The forgotten scars of 1998 U.S. sanctions show India's long march from vulnerability to resilience

The 50% tariffs imposed on India by the Donald Trump government in the U.S. over India's decision to buy Russian oil has brought back memories of one of the worst sanctions that were imposed on India: during the 1998 nuclear tests at Pokhran.

Very recently, the Trump administration further threatened to impose stronger sanctions on those countries who still do not comply with U.S. orders to stop dealing in Russian oil, an issue Washington sees as crucial to the ongoing war in Ukraine.

Sanctions are not a new phenomenon in India-U.S. relationship. In May 1998, following India's nuclear tests at Pokhran, which had bypassed U.S. counterintelligence measures, an angry Washington, under the Glenn Amendment, decided to impose severe sanctions on India. These sanctions were short-lived and were eased within a year. However, they did manage to leave an indelible imprint on Indian economy, scarring it.

As per a research paper authored by scholars Daniel Morrow and Michael Carriere, as a result of the sanctions on India in 1998, two areas were largely impacted: capital flows and investor sentiment.

As India went ahead and completed successfully its nuclear tests, despite massive pressure and surveillance from Washington, the latter, as a consequence, immediately stopped aid worth $51.3 million, suspended projects funded by the Export-Import Bank (Ex-Im) and Overseas Private Investment Corporation (OPIC), and blocked new commitments from the Trade Development Agency. This directly affected major infrastructure projects, including Enron’s $2.5 billion Dabhol power plant and Cogentrix’s $350 million Bangalore power project, as per Morrow and Carriere.

But the duo's data pertaining to India's Global Depository Receipts (GDR) of 1998 offers a good illustration to gauge how international investors reacted to the country’s nuclear tests and the sanctions that followed. A GDR is a financial instrument issued by an international bank that represents shares of a foreign company and is traded on global stock exchanges, usually in Europe or Asia. For Indian companies, GDRs became a popular way in the 1990s to raise capital abroad without the complexities of direct foreign listings. For investors, they provided an easier route to gain exposure to Indian equities. The GDR premium, which compares the price of GDRs abroad to the underlying Indian shares, is often seen as a barometer of foreign investor confidence.

As per the graph showcasing India’s GDR premium, from the period of January to December 1998, the premium was comfortably positive, averaging between 7 and 10%. This meant that international investors were willing to pay extra for Indian equities. This showed optimism.

However, after the second round of nuclear tests in mid-May, the mood soured. On May 14, the first trading day after the tests, the premium began to slide, and following the formal announcement of U.S. sanctions on June 18, it plunged into negative territory, touching nearly –12%. This sharp reversal fall shows that not all was well with India's position in the global capital markets, following the imposition of sanctions.

There was recovery, however, as the U.S. eased agri-credit in July of the same year, which could have reassured investors somewhat. But that does not mean that volatility did not exist in India.

As the data shows, a bigger rebound was witnessed in September of that year, which coincided with India's decision to sign the Comprehensive Test Ban Treaty (CTBT), followed by U.S. presidential waiver authority in October and the lifting of most sanctions in November. By early November, the GDR premium had not only returned to positive territory but also climbed steadily through December, reflecting renewed confidence.

The authors also show that during the period the sanctions, the most significant economic impact that India suffered was on private capital flows. In April–June 1998, net inflows to India were $4.2 billion lower than in the same quarter a year earlier, i.e. about 1% of GDP and 4% of gross domestic investment.

Foreign investment, both direct and portfolio, fell sharply too after the tests. External commercial borrowing also declined. Although India partly offset these losses with $4 billion raised via Resurgent India Bonds from the diaspora, the disruption showed how vulnerable India was to international sentiment. This point attains even more importance when seen in the context of India's 1991 economic reforms. Barely seven years had elapsed since the opening up of the economy and India's balance of payments crisis. Therefore, the vulnerability for India was especially acute at that point of time.

This is borne out by the fact that the BSE dropped 27% between May (check figure above) and December 1998, compared to just a 4% decline in other Asian markets, during the same period of time. Similarly, credit rating agencies during that point of time had come down heavily on India, linking their downgrades explicitly to the nuclear tests and the sanctions. Standard & Poor’s, for instance, revised India’s outlook to “negative” on May 22, 1998, citing “erosion of India’s external financial position following the imposition of sanctions.” Just on cue, Moody’s too downgraded India in June, highlighting in its note that sanctions would hinder infrastructure development. Duff & Phelps warned that India would be forced to rely on “more costly avenues of borrowing.”

Morrow and Carriere do argue that India possessed considerable foreign exchange reserves as firepower ($26 billion in April 1998, equal to six months of imports) and this cushioned immediate shocks. But there is no denying the fact that sanctions, during the turbulent year of 1998, did indirectly hurt growth prospects by reducing capital inflows and damaging investor confidence. The authors, however, conclude by saying that the sanctions’ direct fiscal impact was modest, but their indirect impact via global capital markets was significant.