Thursday, February 7, 2013

The monetary noose tightens around Iran


Some interesting things have happened on the Iran monetary sanctions front since I last wrote on the topic.

In my first post I explained how the sanctions work. In my second post, I speculated about the so-called gold-for-gas trade, one of the routes Iran had been using to get around the sanctions. To recap, here's how the trade works. Turkish companies buy Iranian natural gas with Turkish lira deposits at Halk Bank, a large government-owned bank based in Ankara. Iran then converts these deposits into gold and re-imports the metal back into Iran (primarily via Dubai) in order to use it to purchase goods elsewhere or to fortify its FX reserves. There was nothing about the gold-for-gas route that contravened the letter of US sanctions.

Now there is a new rule that will plug the gold-for-gas trade.

Measures included in the 2013 National Defense Authorization Act signed by President Obama on January 3, namely Title XII, Subtitle D, known as The Iran Freedom and Counter-Proliferation Act of 2012 (IFCPA), require the President to impose sanctions against any financial institution that enables Iranian entities to purchase precious metals. These rules will come into effect on July 1, 2013.

This means that the so-called gold-for-gas trade has only a few months left to run. As of July 1, if Iran wishes to make purchases through its account, Halk Bank will have to ensure that whatever it buys does not include gold, silver, or platinum (no, there is no platinum coin loop-hole).

But there are even bigger changes afoot. As of February 6, 2013, measures enacted in last August's Iran Threat Reduction and Syria Human Rights Act of 2012 (TRA) restrict all buyers of Iranian crude to a purely bilateral trade relationship. In essence, buyers can only transact with Iran using financial institutions located in the buying country. Furthermore, TRA requires that any revenues that Iran earns from oil sales remain "locked" in accounts within the buying country. If these requirements are ignored, President Obama is required to impose sanctions on transgressing banks. Since these sanctions involve cutting off said bank's access to the US payments system, few banks are likely to risk ignoring them.

TRA will have major repercussions for the way Iran does business with its clients, in particular India. For the last two years, Iran and India have been transacting this way: 45% of Iran-India oil trading has been conducted in rupees using the Calcutta-based UCO Bank. Iran's national oil company exports oil to India, earns Indian rupee in its UCO account, then uses these rupees to purchase Indian grain and other goods. What it doesn't spend simply accumulates at UCO. Billions of dollars have accumulated at UCO because India simply doesn't produce enough goods and services that Iranians want.

The other 55% of the India-Iran oil trade has been conducted via the same Halk Bank that facilitates Turkey's gold-for-gas trade. India kept a euro account at Halk Bank which it used to pay Iran for oil. Given the wide liquidity of euros, Iran could easily spend these balances on. The TRA requirement that all transactions be bilateral forces India to cease Halk Bank payments and reroute everything to UCO. Huge rupee balances were already accumulating at UCO when 55% of crude oil trade was settled at Halk Bank. With 100% now being settled at UCO, Iran's rupee hoard will become even more massive.

Nor is this solely an Indian phenomenon. Iran will be prevented from repatriating profits earned in trade with all of its major oil customers. Going forward, large Iranian yen balances will steadily build up in Japanese banks, won in Korean banks, rand in South African banks, etc. These balances could be drawn down by Iranian purchases of permitted (ie. non-sanctioned) goods and services in the host country. But Iran tends to run current account surpluses with these partners – it exports more than it imports. The balances, therefore, are likely to continue accumulating in the host nation.

On an abstract level, the sanctions are dramatically reducing the liquidity of Iranian wealth. By impairing the ease of transacting in Iranian goods and Iranian-held foreign bank deposits, the US has reduced the extra bit of option-value that liquidity adds to wealth. In India, for instance, a rupee is worth a rupee, except if you're Iran. The range of options available to an Iranian-held rupee is far less than a regular rupee – as such they are worth less.

This demonstrates the raw monetary power that the US is able to exercise on the world by levering its central position in the international banking web. Americans may not feel the external effects of US monetary policy. But as we can see, this policy is creating large changes in the patterns of trade throughout the entire Middle East and Asia.

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