The Sad Demise Of India-Iran Payments System – Analysis

By Kandaswamy Subramanian

The system which was in force for over two decades facilitating payments for supply of crude oil from Iran to India was precipitately destroyed on 27th December last year. It was done by the Reserve Bank of India (RBI) through a seemingly routine circular[i] to banks. It stipulated “that all eligible current account transactions including trade transactions with Iran should be settled in any permitted currency outside the ACU mechanism.” It was truly a burial of the ACU. The RBI could not have done it on its own without instructions from the Government of India. And, true to style, the government never owned up responsibility.

The net effect of the RBI circular was to close down the Asian Currency Union (ACU) which has been in operation since 1974. It was a part of the U.N. system coming under the umbrella of ESCAP. The circumstances leading to the change in payment procedure were never known or disclosed. However, Wikileaks and several other reliable sources did establish that the step was taken by the Government of India under pressure from the U.S., especially its Treasury. Major papers like the Wall Street Journal, New York Times, Financial Times of London, etc. were jubilant and celebrated the gesture of India to cooperate with the U.S. in curbing Iran’s financing of its nuclear program. Not embarrassed over such evidence, available in abundance, spokespersons of the government of India continued to maintain that India acted on its own and not under pressure from U.S.

It was also evident that there were no prior consultations with the Iranian authorities before taking the step. When it came to the notice of Iranian authorities such as the National Iranian Oil Company (NIOC) they expressed dismay or consternation over the Indian move. There was sudden fear or panic about supply disruption and intense debates commenced to seek alternative payment arrangements to maintain the continuity of supplies. Truly, it was a grievous neglect; and efforts should have been made well in advance to install an alternative system before disbanding the ACU.

By any test, the problem was important and urgent considering that Iran is the second largest supplier of crude to India next to Saudi Arabia. India imports 80 percent of its oil needs, getting 400,000 barrels a day from Iran. Iran accounts for 15 percent India’s energy imports and the annual bill is estimated at $12 billion. It was to Iran’s credit that notwithstanding payment disruption, it continued to maintain supplies alongside negotiations for a new payment system. It took more than two months of negotiations for a new system to be worked out.

On February 4, there were news flashes about a new payment system. A breakthrough was reported in India-Iran negotiations.[ii] Reports suggested that the decision had been taken at a high-level meeting attended by National Security Adviser Shiv Shankar Menon, Foreign Secretary Nirupama Rao, Economic Affairs Secretary R. Gopalan and Petroleum Secretary Sundereshan. The decision was to make euro payments to Iran through the Hamburg-based Europaisch-Iranische Handels Bank A.G. (EIH).

The system as proposed was simple and neat. Indeed, it sounded clever and was deemed a diplomatic tour de force. Badrakumar, a former diplomat and one of our leading strategic analysts, described it as “a diplomatic feat.”[iii]

The new system was manual perfect. The National Iranian Oil Company (NIOC) handles its transactions with the EIH. The EIH, in its turn, has a tranche with the Deutsche Bundesbank (DBB) which is Germany’s central bank. The State Bank of India (SBI) which handles oil transactions on behalf of state-owned and private oil companies in India will make payments in euro to the DBB on behalf of the NIOC. SBI will also provide certificates about end use of payments so as to comply with the legal requirements of UNSC sanctions against Iran. The DBB will receive the payments on behalf of EIH and EIH will pass on the credits to the NIOC.

Legally, the scheme was beyond reproach. The SBI deals legally with the DBB which is the central bank of Germany. The DBB, as a central bank, has long standing relations with the EIH. The payments are for oil supplies and such supplies are not attracted under the UNSC or EU sanctions. Further, they are also supported by certificates from the SBI regarding end use. What more can the U.S. Treasury require?

There was great relief in India among the oil circles when this payment procedure was announced. Iranian supplies were resumed and the backlog was also cleared. It seemed that a hurdle had been crossed, thanks to our diplomatic skills. The U.S. has been outwitted and it would be “business as usual.”

Unfortunately, this was not to be. Ghosts from the U.S. continued to haunt India. Surprisingly, the authorities in India in the concerned Ministries like the External Affairs, Finance, Petroleum & Natural Gas and the Reserve Bank of India had underestimated the determination and tenacity with which the U.S. would hunt issues concerning Iran sanctions. They would charge the parties mindlessly of lacking in good faith, regardless of legal norms and niceties. The normal American approach of working with “rules-based systems” as in the W.T.O., IMF, World Bank, etc. is given the go-by when they decide to hound ‘suspect’ agencies. Unfortunately, the EIH was one such. When the wise men (and one woman!) of India met and hit upon the idea of using the EIH as the alternative route to pay NIOC, they did not provide for this imponderable factor.

In two of my earlier articles[iv] on this subject, I have analysed at length the related issues and doubted the wisdom and longer term sustainability of the revised payment system. After giving an exhaustive background to the role which the E.I.H. plays in Germany and the relentless efforts made by the U.S. authorities for its closure, I had said, “It would be evident from the above narration that EIH and its future hang by a thread. It is unclear how strong the thread is and how long Germany and the EU would hold on to it.”

I had also argued that use of EIH to finance our oil supplies “makes us lean heavily on German shoulders.” Our energy strategy becomes hostage to changing and unpredictable U.S.-German foreign policy relations which are already under strain over many issues, especially Iran sanctions. I wondered how long Germany could undertake a role much to the growing annoyance of the U.S.

Sadly, the demise of the new system has come about sooner than I had thought. It was still born and had not even started breathing. It did not even complete two months and was snapped abruptly on 4 April, 2011. Reuters reported that German Chancellor Angela Merkel had “intervened to stop billions of euros of Indian oil payments from reaching Iranian accounts via Germany.”

It was relying on Handelsblatt, a German business daily, which citing government sources said, “Germany will no longer authorise its central bank, and the Bundesbank to clear the payments headed to Hamburg-based EIH- a bank under the U.S. but not EU sanctions.” Most of the major papers have carried reports about this abrupt closure of the EIH route for India’s payments to Iran. While German, European and Israeli sources suggest that Merkel had intervened to stop the arrangement, reports by Reuters[v] and Financial Times[vi] suggest, “India has agreed to stop funneling payments for Iranian oil through banks in Germany in a move Berlin hopes will ease US pressure for it to take more drastic steps, German officials say.” They also added that talks between Germany and India had produced a pledge from New Delhi that this practice was now ‘obsolete’ and India would seek a more permanent solution! This is the flimsiest fig leaf that covers our embarrassment. Leaving aside the jibe, how did the sudden volte face come about? Thereby hangs a tale of German foreign policy and the compulsions of the coalition politics.

Given the history the EIH, especially the antipathy of the U.S. and its relentless efforts to close it down with a view to strangulate Iran’s finances, it was unrealistic to have presumed that the U.S. Treasury would wink at an arrangement which circumvented Iran sanctions, directly or indirectly. Further, the amount involved is large and recurring in nature and cannot be hidden from scrutiny for long. Added to the U.S. pressures were those from Israel and the Jewish press (lobby!) which was shrill in demanding the closure of the EIH.

Germany has special relations with Israel and makes extra efforts to deepen its relations with it. While bowing to Jewish groups, it beckons to the historical baggage (guilt!) and tries to make amends.

Lastly, the coalition politics in Germany is in a flux and the Christian Democratic Union (CDU) is losing its dominance. The Free Democratic Party (FDP), a junior partner having a say on foreign policy issues, was getting marginalized. The confluence of these currents will atrophy Merkel’s determination to defend the EIH against U.S. onslaughts.

News about EIH route for Indian payments to Iran leaked out very soon. When reports of the arrangement came out in the open, it caused a furore and waves of misgivings. The Jerusalem Post[vii] reported: “New disclosures earlier this week have catapulted the scandal-plagued Hamburg-based Iranian bank …EIH, the German Foreign Ministry and Germany’s Central Bank … into a new controversy about Germany circumventing sanctions against Iran’s nuclear and missile programs.” Questions were raised with all the concerned government agencies by civil society organisations.

One report in Spiegel Online suggested that the payment deal was connected to the release of two German journalists from an Iranian prison in February after they had been detained as spies since October, 2010. German Foreign Minister Guido Westerwelle flew to Tehran to meet the Iranian President Mahmoud Ahmadinejad in the first bilateral encounter to return the journalists after ‘difficult’ negotiations. In return, he is alleged to have ‘rubber stamped’ the payment procedure.

It is difficult to verify this report. However, it was known that Westerwelle, as foreign minister, had taken several decisions which were controversial. The major one relates to Germany abstaining in the vote on the UNSC Resolution 1973 concerning ‘no fly zone’ in Libya. Surprisingly and to the dismay of its European allies, Germany voted with China and Russia. It was the first ever post-war split in the European ranks.

The New York Times carried a report[viii] on 31st March, 2011 which created a stir in diplomatic circles. It may be recalled that a report on the role of the ACU carried by the Wall Street Journal[ix] led, among others, to intensify U.S. pressure on India to wind it up. The NYT report detailed the efforts made by the U.S. Treasury to shut down the EIH. Treasury had already added it to the list of ‘designated’ banks whose activities are blocked. Two shareholders of the EIH viz. Bank Mellat and Bank of Industry and Mine had also been designated. The U.S. posture is that once an agency is ‘designated’, thou shalt not have any dealing with it. It is trying to enforce this unstated law with its hegemonic role in the global financial system.

The US Treasury was forthright. It said, “Treasury is concerned about recent reports that the German government authorized the use of E.I.H. as a conduit for India’s oil payments to Iran.” It went on to add, “Treasury will continue to engage with both German and Indian authorities about this situation, and will continue to work with all the allies to isolate E.I.H.”

There is evidence that at least until end March 2011, Germany stood by the E.I.H. In replies to its critics, a spokesman of the German Finance Ministry said, “Regarding the alleged involvement of the Bank in financing the nuclear and missile programs of Iran, I can say that the bank is under strict control and constant supervision by the German regulatory authorities.”

The Bundesbank said it had no choice. As it explained, “If an account holder of the German Bundesbank instructs it to carry out a payment that is allowed by the regulations of the European Union, the Bundesbank is obligated to carry out the transaction.” It went on to elaborate how individual transactions are monitored.

German Foreign Ministry took the line that the EIH is not listed under the E.U. sanctions. A spokesman for the Ministry said on 28th March, during a press conference in Berlin, “Therefore there is no legal basis to block the business activities.” It is also significant that the German Foreign Minister had replied to U.S. Senators. His reply “emphasized that the European-Iranian Trade Bank is strictly manipulated by the German bank supervision authorities, and the federal government actively pursues any evidence of activities relevant to proliferation relating to Iran. This is true of all business in Germany, including the European Trade Bank.”

All support to the E.I.H. and the resolve to stand by it seem to have evaporated in the first week of April. What really happened around that time? The shocking answer is: Coalition politics!

Local elections in Germany in two states (Lander) – Baden Wurttemberg Rhineland-Pfalz- have led to tectonic changes in German politics, especially over government policies. The CDU has lost power in the former after 58 years and its future and ability to hold on to power at the federal level is much in doubt. Angela Merkel is in a position similar to that faced by Gerhard Schroder in the summer of 2005. The crisis has deepened with the fall of the FDP and, to add her misery, the rise of the Green Party. In particular, the rise of the Green Party has signaled radical changes and is already impacting on policies such as on nuclear energy. In the wake of the Japanese nuclear tragedy at Fukushima, Angela Merkel has stalled the German nuclear power option and declared a moratorium on nuclear power. In the coming months, there could be other changes of major import.

The most important development in relation to this EIH issue is that the FDP has been routed and Mr. Westerwelle, foreign minister, has declared his resignation as chairman of FDP. Though he continues as Foreign Minister, there are demands for his resignation from the post. He may not remain in that post for long.

As we had narrated in our earlier articles, it was the FDP which had stood by the E.I.H. as a vehicle to maintain trading relations with Iran. FDP derived its support from a class of small and medium sized companies which continued to deal with Iranian companies. With the rout of the FDP in local elections, the “dream coalition” of CDU, CSU and FDP at the federal level is in disarray. As a blog in Foreignpolicy[x] puts it, “Accused of German equivalent of pork barrel policy and facing personnel setbacks on all levels…the government stumbled along.”

The fall of Westerwelle -the FDP- in the local elections has created new challenges for Merkel. She has already commenced appeasement of the rising Green Party by her decision on nuclear power. As explained earlier, Westerwelle was responsible for controversial decisions in foreign policy. The most important is the one concerning Germany’s policy towards U.N. sanctions on Libya. Approval for EIH arrangement is also connected with him. The question is: How long will Merkel continue with those decisions?

The issues are too complex to be explained in this paper. It may require a separate paper. Therefore, we refer only to the broader compulsions underlying the policy. Though Westerwelle’s decision to abstain on UNSC Resolution 1973 has split the European ranks and led to an acrimonious debate in Europe and Germany, it was a decision which seeks to advance Germany’s national interests. Initially, he received some support for his stance. Chancellor Merkel, Defence Minister Thomas de Maiziere (both CDU) and former Foreign Minister Frank Walter Steinmeir (SPD) lent support. As explained by World Socialist Web Site[xi] “The military intervention in Libya was regarded by leading German business and foreign policy circles as a unilateral French initiative and an attack on Germany’s extensive interests in the region.”

In recent years, Germany has been trying to promote its economic interests in the Middle East and North Africa. It is making extra-ordinary efforts to move away from dependence on Russian sources and to diversify its sources. Libya is Germany’s fourth most important oil supplier. Algeria is eighth in place.

These efforts are meeting with intense competition from its neighbours, especially France. Fortress Europe is no longer a guarantee for German growth. The European Union is falling apart and the arguments about euro’s strength ring hollow. There are more costs, in the form of bailouts of members, falling on Germany as a leading member of the EU. It is no wonder it has given rise to a major dilemma.

World Socialist Web Site captured[xii] the situation graphically saying: “The dilemma that led him (Westerwelle) to abstain in the Security Council and which has haunted German foreign policy since the founding of the country 140 years ago still remains. Boxed into the narrow European nation-state system, German capitalism has always sought access to raw materials, energy resources and markets. In so doing it has inevitably come into conflicts with its neighbours.”

Chancellor Merkel has to live with this historical dilemma and face her European friends like Sarkozy. European ranks are divided and the U.S. has abdicated its leadership. It is not clear how long the unsettled conditions will continue in the Middle East and North Africa and what the future course will be. Till then, the internal bickering within Europe and the E.U. will continue.

There is a final twist. With Westerwelle out of the reckoning, it was easy for Chancellor Merkel to snap the EIH route for India. It will appease the Israelis and the Jewish lobby. It will be buy peace from the U.S. on the sanctions front. However, Merkel and her successors will have to carry the battle within Europe over the resources in the Middle East, North Africa, Asia or wherever. It is not the end of History but the beginning of another.

For India, the decision about the EIH is shocking. It creates new uncertainties and costs. Unlike China, India has no options. China arranges Yuan swaps for the purchase of oil as also sale of petro products. It can operate outside of the dollar and euro and is making efforts to internationalise the Yuan. It does not accept the U.S.’ sanctions regime and insisted on its right to deal in oil with Iran. It can resist U.S. demands.

India is unable to adopt the China model as our trade is not balanced and, except for tea and some commodities in small quantities, we have nothing much to offer in return. As repeatedly explained in these articles, the U.S. is able to exploit its hegemonic status in the global banking system and stop all remittances. It has also assumed unilateral powers to ban and/or fine the banks of other countries which deal with Iran’s banks. The Indian banking system cannot rid itself of its involvement with U.S. banks. The SBI can narrate the travails it faced some years ago when it financed covertly certain dual use items of import into India.

A shortfall of imports estimated at 15 percent of our total requirements will have to be met from non-Iranian sources. We will be driven to the spot market. At a time when the crude prices are rising precipitously due to the Middle East crisis, the increase in spot rate will be a few dollars more. This may create a major crisis – both in terms of energy shortage and inflation. It is a grim scenario. It is not clear whether policy makers in North and South Blocks are seized of it.

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[i] RBI circular No. RBI/2010-11/335 dated December 27, 2010 at http://www.rbi.org.in/scripts/html

[ii] http://www.thehindu.com/2011/02/04/stories/2011020465551400.htm

[iii] Indian diplomacy scores hat trick, Indian Punchline at http://www.blogs.rediff.com/mkbadrakumar/2011/02/4.

[iv] Change in payment procedure of Asian Currency Union to Supplies from Iran: Implications, at

http://www.southasiaanalysis.org/papers44/paper4328. More on Change in Payment Procedure of Asian Currency Union to Supplies from Iran: Implications at http://www.southasiaanalysis.org/papers44/paper 4338.html.

[v] Iran-India oil trade halted in Germany-official UPDATE1, Reuters, April 6, 2011.

[vi] India to stop paying through German bank, Financial Times, April 5, 2011.

[vii] German gov’t, Iranian bank, EIH circumvent sanctions, The Jerusalem Post, March 31, 2011.

[viii] U.S. Presses Germany to Block Indian Payments to Iran for Oil, The New York Times, and March 31, 2011 at http://www.ntimes.com/2011/03/31/business/global/31ht/iranoil31html.

[ix] How Iran Skirts Sanctions, Avis Jorish, The Wall Street Journal, November 4, 2009.

[x] http://europe.foreignpolicyblogs.com/2011/03/28/germany-post-baden-wurtemberg

[xi] The resignation of Guido Westerwelle as Free Democratic Party chairman and German Vice Chancellor, World Socialist Web Site, Ulrich Rippert, 6 April, 2011 at http://www.wsws/org/tools/index

[xii] Ibid