India is developing the Chabahar port in Iran to improve connectivity with Afghanistan and Central Asia.
The direct impact will be felt in costlier oil imports for India. It will also damage the country’s trade balance and may force the government to bring back subsidies on petroleum products like diesel and petrol, which could throw India’s fiscal and trade deficit out of control.
On Tuesday, May 8, US President Donald Trump fulfilled an election promise that will end up costing India billions of dollars in costlier oil imports. This burden will eventually fall on consumers, in the form of higher prices and on taxpayers, in form of higher subsidies on critical products.
Trump ‘tore up’ the Iran nuclear deal, also known as the JCPOA (Joint Comprehensive Plan of Action). In the JCPOA, which was concluded in July 2015 between Iran and six global powers — US, China, Russia, France, UK and Germany — Iran agreed to restrict its nuclear programme in return for relief from crippling economic sanctions. Even while the JCPOA was in force, Iran continued to remain under US sanctions which imposed significant constraints on its economy, some of which date back to the 1979 Islamic Revolution, when the US embassy staff were taken hostage. The US state department subsequently designated Iran as a state sponsor of terror since 1984. In November 2016, the US Congress voted 419-1 to reauthorise the 1996 Iran Sanctions Act for 10 years. In October 2017, the US Congress voted 423-2 authorising the US president to impose new sanctions on Iran for testing ballistic missiles. Considering those lopsided Congressional votes, a US rethink on restoring Iran sanctions appears unlikely in the near future. So India will have to live with this reality for the foreseeable future.
What has the JCPOA done?
Iran has massive reserves of oil and natural gas, but produces much below its potential because sanctions have kept away investors and customers. With JCPOA in force, Iran could freely export its petroleum and increase its oil production by 1.1 million barrels/day from the 2014 level, to 3.8 million barrels per day in early 2018. This was one of the factors responsible for bringing down the price of oil from over $100/barrel in 2014 to below $50/barrel in the subsequent years. This was an enormous relief for India, which imports 1.4 billion barrels of oil annually — and saved over $70 billion on its annual oil import bill in 2015-17.
What the US withdrawal means?
Trump’s decision will bring petroleum-related transactions with National Iranian Oil Company (NIOC) and financial transactions with the Central Bank of Iran under US sanctions in 180 days (by November). This once again makes it tougher for buyers such as India to pay for Iranian crude oil — as happened in the past. Iran may be forced to cut down its oil production — as it had to do pre-2015, hurting global oil supply. In an oil market with increasingly tight supply, this is sure to push up prices. The Brent price, a widely used benchmark, crossed $77/barrel on May 10 — up by more than 50 per cent in one year.
The reimposition of sanctions on Iran is one of the factors pushing up prices and contributing to this unhappy situation. For India, this is the perfect storm. Low global oil prices of the past few years cut investment in developing new oil fields, reducing oil supply. Simultaneously, poor economic policies have pushed major oil exporter Venezuela to the brink as oil production is down by 40 per cent. Adding Iran sanctions to this mix compounds the problem.
How will India be affected?
The increase in oil prices will hurt India considerably. During 2016-17, India imported oil at $47.6/barrel. At current prices, India will have to spend at least $70/barrel — an extra $30 billion headed out of India annually. It will damage the country’s trade balance, and may force the government to bring back subsidies on petroleum products such as diesel and petrol, as happened from 2004-14. This can throw India’s fiscal and trade deficit out of control. However, these amounts are too large to be solely absorbed by the government or its oil companies. Higher price of oil will also trickle down to the end consumers — making diesel, petrol and air-travel more expensive. Diesel is also the primary fuel for transport in India, so an increase in diesel prices will also impact other commodities where transport costs are significant.
India is developing the Chabahar port in Iran to improve connectivity with Afghanistan and Central Asia. With renewed sanctions on financial transactions with Iran, the Chabahar port effort will slow down and impact Afghanistan’s stability. Chabahar port is also the hub for the International North South Corridor that India wants to develop for better connectivity with Central Asia and Russia, and as a counter to China’s Belt & Road Initiative. With Iran under sanctions, INSTC too will be affected.
What can India do?
India cannot walk away from its commitments to an important regional partner on account of US sanctions. This is a re-run of US sanctions on Russia; and a blow to India, which relies on Russia for high-tech defence hardware and technology.
How can India safeguard its own interests?
In the past, India bypassed the sanctions on Iran partly by moving the oil trade to Indian Rupees. This trade was handled by the government-owned UCO Bank, which has no overseas exposure, and was less vulnerable to US sanctions. Money owed to Iran was held in a Rupee account with UCO Bank and used by Iran to purchase goods from India. New Delhi can revive this arrangement.
India must also show its resolve by moving ahead with proposed investments in Iran. Iran has the world’s largest reserves of natural gas, which cannot reach energy hungry markets such as India because of sanctions and adverse geography. One way to use this natural gas is to convert it into fertiliser, which can be transported easily. India’s state-owned Rashtriya Chemicals and Fertilizers had proposed earlier to set up a fertilizer plant in Iran. This project can help Iran find markets for its gas and India to address its need for food security. Simultaneously, India also needs to work on long-term programmes to curb its dependence on imported oil.
Amit Bhandari is Fellow, Energy and Environment Studies at Gateway House, a foreign policy think tank based in Mumbai, while Kunal Kulkarni is a lawyer and senior researcher at Gateway House