Economic Sanctions and SWIFT bans: Do they have an impact?

I recently read somewhere that whenever the title of an article starts with a question, the answer can usually be summed up in one word- NO! So, I wanted to test that out with my newsletter, by evaluating the means by which economic sanctions are imposed, and how, if at all, they impact the country. How do economic sanctions impact the domestic economy, how do they impose restrictions on international trade relations? And to deep dive into this, I thought I’d take the example of the Economic Sanctions which were imposed on India in 1998 following the Pokhran Tests.

?And to do that let’s start with a brief description and?the usual history lesson.

?What is an Economic Sanction?

Imagine a group of very different people came together with the aim of self-improvement, be it either on the financial front, commerce or general humanitarian. But each of us have our own protocols, and beliefs, some of which often conflict with the others. So, expecting one uniform code of conduct may be slightly hard. Also, you wouldn’t appreciate it if I told you how you should run your house now would you?

So, to prevent this stepping on each other's toes, we all agree on some basic set of dos and don’ts.

?However, if Nash Equilibrium were to come into play, we may all not have much of an incentive to maintain the status quo if we saw a potential for us to make a slight gain, or to be slightly better off than the others. This is where the threat of Economic Sanctions comes into play.

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Economic Sanctions are a tool used by governments around the world to on nonstate or sate actors who threaten or violate the international norms. It is the customary withdrawal of trade and financial relationships with the identified bad actor. It could involve the targeted blocking of transactions, freezing of international assets and other such means so that the cash flows available to the country are choked.?The intention is to dry their funds so that they cease their violent activities.

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Pokhran Test and NATO’s reaction

In May 1998, India literally caught the intelligence agencies of the world sleeping, when they conducted a series of nuclear fission and thermonuclear test rounds in Pokhran , a desert in Rajasthan, India. Soon after in the early hours of the day, the then Prime Minister of India, Late Atal Bihari Vajpayee , held a press conference to announce the successful completion of the tests by BARC, which put India on the map as a Nuclear-powered nation.

While the nation celebrated the show of technical prowess, the world at large was not happy about it.

?While the Sensex fell 7% between 11th and 13th of May,1998 it recovered 5% in the next 3 trading sessions. The Rupee though, during that year depreciated 1.2% against the dollar, a clear indication of what the sentiments were internally amongst the citizens and amongst the world at large.

Amongst the countries which imposed economic sanctions against India were USA, which stopped at forms of transactions except humanitarian aid. The other country which imposed government to government sanction was Japan. Several other countries also imposed sanctions on the trade of weapons and defense equipment.

Economic Sanctions and Impact on India foreign Trade relations

Now to see what was the impact of these trade and financial sanctions I thought of looking at the Balance of trade data for the period. But first, what is Balance of Trade? Ever since India opened its economy in early 1990s, economists have been monitoring this metric. The balance of trade is nothing but the difference between value of exports and import of a country.

As expected, the Balance of trade after the sanctions were imposed on India in May 1998, fell by 25%, which meant fewer countries were willing to by goods from India.

While part of the reason for BoP to decline was indeed due to the trade sanctions, another reason was due to Rupee depreciating against the Dollar. The chart below shows Rupee vs Dollar as of the end of the year. And we can see that the Rupee did indeed depreciate by 14%, and international community started to feel less confident about the prospects of India.

Economic Sanctions and Impact on India’s domestic GDP

When it came to the GDP well, despite the sanctions in 1998, the year saw a growth of 6% in GDP over the last year. However what did see a 1% drop in the Per Capita Income. Which means while the sanctions didn’t have much of an effect on the overall economic growth of the nation the segment that was impacted were the residents.

Given this, I also wanted to look into the Gini coefficient for the same period. Gini coefficient is a classic tool in the economists kit, which helps them to understand the disparity in wealth amongst the population. The geeky explanation is that the Gini Coefficient is the statistical dispersion that represents the wealth inequality within a group. The higher the Gini Coefficient the more the wealth is concentrated in the hands of a few. And while I could find on data for every five years, what is did observe is the slop of the curve was slightly more than periods before 1996. Which leads me to believe that wealth disparity grew significant during the period.

New Age cross border payment systems

But since 1998 and 2022 a lot has changed on the payments front, especially for cross border payments. From blockchain to alternatives to SWIFT messaging, the world has come a long way. So, how effective are economic sanctions, and does it warrant the “Toothless” remark that several people have been calling it?

But for a little bit of context what is SWIFT? SWIFT stands for Society for Worldwide Interbank Financial Telecommunications. Simply put SWIFT is a messaging standard for cross border payments. If you’re a part of the SWIFT messaging system, you don’t need to set up separate transfer protocols between each and every bank in each and every country you intend to have foreign trade relations with.

What happens if you are excluded from the SWIFT system ? About a decade and half ago that would’ve meant you would need to go a circuitous route in order to establish trade relations with other countries. And that can act as a serious deterrent to corporate and government who are always pressed for time.

This is what the world leaders were hoping for when they imposed SWIFT sanctions on some key banks in Russia , including their central bank, effectively debarring them from using the SWIFT network. The aim was to prevent Putin from using $630 Billion in foreign reserves from funding the war.

Unfortunately since 2014, Russia has been developing an alternative to SWIFT, when the world leaders had then threatened a SWIFT Ban following Russia’s annexation of Crimea known as SPFS (Don’t ask me the full form it was something extremely complex in Russian which loosely translated to System for Transfer of Financial Messages. Then there is Mir , launched in 2017 for accepting card payments across the globe, though the adoption for that has been pretty poor.

Another option available is adopting China’s CIPS or Cross border Interbank Payment System . This is of serious concern to the western world as if this sees wide adoption, there is a possibility of Yuan becoming the predominant global currency. And given the Balance of Trade between US and China, that cannot be good news for Dollar, or countries with significant Dollar reserves.

But the biggest threat is probably from alternative payments modes, which are decentralized, like the blockchain based cryptocurrency – Bitcoin. Already the SWIFT ban has the crypto community talking about the governance of centrally controlled systems. SWIFT, which is a Belguim Cooperative society, owned by member financial institutions, which are typically central banks of some member countries. In fact, crypto did indeed help Putin circumvent the first wave of sanctions which were placed. This is also my biggest grouse with a completely decentralized payment network, because if there are bad actors then there is no one way to extricate them from the system. But let’s reserve that for another time, shall we?

So to conclude, sanctions do have an impact but maybe not as targeted as government would like it to believe. But in situations as tense as the ones we are living in, some actions to deter or stop a war are better than none right ? ??

P.S : If you liked this, then do subscribe to my newsletter, Kam Questions, where I look under the hood of popular (mis)conceptions to decipher what is actually happening. While my niche is the Fintech space, I also attempt to write about other Digital Businesses and their Strategies too. So if you think someone else will benefit from the content I put out, do share it with them. Its free :D

P.P.S: All graphs and charts are made by me, a creatively challenged person. So I admit it may look hideous. Hence reaching out to my awesome community on tips on how I can better visualize my content! All critique, feedback and suggestions are welcome.

P.P.P.S : I shall be taking a couple of weeks off to plan for my Women in Finance, Tech and Fintech, as a part of my Women's day celebrations. The aim is to give young women a boost in motivation, by listening to the journey of some powerful women in the space, and hopefully motivate lot more into the sector as well! So do tune in to the events!

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