The Iran Driver for the Rupee

Teheran Market

India wants its businessmen to sell more to Iran. No big deal, you may say in these days of global slowdown. But here’s the caveat – North Block wants Indian business to sell in rupees and not in the dollars they are used to and has this December, sent out trade delegations to Teheran to explore rupee trade deals.

India had agreed to buy about 45 per cent of the $ 11  billion in oil it purchases from Iran in rupees, to be liquidated by that country in buying Indian goods, early this year, after US and EU imposed sanctions ended the earlier preferred routes of paying through Turkish and Gulf based banks. The money was to be parked in Uco Bank to facilitate Iranian purchases from India. Not much happened after that.

Strangely, instead of the Indians getting worried about the $ 5 billion lying idle in Uco Bank, it was the Iranians who started fretting. Iranian ministers and diplomats complained that Indians lacked business acumen and pointedly compared them with the Chinese, who in their words “were flooding the markets of Iran with Chinese-made goods” traded in Renminbi, which Iran had accrued by selling some 25-30 million tons of crude a year, to the Middle Kingdom.

To push Indian business to try liquidate the huge rupee positions Iran is building up, the Indian government has started encouraging Indian trade delegations to make their way to Teheran.  From December 17-19, a trade delegation of pharmaceutical  firms were sent out to explore rupee deals to sell bulk drugs to Iran.

This followed a letter from the Commerce Ministry which informed drug makers that “ECGC has agreed to provide guarantee cover up to Rs.300 crores ($600 million) to UCO Bank and also to waive the restrictive clause of “insufficient funds” for negotiation of L/C  (letter of credit) by the banks. “ Incidentally, the December trip was the second one organised for pharmaceutical firms, in 2012 to Iran which has a $ 3 billion market for medicines.

The pharmaceutical firms are not the only ones, being encouraged to fly down to Teheran. Engineering firms were sent on trips  to Teheran to explore similar rupee based deals. India wants to rachet up two-way trade from a current $ 14 billion to $ 25 billion over the next four years, with trade evenly balanced between the two countries, instead of the current situation where Iranian sales of oil and gas outweigh Indian sales of food, medicines, chemicals and engineered goods by 11:3.

Iran is already the largest importer of rice from India, with India exporting around 1 million tonnes of basmati rice to Iran. Iran is also one of the biggest buyers of Indian orthodox quality tea, consuming about 15 million kg every year. India has also sealed deals to export 176,000 tons of sugar to Iran so far this year .“The chances of selling more food to Iran are consequently limited. India needs to sell manufactures to Iran, if it wants to take on China … its brands have to be present in Taheran markets more prominently,” said Commerce Ministry officials.

But there are problems in doing business with Iran too. In theory,  Uco Bank will pay Indian exporters out of the account maintained by it on behalf of Bank Markazi, the Iranian central bank, when any of four Iranian Banks  — Bank Parsian, Saman Bank, Pasargad bank and EN Bank — issue valid letters of credit.

However, in reality, LCs take a long time in coming as importers and exporters are put on bureaucratic queue by the Iranian banks. The quick-fluctuating price of Rials makes pricing a tough job too. Even when Indian exports have reached Iran, payments against LCs take a huge time, with Iranian banks taking their own sweet time.

However, the good thing about the Indo-Iranian rupee trade, officials in Finance Ministry say is that this is “encouraging the idea that the rupee can become a currency for international trade … yes there are glitches, but if resolved, India could start exporting more in rupees and cutting out the risk of global forex fluctuations.”

Both the Indian rupee and the Chinese currency are convertible on the current account but not on the capital account, but the Indian rupee’s value is market determined while the Chinese currency’s value is fixed by its central bankers. However, it’s the Renminbi which is talked about in international banking circles, whenever debates occur over new hard currencies which would join the Dollar,  Euro, Pound and Yen in global trade.

Currently, the rupee is officially used for international transactions only with Bhutan and Nepal. Though unofficially, traders in UAE, Singapore, Malaysia, Afghanistan and other neighbouring Asian nations deal in rupees.

According to reports, the Sri Lankan Central Bank’s Monetary Board which earlier this year decided to include Renminbi in the list of designated currencies permitted for international transactions through banks in Sri Lanka, is considering placing the Indian currency too on its list of designated currencies.

Yen, Rupee and Risk Swaps

Worried by the rate at which the rupee has been falling against the dollar with currency speculators beating down the Indian currency, the government has reacted with alacrity to a Japanese offer to renew a currency swap agreement which had lapsed June, this year.
Japan of course wants to do more than just swap financial risks. Lurking behind the two nation's economic enagagement, are serious strategic considerations which could shape Asia in the future.

The last forex swap deal between the two nations, was for $ 3 billion and provided for either side pitching in with $ 1.5 billion to help shore up the other’s currency. This time round the war chest will be larger at $ 15 billion, with both sides committing $ 7.5 billion which the other side can use.

Japanese Prime Minister Yoshihiko Noda who arrived on Tuesday, December 27, is expected to finalise the deal. Japan’s forex reserves are at a high of $ 1.3 trillion, the second highest forex reserves globally but it has still signed up for currency swap deals with a number of key countries.

The arrangement will allow the Reserve Bank of India to borrow dollars from the Bank of Japan to sell in the forex market to stabilise the rupee. BoJ will have similar rights in case the Yen is under attack.

India’s currency has been under attack in recent weeks. Partly, because foreign institutional investors who play in the bourses of this country  have been selling stocks, converting their earnings into dollars and taking it out to invest in other markets. The rupee's value has fallen by some 20 per cent since June, 2010.

In part, the rupee is falling as it is also under attack from currency speculators who are betting against the currency. India, despite having one of the largest forex reserves, globally, holds much of this reserve in the form of debt inflows. Of India’s $ 302 billion reserves, net foreign liabilities which include Non Resident Indian (NRI) deposits, FII investments, foreign borrowing by Indian corporates, stand at $230 billion or so. This high proportion of debt in India's forex assets makes the rupee vulnerable to speculative runs on it, especially near dates when large portions of this debt come up for redemption.
Large bits of the NRI deposits and some of the corporate debt mature in the coming year, which perhaps explains why currency speculators have started pulling down the rupee and also why India is in a hurry to sign up on swap deals.
Japan, has a stake in the rupee's well being. India, an important trade partner for the island nation, whose auto parts and capital goods sales to the South Asian nation, has been impacted by the rising price of the Dollar/Yen. Japan probably feels if it can help check the erosion of the value of the rupee, it can protect its market share here. A stronger rupee could enthuse Indians to import more Japanese goods as the Japanese prices would then look more affordable .
Japan’s competitors in the Indian market are China and Korea and China has already started floating Renminbi loans so that India can purchase  power and telecom equipment from it at attractive rates bypassing the strengthening Dollar.

But underlining all this economic bonmhomie are strategic considerations. Japan is also wary of a militarily rising China, which has been making territorial demands on it, and has been consequently looking to balance China by engaging with India both strategically as well as economically.

The Japanese government is alarmed by aggressive Chinese naval moves in the East China Sea, where it disputes Japanese control over the Senkaku islands as well as by anti-Japanese demonstrations in China, and has been quietly advising its firms to look westwards towards Vietnam in the Asean region and towards India.
The Japanese currency swap deal should be seen in this broader strategic and economic context.
Luckily, Japanese businessmen too feel India is a better business bet in the long run. A survey conducted some time back, by the Japan Bank for International Cooperation for the island nation’s Ministry for Economy, Trade and Industry, shows some 75 per cent of Japanese businessmen considered India as “the most promising country” ahead of China, Brazil, Vietnam and the US.
More than 1,200 Japanese firms have already invested in India including Suzuki, Honda, Nissan, Toyo, Mitsubishi, Panasonic, Daikin, Toyota, Komatsu, Sanyo, Nissin and Shimadzu. While a second wave of investment by small and medium Japanese enterprises as well as major players expanding their business has started earlier this year.
The two main political parties in the island nation - the Liberal Democratic party which ruled Japan  for more than 40 years since 1955 and Democratic Party which currently rules it - are both agreed on the need for closer strategic and economic ties with India.
Takeshi Iwaya, LDP’s shadow defence minister and member of the Japanese Diet had told this writer when he visited Japan, in Autmn this year, : “threats surrounding Japan are increasing, China is expanding its military technology and  capacity at a ferocious speed …  Japanese alliance with US will remain our cornerstone  …(but) we have to work out common strategic objectives and economic agenda with India.”
A case of double risk swaps both ways?

Postscript:
Hours before Prime Minister Noda left for India on Tuesday, Japan's security council relaxed a four decades-old arms exports ban. Though India was the world's top weapons importer last year, the lifting of the ban is seen as a move which could be used by firms like Mitsubishi to cooperate with Indian shipyards and factories in building defence vessels and  missile defence systems, rather than India buying off the shelf hardware from the East Asian powerhouse.

Mitsubishi has a deal with India’s L and T Shipyards and defence analysts say that the two could use the opportunity to co-produce a wide range of Naval vesels. As it is the two countries are working in the words of  former Prime Minister Shinzo Abe, so that "sooner rather than later, Japan's navy and the Indian navy are seamlessly interconnected."

India has cooperated with Israel in missile design, while Japan has deals with the US on missile development. Well known Indian defence analyst Brahma Chellaney in an article in Japan Times on December 28, mooted a deal between the two Asian powers – India and Japan - in this sphere.    


Related Reading:
To read a very US-centric take on the US-Japan-India trilateral in mid December, readers maybe interested in Josh Rogin's blog at the Cable : http://thecable.foreignpolicy.com/blog/11505 .