In the spirit of the saying,
Jaw-jaw is better than war-war, Iran
and a group of six nations led by the United States announced a historic
agreement aimed at restricting Tehran's nuclear weapons program for at least a
decade in return for a phased lifting of sanctions. The deal requires Iran to
scale back its sensitive nuclear activities and bring it under international
supervision. In return, the Gulf nation will get access to $100bn in frozen
assets and its central bank and industries will be free do business with the
world. Consequently, the investors are beginning to size up the potential of an
economy that has been isolated for three decades.
Since the Islamic revolution
in 1979, ever expanding sanctions, on one pretext or the other, by the United
Nations, United States and the European Union has been a regular feature of
contemporary geopolitics. The embargo on wide swatches of the Iranian economy
stymied its industries and resulted in its economy being 20% smaller than it otherwise
would have been. Its oil exports that account for 85% of export revenues and a
half of government expenditure plummeted drastically. And isolation from the
international banking system caused rial (i.e.
Iran's currency) to lose two-thirds of its value against the US dollar which in
turn sent inflation soaring to 40%.
Crushed by economic
hardship, Iran opened up negotiations, in 2013, on the nuclear and other
broader set of issues with the world powers, and after twenty months of arduous
talks a landmark deal was concluded. Effectively, the agreement will end Iran's
international isolation and will bring it back into the global economic fold.
Opportunities and challenges for India post easing of the sanctions on
Iran
Despite crippling sanctions,
India was among a handful of countries that continued to trade with Iran,
though it dragged its feet on many agreed investments. The easing of sanctions
is expected to reinvigorate India’s economic and strategic engagement with
Tehran, but many fear that the Gulf nation may now strike a hard bargain, or
even turn to more competitive players. However, given India’s goodwill in Iran
due to its continued engagement, it is likely that Indian companies will gain
in the future.
Crude prices:
With unbalanced fundamentals (demand-supply mismatch) and no major
geopolitical disruption in sight, it is expected that crude prices will remain
soft in the foreseeable future. Not only that, with oil markets well supplied,
exporters are offering sweeter deals in terms of increased credit period,
nominal discount and free shipments to grab a bigger slice of the Asian
markets. Cumulatively, these developments suggest a benign impact on the
financials of Indian oil companies, and on country’s macro fundamentals.
As per the data from the
Organization of the Petroleum Exporting Countries (OPEC), daily world supply of
crude exceeded demand by almost 3mn barrels per day (bpd) for the period April
to June 2015 on account of record production by the United States, OPEC and
Russia; as also due to slowdown in global economy that has stymied crude demand.
However, despite the glut, Iraq has added 0.1mn bpd to its exports since June,
and post easing of sanctions, Iranian officials predict a quick rebound of up
to 0.4mn bpd and an additional 0.6mn bpd after six months. Iran, as number two
producer within OPEC, exported around 2.5mn bpd until 2011 before stringent
sanctions halved its shipments in last couple of years, and it will push hard
to regain its position and market share.
As for shale drillers in the
United States, production primarily depends on productivity of wells,
efficiency gains in production and breakeven price (that ranges anywhere
between $25 to over $100 per barrel). On an average, just 25% of wells account
for about 80% of the initial shale oil production. Moreover, the sector has
been witnessing 20-30% efficiency gains every year resulting in steady
reduction in the actual cost per barrel. It is, therefore, not surprising that
with fall in global crude prices, rig counts have decelerated but production
has continued to grow as drillers concentrate on more productive areas. The
phenomenon is similar to the US natural gas industry where operating rigs currently
are down by 80%, yet total production has grown 40% since 2009. Consequently, excess
global supplies and tepid demand growth for crude is expected to keep a lid on
prices which in turn will have a positive impact on India’s macro fundamentals.
Infrastructure Investments:
India has interests in railways, port, aluminium, steel, fertilizer, and
oil & gas sectors in Iran. However, China too enjoys a healthy relations with
Iran and has entered the country in a big way, the first of many projects being
a high-speed rail line between the cities of Tehran and Isfahan. Given that
Indian companies have already made inroads into the Iranian market, they will
now have to match China’s speed and scale of project execution.
Iran has about 10% of oil,
18% of gas and 3% of the world's mineral reserves and the country needs significant
investments in these sectors. With embargo gone, the government is said to be
working on new oil and gas contracts, by some estimates worth $100bn. ONGC
Videsh is expected to make renewed pitch to invest nearly $7bn in its biggest
gas discovery that holds 12.8 trillion cubic feet of gas. Though it has already
spent around $100m to develop the facility, production was stalled due to
sanctions. New Delhi is currently engaged in lengthy negotiations as Tehran
intends to auction the site instead.
In addition, India has also
signed a memorandum of understanding (MoU) in May this year to invest in the
Chabahar port in Iran to have an unhindered access to resource-rich Afghanistan
and Central Asia. The port will be developed by an Indian joint venture company
at a cost of $85mn and a fertilizer plant is expected to come up in its
vicinity as Iran has promised to supply natural gas at $2.85 per unit for urea
production. Importing this urea to India will be 50% cheaper than the domestic
output, thus leading to a drastic reduction in the fertilizer subsidy. On top
of that, Iran has also offered preferential tariffs for Indian exports passing
through the aforementioned port and headed to Afghanistan and Central Asia.
Other major investments,
where talks are currently underway, are expected to be in steel, aluminium and
railways. The National Aluminium Company Limited (NALCO) is considering a $3bn
aluminum smelter complex along with a thousand megawatt captive power plant to
produce 5 lakh metric tons of aluminum per year. In the railways sector, Indian
companies led by the Steel Authority of India Limited (SAIL) have signed a
$233mn contract to supply more than 1.5 lakh tons of rail tracks to develop
Iranian railways. Tehran wants to spend up to $8bn over the next six years to
revamp and expand its railway network, and to this effect will require about
3mn tons of steel rails.
Trade:
Post easing of the sanctions, Indian exports of many items (corn,
soyabean, sugar and engineering products) are likely to go down due to
international competition whereas shipments of rice and other products like
tea, iron ore, steel may either increase or remain flat. On the import side,
India has already stepped up oil purchases from the Gulf nation by over 50% on
year on year basis. Therefore, although it is expected that Indian exports to
Iran will jump by over a third to $6 billion this fiscal year, overall trade
deficit with the Iran is likely to widen in the coming months. Nevertheless in
years to come, new opportunities could open up for Indian pharmaceuticals and
IT sector to boost their business in Iran.
Current bilateral trade
between India and Iran is about $14bn with the balance heavily in Tehran's
favor due to oil imports by India. Indian exports to Iran were around $4.2bn
last year, comprising mainly of food items. To circumvent payment settlement complications
arising from the sanctions, India started a rupee-denominated trade with Iran
in 2012 whereby Indian refiners settled 45% of payments by depositing rupee in
the Iran Account in Mumbai. Iran then used these funds to import various goods
from India, leading to doubling of Indian exports to Tehran in past two years. India,
consequently, became Iran's top rice supplier, accounting for about 90% of its
basmati rice requirements. And shipments of commodities such as corn, sugar,
soybean, tea, iron, steel, chemicals, machinery, and vehicles too soared as
India faced little competition against the backdrop of sanctions.
With embargo relaxed and new
avenues for trade available, Iran will return to conventional deals with India
and thus agri-exports are expected to face intense competition. The South
American countries will out-price India in products such as soyabean, sugar and
corn. And a 20% depreciation of euro over the past year will help European
firms win market share from India in automobile parts and machinery tools.
Nevertheless, it’s not all
gloom and doom for Indian exporters. The Federation of Indian Export Organizations
(FIEO) expects shipments of products such as rice and tea to continue on an
upward trajectory, given India’s monopoly in basmati rice and abundance
production of many food items. In fact, the All India Rice Exporters'
Association anticipates 10-15% rise in basmati rice exports to Iran. In addition,
opening up of Iran also provides future opportunities for Indian
pharmaceuticals and IT exports.
Rupee:
Bullet payment of about $6.5bn to clear past oil dues of Iran is
expected to bring rupee under pressure. But oil companies were advised by the
finance ministry, in advance, to make staggered purchases of dollars from the
market for the aforesaid purpose, hence no significant depreciation is expected.
India is the second biggest buyer
of Iranian oil after China, though it was forced to drastically cut down its
imports from Tehran on account of the sanctions. Under the payment settlement mechanism
devised to beat the embargo, Indian oil companies have to clear past dues of
Iran to the tune of $6.5bn for crude oil purchases. With sanctions gone, many fear that a
bullet repayment would put pressure on the rupee and impact overall imports.
However, expecting this development, the oil companies were advised by the finance
ministry, in advance, to make staggered purchases of dollars from the market
for the aforesaid purpose.
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