India should circumvent Iran’s dominance

United States President Donald Trump has prohibited the US banks from undertaking receipts and payments with Iran beginning from November 4. Global trade in oil is mainly undertaken in US dollars. The ships carrying crude oil are mostly insured by the US companies. Trump wants to bring Iran to its knees by prohibiting the US banks and insurers from participating in the trade of Iran oil and thereby strangulating its oil exports. 

Rest of the world, including China, Europe, India and Russia, is not amused. They want to continue to buy oil from Iraq. The US has not prohibited purchase of oil from Iran. It has only prohibited the payment for oil to be made in United States Dollars (USD) through US banks. At present, India pays to Iran in US dollars through US banks for the oil purchased from Iran. 

Then Iran pays to India in US dollars through US banks for the Basmati rice purchased from India. There is no fundamental requirement for India and Iran to go through the US banks in undertaking these transactions. They can trade in either Iranian riyal or Indian rupee. During the last sanctions imposed by the United Nations on Iran in 2012-15, India and Iran had done precisely this. 

Iran had opened an account in UCO Bank, Kolkata. Indian importers of oil deposited the payment in Iran’s account in the UCO Bank. Iran paid to Indian Basmati rice exporters is rupees from its account the UCO Bank. In this way, the unnecessary routing of transactions in US dollars through US banks was avoided. India is on way to repeat this approach. 

Recently, the Reserve Bank has granted permission to two Iranian banks Pasargad and Saman to open branches in India. India can deposit the payment for Iran Oil in rupees in these banks. Iran’s Basmati rice importers could use these rupees to pay from imports from India. In this way, India and Iran can circumvent the US sanctions to the extent of India’s exports to Iran.

The remaining payments can also be largely circumvented. Let us say, Iran has to buy trucks from Germany and has to make payment to German truck manufacturers in euros. India can deposit the payment in euros in an account of Iran opened in a German bank. Iran can then use the euros to pay German truck manufacturers. 

The problem faced by us in the face of the US Sanctions is also faced by other countries. In order to circumvent this, China, Russia and the European countries are planning to set up an alternate banking system so that they can make payments for oil imported from Iran without having to go through US banks. India should join this alternate banking system and continue to import oil from Iran despite US sanctions. 

The emergence of this alternate global banking system will end the hegemony of US banks on the global financial transactions. About 39 percent of global financial transactions are made through the US banks denominated in US dollars today. About 35 percent are made through European banks denominated in euros. The emergence of the alternate banking system is likely to lead to a steep decline in the share of the US banks in the global financial transactions and lead to a corresponding decline in the political might of the US.

Iran sanctions could undo the US economy for another reason. The US economy is buoyant today because the US dollar is serving as the ‘global reserve currency’. Every country holds some money in an international bank to facilitate its transactions and to protect its economy against unexpected exigencies. This reserve money is mostly held in US dollars in US banks. It is an unsolicited loan to the US. The US gets a loan of, say, USD 100 billion, when the Reserve Bank of India deposits this money in the US banks to augment its foreign exchange reserves. 

China, Japan and most countries of the world have similarly deposited monies in US Banks. The total foreign deposits in US Banks are about USD 21 trillion. Of this, about USD 1 trillion each have been deposited by China and Japan. The strongarm tactics of President Trump is likely to encourage countries to withdraw their reserves from US dollars and deposit the same in European, Chinese, Japanese or Indian banks. Russia, for example, has withdrawn USD 85 billion out of its deposits of USD 150 billion in the US. The aversion among countries of the world to Trump’s tactics may lead to the US being deprived of these loans. 

Such a shift could bring the US to its knees, instead of Iran. The US government deficit, that is, the amount spent by the government in excess of its income, has risen from USD 600 billion in the last year of Obama Presidency, to USD 890 billion this year. The global competitiveness of the US economy is also being eroded. The US imports rose 0.6 percent while exports slid 0.8 percent between July and August this year. Thus, the present “prosperity” of the US is not because of the competitiveness of that economy. The prosperity is because of the increase in debt. The government is borrowing heavily and using that money to generate jobs and incomes for the US citizens. It is like a business in trouble borrowing to make a five-star office. This cannot sustain.

On the one hand, the dependence of the US economy on foreign borrowing is increasing because of the increase in US government deficit. On the other hand, Trump’s use of the banking system to strangulate Iran is pushing the world away from lending to the US. The combined impact of these tendencies will lead to trouble for the US economy.

The sanctions have some force because of the present dominance of the US. However, there are many chinks in the US armour. US exports are down while imports are up. The US government deficit is increasing. The use of US banks for making payments to Iran is reducing. The inflow of deposits in the US is declining. The present buoyancy of the US economy is, therefore, unlikely to sustain.

India has to chart its course in this situation. The way forward is to join the China, Europe, Japan and Russia in establishing an alternate global payment pathway bypassing the US banks. Secondly, India should lead a global campaign to withdraw foreign reserves from the US dollar. We should try to whittle away the US economy and move towards a multi-polar world economy in which, hopefully, we will have a greater say.

Dr Bharat Jhunjhunwala - Author was formerly Professor of Economics at IIM Bengaluru