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S. Venkitaramanan

With the US' aggressive posture vis-à-vis Iraq, there is real and growing danger of a conflagration that could have serious economic and political consequences for India, the US and the world. India, in particular, will be hit hard as crude pr ices will go through the roof, making the essential imports exorbitant. One can only hope, therefore, that the New Year will see positive developments on the Iraq-US relationship.

THE clouds of war are gathering in the Middle East with the hegemon from Washington bracing for war. Iraq is playing cat and mouse with the UN inspectors looking for weapons of mass destruction, while world opinion has tamed US into working within the confines of the UN resolution.

In spite of all this, there is real and growing danger of a conflagration, which could have serious economic and political consequences for India, US and the world.

The last conflict in the Gulf was in 1990-91. It coincided with and caused the eruption of a deep financial crisis in India. In fact, there are analysts, who are of the view that India's economic crisis of 1990-91 was precipitated not so much by its own financial mismanagement as by the impact of the Gulf crisis.

First and foremost, it raised the price of oil and fed an inflationary spiral in India as in the rest of the world. Fears of instability arising from the Gulf crisis also led to volatility of forex flows. NRI deposits, which had then been the mainstay of India's balance of payments, started flowing out. The remittances from Indians employed overseas also declined, consequent on the war-like situation.

Particularly, it impacted economies of remittance-dependent States and regions such as Kerala. The forex reserves started getting depleted. India had to go to the IMF, besides pledging gold to foreign central banks, and initiate a traumatic onrush into economic reforms — essential, but speeded by the crisis.

The crisis of 1990-91 was unprecedented both in terms of its intensity and duration. The level of foreign currency assets came down to $1.2 billion at the end of April 1991. India had to experience a further threat of decline in reserves because the low level of reserves was itself both the cause and effect of a reduced inflow of FCNR deposits.

There was also unwillingness on the part of international financial channels to renew short-term credit to Indian entities. Forex vulnerability feeds on itself. SBI — and, therefore, India — had to depend on overnight advances in New York, London and Tokyo markets to keep itself afloat. India was teetering at the edge of a default, primarily in the form of SBI's possible failure to meet its obligations.

Then followed the inevitable application to IMF, IBRD and ADB for assistance. There was also resort to exceptional financing in the form of bridge finance by pledging gold with international money centres as well as with the Bank of England and Bank of Japan. Those were nightmarish times, which hopefully India will never have to go through again.

The sources of our improved security lie in our successful economic and financial management, resulting in abundant forex reserves as well as foodstocks. The main lacuna is, however, the absence of an adequate fallback for p.o.l. products in terms of safety reserves. Imports account substantially for our p.o.l. needs. A safety reserve of oil and p.o.l. products seems a critical need for a modern economy, like India, dependent on imports from abroad. It may already be too late to plan for such a facility.

Are we in for a replay of 1990, with growing prospects of another Gulf war? While the rights and wrongs of the US stand on Iraq are outside the scope of this article, what matters is the clear determination of the US President, Mr George Bush Jr., to achieve a regime change in Iraq. The result will be a bloody war, with or without UN sponsorship.

The economic consequences of a US-led conflagration in West Asia will follow obviously the pattern of experience of the 1990s. Crude prices will go through the roof. Besides, oil shortages will develop due to the closure of normal access to West Asian ports.

True, the US has built up a huge crude oil reserve. But even this reserve has its limits. We in India will be left fully exposed if a war hits our crude imports.

A less malignant, but nonetheless deleterious, effect would be the rise in petroleum product prices. Now that the administered price mechanism has been dismantled, global price increases will be transmitted to the ultimate consumer instantaneously.

A sharp rise in crude and related prices and consequent inflationary pressures will result and adversely affect the prospects of industrial and agricultural growth. As a result, India will have to be prepared for an inevitable slowdown in the economy. The recent record, in which India's policy-makers have been legitimately talking about being one of the fastest growing economies in the world, will naturally be affected. India's growth will take a hit.

The impact of a Gulf war on the US economy will be even more potentially damaging than immediately for India. The channelling of $200-300 billion of resources for the conduct of war will adversely affect the US economy. At the same time, it has to be granted that a war effort can have a stimulative effect on the economy, to the extent it puts more money into consumers' pockets.

So far as the normal trade channels, unconnected with the war-effort are concerned, the US' imports from the rest of the world will definitely suffer a dent. As one of India's largest trading partners, the US' economic fortunes will have a bearing on India's exports.

The impact on the IT sector is, however, a different question. Conventional business process outsourcing may continue, but not expand at the same pace as till now. The opening up of the US' IT sector may also be affected by war-time security concerns. The consequent overall impact on India's IT exports will perhaps affect the expected high rate of growth by India's software entrepreneurs.

There will also be adverse repercussions insofar as FDI and foreign institutional investors are concerned.

The constraints, which a war-time economy imposes on US' financial sector, will also affect the outflows from the US to other countries, particularly those near the conflict zone. Inflows of capital on both FDI and FII, which are contributing to our booming reserve growth, are likely to be reduced.

Whether India will go through the same traumatic experience as in 1990-91 is, however, doubtful. Fortunately for us, we have accumulated a buffer stock of forex as well as food, which will help us as against the fragile position with a week's import requirements as reserve, which we had in 1990-91. Further, the inflationary situation is well under control. India's credibility is also at an all-time high, both in the national and international financial markets, notwithstanding the downgrading by a rating agency.

In spite of all these plus factors on our side, it behoves the Indian authorities to take care. It is the path of wisdom to be ready with preventive corrective action, even in the best of circumstances, although some voices may argue that such action may create panic.

At a minimum, we have to prepare for alternative sources for crude, in the event of a closure of the West Asian sources over a long haul.

Similarly, we have to be prepared for the adverse impact of a slowdown in employment opportunities in West Asia, particularly in States, like Kerala. Exports of commodities, which are today targeted at the West Asia also should seek alternative channels. All this will not happen overnight. It needs careful planning and implementation. A contingency plan for an impending Gulf War II is the minimum that we can expect our planners and policy-makers.

On the question of foreign policy, India does face a different dilemma, which has its own economic consequences. Traditionally friendly to Iraq, India has obvious reservations about taking anti-Iraq stand. Further, there is a significant export of food under the food for oil programme going on between India and Iraq.

At the same time, since the 1990s, there has been a welcome improvement of relations — economic and diplomatic — between India and the US. It is difficult for India to take a consciously anti-US position, considering the various linkages between the US and India, especially in technology and finance.

India has also to take into account the implications of the ongoing war against terrorism and the impact of the US' stance on this matter so far as our own cross-border terrorism issue is concerned.

Overall, it is a witch's brew, which events have placed before us. India's policy choices are restricted because of the changing global situation and evolving US-India's relationships.

One can only hope that the New Year will see a positive development on the Iraq-US relationship. A war is a messy business, both in terms of loss of innocent lives and the economic impact.

Not for nothing are powerful demonstrations being staged in all the capitals of the world, protesting against the US' aggressive posture and plans. India will be one of the chief beneficiaries if peace breaks out and the US' current aggressive intentions against Iraq are contained, short of war.

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