Iran Nuclear Deal And Its Cancellation Effect on Indian Economy

Written By: Gauri Jaitely, Student of  XII (Humanities)  

Issue

Iran nuclear deal was signed in 2015 under Barak Obama, then US president and it has been called as the worst deal ever by Trump, incumbent US president. Trump has threatened to reintroduce sanctions on Iran on May 12 when it’s coming for renewal, unless Britain, France and Germany agree to renegotiate the Iran nuclear accord, if he walks away with this deal then many problems may arise globally.

Overview:

Four decades ago, the Iranian Islamic revolution took place in 1979 in Iran. As a result, Pahlavi dynasty was overthrown and it was replaced by Ali Khamenei and became the supreme leader of Iran. The Pahlavi Dynasty was backed by the United States of America while Iranian revolution was supported by Soviet Union (now Russia) during the Cold War. The geopolitics of middle east since Iranian revolution has entered into a very complex trap for the oil and trade routes. The recent instances are wars in Syria and Yemen. Iran felt safe till before fall of USSR in 1991. After the operation desert storm known as a first gulf war, America has emerged as a soul power in the world politics. Iran feels isolated because of its rivals namely Israel and Saudi Arabia, both have been backed by America.

 In 2000’s Iran started its uranium enrichment programme to develop atom bombs to overcome its isolation in the Middle East. As a consequence, America with the support of UN had imposed economic sanctions on Iran and Iran fall into recession. However, with the initiative of then, US president Barak Obama and secretary of state John Kerry along with another 5 powers (permanent members of UNSC+ Germany) had reached an agreement which namely known as Iran nuclear accord 2015 and also called Joint Comprehensive Action Programme.

What was Iran Nuclear Agreement

According to this deal, Iran agreed to use nuclear energy peacefully in return of lifting up the sanctions. Under this deal, Tehran acceded to a 10years restriction on the nuclear programme, agreed to shut down thousands of its centrifuges and exported most of its bomb-making material. This deal was signed by P5+1 states i.e. US, UK, Russia, China, France (permanent members of UNSC¹) + Germany
.

What is uranium enrichment?
Uran­ium is an element that is similar to iron. Like iron, you dig uranium ore out of the ground and then process it to extract the pure uranium from the ore. When you finish processing uranium ore, what you have is uranium oxide. Uranium oxide contains two types (or isotopes) of uranium: U-235 and U-238. U-235 is what you need if you want to make a bomb or fuel a nuclear power plant. But the uranium oxide from the mine is about 99.3 percent U-238, The rest is U-235 (0.7 percent).

A power plant requires uranium with three to four percent U-235 (this is known as low-enriched or reactor-grade uranium), and a bomb needs uranium with a whopping 90 percent U-235 (highly enriched uranium)
So you need to somehow separate the U-235 from the U-238 and increase the amount of U-235. The process of concentrating the U-235 is called enrichment, and centrifuges are a central part of the process i.e. method to increase the enrichment of U-235

Why Trump wants to renegotiate?

Trump believes that Iran deal is the “worst deal ever negotiated” and also call it “insane”. Mr Trump, in his first foreign visit in Saudi Arabia as a president, was in 2017 which shows his keenness to have good relations with Saudi Arabia. He seeks to repair with Washington’s closest Arab ally. Saudi Arabia and Israel were not happy with the Iran nuclear agreement since Iran is their strongest foe in Arab peninsula because of Arab Sunni issues apart from the others. Saudi Arabia is also largest oil supplier and a geographically important location to maintain American hegemony in the middle east and Central Asia.

The relation between the US and Saudi Arabia were deteriorating since the nuclear accord was signed. And hence Trump is trying to compensate to Saudi Arabia as well as to Israel to fight a proxy war in Syria and Yemen through withdrawal from the agreement. Since Iran economy is in good condition after lifting economic sanctions. Iran's economy was in a deep recession in the years before the nuclear agreement. The International Monetary Fund reported that the real GDP of Iran grew 12.5% in the first year following the implementation of the deal. Israel and Saudi Arabia have a fear that the booming economy of Iran will sponsor more arms and other support in Syria and Yemen where Saudi Arabia and Iran are fighting a proxy war along with America and Russia.

CONSEQUENCES

Iran supplies oil about 5,00,000 barrels a day after sanctions on Iran are imposed, the supply of oil internationally will go down and a situation of excess demand will arise. This will lead to a rise in demand for US $ which will lead to the appreciation of US $ which will directly hit exports of US. For example, the average rate of crude oil was about $53 per barrel in 2017 (one barrel approx. 159 litters) and crude oil price keeps increasing, if average rate reaches $80 in 2018-19 then rate of US currency will go up against the other foreign currency like euro, because demand for US dollar will increase by $27 ($53-$80) per barrel. More demand for the dollar will lead to the appreciation of US dollar and this situation will less competitive for US exporters. Suppose, an Indian customer imports apple worth $1000, equivalent rupees 65,000 in 2017 (1$= Rs65). Now one US dollar is equivalent to Rs 68 now the customer has to pay rupees 68,000 for the same quantity of apples (if price and quality are constant). In other words, the customer has to pay rupees 3000 extra so the customer might not import from America.

In the long run, oil supply will decrease and hence price of oil will rise globally since OPEC (organisation of petroleum exporting countries) and Russia have already been cut the supply of oil production in order to raise its price. The short supply of oil for growth-hungry emerging economies like China and India is a nightmare and consequences, many businesses will be affected. However, high oil price is an incentive for other sources of energy, viz green energy and solar to develop them.

ISIS, an Islamic terrorist organization has many oil fields under its control and rise in the price of oil will make them more powerful. EU is already facing BREXIT and if Iran deal is walked off there will be more disturbance which is not desirable for their economy.

Now, Iranian hardliners could resume working on its nuclear programme and will also participate actively in Syria and Yemen war.

Higher the oil price will give an economic boom of Russia since Russian 90% of the fiscal budget comes from oil revenue. Russia is fighting a proxy war with its allies namely with Iran in Syria and Yemen against the America, Israel and Saudi Arabia. After the cancellation of the accord, Iran might start its uranium enrichment programme and this will lead to the nuclear arms race in the Middle East.

Russia due to rise in the price of oil and appreciation of US $ will become more powerful. Russia supports Iran in Syria and Yemen for its proxy war, thus Iran and Russia together will become more powerful against US which is not a desirable situation for the US and its allies.

Affect on Indian Economy

In Economics

With the imposition of sanctions on Iran by US president, it will lead to the decline in oil export of Iran which raises the cost of oil due to excess demand. If we say that increase in prices will reduce demand then it is not possible in case oil as its demand is inelastic i.e. essential commodity at least in short run because alternative energies like solar etc still are not widely available and EVs (electric vehicles) also need to be tested on the road because of it speed of its chargeability. Now if Indian importers want same quantity of oil then they have to pay more US$. It means depreciation of rupees in terms of the dollar. Further, the FIIs and other foreign exchange account holders will withdraw from Indian economy and flight to the USA and other safe places in search of higher returns.

With the increase in oil prices, it will affect tremendously on production as the cost of productions rises due to rise in transportation cost and others input cost. It creates inflationary pressure in economy and the central bank (RBI) will not have other choice to raise the interest rate. To cope with inflation the central bank, normally increase the interest rate. The MPC (Monetary Policy Committee) of RBI has target interest rates are 4%(lower band) and 6% (upper band). Means, if inflation will have above 6 %, it will be treated inflation and vice versa. However, India’s CPI (Consumer Price Index) was between 4.3%-4.8%.

Dearer oil rate will also raise our current accounts deficit (imports more than exports, $39 billion in Q4, in the year 2017-18) because India has to pay more foreign exchange to buy oil from the global market.  The crude oil imports bill in 2017-18 was $80 billion. The fiscal deficit already is increasing from 3.2% to 3.5 % of GDP. India imported nearly 1billion barrel crude oil per annually. This means if every $1 barrel increase in the price raises oil import bill by $1 billion. Average barrel crude oil has averaged $67 per barrel in the current fiscal year so far as compared with $53 per barrel in the previous fiscal year. If the average oil price would be $80 per barrel in the year 2019, then India’s import bill could rise by $17billion ($80-$53) and as a result, current account deficit will also raise.  This will be a big test for Mr Modi in general election in 2019.

In Businesses:

Indian industry will be affected due to their input costs will increase. Now to overcome this situation they will compel to increase their prices of goods and services to maintain their margins. With the increase in prices consumer might react and buying less as earlier. So it will ultimately reduce the firms' revenues.

Another impact on businesses will that now high leverage firms (firm who has more debt in their capital structure) will face losses or decrease in EPS (earning per share) because cost of debt which is interest rate increases by RBI to control inflation, reduction in EPS will reduce the confidence of shareholders to invest which will again put the share market down for high leverage firms. India banking is already facing NPAs (Non- Performing Assets), the bad loans amount is about 10 lakh crore and counting.

The firms who borrowed in dollar terms will also have to pay more interest as payment of interest is in US$ and dollar is appreciating in terms of rupees so more dollar is needed to pay the interest.

In Global Politics
The incumbent Prime Minister Mr Narender Modi’s foreign policy is to encircle Pakistan through Iran and Afghanistan (neighbouring countries of Pakistan). India’s foreign policy is pro-USA, Israel and Saudi Arabia since Modi becomes head of the government and simultaneously, having good relation with Iran.  After the one side cancellation of the deal of Trump and re-impose economics bans on Iran, India will also get disturbed to maintain a relationship with Iran. India can access to Afghanistan through Iran or Pakistan, however, Pakistan does not allow India to gain access to Afghanistan (India is building infrastructures in war-torn and land lock country).

The investment made by Indian investors in Iran might face a setback as the business in Iran will more risky and volatile for investment point of view. Further, Chabahar Port is being co-built by India in Iran ‘s coastal at Arabian Sea region which facilitated trade and connected between India and Iran.

Bottom line: The Trump’s foreign policy will change world order, that order which was built after second world war (1945) and fall of Soviet Union in 1990. China will take advantage. Meeting in Singapore of Trump and Kim in June, Trump will have less negotiating power.


Sources: The Economist, Economic Times, Mint, NCERT,
References: Lalit Singh- IEBP Advance Learning, Rohini, New Delhi,  Sushant Malhotra, Student of XIIth, (Commerce).