August 01, 2011

India- Iran oil impasse

Guest Column by Kandaswami Subramanian

When the Reserve Bank of India (RBI) decided in December last year to disband the Asian Currency Union (ACU), which provided a smooth window to pay for the supply of oil from Iran, it would not have been prepared for the impasse it would create, not only for oil payments, but also, at the end, for the supply itself. After seven months of agonizing uncertainties over supplies, contentious debates and disputes between Indian and Iranian authorities over alternative arrangements for payments, the issue remains unresolved. Each day it gets buried under diplomatic shrouds. There is a continuing opacity on the direction of India Iran relations. Too many questions arise.

It is unclear why the ACU was abandoned. Indeed, it was a precipitate decision. There is evidence that it was done under pressure from the U.S. authorities as a part of the bargain underlying India-U.S. civil nuclear agreement. Needless to say, this has been strongly denied by the spokespersons of the Ministry of External Affairs the timing was significant as it was done within days after the visit of President Barrack Obama to India. Major western papers like the Wall Street Journal and New York Times celebrated the decision as one supportive of U.S. led sanctions against Iran.

It is also clear that Indian authorities did not hold prior consultation with Iranian authorities before snuffing the ACU mechanism. Iranian authorities continue to harbour a grudge against India and feel that the ACU should not have been shut down. The present writer had examined these issues at length in two earlier articles.[i]

It is unclear whether the concerned Ministries – Ministry of External Affairs, Ministry of Finance and the Ministry of Petroleum & Natural Gas – and the RBI had weighed in the consequences of the abrupt decision to shut down the ACU without working out an alternative arrangement to ensure timely payments for oil supplies. Apparently, there was none. Perhaps, they had misjudged and assumed that an alternative payment system could be established without much difficulty to replace the ACU. This assumption was egregious.

To be fair, they could be given the benefit of doubt if we studied the efficacy of US-Iran sanctions as they operated around that time. During those years, it was possible for many countries and companies to circumvent sanctions through covert arrangements or through currencies other than the U.S. dollar or the Euro. A study by the Institute for Defence Studies and Analyses (IDSA) [ii] referred to this record. It said, “Despite years of sanctions, several countries appear undeterred from doing business with Iran, particularly in the energy sector. This is partly due to lack of punitive action on the part of the US through waivers.” Truly they were gaping waivers and, as reported by the New York Times in an article[iii], there were over 10,000 waivers. Some of the officials of MEA and Finance also referred nonchalantly to the possibility of arranging remittance through other countries such as those in the Gulf and other currencies such as dirham or Yen. These assumptions were unrealistic and had not reckoned with later developments.

Broadly, there were two major developments working against Iran and its partners like India. The first and the more important one was that the U.S. was tightening the sanctions virulently against Iran, especially with the adoption of U.N. Security Council Resolution 1929 on June 9, 2010, the emphasis of U.S. measures has been to target Iran’s energy sector and to isolate that country from the international financial system. The Iran Sanctions Act (ISA) was expanded with the passing of the Comprehensive Iran Sanctions, Accountability, and Divestment Act of 2010 (CISADA, P.L.111-95).[iv] The expanded Act seeks to curtail additional types of activity such as selling gasoline and gasoline production-related equipment and services to Iran and to restrict international banking relations with Iran.

Under executive powers vested in the Act any foreign bank dealing with Iran could be denied correspondent or other relations with U.S. banks. With its hegemony in the financial market, it would be possible for the Treasury to ban all banking transactions for any designated party. A division in the U.S. Treasury working under a Deputy Secretary was keeping a watchful eye for suspects. A U.S. bank on banking would deny the concerned country access to dollar or remittance through dollar.

The other major development was that the U.S. could exert pressure on the members of the E.U. and resolve the differences that had plagued their relations over the scope and contents of sanctions for a long time. As narrated by Patrick Clawson of United States Institute of Peace in a blog [v] “A few years ago European governments were reluctant to forego business opportunities with Iran and the State Department seemed inactive on the sanctions front-in contrast to activism by the Treasury Department.” In a meeting held in Brussels on 23 May 2011, EU foreign Ministers agreed to go along with the U.S. As Patrick Clawson added, “Now the United States and Europe seem to be on the same page of tougher sanctions.”[ vi] The EU added more than 100 new entities to a list of companies and people affected by EU sanctions. They included new asset freezes; visa bans and a range of financial trade sanctions. The most important inclusion in the ban list was the notorious Europaisch-Iranische Handelsbank A.G. (EIH).

The EIH was the temporary window India resorted to as an option to arrange payments to Iran. When it was evolved, it was treated as a diplomatic tour de force. In an earlier article [vii], I had doubted the wisdom of doing it and, especially, its sustainability. It made our energy security dependent on Germany and its complex diplomatic relations with the U.S. No wonder, it was short-lived and had to be given up in two months. The German Chancellor Angela Market abruptly terminated it. When she took the decision, the background was not wholly clear. But the EU meeting of May referred to earlier and the growing convergence of policies over Iran sanctions between the U.S. and E.U. told the full story. With the damning of the EIH as a conduit, the Indian situation vis-à-vis Iran turned rudderless.

News reports that have been covering this area from time to time suggested how the Government of India and the RBI were trying to work out several alternatives to sort out the payment problem. In the early months government officials used to say, “We are looking at option such as the euro and are trying to identify banks that could be used for receiving and making payments.” Petroleum Secretary sounded optimistic when making such statements. Sadly, by then the sanctions noose had tightened and all the loopholes had been plugged. The U.S. Treasury was keeping track of payments flows, their routes and methods. It had the full cooperation of OECD countries, which controlled the global financial markets through their banks. The RBI would have become more circumspect with its relationship with other central banks. Global codes on controlling terrorist financing did bind the RBI. Unfortunately, it was the U.S. Treasury, which was in the driving seat in all these matters. Thus, the efforts to seek alternative currency routes had to be abandoned.

Iran or rather the National Iran Oil Company (NIOC) continued to supply oil to Indian refineries even when payments in convertible currency were not made. As a short-term device payments were made in rupees to a joint account in the hope that the payment issue could be resolved soon and the amounts remitted to Iran. It is to the credit of Iranian authorities that they continued to maintain the supplies even when payments were delayed. However, contrary statements began to fly and Iranian officials made repeated assurances that oil supplies would not be cut.

One of the options examined was to arrange payments in rupees to Iranian account with banks in India. The idea was that the rupee could be used by the Iranian government for certain limited purposes. There were reports that a paper for the Cabinet was being submitted. This was not pursued as the RBI had cautioned against the risks attached to such a method. Monthly payments to Iran work out to $1 billion. It would create tremendous banking and liquidity problems and create financial instability. The idea was given up. The idea would not be palatable to Iran in any case. Iran is in need for of finances for its own survival and its needs money for both exploration and revamping its refineries. It can ill afford to get its money blocked in India. Further, it needs payments in foreign exchange to be able to maintain the strength of its own currency, rial.

Yet another idea pursued was to work out bilateral trade with Iran. However, the odds are loaded heavily against India. Oil payments to Iran work out to @12 billion per annum. Indian exports are estimated at one tenth of it, estimated at $1.85 billion in 209-10. Indian exports consist of coffee, cereal, iron & steel, chemicals, pharmaceuticals, rubber and chemicals. There is scope for exporting railway equipment. There was no way by which Indian exports could be stepped in the short run to match imports from Iran.

While on this issue, it is interesting that China and Iran are said to be in talks over a barter system to exchange Iranian oil for Chinese goods and services. A recent report in Financial Times [viii] has made waves and has been carried in many other papers and news sites. The report suggests that US financial sanctions have blocked China from paying at least $20 billion for oil imports. China and Iran’s bilateral trade was around $29.3 billion last year and is growing. They have several infrastructure and collaboration agreements that will bring about Chinese investments in Iran and Iran would export large quantities of chrome ore to China. As the report summarises: ”Unlike India, which exports almost nothing to Iran, China is dominant in Iranian business and could use as barter system to balance trade between the two countries.” It is not surprising that India could not pursue the barter route to balance its trade with Iran.

Even as Indian authorities were struggling to resolve the impasse, the Iranians were losing their patience. From early July this years there were reports that Iran had set August 2011 as a deadline for India to pay its outstanding debt on the oil account. It was estimated at $5 billion. (Recent reports raise it to $9 billion.) NIOC was said to have issued the warning on July 1 saying “if India did not find a way to pay the price of the oil it has purchased from Iran over the past two years, Iran will stop sending more oil to India as of August 2011.” The Wall Street Journal also carried a report on this warning. [ix] What was more significant was its reference to Indian refineries making efforts to secure oil from other sources like Abu Dhabi, Saudi Arabia, Kuwait, etc.

Reuters carried a more detailed report [x] on the efforts being made by India to maintain supply lines and how India saw no shortage. BPCL, HPCL and ESSAR did not receive allocation for August from Iran. However, they confirmed that they were in talks with Saudi Arabia, etc and had been assured of supplies.

Iran’s foreign Ministry spokesman Ramin Mehmanaparasat said on July 19 that his country would cut crude oil supplies to India from August in view of undue delays on the part of the Indian government to work out appropriate mechanism to settle outstanding payments for imports. This was a day before the visit of Secretary Hillary Clinton to India. Perhaps the intention was that India would take up the matter with the visiting Secretary. If so, he had miscalculated. An official accompanying Hillary Clinton said that a solution to a seven-month long payments issue between India and Iran over crude supplies was in sight, after six months of work with the United States. In fact, similar intriguing statements had emerged earlier from U.S. sources. The true import of these statements was not known then. It is becoming more and more evident now. U.S. will bring in Saudi Arabia to check the oil muscle of Iran. It suits the strategic objectives of the U.S. and the Saudi Kingdom.

In recent years, Saudi Arabia has taken steps to strengthen its political and economic ties with Asia’s growing economies. The Delhi Declaration that was issued in January 2006 after the visit of the Saudi Monarch laid down the contours of strategic objectives between the two countries as analysed in one of the SAAG Papers[xi]. This was followed up later during the visit of Dr. Manmohan Singh to the Kingdom of Saudi Arabia in March 2010 leading to the signing of Riyadh Declaration. As analysed by Aaron Mattis [xii], “These petropolitical partnerships are key to Saudi Arabia’s efforts to contain Iran’s political influence and military growth, especially its nuclear program. Through oil diplomacy, Saudi Arabia hopes to sap Iran of important regional partners, a diplomatic coup the United States and other Western national have so far failed to achieve.” And “Saudi Arabia the only country that produces more oil than Iran, is determined to eliminate Iran’s geopolitical trump card.”

It is not surprising that the U.S. has been egging on the Kingdom to pursue these objectives to neutralize Iran’s clout derived from oil supplies. At the urging of Hillary Clinton the Saudi Foreign Minister Prince Saudi al-Faisal assured China that the Kingdom would meet China’s energy needs if it stops importing from Iran.

Given this background, it is now easier to understand the statements the State Department official made during the visit of Hillary Clinton to India. They will convince the Saudis to fill the void created by the Iranians.

The groundwork for increased supplies was indeed created by the Saudis during the last OPEC Meeting held in June. It was a momentous when Saudi Arabia was isolated. As reported by Bloomberg[xiii] it was the first time in at least 20 years of its history. The meeting ended with no decision and even the Libyan representative with its government in disarray voted against any increase in quota. Saudi Arabia was the solitary member to plead for an increase. It had good economic rationale such as that higher prices would depress growth and demand for oil. More importantly, it was keen to fulfill its strategic objectives to ensure supplies to countries like India subject disruption threats from Iran. For the U.S. there is the additional objective: its own attempts to stifle Iran’s economic capacity will not be achieved unless adversely affected countries get their energy needs vital for their growth and survival.

Perhaps, Saudi Arabia has acted at the behest of the U.S. It is difficult to assess how long this alliance with Saudi Arabia will last. Given the disturbed conditions in the Middle East and the other vulnerabilities of the Kingdom, it may offer temporary relief. However, it drives us deeper into the U.S. fold.

(The writer is a Former Joint Secretary, Ministry of Finance, Government of India)

[i] Change in payment procedure of Asian Currency Union to Supplies from Iran: Implications at http://www.southaisa analysis.org/papers44/paper4328. More on Change in Payment Procedure of Asian Currency Union to Supplies from Iran: Implications at http://www.southasianalyisis.org/papers44/paper4338.html.

[ii] Shebonti Ray Dadwal and M. Hahtab Alam Rizvi: US Sanctions on Iran and tier Impact on India, June 21, 2010, IDSA Issue Brief

[iii] Jo Becker, US Approved Business with Blacklisted Nation, New York Times, December 23, 2010.

[iv] Kenneth Katzman, Iran Sanctions, Congressional Research Service Report, June 22, 2011.

[v] Patrick Clawson, Escalating sanctions on Iran, June 3, 2011 at http://iranprimer.usip.org/blog/all/Patrick Clawson

[vi] Ibid.

[vii] Subramanian, K: The sad demise of India-Iran payments system, South Asia Analysis Group, Paper No.4423, 12-Apr-2011 at http://www.southasiaanalysis.org/paper44/paper4423.html

[viii] Financial Times, China and Iran plan oil barter, July 24, 2011 at http://www.ft.com/intl/cms/s/2082e954-b604-1e0-8be4d-00144feabdc0.html.

[ix] India Looks Beyond Iran for oil, The Wall Street Journal, July 19, 2011.

[x] Reuters, UPDATE 6-Iran halts oil supply, but India see no shortage, July 21, 2011.

[xi] Kapila, Dr. Subash: India - Saudi Arabia: The strategic significance of the Delhi Declaration (January 2006), South Asia Analysis Group Paper No.1734, 14.03.2006

[xii] Aaron Mattis, Saudi Arabia’s Struggle to Contain Iran, Harvard International Review, May 1, 2010.

[xiii] Bloomberg, OPEC Oil Accord Breaks Down After Six Nations Block Plan to Boost Output, June 9, 2011.

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