Trade Winds July 2015

TRADE WINDS July, 2015

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July Edition

Dear Reader, Trade Winds is an initiative by the student community at Indian Institute Of Foreign Trade to provide an enriching and learning experience for everyone. With articles by our students, we offer an opportunity for budding MBAs to express their thoughts about various issues..

IIFT has been the premier B-school in India for disseminating trade knowledge and has been involved in trade policy formulation for India. Thus the views of faculty, alumni and industrial personalities along with the students is aimed at pushing the limits higher.

Along with the focus theme on Africa, this editions focuses on India’s relations with the US. Different perspectives about the importance of trade and RTA are also included along with an analysis of the Iran.

We, Team Trade Winds, hope to provide an enriching reading experience to all. Happy Reading!

Team Trade Winds Trade Winds, the bi-monthly magazine of International Trade Club of IIFT is the result of contribution of various stakeholders. We would like to thank all the contributors of articles and BLASH – The Trade Club at IIFT. Team Trade Winds is also involved in the fortnightly publication of the Trade Digest newsletter. The team comprises of the following: Editors: Anirudh Namboodiri, Mihir Anand MBA(IB) 2014-16

Yours sincerely, “We are planning to give more market-linked export sops to different products this time instead of incentivizing products and markets separately. We can then plan our promotion and marketing drive better. There will also be focus on promoting services exports”- DGFT

Team Trade Winds

Trade Winds | July Edition

SECTION

PAGE NUMBER

Focus Theme

4

Inward introspection

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World of Trade

10

Regional Trade Blocks

13

Country Watch - Iran

19

30

Indian Institute of Foreign Trade

Focus Theme: The Rise of Africa

Trade Winds | July Edition

Focus Theme: The Rise of Africa This special feature strives to highlight the rise of Africa as the land of opportunity. Shunned as the dark, hopeless continent once, it is now being hailed as being a potential goldmine for businesses. There is a lot of anticipation when it comes to African markets. At the same time, there is need for caution as the continent is plagued with unrest, disease and war.

Africa

By Mihir Anand MBA (IB) 2014-16

May, 2000 “Floods in Mozambique; threats of famine in Ethiopia (again); mass murder in Uganda; the implosion of Sierra Leone; and a string of wars across the continent.

The new millennium has brought more disaster than hope to Africa. Worse, the few candles of hope are flickering weakly.”

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A large middle class is emerging and is fueling the continent. Also, the commodities boom is a major driver behind the rapid growth story.

December, 2011 “Since The Economist regrettably labelled Africa ‘the hopeless continent’ a decade ago, a profound change has taken hold.”

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Indian Institute of Foreign Trade

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Focus Theme: The rise of Africa

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Major Commodities by exports

Sources: 1. The Economist, Intelligence Unit 2. GlobalPost/CIA Factbook 3. afrographique.tumblr.com Indian Institute of Foreign Trade

4. Standard Bank, Africa: BRIC and Africa

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Inward Introspection

Inward Introspection International trade will be facilitated in India only if there is coordinated approach to remove all the obstacles. Inward Introspection analyzes the current issues concerning international trade in India with an analysis and future outlook.

India-US Trade Relations: Barriers and Bridges

By Ankit Jaiswal, MBA (IB) 2014-16 India and the US, the two largest democracies of the world, have witnessed significant growth in their bilateral trade and investment relationship in the previous two decades. In the early part of 1990s, India embraced free enterprise system and started its journey to become an economic powerhouse. Now the world’s third largest economy, India has become one of the largest trading partners of the US. Currently, the two countries have a bilateral trade worth $100 bn, which shows a tremendous increase from a modest $5.6 bn in 1990. India’s major merchandise exports to the US are textiles, precious stones & metals, mineral fuel, oil, and pharmaceutical products.

Whereas, it majorly imports precious stones & metals, aircraft & spacecraft parts, machinery and electrical machinery.

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The improved relations between the two countries are signs of a changing political situation in the world

Though the growth of economic relationship between the two countries has been impressive, this has been because of a low base factor and there’s a vast scope of improving and deepening the bilateral trade and investment relationship. China, which has a comparable population to India, conducted approximately $600 bn worth of bilateral trade with the US in the previous year. Similarly, South Korea, whose GDP is 60% that of India’s, had an almost similar level of merchandise trade with the US as did India.

Indian government’s policies have been constantly held responsible by the US authorities for acting as a barrier to American investment and exports to India. There are two major areas of concern for the American

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India-US Bilateral Merchandise Trade 45000

40514

Inward Introspection

40000

41829 38416

36156

35000 29533

30000 25000 20000

21831

24073

25704 21166

18804

17682

15572

14969

21504

22105

21875

19250

17440

16441

15000 10000

7919

6109

9674

5000 0 2004

2005

2006

2007

2008

India's exports to US (US $ mn)

2009

2010

2011

2012

2013

Jan-Oct 2014

India's imports from US (US $ mn)

Source: https://www.indianembassy.org/pages.php?id=42 customs procedures, and taxes & financial regulations. Intellectual property policy is another big issue that has had a negative impact on certain industries. Studies show that if these two hurdles are eliminated, there would be a two-thirds increase in the US exports to India, and the US investment in India would approximately double in size.

One sector that has seen substantial growth in the last few years is the services sector, which grew seven-fold in the last decade. India’s services exports to the US grew by over 900 percent from $2 bn in 2004 to $20 bn in 2014.

At the same time, America’s exports to India grew by around 250 percent from $4 bn in 2004 $14 bn in 2014. Since 2006, services trade deficit of the US with India has been growing. This is in spite of the fact that the US has a positive trade surplus in services with the rest of the world. This has happened largely due to the growing stature of India as a major outsourcing destination by the US companies. American companies outsource business services to India because of lower cost services inputs which makes them more efficient and competitive, both in the US and overseas. Though concerns have been raised

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in the US that it can negatively impact their job market. For the US, the largest services exports to India have been tourism and education.

US investment in India through FDI has increased by 500 percent from $5 bn in 2004 to $30 bn in 2014. Meanwhile, India’s investment in the US increased by around 1400 percent from $400 mn in 2004 to $6 bn in 2014.

In his recent US visit, Indian Prime Minister Narendra Modi discussed various trade issues with the US President Barack Obama. The two leaders targeted a five-fold jump in bilateral trade to $500 bn and pondered on ways to boost the business environment between the two countries. Meanwhile, the Defence Cooperation Agreement between the two countries was extended by another 10 years.

The deal was to expire in June 2015 but now it will be valid till 2025. The development followed after India increased FDI cap for the defence sector to 49% from the previous 26%.

The pact was originally signed by the then Defence Minister of India Pranab Mukherjee and his US counterpart Donald Rumsfeld.

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The India-US civil nuclear agreement had hit a roadblock, when a nuclear liability law was passed by India in 2010. During their last meeting in the US, Modi and Obama stressed on their commitment to take forward the civil nuclear partnership agreement and resolve the related issues at the earliest. This is particularly very important for India in order to fulfil its energy security needs.

Recently, both sides resolved the standoff over the WTO’s trade facilitation agreement.

Initially, there were differences over public stockholding of food grains, but the US agreed to an indefinite peace clause until a permanent settlement of the issue. This development has made possible a significant global deal which is touted as the most important deal since the 1990s. It proved to be a major political victory for the current NDA government at the centre. Apart from enhancing the trade relations between India and US, the TFA when implemented, would act as a huge positive catalyst for the world trading system.

To fully tap the bilateral trade opportunities, the two nations must commit to a deadline for concluding a Bilateral Investment Treaty. It will indicate the Indian government’s support for the growing investment by the US and provide a rule-bound framework for the same. US authorities should develop a dialog with the regulators in India for stronger enforcement and protection of intellectual property rights.

H-1B visa policy should be relaxed as it can make the Indian IT services industry more efficient in providing services, thus benefitting the business environment between the two

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countries. The trade policy of the new Indian government is yet to be formulated. This provides an opportunity to the US for developing a dialog with India to examine what economic reforms can be brought in order to enhance the bilateral trade partnership. A few minor concerns, if addressed, can build a foundation for a relationship that would be mutually beneficial and will help bolster the relationship between the two great nations.

Bibliography: https://www.indianembassy.org/pages.php?id =42 http://www.brookings.edu/research/opinions /2014/09/23-india-us-trade-investmentrelationship-meltzer http://www.thehindu.com/opinion/oped/new-opportunities-for-indiaustrade/article6439226.ece http://www.businessstandard.com/article/economy-policy/modiobama-discuss-trade-us-extends-defencepact-by-10-years-114100100034_1.html http://articles.economictimes.indiatimes.com /2014-10-01/news/54516766_1_primeminister-narendra-modi-world-tradeorganisation-trade-policy-forum http://www.livemint.com/Politics/v2gAFo8ko ulnFNRr5p943O/India-likely-to-announceWTO-breakthrough.html http://timesofindia.indiatimes.com/business/i ndia-business/Indian-policies-creating-tradebarriers-US-report/articleshow/45623910.cms

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World of Trade World of Trade

An increasing globalized world was facilitated by the formation of WTO. World of Trade covers topics pertaining to WTO – issues, potential for growth, opportunities and threats.

Trade Vs GDP Trend: A troubling trajectory

By Ritwik Singh & Arpit Rathi MBA (IB) 2014-16

The historical relationship between global trade and GDP over the past years is analyzed to predict future trends

The rise in global GDP hasn’t been backed by a similar rise in trade. While the emergence of global supply chain backed by technological and policy boosts has been able to enhance trade, the subsequent emerging nature of hidden protectionism has inhibited its desired growth. Before 2008 world trade volume grew

at twice the rate of global real GDP for about 25 years but the sudden stalling of growth in trade at a slightly lesser rate than GDP has come under serious scrutiny in the world of trade.

Growth in the volume of world merchandise trade and GDP, 2005-15a Annual % change 15 10 5 0 2005 2006 2007 2008 2009 2010 2011 2012 2013

2014 2015

-5

Figures for 2013 and 2014 are projections.

Source: WTO Secretariat

-10 -15 Export

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GDP

Average of Exports

Average of GDP

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Factors that led to increase in trade from 1990-2008: Decreasing Cost of Trade: Decreasing costs of transportation, communication, currency exchange and tariffs have led to an overall decrease in cost of trading goods internationally.

Emerging Global Value Chain: Removal of trade barriers after the Uruguay round in 1994 and formation of WTO resulted in the emergence of global supply Chain. Availability of cheap labour, access to strategic assets that helps to tap foreign assets and other factors which helps make the value chain more efficient have helped boost international trade. Another benefit of the global value chain is the propagation of macroeconomic shocks throughout, hence mitigating its impact.

Increasing Per Capita Income: Rising income leads to shift from basic food and clothing products to manufacturing goods thus resulting in better prospects for product differentiation, diversification and International trade.

Rise of the developing world: Emerging economies have seen a rise in their income over the past few decades. The developing countries now account for more than half of the world output. Reduction of MFN tariffs has played a key role in the expansion of trade in developing countries.

Increasing price of commodities and Productivity growth: The prices of tradable goods have doubled since 2000 due to robust demand from the large developing countries.

In addition, the tradable goods sector has witnessed higher productivity growth than the non-tradable goods.

Causes of the slowdown since 2008 From 1990-2008 the real GDP grew at about 3.2 percent whereas the world trade volume rose by 6.0 percent. Whereas since 2008 even though trade volume growth increased, it was only slightly greater than real GDP growth.

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The ratio of Trade to GDP was 2.4(highest) in 2000 but has since fallen to 1.7 in 2013. The major causes of the slowdown are: EU recession: Recession in Euro Zone led to high unemployment in euro area economies (Germany being a notable exception). The Euro Crisis have had a dramatic impact on the trade flow. Moreover, even after signs of revival the Trade to GDP trend hasn’t responded in a similar manner.

Uncertainty about Fed's tapering timing: The timing of the Federal Reserve’s winding down of its monetary stimulus in the United States has been uncertain as a result of which it contributed to financial volatility in developing economies.

Failure of export led growth model: Export led growth model in developing countries have resulted in global excess supply as most of the countries intended to grow on the back of demand expansion in other countries but couldn’t succeed. At the same time export from one destination crowds out export from another thus failing to result in a global increase in trade.

Rise of hidden protectionism: A large number of countries provide government subsidies to protect their local manufacturers. Also on certain occasions, deliberate interference in currency market has deterred trade. Hidden protectionism has resulted in negative multiplier effect affecting many more countries that has subsequently resulted in trade wars among them.

Is the decreasing Trade to GDP ratio really worth worrying?

Paul Krugman, noble prize winning economist, stated, “ever-growing trade relative to GDP isn’t a natural law, it’s just something that happened to result from the policies and technologies of the past few generations. We should be neither amazed nor disturbed if it stops happening.”

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Some of the major arguments raised to dismiss the apprehension caused by decreasing Trade to GDP ratio are: Slowdown in convergence: The rise in trade to GDP ratio was mainly due to poorer countries catching up with rich countries.

Convergence resulted in more equitable distribution of world output. The slowdown in trade can be attributed to slowdown in convergence rather than some abovementioned factor.

Reducing trade barriers: China has been giving large structural shocks to the US, Europe and Japan through burgeoning exports still there has been no retaliation from them in the form of imposing trade barriers. At the same time the increasing involvement in The Pacific by US and China and subsequent formulation of trade initiative involving them could lower trade barriers.

Mismeasurement: It has been argued that there has been a sharp rise in trade in software and other digital goods that have been difficult to record. Subsequent measures are being incorporated to create a new trade data based on where economic value is added.

What does the future hold in store?

WTO Director-General Roberto AzevĂŞdo said. “It's clear that trade is going to improve as the world economy improves. But I know that just waiting for an automatic increase in trade will not be enough for WTO Members. "It is not

viable to say at present whether something like a 2:1 ratio between trade and GDP will reassert itself but the recent events suggests significant improvement will take place.

With the European Union gaining traction (EU has a share of 33% of world imports) and the US economy gaining momentum the global trade environment is set to improve, the forecast for 2015(1.714) is itself suggestive of that.

Increasing trade negotiations between countries specially US and China, in November last year they struck a deal which allows a proposed treaty on trade in information technology among willing members of the World Trade Organisation to proceed, has provided a positive signal for increasing trade among nations.

At the same time, there are certain gathering risks that could disrupt trade flow and impact trade to GDP ratio.

Civil conflicts and territorial disputes in the Middle East, Asia and Eastern Europe could result in high energy prices and subsequently hamper trade.

Developing economies can face significant problems including large current account deficits (a major problem pertinent in Turkey and India), Argentina’s currency crises is another example. Along with these some other pertinent risks could be overinvestment in productive capacity, continuing protectionism to boost internal production and inhibit external demand .

Impact of convergence on world trade 13 12 11 10 9 8 7 6

25 20 15 10

Source: Figure 2.3 in Subramanian and Kessler (2013).

1990 1992 1994 1996 1998 2000 2002 2004 2006 2008 2010 Share of world GDP(in percent)

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Number of country equivalent

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Regional Trade Blocks

Regional Trade Blocks The rise in number of agreements between different blocks of late is raising questions on even the future of WTO. Regional Trade Blocks analyses the past, present and future of these trade blocks.

Are Regional Trade Agreements really the need of the hour

By Anjali Mirchandani MBA (IB) 2014-16 RTA’s around the world have been on a rise post the 1990’s. As of June 2014, around 585 notifications of RTAs have been received by World Trade Organisation. What is this wave that has reached the crest? Is it all so new?

During mid 1990s, trade liberalization and the drive of global free trade underwent a transformation. The political class shifted away from what was perceived as a relatively slow process of multilateral tariff negotiation to smaller and bilateral treaties- the RTAs. Basically RTAs are not a new found phenomenon, but a historic one. Previously, whenever multilateral trade talks broke down, bilateral trade agreements filled the void. Such an arrangement gave the states enough room to move towards freer trade in their own sweet time, and for their own benefits.

But, RTA, precisely is a bit different from Free trade Agreement, in the sense that, it’s a form of preferential agreement among signatories to liberalise trade them, whereas FTA relaxes barriers for the rest of the world. RTA’s can thus be termed as discriminatory trade. Nowadays, RTAs have extended to providing coordination for investment in their cities(eg. relaxing interest rates, non-tariff barriers, etc.) The RTAs can have various levels or types: Indian Institute of Foreign Trade

A brief study of the various RTAs and their impact on the respective countries to determine their effectiveness

First, at the most basic level- RTAs lowers trade barriers among members. An example of such an agreement is the Papua New Guinea Australia Trade and Commercial Relations Agreement (PATCRA II) that has been in effect since 1977.

Second, an RTA is a reciprocal arrangement between the members, wherein trade barriers, usually tariffs, are abolished; however members are free to pursue external trade policy. A prominent example would be the North American Free Trade Agreement (NAFTA).

The third level of economic integration is the Customs Union. In a Customs Union, trade barriers among members are eliminated. Also, the participating nations adopt a common external trade policy. The Customs Union of the Southern Cone -Mercosur-represents such an arrangement.

The fourth level of economic integration is the Common Market. In a Common Market, countries remove all barriers to movement of both goods and factors. It is Customs union plus the free mobility of people and capital.

One example of Common Market is the Common Market for Eastern and Southern Africa (Comesa).

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The fifth level of economic integration is the Economic Union, wherein, besides the free goods and factor movements, member countries also adopt common macroeconomic and regulatory policies. An apt example of Economic Union is the European Union (EU).

In a nutshell, RTAs or PTAs, were designed to benefit the Less Developed Countries, by the way of gaining access to larger export markets, and restraining access to domestic markets. Moreover, around 50 per cent of world trade is currently carried out under preferential trade arrangements. Preferential trade is growing at a faster rate than global trade - between 1993 and 1997, preferential trade grew at 66 per cent annually while global trade grew at 34 per cent annually.

Which brings us back to the same question‌.Are RTAs really doing the trick i.e. help LDCs by the way of economic development or leading to regionalism and reducing efficient global trade?

RTAs by their very nature are discriminatory, and an aberration from the WTO’s MFN(Most Favoured Nation) principle, the founding stone of multilateral trading system. Regional trade agreements imply both trade liberalisation and trade discrimination. Discrimination might be fruitful only when it promotes the transfer of resources from inefficient domestic suppliers to efficient producers within the region i.e. when there is trade creation.

However, it is detrimental when such transfer takes place from efficient to inefficient hands, i.e. trade diversion. The trends support two key statements, Generally, trade creation is the norm, and trade diversion an exception.

Even if the latter happens, its magnitude is normally, relatively paltry.

India’s RTAs with the world India traditionally has been the proponent of multilateral free trade, however given the needs of its economy; it too has joined the fray of RTAs. But the question of whether RTA is beneficial to us, depends upon how crucially our share is to the world trade. Currently, we are a marginal player in global trade, and thus wield little impact over it, less than 2 %. Also we are not a part of any major RTA that has a strong influence on world trade like NAFTA or EU. Most of our RTAs are with emerging economies or upcoming newly industrialised nations of SE Asia. We can stand to lose from the trade diverting effects of RTAs we are not involved in. The Indian textile sector, for example has been affected, as the US gives a preferential treatment and suty free access to textile products from Mexico under NAFTA.

Source: World Trade Organisation, website Indian Institute of Foreign Trade

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Are regional trade agreements welcome? – A word of caution The benign view that burgeoning trade creation over rides diversion doesn’t imply RTAs are all good. It has been observed that the spate of RTAs have slowed the negotiations of multilateral trade agreements at WTO. Another concern is that RTAs may create interest groups that block further liberalisation initiatives.

There has been equal number of counter theories as well. The very question whether regionalism helps or hinders multilateralism – does not lend itself easily to testing.

Questions linger- Would they have been any faster, or easier, had there been fewer (or more) RTAs? This is a very difficult question.

As a result, to date empirical scrutiny has not been able to help us distinguish what can be good RTAs from what are presumably hindering ones.

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The last word The rising wave of regionalism has been mostly beneficial to the world trade. Empirical studies have shown that- trade creation rather than trade diversion is the norm, given that governments choose their members with utmost care. Although a part of argument is that- regionalism might endanger multilateralism, at this juncture, the preferred way of reciprocal liberalisation for most nations, is RTAs. A way must be found to integrate regionalism with multilateralism if the opportunity has to be cashed in.

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Regional Trade Blocks

COMESA: Promoting Trade in Africa

By Ashutosh Tyagi & Raja Sekhar Reddy MBA (IB) 2014-16 COMESA is a market place for trading in African region which covers geographical area of 12 million sq. km and a population of more than 390 million. It includes 19 countries of the Southern and Eastern region of Africa. The Secretariat of COMESA is located at Lusaka, Zambia. Intra-COMESA trade has now reached to 20.9 billion USD (approx.). The member states of the COMESA are represented in Figure I.

Fig I. Member States of COMESA Introduction The feeling for being self-reliant had inspired African nations to form close tie-ups on the basis of mutual sub regional agreements for enhancing stability and prosperity of the region. The events in 1970s, which included deteriorating conditions of eastern and central African federations and increasing Indian Institute of Foreign Trade

An analysis of the Common Market for Eastern and Southern Africa an its role in promoting trade

disparity among the rising industrialized countries and under-developed countries evoked the need to form close ties at multiple fronts.

Over the past few decades, African countries formed blocks for unified growth and promotion of trade in the region. COMESA was established in 1994 and Free Trade Agreement was established among the initial nine member states in October 2000. This was marked by the elimination of tariffs for the products originating in COMESA member states for promotion of trade in the region.

COMESA has often been described as a customs union which is defined as a creation of single customs territory from many customs territory by eliminating the trade barriers.

Principles and objectives COMESA (Common Market for Eastern and Southern Africa) was formed to represents free sovereign states of Africa which aim at promoting peace and security in the region along with focusing on the upliftment and growth of the African region by acting as a large economic and trading unit. COMESA’s main objective includes enhancing the standard of living of the citizens in a secure and sustainable manner. For this, the consolidation of markets, implementing sector programs, sectorial synergy and private sector contribution are the key criteria.

Promotion of trade is also one of the major objectives of COMESA and it aims at

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creating an environment of close macroeconomic cooperation along with improving industrial productivity and competitiveness of the member states in the global scenario.

Activities and accomplishments COMESA has adopted three approaches for planning its activities based on the duration of the projects. This includes long term vision, medium term and planning cycle for single years. COMESA has gradually progressed consistently in a stage by stage manner from preferential trade area to a monetary union through the stages of Free Trade Area, Customs Union and Common Market.

COMESA has played a pivotal role in mitigating the impact of the financial crisis in African region. However, the expected slow global recovery and the impact of external liquidity crunch have affected growth in Africa. This can be seen on the production level of certain sectors such as mining, manufacturing sectors and lower demands for African exports.

COMESA is known for introducing free trade agreement in African region. The official launch of customs union has helped to create an economic community dominated by a single currency. It has taken active steps for consolidating the Free Trade Agreement into a reality by placing important structures for the functional operation of Customs Union and Common Market. Also, the protocols and regulations regarding the free movement of people and goods across the region.. COMESA contributes to 32.7% of total GDP of Africa and 37.4% of agricultural gross domestic product contribution. It has also helped in standardizing and implementing social welfare schemes, immigration and labor mobility policies.

Recent Activities COMESA recently celebrated 20th anniversary of formation on 8th Dec 2014 and has played a vital role in facilitating trade and industrialization. The gala event highlighted the role played by COMESA in the past two decades and also the significance of the toprated trade and financial institutions across the continent

Figure II: Share of member states in COMESA GDP Indian Institute of Foreign Trade

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COMESA has continuously contributed in a significant way in improving the conditions of citizen in the member states. The elimination of financial costs related to customs bonds, enhancing performance and communication for facilitating trade through Management Inventory Systems such as Advanced Cargo Information Systems and trade statistics systems such as ACYCUDA++, has helped the region over the past many years. Also, the simplified trade regime which was introduced for traders who operate on a small scale and across many countries helped in easy and quick trade of goods.

The comprehensive Africa agriculture development program which is an effort to setup a framework for the development of agriculture in southern and eastern Africa is also being implemented by COMESA. The alliance for commodity trade in eastern and southern Africa (ACTESA) is also boosting the regional trade in Agricultural commodities including all seeds, livestock, forest and natural products.

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Opportunities The implementation of COMESA programs has been thwarted by the limited capabilities of the member states. Budget constraints have also affected the different initiatives.

Information flow is also a challenge for COMESA. One of the major hurdles of COMESA is the ownership of the programmers at the grassroots level.

The opportunities for COMESA can be realized if the emphasis is laid on achieving concrete results and obtaining funding from member states for various programs. The national development plans of the state should also give priority to planned programs. The political and economic will of the member states has to be in line with the aims and objectives of COMESA. If the hurdles are tackled properly then COMESA can play a very important role in realizing the full potential of Africa and improving the living standards of the population in the region.

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Country Watch

Country Watch International Trade is often influenced greatly by various country-specific factors. Recent issues of certain countries are studied to assess their impact on the country’s trade with India and the res of the world

Iran

By Anirudh Namboodiri, Samarth Kothari MBA (IB) 2014-16 The Joint Comprehensive Plan of Action (JCPOA) that has been agreed between Iran and the P5+1 nations (the five permanent members of the United Nations Security Council—China, France, Russia, United Kingdom, United States — plus Germany) signed on July 14, 2015 after nearly an year of negotiation marks an important step in the resolution of the decade-long crippling sanctions imposed on Iran by the United Nations, led by the United States. While this could be seen as a positive step in keeping peace in an increasingly volatile and dangerously nuclear Middle-east, there is more to it than meets the eye, from India’s perspective.

The impact of recent diplomatic events on Iran’s trade with India and the res of the world is analyzed

Proliferation Treaty (NPT) and started building the nuclear facilities. However, the Islamic revolution in 1979 changed the face of the nation. The American embassy hostage crisis ensured that any further nuclear co-operation between the two countries was difficult. With clear indications that Saddam Hussain was pursuing a nuclear program in Iraq during the Iran-Iraq war, it is believed that Iran sought assistance from Germany to complete the construction of its nuclear facility Bushehr. It even sought help from the father of Pakistan’s nuclear program Abdul Qadeer Khan.

Why does Iran need to be nuclear so badly?

As the third largest producer of crude oil in the world, Iran cannot make a convincing argument of needing nuclear power for its energy security. However, the world was surprisingly trusting of Iran’s good intentions in the 1950s when the United States offered assistance to Iran to develop its civilian nuclear program.

Soon, it became a member of the Non-

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Country Watch

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With growing intelligence reports that Iran could be secretly building a nuclear weapon, US President Bill Clinton signed a bill imposing sanctions on foreign companies with investments in Iran. In 1999, amid growing concern in the middle-east about the growing power of a nuclear Israel, Iranian President Mohammad Khatami visited Saudi Arabia and supported the proposal of a nuclear-free middle east. However, Mujahedeen Khalq an Iranian dissident group, obtained and shared documents revealing a clandestine nuclear program previously unknown to the United Nations. Which revealed a vast uranium enrichment plant at Natanz and a heavy water plant at Arak. After showing willingness to drop its nuclear weapons program and agreeing to IAEA inspections, in 2003, Iran violated the agreement accusing the Europeans of reneging on the promised economic and political incentives. In July 2005, American intelligence reports revealed reports of Iran’s weaponization program known as Project 110 and Project 111.

The UN Sanctions In the first round of sanctions in 2006, the UN Security Council approved sanctions intended to curb Iran’s nuclear program, which banned the import and export of materials and technology used in uranium enrichment and reprocessing and in the production of ballistic missiles. In June 2010, the United Nations Security Council implemented its fourth round of sanctions against Iran’s nuclear program. In addition, Iran was barred from investing in other countries' nuclear enrichment plants and uranium mines. In 2011, major Western powers took significant steps to cut Iran off from the international financial system with coordinated sanctions aimed at its central bank and commercial banks. The United States imposed sanctions on companies involved in Iran’s nuclear industry, as well as on its oil industry. In 2012, an embargo on Iranian oil played a large role in restricting Iran's ability to sell its most important export –

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crude oil. In retaliation, Iran announced legislation intended to disrupt traffic in the Strait of Hormuz and tested missiles in a desert drill clearly intended as a warning to Israel and the United States. After months of harsh, American-led sanctions, Iran's currency, the rial, plunged 40 percent. The currency lost about half its value in 2012.

Most of that decline came in a frenzy of speculative selling by Iranians worried that rapid inflation could render their money worthless. The sanctions also presented a new complication to Iran's banking authorities: they may not be able to print enough money.

Meanwhile, the European Union toughened sanctions against Iran, banning trade in finance, metals and natural gas, and making other business transactions more cumbersome. In 2013, a new round of American sanctions took effect which mandated that any country that buys Iranian oil must put the purchase money into a local bank account. Iran was not allowed repatriate the money and could use it only to buy goods within that country. Violators risked facing severe penalties in doing business with the United States.

Talks between a more amiable Iran, led by the mild-mannered Hassan Rouhani, and the United States resumed for the first time since 1979 in July 2013. Finally, in November 2013, an agreement was made to temporarily freeze Iran’s nuclear program. After intense negotiations between the two sides and talks lasting more than a year, an in-principle agreement has been reached between the two sides recently.

Impact of Iran sanctions on India When the sanctions were imposed on Iran by the UN Security Council, both the government and private sector of US & Europe boycotted both trade and investments in Iran. India, Russia, China & Venezuela were one of the few countries which continued their trade

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Trade Winds | July Edition

Country Watch

With Iran. Even though the US was putting a lot of pressure on India to support the international sanctions, India managed to hold its ground citing extreme dependence on imports from Iran.

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Indian Crude Oil imports from Iran (in million tonnes)

20 15 10 5

18.382

20.321

23.809

11.611

0 2006

2007

2008

2009

Year Source: ITC Trademap Trade post 1st round of sanctions in 2006-09 When the economic sanctions were imposed on Iran, India as a state policy did not openly support them. In fact, India used these as an opportunity to increase its imports of its largest import - crude oil. Iran reciprocated the gesture by offering a special treatment to its ally: • Iran offered discounts of up to $5 per barrel of crude oil • Free delivery of oil, saving almost 70 cents to $1 per barrel • Credit period of 90 days to Indian buyers, when the industry norm was 30-60 days Ironically, the sanctions actually increased the trade between India and Iran from 2006-09 due to these favourable terms. The crude oil imported rose from 11.611 tonnes in 2006 to an all-time high of 23.809 million tonnes in 2009.

Indian Institute of Foreign Trade

Trade post increased round of sanctions from 2010 Due to increased tensions in the middle-east, the US intensified its sanctions on Iran and even started blacklisted foreign companies doing business in Iran from their US operations. Even India had to make commitments to reduce its trade with Iran.

India had to show its solidarity with the international community, in order to become a serious contender for the permanent seat at the UN Security Council. Some problems faced

by Indian importers as a result of these sanctions were: • No company was ready to provide insurance cover on tankers from Iran • In 2012, US’ modified sanctions on Iran mandated 100 per cent payment in the currency of the importing country for Iranian products Due to these issues, India’s crude oil imports from Iran have been witnessing a decreasing trend. The US had asked India to limit its imports to below 8 million tonnes over a period of 5 years.

Indian Crude Oil imports from Iran (in million tonnes) 20 15 10

17.239

5

13.107 15.171

10.662

13.547

0 2010

2011

2012

2013

2014

Year Source: ITC Trademap

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India’s exports to Iran Historically, India has had a large trade deficit with Iran, although India imports crude oil and exports refined petroleum back to Iran, among other countries. This trade deficit narrowed down after the Iran sanctions, due to increasing Indian exports. India primarily exports rice, cereals, pharmaceutical products, machine tools, automobile parts and steel to Iran, all of which are permitted under sanctions. Till 2012, India under the sanctions had to pay for the oil it imported from Iran in a 45:55 (rupee: euro) arrangement. Therefore Iran used to finance its imports from India from the 45% rupee balance in UCO bank a/c.

In 2012, US sanctions made it compulsory for importing countries to pay 100% in their local currency. As a result, Indian exports to Iran increased from $2.5 bn to $5 bn from 2012 to 2014. Therefore Indian exporters benefitted.

India has allowed re-export of imported products to Iran under the provided 15 per cent value addition takes place in the country.

Way Forward Not only businessmen, but also the Iranian

middle-class was severely affected by the UN sanctions throughout the last decade. A survey by the Islamic Republic News Agency said 82.6 percent of Iranians expressed “optimism” and “happiness” over the nuclear accord.

Many Indian exporters have enjoyed a threeyear run from 2012-15, when the Indian government chose not to support all the sanctions. India’s exports to Iran doubled and bilateral trade deficit almost halved during this period. S.C. Ralhan, president of the Federation of Indian Export Organisations (FIEO) says “The lifting of Western sanctions on Iran would have an adverse impact, particularly on non-agricultural commodities,". Millions of farmers too would take a hit from the easing of sanctions, a large buyer of basmati rice, soymeal, sugar, barley and meat. Under sanctions, Iran paid a premium of up to 20 percent over global prices to buy from India. Going forward, Iran is expected to shift to other suppliers like South American countries, who can supply at much lower prices compared to India. Firms from Germany, Italy and France that once dominated the Iran market will be back,

Indian Exports to Iran (in Billion USD) 6 5 4 3

5.433 4.404

2 1

1.617

1.845

2.335

1.949

2006

2007

2008

2009

2.509

2.462

2.572

2010

2011

2012

0 2013

2014

Year Source: ITC Trademap

Indian Institute of Foreign Trade

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selling consumer products ranging from clothing to cars. Oil buyers have been ordered to raise $6.5 billion in hard currency to settle oil dues that they have been unable to pay due to the sanctions. The state-controlled UCO Bank holds $2.8 billion in Iranian oil money, which would be unlocked by the lifting of sanctions, forcing up funding costs.

It is ironic that the countries like India and Russia, which have been supporting Iran the most during the sanctions will be the most negatively affected due to the lifting of these sanctions. However, in the long-term, the return to a more free market trade may work well for sectors like IT & pharmaceutical, where India has a better efficiency compared to its competitors. The 2.5 million strong Iranian middle class will be an excellent new market for India. More importantly, India can leverage its cultural and trade relationship with Iran as a bargaining chip for future negotiations. Iran has asked India to invest $8 billion to build a new terminal in the port of Chabahar, facilitating trade with central Asia. A quick development of the Chabahar port in Iran will act as a counter to Chinese encirclement of India through Gwadar port in

Indian Institute of Foreign Trade

Pakistan. Also, work on the Iran-Pakistan-India pipeline can be expected to progress.

However, India will have to balance its relationship with the Shia-dominated Iran and Sunni-dominated Saudi Arabia & Israel, especially with a proxy war escalating in the Middle East and the US cutting down its presence in the region. Whether the charismatic Indian Prime Minister Narendra Modi with his proactive foreign policy will be able to maneuver our relation with Iran to new heights remains to be seen.

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