By Kandaswami Subramanian
When the Reserve Bank of India (RBI) issued the circular to banks on 27th December 2010, it was more like a routine handout informing them of a change in the payment procedure governing the Asian Clearance Union (ACU). The RBI could not have realized that it had struck at the root of the ACU and nearly destroyed it. More importantly, it signaled that the Government of India was radically shifting course in its broader policy relations with Iran. Viewed historically, it is truly a dramatic, if puzzling, shift. The future course of India’s policy governing relations with Iran and those in Central Asia is in limbo. At stake are our strategic interests, especially in the energy sector.
The casual manner in which the change in the ACU mechanism was effected suggested that it was a precipitate act undertaken without any advance preparation or thinking on an alternative mechanism to ensure continuity of oil supplies from Iran. By any test, it was a grievous neglect. It threatened to disrupt oil supplies from Iran with heavy cost implications and led to weeks of uncertainty. Viewed against the fact that Iran is the second largest supplier of crude oil after Saudi Arabia, India cannot afford to trifle with Iranian supplies. The country imports 80 percent of its oil needs and gets 400,000 barrels a day from Iran. Indian refiners, mostly state-owned companies, import annually around $12 billion of crude oil from Iran.
All these payments were cleared through the ACU even after the U.S. Government and its Treasury had put through sanctions against Iran. In fact, India was the foremost beneficiary of the ACU and the wheels of trade between the two countries were oiled by it. Unlike other regional currency arrangements, ACU is a relatively minor show with no visibility. Data revealed that Iran’s trade through the ACU rose to over $12.2 billion in the first 11 months of 2010 and had risen from $7.8 billion in 2009. Most of it was on Indian account. Other members of the ACU such as Bangladesh, Bhutan, Myanmar, Nepal, Pakistan and Sri Lanka are minor partners.
When the RBI changed the procedure, it was evident from news reports that there were no prior consultations with the Iranian authorities. It led to uncertainty over future supplies by the National Iranian Oil Company (NIOC) and also misunderstanding. Al Jazeera [i] reported how an oil trade dispute between India and Iran had erupted with Tehran refusing to sell oil to India under the new rules. An NIOC source said any mechanism outside the ACU “is not acceptable” because “this exercise is in place for so many years.” “How can India unilaterally decide to halt it without any alternative mechanism? How can you demolish a building without renting out an apartment?” the source asked.
There were continuing verbal bouts, alongside negotiations, over an alternative payment mechanism. In the background of US’ Iran sanctions, the options were getting extremely narrowed down. Dollar payments and clearance through dollar by US banks were ruled out. Iranian banks and financial institutions were getting banned or shut down from several countries under U.S. pressure. They were notified as “designated” (read, terrorist!) organisations. Bilateral payment arrangements were unworkable between the two countries given the trade imbalances.
It appeared that the euro was the sole surviving option. However, it was difficult to work out a mechanism that would not violate the UN sanctions or, at the same time, fall foul of the detailed and arcane provisions of US sanctions. The Executive Order 13382 issued by President George Bush on June 29, 2005 was over-arching. These were followed up, later, by laws and regulations culminating in legislation on 24 June, 2010 which prohibited financial transactions with or through U.S. banks. The idea was to stymie Iranian capacity to undertake nuclear programs.
UN sanctions were the bottom line for all countries. The UN Security Council (UNSC) itself was riven with acute and interminable differences and there was no agreement except on a diluted framework. U.S. built its own armoury around the UN sanctions and was constantly suspicious or fearful of other countries defeating or circumventing its sanctions. There were diplomatic wrangles over the niceties and finer points of U.N. sanctions which were queered by conflict of strategic objectives between US, EU and Germany and within the EU. Against such miasma over Iran sanctions, it was not easy to find an alternative route to make payments in euro to Iran.
After a lapse of five weeks, there are reports [ii] of an agreement reached with the Iranian authorities. As Bhadrakumar [iii] explained, he was thrilled by the news that the deadlock over oil trade with Iran has been resolved. “The manner in which it has been resolved is extremely significant. …. The inconvertible truth is that oil trade with Iran is much more than a matter of crude imports. It is a strategic template of India’s foreign policy, viewed from many directions.” If we delve deeper into the issues, it is difficult to share the optimism. It has to be weighed against the circumstances under which the ACU was terminated and the stability and sustainability of the new mechanism.
The ACU was established in 1974 as a result of the initiative taken by the United Nations Economic and Social Commission for Asia and the Pacific (ESCAP). The idea was to promote cooperation between the countries in the region. It also provided for a payment system to clear trading among its members. A regional monetary account, the Asian Monetary Unit (AMU) was created for settlement of trading transactions. Unfortunately, the idea of a regional unit did not take off and AMU came to be equated with euro or dollar as ACU dollar or ACU euro. The accounts were maintained by respective central banks with the headquarters in Tehran. Provision of liquidity to members was the primary role. Those were the years of extreme foreign exchange stringency and liquidity was vital to maintain trade flows.
In the early years of the ACU, there were great expectations over its role to promote regional cooperation. Even in later years, there was hope that it could match the Chiang Mai Initiative (CMI) of the ASEAN and play a crucial role on currency issues. India played a key role in the ACU and topped the turnover table year after year [iv]. Its share in the volume of transactions then was 40 percent followed by Iran. There was hope that its membership would be expanded. These hopes were belied and the ACU languished. In later years, its only role was to finance India-Iran trade, especially crude oil supplies. This came about in response to the increasing vehemence and widening of U.S.-Iran sanctions and the restrictions imposed on U.S. banks to handle Iranian trade directly or indirectly. Iranian banks, state-owned or otherwise, came to be ‘designated’ and/or closed down.
Until January 2009, the ACU could deal in dollars. With the increasing severity of US sanctions and with the US Office of Foreign Assets Control prohibiting all US dollar transactions, directly or indirectly involving Iranian banks and companies and also the settlement of third country trade transactions, Iranian entities were denied access to the US financial and commercial system. To get over the roadblocks, the RBI issued a circular on December 26, 2008 permitting settlement in either dollar or euro. The net result was that after 1st January 2009, euro remained the only currency to pay for Iranian supplies and the ACU the only conduit to maintain the flow of India-Iran trade, i.e. crude oil supplies.
In continuing with the ACU, there was no violation of UN sanctions inasmuch as those sanctions exempted oil supplies. This was the basis on which Russia and China supported the US resolution before the UNSC. Moreover, ACU was an entity coming within the UN system and could not be ‘designated’ as ‘terrorist’ under any national law. Further, all transactions were undertaken by the respective central banks and not private agencies outside government. India could well have defended its reliance on the ACU, particularly in the context of its dependence on the ACU mechanism to finance Iranian crude oil supplies and to meet its energy needs. Other countries like Brazil and Turkey had resisted US pressures under similar circumstances. China, with its P-5 status and economic clout, could set the terms of sanctions in the UNSC and safeguard its interests. It continues to make large value investments in the energy sector in Iran.
Getting back to the ACU story, the ACU has been under attack from the U.S. Treasury for a long time. The Treasury took the view that the ACU was being abused by Iran and some other countries to skirt sanctions. In a vitriolic piece in The Wall Street Journal [v] a former Treasury Official categorized ACU as a money laundering and terrorist financing outfit which had escaped the attention of the Treasury. He referred to the manner in which Iran financed its trade and how more than 50 per cent of ACU turnover was on Iranian account. He exhorted thus: “The U.S. government may want to make clear to both India and the ACU that helping Iran circumvent sanctions has consequences.” (Emphasis added.) He went on to urge that the U.S. should designate the ACU as “a primary money laundering concern” and issue advisories to other financial institutions to refrain from associating with it.
The message to India was loud and clear. The Treasury and senior advisers like Lawrence Summers having special relations (chums on back-slapping terms exchanging e-mails on high policies!) with their counterparts in India like Montek Singh Ahluwalia would not have kept quiet.
In no time, The Wall Street Journal greeted India’s move [vi] as “India has tightened the web of sanctions around Iran by barring Indian companies from a range of deals transacted through a key trade-finance clearing house.” It referred to the US allegations that “firms are dealing through their central banks with blacklisted companies such as firms owned by Iran’s elite Revolutionary Guard.” It also explained that “The U.S. Treasury has regularly raised the issue with India for more than with a year” (emphasis added) and how these “accelerated after President Barack Obama’s visit to Indian in early November when he endorsed India’s bid to become a veto wielding member of the U.N. Security Council and to join the Nuclear Supplier’s Group.” Some analysts described India’s move as an advance payment to prove its ‘responsible’ behavior to become a permanent member of the UNSC!
The response of the U.S. Treasury to the RBI circular was instant. In a statement to The Wall Street Journal [vii] Stuart Levey, the Treasury Department’s point man on Iran sanctions, said, “This is a significant action by India.” He went on to add, “The latest RBI move will make clear to Indian companies that working through the ACU doesn’t necessarily mean an Iranian counterpart has an international seal of approval.” This was travesty of truth – rather, the U.S. was raising ghosts and knocking them down. Sadly, India had succumbed to U.S. pressure.
It is unclear when and why India decided to shift gear. For years, Indian policy has been to cultivate Iran and deepen relations with it on all fronts, including military. We have stepped up investments in the energy sector and these were done within the permissible limits after the U.N. sanctions were imposed. The policy was to use Iran as the gateway to Central Asia for oil strike oil sources and also to counter China’s expansion in the region. For some years the government was working out the intractable contours of the IPI pipeline project.
India has been a longstanding and adamant supporter of states’ rights-including Iran’s – to civil nuclear energy and has always pushed for talks between the West and Iran, rather than sanctions. In the earlier meetings of IAEA, it voted against U.S. proposals or abstained. However, with the Indo-U.S. Civil Nuclear Agreement taking priority in its longer term strategies, other priorities seem to have taken hold. IPI has been abandoned and TAPI is the newly adopted baby. [viii] The change of course is diametrically to the policies pursued in the past.
Even as recently as July 5, 2010, Nirupama Rao, Foreign Secretary, made a very important speech on India-Iran Relations at the “IDSA-IPIS Strategic Dialogue: An enduring relationship” [ix] at the Institute for Defence Studies and Analyses. As she described: “Iran is a country extremely important to India from the perspective of energy security. There is a natural complementarity between the needs of energy hungry India which hopes to grow at a rate of 8-10% in the coming years and Iran which is home to third largest proven oil reserves and second largest gas reserves. Iran is not only located relatively close to India permitting transportation of oil and gas at relatively low cost over sea as well as land, it also has the potential of being a transit country for supply of third country energy to India given its increasing links in this field with the landlocked countries of Central Asia.” She highlighted the “unique” civilizational ties and “the instinctive feeling of goodwill” between the two countries. She explained how ties with Tehran were a “fundamental component” of Indian foreign policy and how there had been a “convergence of views” on important policy issues.
Referring specifically to Iran sanctions she added, “We are justifiably concerned that the extra territorial sanctions recently imposed by individual countries, with their restrictions on investment by third countries in Iran’s energy sector can have direct and adverse impact on Indian companies and more importantly on our energy security and our attempts to meet the development needs of our people.”
It was clear that here was uneasiness over Iran sanctions, especially over its adverse impact on India. There were reports that the Ministry of External Affairs was prepared to work on “creative mechanisms” [x] to get over U.S. sanctions. The mechanism, among others, included the formation of a joint consortium with companies from Russia, China, Kuwait, etc. so as to make it difficult to single out countries or firms and to create new corporate bodies with no financial ties to the U.S. or EU to insulate them from any retaliation from the West.
In a paper [xi] titled “International Sanctions on Iran and Way Forward for India-Iran Relations,” the Ministry of External Affairs wrote: “Political engagement with Iran, while of great importance, may not be sufficient to ensure that our interests are protected. Economic engagement with Iran is also necessary and would help us in promoting our energy security, connectivity and opening of new markets, and to underpin our political objectives.” The paper went to express the fear that China might “step into the vacuum created by the exit of western and other companies” following the latest round of sanctions.
Viewed from the other side of the Atlantic, India’s growing relations with Iran led to strains in the India- U.S. relations. As an analyst at the Center for Strategic & International Studies (CSIS) observed, “The intersection of Iran’s controversial nuclear program, the West’s persistent efforts to slow it and India’s interests in maintaining economic ties with Iran have made for complicated relationships between the three.” [xii] This growing relationship was a source of consternation in Washington. There were reports that senior members of Congress had signaled to Prime Minister Dr. Singh way back in 2007 that the final approval of a civilian nuclear cooperation with the U.S. was dependent on New Delhi’s stance on Iran’s nuclear program.
By August 2010, strategic analysts and India watchers in the U.S. had begun to predict that India might “break ranks on Iran.”[xiii] The report noted that if India is pressed by Washington and Brussels, New Delhi would acquiesce. “It is unlikely to follow the lead of Brazil and Turkey and cast a ‘no’ against efforts short of war to compel Iranian compliance with the Nuclear-Non-Proliferation Treaty. After all, India craves international recognition and influence as a world power…. It does not want to sully that image by aligning with a nuclear (outcast) (a contemptible U.S. abuse replaced) like Iran.” It recognizes that politically India would have to walk the delicate lines and economically it would be a difficult decision. The U.S. will therefore have to compensate India through offers of extra trade, finance, etc. to fill the void created by Iran sanctions.
It is evident that India was driven to choose between Washington and Tehran. And “New Delhi finally ceded to Washington’s pressure.” As one report said, “It is hard to pinpoint exactly what may have finally driven New Delhi to take the plunge although there are several possible factors.” [xiv] One factor mentioned is China’s nuclear deal with Pakistan. The other is Pakistan’s $7.6 billion natural gas deal with Iran. And, finally, China’s growing investments in the Iranian oil sector alluded to in the MEA Paper referred to earlier. From a longer-term geo-strategic view, a three-way alliance between China, Pakistan and Iran can be a threat and isolate India in the region. Add to this brew the Afghan phantom and the choice gets more convoluted. In short, India had to make a choice between IPI and TAPI. And India has opted for the TAPI.
Badrakumar [xv] has captured the significance of TAPI and the U.S. initiative in promoting it. As he says, it “holds the key to modulating many complicated issues in the region.” It is a breakthrough in the longstanding efforts U.S. efforts to access fabulous mineral wealth in the Caspian and Central Asian region. Afghanistan gets its share of development benefits. It can meet the energy needs of India and Pakistan. U.S. hopes it can promote India-Pakistan amity. As he sums up, “Its primary drive is to consolidate the U.S. political, military and economic influence in the strategic high plateau that overlooks Russia, Iran, India, Pakistan and China.” When TAPI fructifies, it brings about a newer alliance in the region. It would counter with full force the influence and expansion of China in the region. India by itself cannot put through an alliance and can ill afford the rise of China in the region. Perhaps, India decided to take the plunge and signed the TAPI agreement on December 11, 2010.
It is significant that it was signed within a month after the visit of President Barack Obama to India. There would have been diplomatic exchanges at the highest level resulting in policy decisions and changes. It is not an accident that the RBI circular terminating ACU mechanism was brought about on 27th December, i.e. two weeks after the TAPI agreement. Events flow in succession!
The change in course and the new direction our policy takes in the region have to be tested in the light of rapid developments that unfold in the coming months. It is not clear how the eruption in Egypt and some other countries change the equilibrium. However, the change indeed is radical, bordering on the historic, and amounts to backtracking on policies pursued heretofore. It is a logical consequence of the U.S. tilt in our policy after the signing of the civilian nuclear agreement. It is an attempt to join a new coalition to check the rise of China – not only in Central Asia but also in the South Asia region. Politically, it will draw the ire of nationalists and intellectuals, especially the Leftists. Economically, it is a gamble and depends on many imponderables.
There are doubts whether the new mechanism of using a German bank to make payments in euro on a large scale in a continuing manner will work and whether we can ride on German shoulders forever. There are uncertainties created by changes in German policy towards the U.S. and, in particular, Iran sanctions. There has been a long standing dispute between Germany and the U.S. over the role of EIH. We will analyse these issues in the next part of this paper.
The writer is a Former Joint Secretary, Ministry of Finance, Government of India)
i India succumbs to US pressure: Iran halts oil sales to India, Al Jazeera, 30 December 2010.
ii India, Iran resolve crisis, The Hindu, 04/02/2011.
iii Indian diplomacy scores hat-trick, Indian Punchline at http://blogs.rediff.com/mkbharakumar/2011/02/04
iv BIS Review 31/2003, Speech of Bimal Jalan, Governor of the Reserve Bank of India, at the 32nd ACU Board Meeting, Bangalore, 16 June 2003.
v How Iran Skirts Sanctions, Avi Jorish, The Wall Street Journal, November 4, 2009.
vi India Joins U.S. Efforts to Stifle Iran Trade, The Wall Street Journal, December 29, 2010.
viii U.S. brings Silk Road to India, M.K. Bhadrakumar, The Hindu, 24/12/2010.
x http://www.expressindia.com/latest-new2s/To-engage-Iran-India-looks to-beat-UN-sanctions by being creative-/655365
xii India-Iran-U.S. Relations, Anna Newby, CSIS, Aug. 11, 2010. http://csis.org/print/26652
xv Ibid. Footnote viii