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Iran - The story till now and the economic & strategic impact on India

As much as we would like to pretend otherwise, Iran and its stability are extremely important for India. While the impact due to our dependence on oil is the first thing that comes to mind, the strategic importance of the Chabahar port is often understated. In our first short piece on Iran, shortly after the assassination of the leader of their Quds Force, Qaseem Suleimani we had discussed the options that the country had to retaliate, the impact of each, and the economic impact of the same on India. Today, we decided to deep dive into the issue to give you a background of what got us here, what has happened since then and the economic & strategic impact of that on India.

Before we dive deeper into the issue, it helps to start with a brief background of Iran's history, and how they became the America hating theocracy they are today.

A distant history lesson- A coup, a revolution, and some sanctions:

The year was 1953, and the saviour of democracy everywhere - the United States of America, overthrew the democratically elected leader of Iran- Mohammad Mossadegh via a coup orchestrated by the CIA. The CIA admitted to its involvement exactly 60 years after the event in 2013. Mossadegh had tried to audit the financials of a British oil corporation and limit their control over Iranian oil, so the British & Americans joined hands to overthrow a democracy and replace it with a monarchy. Remember that the next time they tell you about their efforts to bring peace to the Middle East.

The person put in charge (Mohammad Reza Pehlavi) was effectively a US puppet, and ruled Iran for 26 more years until he was overthrown in the Iranian revolution. The monarchy was replaced by the Islamic Republic and has continued to date. Iran since then has had only 2 'Supreme leaders' the current Ali Hosseini Khamenei and his predecessor Sayyid Ruhollah Khomeini. The Iranian theocracy has no clean slate either with links and financial backing provided to numerous regimes and militant organizations including but not restricted to the Assad Regime and Hezbollah and have also been accused of abuse of human rights when dealing with the prisoners of the Iran-Iraq conflict.

A lot of the current issues stem from the nuclear resources that Iran has and is developing, that most in the western world view as a threat, especially to one of the West's closest allies in the middle east, Isreal. The modus operandi to control the Iranian state has often been economic sanctions, with the assumption that economic tensions would destabilize the country and bring them back to the negotiating table. The Iran nuclear deal of 2015 tried to strike a balance between the Iran's needs and the West's apprehensions by including the amount and extent of uranium enrichment, level of international monitoring, and number of sites, and balancing that with reduced economic sanctions. In 2018 Trump abandoned the deal, and imposed sanctions on Iran.

With that context, let's move on to analyzing some of the latest events that have been happening in Iran.

A recent history lesson: A strike, an assassination, and some missiles

The conflicts first began to escalate when more than 30 rockets were fired at an Iraqi military base near Kirkuk, in northern Iraq, killing an American civilian contractor and wounding four American and two Iraqi servicemen. America, in turn, retaliated attacking an Iranian militant organization in Iraq killing upto 24 people there. This was followed by people (whom the Americans claim were organized by Iranian militia) surrounding and throwing stones at the US Embassy in Iraq.

Things really escalated when the American forces (under orders from Donald Trump) decided to assassinate Iran's second most powerful man, the head of their elite Quds force, and perhaps one of their most prolific strategic thinkers - Qassem Soleimani via targetted drone strikes.

The move led a wave of unification, not only within Iran but also in the general middle east. Iran's supreme leader stressed that no amount of retaliation would be sufficient, saying Soleimani's shoe was more important than Trump and his entire cabinet. The Iranian government declared the United States military as a terrorist organization, and consequently all US military personnel as terrorists, and the Iraqi parliament voted to remove US forces from Iraqi soil.

Iran had 3 broad choices in front of them after the event. in our earlier piece, we covered these in detail but mentioning quick highlights here for reference.

"Given the military might of the US, this move seems unlikely, since a full-blown war with the US would be virtual suicide. It would also be counter-productive in their efforts to weakening US presence in the middle east since this would give the US government legitimate reasons to deploy more forces there. The second option would be small scale local attacks on installations and military personnel in the middle east through its host of affiliate organizations spread across the region. 'The death by a thousand cuts' approach could see attacks on everything from military installations and bases to military personnel. (Iran's leader has explicitly guided against attacking non-military citizens) Given the sentiment in the Iranian camp, this option seems most likely. The killing of Soleimani would help drive a common anti-America narrative in the middle east and would be something the Iranians could easily capitalize on to mobilize their unofficial forces. The last, and perhaps the most effective (but unlikely given the emotions running) would be the avoiding of military conflict and instead choosing cyber warfare. Given the honed cyber warfare prowess, this would potentially be a way to inflict damage without significant loss of life on either side."

Since then, however, things have steadily gone downhill for Iran. To begin with their retaliation seemed almost consciously weak, attacking an Iraqi base with 10+ missiles, but ensuring no American casualties (A non-threatening version of option 1). While Iran's state channels did claim that upto 80 Americans died in the attack, the Iraqi and American account, as well as America's muted response post the event gives more credence to the number being closer to zero.

The more important issue however, and something that has led to a withdrawal of tremendous support both internationally as well as within Iran is the error that led to the crash of a Ukrainian plane killing all 176 people on board. The government drew harsh criticism from people from Iran, as well as sharp rebuke from other world leaders. It also significantly weakened Iran's bargaining power on the nuclear deal as well as the potential to retaliate further.

The only way Iran can come out of this on top is if the criminal case that they have filed against the USA in the international criminal court goes to trial, with many leading legal experts believing they have a good chance to win. The killing of Soleimani would have been a severe war crime if the threat posed by him was not imminent according to international law, and as of now, there seems to be little evidence to suggest that it was.

So that's where we stand now on the Iran issue as of now. With Iran's position significantly weakened, and the country running one man short, but the possibility of a small upside if the case goes well.

Why India should care- Oil, allies, and Chabahar

In our earlier piece, we had covered the economic impact if the conflict in the area had escalated."Conflict in the oil-rich region has strong implications for India, which still depends heavily on the middle east for its crude. Crude oil prices jumped almost 4% to US$68.7, with analysts fearing an increase to US$80 in case of further escalation from Iran. The jump would depend on the nature, geographical expanse, and extent of the escalation. Back in India, after a strong period of low inflation, vegetable prices had led the inflation number to edge higher last month. A rising crude could further escalate this increase, as the trucks that bring the food from source to store start running on costlier fuel, making the items that reach you that much more costly. The rising inflation also puts the RBI in a tough situation, now having to deal with the dual problem of trying to get inflation down and spurring growth, and would most likely see the RBI keeping rates constant at current levels. The global conflict combined with the constraints on the RBI would in all likelihood dent India's short-medium term growth rates significantly, and prolong the slowdown."

With odds of a full-fledged war or even extended conflict now being ruled out, the Brent has dipped back from its highs in the days after the event. The risk of an oil price spike, and thus an inflation risk from oil seems to be low on back of that information. (We've covered food inflation in our piece on Stagflation earlier this week).

But India also has key strategic interests in Iran, mainly in its port-Chabahar. The strategic location of the port is key for India's access to West Asian trade and serves as an important route given the hostility from its northern neighbour Pakistan. Not only does this provide access to easy trade with Iran and Afghanistan, but it also enables the much shorter and cheaper route to trade with Russia and Europe via the North-South Transport Corridor. The port also strengthens India's ties with Afghanistan and Iran, two countries that flank Pakistan, giving us an important edge in difficult situations. The port becomes even more important given Pakistan's Gwadar port and China's increasing presence globally via is "String of Pearls" initiative.

As the situation progresses India will have to play a balancing act, managing its relationships and strategic interest not only with its Asian neighbour but also with its western allies. For now, we take the reducing military tensions as a positive and hope things continue to proceed peacefully for everyone involved.

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