to have spent a considerable amount out of the $500 million committed for the venture. It is difficult to see Ford pulling out of the venture merely because the subsequent instalments of investments in the project will not enjoy an insurance cover.

If, on the other hand, the protection is for the project as a whole, future inflows from the entire $10 billion of committed investments would appear to be safe.

THE Indian Government does not appear to be pinning its hopes solely on a favourable interpretation of the law on investment protection. It is trying to force the hands of U.S. companies for some affirmative action with regard to their involvement in the Indian market. Significantly, the Government has in recent days been clearing investment proposals in great haste. Even proposals that might be regarded as somewhat controversial have been expeditiously approved.

The Canadian aluminium major Alcan is in the midst of a takeover battle with Sterlite Industries over its Indian operations in Indal, a Calcutta-based company. Sterlite made an open offer to acquire shares from Indal's minority shareholders, thereby threatening Alcan's hold over the company; the Canadian company's proposal for making a counter-offer, sent to the Government, was gathering dust at the offices of the Foreign Investment Promotion Board. But in the aftermath of the nuclear tests, the Government bestirred itself and promptly cleared the proposal. This is sure to place the Canadian enterprise in a dilemma. Should it follow up on its offer and inject fresh sums of money into the venture? Were it to do so, the company would doubtless send out a signal to investors in the rest of the Western world that sanctions or no sanctions, it is extremely bullish on India. On the other hand, if it chooses not to respond positively, the company will irretrievably lose management control over Indal. Sterlite will then be free to pick up a stake from the public and even from financial institutions. The Government's game plan appears to be to force the hands of Western enterprises seeking a share of the Indian market so that they place their bets one way or the other.

UNDER the NPPA, the U.S. administration "shall oppose" the extension of any loan or financial or technical assistance by the World Bank and other multilateral institutions to the country against whom sanctions are being imposed. The key word here is "oppose". If this is taken to mean that the U.S. will merely record its protest at any decision of the Bank's board to extend fresh loans, then proposals involving India can be expected to go through. Even a formal vote against the proposal may not cause much damage as the U.S.' voting strength is nowhere near 51 per cent of the total. On the other hand, if the law is supposed to enjoin upon the administration to employ all means at its disposal, including actively canvassing support among other member-nations with the requisite voting strength to vote against, then fresh loan applications from India could be in trouble.

But even if such applications are blocked, they may not have any immediate cash flow implication because the time lag between sanction and inflows is fairly big. Between 1985 and 1997, external aid amounted to over Rs.1 trillions and net utilisation of the outstanding sanction of loans is still Rs.561.41 billions (source: RBI Annual report of Currency and Finance 1996-97). At the current rate of utilisation of approximately Rs.100 billions a year (according to RBI data, the utlisation in 1995-96 was of the order of Rs.101 billions,) it will be some years before the denial of fresh loan sanctions begins to affect India's balance of payments.

All things considered, it is too early to say how things will shape up on the foreign investment front consequent on the imposition of U.S. sanctions. Who will prove to be right? Those who predict that India will pay a huge economic price for the Pokhran explosions? Or the Indian officials who suggest it will be no big deal?