April 25, 2019

U.S. Secretary of State Mike Pompeo announced that the U.S. will not renew exemptions from its sanctions for importing oil from Iran. 

What was the story so far of U.S. sanctions on Iran? 

  • JCPOA withdrawal: In May 2018, U.S. President Donald Trump announced that the U.S. is withdrawing from the Joint Comprehensive Plan of Action (JCPOA) or “ Iran deal”. 

  • Sanctions: This led to re-triggering of sanctions imposed prior to nuclear deal. These target Iran’s ability to purchase U.S. Dollar notes & Trade in metals, besides other currency transactions. These sanctions kicked-in from November 2018 targeting Iran’s oil exports and energy sector. 

  • Significant Reduction Exceptions (SREs): 
    • In November 2018, U.S. granted exemptions from its sanctions for importing oil from Iran for a 180-day period for India and seven other countries (namely China, Japan, South Korea, Turkey, Italy, Greece and Taiwan). 

    • These sanctions – also known as Significant Reduction Exceptions (SREs) to existing importers of Iranian oil – are due to expire on May 2, 2019. 

What are the possible reasons behind recent decision by United States? 

  • Now, U.S. has decided to not renew the exemptions from its sanctions for importing oil from Iran so as to achieve its national security objectives and pressurize Iran on denuclearisation.

  • The decision to eliminate all SREs follows the designation of the Islamic Revolutionary Guard Corps as a Foreign Terrorist Organization, another step towards putting pressure on Iran.

  • The sanctions have provided the U.S. an opportunity to put more of its own crude on the market. U.S. crude production was 1.6 million bpd higher than it was in 2017, and an additional 1.5 million bpd is expected in 2019.

  • On the other hand, Oil exports from Iran hit a low of 1.0 million bpd in March this year – down from 2.5 million bpd in April 2018.

How has Iran reacted to the decision?

  • Iran has threatened to close the Strait of Hormuz through which a third of the world’s seaborne oil passes every day. Blocking this choke point can lead to huge increases in energy costs and world energy prices.

  • According to analysts, Iran cannot legally close the waterway unilaterally because part of it is in Oman’s territorial waters. However, ships pass through Iranian waters, which Iran’s Islamic Revolutionary Guards Navy controls.

  • To this, the US has said that closing the Hormuz Strait will amount to an escalation with an unknown fallout — this is one reason Iran has, in 40 years of hostility with the West, never yet acted on its threats to close the Strait.

What are the Potential impact of this decision on India?

  • Energy Security: Iran was the fourth largest supplier of oil to India in 2018-19. The big concern is that the substitute crude suppliers — Saudi Arabia, Kuwait, Iraq, Nigeria and the US — do not offer the attractive options that Iran does, including 60-day credit, and free insurance and shipping.

  • Current account deficit: Higher crude oil prices will widen the trade deficit and current account deficit.

  • Rupee: The currency could be impacted if the trade and current account deficits were to widen. An increase in the import bill will tend to put pressure on the rupee.

  • Inflation: There could be significant impact on inflation, given how crude oil prices move and the extent to which the government allows the pass-through to the consumer. Analysts do not expect a full pass-through until the elections are over.

  • Fiscal impact:
    • On the revenue side, higher oil prices mean more revenue for the states as tax is ad valorem; for the Centre, though, it may not materially impact the finances much as the duty rates are fixed.

    • The expenditure impact would primarily be on account of fuel subsidy provided on LPG and kerosene.

  • After the announcement, Indian benchmark indices slid by around 1.3%, as investors rushed to sell shares on concerns that rising oil prices could stoke inflation and dent the already weak consumption story.

How has the government of India reacted?

  • India has said the country is “sufficiently prepared” to deal with the impact of the US decision to curtail the temporary exemption from sanctions on the purchase of Iranian oil.

  • It said that “a robust plan” has been put in place for adequate supply of crude to refineries.

  • Analysts expect that India and China could show a degree of defiance while cutting back on their exposure to Iranian crude as India’s ties with Iran are significant and historic, and it will work hard to maintain some links.

  • According to experts, India will cut imports substantially, but probably maintain approximately 100,000 bpd (barrels per day) of Iranian imports paid for using a rupee payment system.