Pergau deal highlights sweetened trade success: David Bowen looks at the use of aid to make deals

THE ROW over the link between British aid and arms sales to Malaysia has put the delicate issue of mixing aid and trade firmly back in the spotlight.

'People who see the aid programme as primarily for poor people in poor countries believe this is the ultimate example of its misuse,' a former trade official said. 'Those who believe it should have a commercial use think there is nothing much wrong with it.'

The apparent link with an arms deal is a politically important element in the Malaysian affair, but not the one that baffles trade experts. The arms to Iraq affair shows the potential for blurring the distinction between civil and military products, while the French have been quite open about a deal with India that wraps Mirage 2000 fighters with a nuclear electricity project and a telephone network.

What has surprised observers is the sheer size of the aid element in the Pergau hydroelectric deal. A former government official said that the Export Credits Guarantee Department would have backed a higher proportion of near-commercial rate finance. 'It wasn't as though it couldn't do it,' he said.

The principle of using aid to 'sweeten' trade deals is well established. In large projects, buyers are given 10 to 15 years to pay. Most finance comes from a consortium of banks, with the final risk taken by the state export credit agency. When bidding for these projects, the cost of the financing is often the most important element: a slightly lower interest rate can reduce the debt burden by tens of millions of pounds, and the country that can offer the cheapest, 'softest' loan has a good chance of winning.

In the early Eighties some countries, notably France and Italy, mixed aid and bank loans so freely that the Americans retaliated by creating a war chest of aid, and forced through an internationally agreed minimum aid level - at first 25 per cent, now 35 per cent - to make the practice more expensive.

Although the British government tried to give the impression that it never subsidised, and was the victim of much unfair competition, its aid and trade provision has always been quite powerful. In 1986, the Overseas Development Agency provided a pounds 59m grant to soften the financing of a water supply project being built in Malaysia by Biwater.

To exporters, the Pergau deal was another attempt at opening the gates to one of the most profitable markets in the world. Malaysia is fast-growing, politically quite stable, and in need of much fundamental modernisation.

Exporters are intrigued that there should be a scandal about the over- generosity of the British government. The deal was agreed just as the Treasury was slashing the level of cover and increasing the premium rates charged by the ECGD, putting UK companies at a hefty disadvantage. That caused such an outcry that the moves have been reversed.

Since Michael Heseltine took over at the Department of Trade and Industry in 1992, exporters have felt that the Government really has become aggressive in their interests. Richard Needham, the trade minister, says he wants to double the value of capital goods exports this decade. The main targets will be the dynamic markets in South-east Asia - including Malaysia.