Rajat Dubey asked: Why did India decide to withdraw from ACU? How will the new agreement with Iran solve the problem?

Shebonti Ray Dadwal replies: In December 2010, the RBI decided to stop using the Asian Clearing Union (ACU) to pay Iran for its crude - under US pressure. The ACU, which was established at the initiative of the United Nations Economic and Social Commission for Asia and Pacific (ESCAP) and in operation since 1974, is a currency mechanism set up to help countries economise on their forex reserves by allowing them to conduct bilateral barter trade and make payments using the Asian Monetary Units (currency units indexed to the US dollar and the euro that allowed countries to hold surpluses and deficits outside their formal foreign exchange reserves).

Washington and its Western allies had been pressuring India not to use the ACU to pay Iran on the grounds that this mechanism was too opaque, thereby making it difficult to ascertain whether the money flowing into Iran's coffers was not being used for the country's nuclear programme. Under pressure from the US Treasury, the Indian government withdrew from the ACU facility. A RBI circular on December 27, 2010 noted that “all eligible current account transactions including trade transactions with Iran should be settled in any permitted currency outside the ACU mechanism.”

In order to pay Iran, India first turned to a complex mechanism using the Hamburg-based Europaisch-Iranische Handels Bank (EIH) via the German Central Bank and the State Bank of India between February to April 2011 as the procedure did not violate UNSC or EU sanctions. However, pressure on German Chancellor Angela Merkel from the US increased and in April 2011 this route was also closed by Germany. India then made an arrangement with Turkey's Halkbank, 75 per cent of which was owned by the Turkish government, which had refused to abide by US and EU sanctions. But Halkbank too was put under tremendous pressure to close this payment avenue as well.

India, unlike China, does not have the wherewithal to conduct barter trade with Iran, given the huge imbalance in their bilateral trade. After weeks of negotiations, both countries agreed in February 2012 that India would pay 45 per cent of its oil bill in rupees which would be held in the Kolkata-based UCO bank (which has minimum, if any, exposure to the US market) and IDBI bank and paid out to two Iranian private banks, Bank Parsian and Karafarin Bank. The rest of the oil bill will be sorted out in time. To further facilitate this mechanism, India had also agreed to waive a withholding tax of 40 per cent of net income, i.e., while making payments to Iranian crude oil suppliers, Indian refiners will not have to deduct taxes.

Moreover, to correct the trade imbalance, India and Iran are trying to substantially increase Indian export basket to Iran. In March, an Indian trade delegation went to Iran for this purpose, but came back largely disappointed. Indian traders had hoped to export wheat, rice, tea, pharmaceuticals, iron and steel. Early this month, a 56-member Iranian team also visited India to look at options to boost trade. While statements, such as potential bilateral trade reaching $24-25 billion, are making the rounds, nothing concrete has come out of the discussions, barring a few small deals in Indian export of soy meal and animal feed to Iran.

Hence, while the rupee trade has allowed India to pay Iran some $7 billion for earlier oil, India will have to either boost exports to Iran to continue buying oil from Iran or cut its oil imports from the country.