The Impact of Sanctions on Iran-GCC Economic Relations

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The Impact of Sanctions on Iran-GCC

Economic RelationsNader Habibi

In June 2010 the United Nations approved a fourth roundof sanctions against Iran, and a few weeks later severalnations announced additional unilateral measures. Thereis now strong evidence to suggest that despite repeateddenials by some Iranian leaders, these sanctions are imposinga heavy cost on the Iranian economy. Some of Irans major

trade partners, such as South Korea, are among the latestcountries to have introduced unilateral trade sanctionsagainst Iran. During the past two decades, imposition of thesanctions has evolved into a dynamic game between Iranand the United States: Every new round of sanctions by theU.S. or the international community has provoked a seriesof countermeasures by the Iranian government intendedto neutralize them. The impact of this back-and-forth hasbecome highly visible in the economic relations between

Iran and the six member countries of the Gulf CooperationCouncil, or GCC (Bahrain, Kuwait, Oman, Qatar, SaudiArabia, and the United Arab Emirates [UAE]).In the past, GCC countries often exhibited a lukewarm attitude both towardinternational economic sanctions and with respect to possible military actionagainst Irans nuclear program. While reluctantly going along with the UN-approved international sanctions (though the record varies from countryto country), GCC countries generally refused to cooperate with unilateralU.S. sanctions. It now appears, however, that since January 2010 some GCCcountries, particularly Saudi Arabia, have become more vocal in expressing their

November 2010

No. 45

Judith and Sidney Swartz DirectorProf. Shai Feldman

Associate Director

Kristina Cherniahivsky

Assistant Director for ResearchNaghmeh Sohrabi, PhD

Senior FellowsAbdel Monem Said Aly, PhDKhalil Shikaki, PhD

Henry J. Leir Professor of theEconomics of the Middle EastNader Habibi

Sylvia K. Hassenfeld Professorof Islamic and Middle Eastern StudiesKanan Makiya

Junior Scholar FellowsFuat Dundar, PhDLiad Porat, PhDJoshua W. Walker, PhD

President of Brandeis UniversityJehuda Reinharz, PhD


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Nader Habibi is theHenry J. Leir Professorof the Economics of theMiddle East at BrandeisUniversity and a seniormember of the CrownCenter research staff.

The opinions and findings expressed in thisessay are those of the author exclusively, anddo not reflect the official positions or policiesof the Crown Center for Middle East Studiesor Brandeis University.

concerns about Irans nuclear program and have offered greater cooperation withU.S. efforts to contain it.The growing cooperation of GCC countries with U.S. policies to isolate Iraneconomically represents a major setback in Irans economic and diplomatic effortsto improve its ties with GCC countries at the expense of the United States overthe last ten years. Economic diplomacy was an important pillar of Irans policytoward GCC countries during this period.1 By increasing its volume of trade andinvestment with GCC countries, Iran was hoping to enhance its value to these

countries as an economic partner. And aside from this deliberate policy, Iran wasalso forced to rely more on trade with GCC countriesthe UAE in particularasa result of the escalating sanctions. The difficulties that sanctions caused for Iran intrading with Europe and even with some Asian countries forced Iran to rely moreand more on re-export opportunities vis--vis its Southern neighbors.This Brief offers an overview of Irans economic ties with its GCC neighbors since1980 and of how these relations have been affected by United States sanctionsagainst Iran. It reviews first diplomatic and then economic relations between GCCcountries and Iran after the 1979 Islamic Revolution and then considers the impactof the multiple rounds of anti-Iran economic sanctions on Iran-GCC relations.

Iran-GCC Diplomatic Relations

With the exception of Saudi Arabia and Oman, the members of the GCC arerelatively young states. Kuwait gained independence from the United Kingdomin 1961; Bahrain, Qatar, and the United Arab Emirates were established in 1971after several decades of domination by the United Kingdom. During the 1970sthe Shah of Iran acted as the gendarme of the Persian Gulf with the military andpolitical support of the United States. The GCC states reluctantly accepted thedominant role of Iran, but at the same time they received direct military protectionand diplomatic support from the United States and the United Kingdom. Thisarrangement came to an end with the overthrow of the Shah and the emergence ofthe Islamic Republic of Iran.

Overall, post-1979 relations between Iran and the GCC countries can be dividedinto three distinct phases. The first period, from 1980 to 1989 was dominated bymutual hostility and distrust. While Irans interference in the domestic affairsof these countries was initially ideologically motivated, it assumed a strategicdimension during the second half of the Iran-Iraq war as Iran sought to eliminateGCC support for Iraq by fomenting religious uprisings and instigating regimechange.

Soon after returning to Iran from exile and establishing a new governmentAyatollah Khomeini questioned the legitimacy of the ruling families of theneighboring Arab sheikdoms and openly called for replacing these regimes withIslamic governments. This militant attitude deteriorated the relatively cordiarelations that the countries that would unite to form the GCC had developed withIran in the 1970s. The rulers of these countries felt threatened by the open hostilityof Irans Islamic regime and responded with three distinct policies. They closedranks and created the Gulf Cooperation Council in 1981 as a security pact againstthe perceived threats from Iran (and, to a lesser extent, from Iraq). They intensifiedtheir security and military alliances with the United States. And they offeredsizeable financial support to Iraq during the 198088 Iran-Iraq war.


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The death of Ayatollah Khomeini in 1989 and the ascentof Ali Akbar Hashemi Rafsanjani as Irans new presidentresulted in a pragmatic change in Irans Middle East policyand launched the second phase of Iran-GCC relations,extending from 1989 to 1997. Under President Rafsanjani,Iran abandoned its regime change objectives vis--vis theGCC countries and focused instead, during the first yearsof Mr. Rafsanjanis presidency, on improving diplomaticrelations with its Arab neighbors, with the strategic

objective of encouraging the GCC countries to abandontheir security arrangements with the United States andenter instead into a regional security alliance with Iran.This objective proved unattainable, however. Still skepticalof Irans motives, the GCC countries remained committedto their military alliances with the United States.2 Iraqsinvasion of Kuwait in 1990, which was defeated by U.S.-led international forces, strengthened U.S.-GCC relations,much to Irans displeasure. Nevertheless, although itmaintained neutrality during this war, Iran opposed theIraqi occupation of Kuwait, and this posture provided

an opportunity for a partial improvement in Iran-GCCrelations. Iran and Saudi Arabia restored diplomaticrelations in 1991, though those relations remained relativelycold during the remaining years of Mr. Rafsanjanispresidency. Iran maintained independent diplomaticrelations with the other, smaller GCC countries, but theserelations were often influenced by the state of Saudi-Iranrelations.The third phase of Iran-GCC relations began in 1997 whenIran hosted the annual meeting of the Organization of theIslamic Conference (OIC) only a few months after theinauguration of President Mohammad Khatami. Hostingthe conference increased the legitimacy of the Islamicgovernment of Iran among Muslim nations and paved theway for a further improvement of relations between Iranand Arab countries.3 Better relations with Iran were alsopartly due to the rising power of Crown Prince Abdullah,who had been serving as the de facto leader of Saudi Arabiasince 1995 and was interested in strengthening SaudiArabias regional ties. Former Iranian president Rafsanjanivisited Saudi Arabia in 1998, and this visitthe first high-ranking Iranian visit to the Saudi kingdom since the 1979revolutionled to a further warming of relations. SaudiArabia also encouraged other GCC countries to improvetheir ties with Iran.The expansion of diplomatic and economic ties betweenIran and Saudi Arabia during the third phase was moresubstantial than before and included several diplomaticvisits. One important area of cooperation pertained tocrude oil policy within OPEC. Saudi Arabia and Iran wereboth suffering from the low price of oil in the mid-1990s(when prices fell below $10 per barrel in some months).Improved relations allowed for better coordination of OPEC

production quotas, which eventually led to higher oil pricesafter 1999. Another benefit of improved Iran-Saudi relationswas the resumption in September 1997 of direct flightsbetween Tehran and Jeddah for the first time in eighteenyears.

Irans relations with other GCC members have alsoimproved in recent years, but they remain sensitive tospecific bilateral concerns. Among GCC countries, Oman

and Qatar have maintained the warmest diplomaticrelations with Iran since the 1979 revolution; both countriessought normal and cordial relations with Iran despite beingclose allies of the United States. By contrast, Bahrainsruling regime has had a tense relationship with Iran onaccount of its own ethnic mix. While the ruling regimebelongs to the Sunni sect, Shiites constitute the majorityof the population, and the ruling al-Khalifa family, whichmaintains close ties with the United States and GreatBritain, is concerned about Irans influence among BahrainiShiites. Furthermore, until the late eighteenth centuryBahrain was periodically under Iranian rule before it became

a British protectorate4. After Irans Islamic Revolution, someShiite clerics in Bahrain called for the creation of an Islamicgovernment, but their political aspirations have beenfrustrated by the al-Khalifa ruling family. In recent monthsthe government of Bahrain has arrested many Shiite activistsand revoked the citizenship of a prominent Shiite clergyAyatollah Hossein Mirza Nejati, but Iran has maintaineda neutral stance and refrained from offering any formasupport for the political struggle of Bahraini Shiites.

Iran has a minor territorial dispute with Kuwait and amore serious dispute with the United Arab Emirates. TheIran-Kuwait dispute revolves around an offshore gas fieldcalled Arash by Iran and al-Durra by Kuwaitis.5 The field isclaimed by both nations, and in recent years Iran has tried toresolve the dispute by calling for its joint development. Iran-Kuwait relations deteriorated after the Islamic Revolutionbut in recent years both countries have taken positive stepsto improve their diplomatic and economic ties.Iran and the UAE have an unresolved dispute over threesmall islands in the Persian Gulf. Iran occupied the islandsof Abu Musa, Greater Tunb, and Smaller Tunb in November1971, a month before the British withdrawal from the PersianGulf and the creation of the UAE as an independent nationAt that point the emirate of Sharjeh claimed sovereigntyover Abu Musa, while the emirate of Raas-al-Kheimahclaimed the Tunb islands. As Sharjeh and Raas-al-Kheimahbecame part of the UAE, the islands dispute evolved into anIran-UAE dispute that is yet to be resolved. 6

In spite of this dispute, Iran and the UAE have maintaineddiplomatic relations in the past three decades, and theUAE has emerged as one of Irans largest trade partnersaseeming contradiction that is explained, perhaps, by


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the long history of trade and travel between Iran andthe northern emirates of Sharjeh, Raas-al-Kheimah, andDubai. The emirate of Dubai, in particular, is home to anestimated 400,000 residents of Iranian descent. The al-Maktoum ruling family of Dubai has always maintainedwarm relations with Iran and has welcomed several wavesof Iranian immigrants beginning in the early twentiethcentury, when conservative Iranian merchants who wereopposed to Reza Shahs forced unveiling of women migrated

to Dubai. These first immigrants are now predominantlyArabized and are well integrated within commercial andpolitical circles in Dubai. The latest wave of immigrantsconsists of merchants and professionals who moved toDubai after the Islamic Revolution in search of economicopportunities and cultural freedom. They play an importantrole in bilateral trade and investment between Iran and theUAE.

Irans interest in warmer relations with GCC countrieshas continued through Mahmoud Ahmadinejadspresidency, which began in 2005. While repeatedly making

controversial statements against Israel and expanding Iranssupport for militant Islamic groups such as Hezbollahand Hamas, Ahmadinejad has exhibited a moderate andcooperative attitude toward the GCC states; he has alsovisited several GCC capitals in recent years. Continuitywith respect to Irans new policy toward the GCC has beenmaintained by the Supreme Leader, Ayatollah Khamenei,who plays a dominant role in setting foreign policy andwhose constitutional powers are very broad. The hostileinternational environment and ongoing tensions withthe United States have also compelled Iran to improveits economic and diplomatic ties with its wealthy Arabneighbors.At the same time that direct bilateral relations betweenIran and the GCC were improving in the past decade,Iran and Saudi Arabia were becoming more competitivein their attempt to influence the course of events in therest of the Middle East. With the fall of Saddam Husseinand the empowerment of Shiites in Iraq, Saudi Arabiabecame concerned about the rising influence of Iran andits Shiite allies in the Arab world. The Saudis activelysupported Sunni ethnic groups during Iraqs sectarian civilwar after 2003 and encouraged the United States to insiston constitutional rights for Sunnis in Iraqs post-Saddampolitical structure.Saudi Arabia and Iran are also locked in fierce competitionover Lebanons factional politics. To counter Irans supportfor Hezbollah, Saudi Arabia has backed the Sunni andChristian factions. The competition in Lebanon, however,has assumed some constructive dimensions in recent years.Iran and Saudi Arabia used their influence over Lebanesepolitical factions to mediate a political settlement after the2006 Lebanon-Israel war.7

Economic Relations

Both Iran and the GCC countries trade more withdeveloped countries than with each other or with otherdeveloping countries. As oil-exporting countries they havesimilar economic needs, and few export products thatthey can offer one another; their main import products areindustrial products, machinery, and capital goods, whichthey obtain, for the most part, from developed industrialcountries. As a result, the volume of bilateral trade betweenIran and the GCC has historically represented only a smallshare of each sides total trade.

In the past, Irans exports to its Arab neighbors consistedprimarily of agricultural products and handicrafts. Morerecently, GCC countries have expressed an interestin purchasing natural gas from Iran for residentialconsumption and as feedstock for their growingpetrochemical industries. In the past decade, both Iranand the GCC countries have made advances in low-techand intermediate manufacturing, resulting in a moderateamount of trade in manufactured and industrial productsbetween themmainly in petrochemical products and lightconsumer goods.Until the year 2000, the volume of trade between Iran andthe GCC countries was very limited. As shown in Figure 1the volume of Irans imports from and exports to the GCCwas less than one billion dollars in most years. ThereafterGCC exports to Iran enjoyed dramatic growth, from $1.3billion in 2000 to $13.4 billion in 2008. Irans exports to

GCC countries also increased, but at a slower pacefrom$630 million in 2000 to $2.62 billion in 2008. As a result, theGCC countries have enjoyed a sizeable trade surplus withrespect to Iran, which reached a peak of $10.7 billion in 2008and decreased to $7.3 billion in 2009.

Figure 1. Iran-Arab Trade as Reported by Arab Countries(in millions of dollars)

Source: International Monetary Fund, Direction of Trade Statistics, June

2010.

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

1995

1996

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1999

2000

2001

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2003

2004

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2006

2007

2008

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Arab imports from Iran Arab exports to Iran

GCC imports from Iran GCC exports to Iran


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The sharp increase in Irans imports from GCC countrieswas not evenly distributed among GCC members. Asshown in Table 1, the United Arab Emirates has dominatedGCC exports to Iran, followed by Saudi Arabia as a distantsecond. Th=us, in 2008 the UAE exported $13.2 billionto Iran, while aggregate exports of the other five GCCmembers were only $1.58 billion. Table 1 also reveals thatIrans trade with GCC countries has enjoyed exceptionalgrowth since 2000: Irans imports from the UAE rose 11times during 2000-2008, while imports from other GCCmembers grew 14 fold.

In light of the unresolved islands dispute, it seemsparadoxical that the UAE has emerged as one of Iranslargest trade partners. As I will explain in later sections,however, the complex international dynamics of theUAE federation are the main factor that has led to thisseemingly unlikely situation. What sets the UAE apartfrom other GCC countries is the port city of Dubai, whichserves as a major re-export center for the entire MiddleEast and particularly for Iran. Most of Irans imports fromthe UAE either originate in Dubai or arrive in Dubai forre-export to Iran. Some products are re-exported to Iranafter some minor assembly and repackaging in Dubai. TheUAE Ministry of Foreign Trade has estimated the valueof re-exports to Iran at $7 billion in 2009, reflecting a 16%increase compared with 2008.8

Table 1. Irans Imports from GCC Countries(in millions of dollars)

Year Bahrain Kuwait Oman QatarSaudiArabia

UAE

1995 60 5 3 1 21 4411996 129 4 1 5 77 473

1997 59 15 0 2 55 562

1998 0 0 0 0 0 759

1999 0 0 0 0 0 769

2000 24 8 2 4 74 1,154

2001 65 10 4 5 163 1,502

2002 52 11 2 20 261 1,848

2003 55 25 4 23 405 3,135

2004 42 80 6 66 249 5,476

2005 50 64 3 27 254 7,2852006 101 107 22 31 444 8,980

2007 112 175 51 58 469 10,081

2008 147 229 509 76 615 13,199

2009 100 155 346 52 418 8,973

Source: International Monetary Fund, Direction of Trade Statistics,June 2010, Trade data as reported by the Islamic Republic of Iran to theIMF.

The dominant position of the UAE in GCC exportsto Iran is also evident in Figure 2. The UAE is almostsinglehandedly responsible for the rapid increase in theGCCs share of total imports from Iran in the period 19952008. This share rose from less than 5% in 1995 to 24% in2007, nearly all of the increase accounted for by the UAE.The UAEs share in GCC imports from Iran, however, isless dominant. Although Iran has consistently exportedmore to the UAE than to any other GCC member, the UAE

share has gradually diminished, from 59% in 2002 to 41%after 2005, as shown in Table 2.

Figure 2. Share of GCC in Irans Total Imports of Goods

Source: International Monetary Fund, Direction of Trade Statistics,June, 2010

Since 2004, Saudi Arabia has emerged as the second largestGCC importer from Iran. Saudi imports, which remainedwell below $100 million annually until 2000, grew to$900 million in 2008 before experiencing a sharp declinein 2009. But unlike Iran-UAE trade, which has resulted

in a huge trade surplus for the UAE, Iran-Saudi trade hasbeen relatively more balanced; indeed, in recent years Iranhas enjoyed a trade surplus (see Figure 3). Furthermore,despite the steady increase in the volume of bilateral tradebetween the two countries, the relative share of Iran andSaudi Arabia in each others foreign trade remains small.As a result, it seems unlikely that trade and economicconsiderations will serve as a major determining factorwith respect to diplomatic relations between the twocountries.

0%

5%

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20%

25%

30%

1995

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2001

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GCC United Arab Emirates


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Table 2. Irans Exports to GCC countries(in millions of dollars)

Year Bahrain Kuwait Oman QatarSaudi

Arabia UAE

1995 18 83 31 22 60 269

1996 15 66 29 23 59 308

1997 4 61 33 16 66 338

1998 17 73 24 18 66 325

1999 0 103 40 22 76 1,742

2000 0 134 61 23 98 315

2001 0 130 46 25 119 348

2002 0 123 22 19 90 365

2003 0 137 46 18 115 381

2004 0 157 41 14 274 438

2005 0 209 53 52 487 582

2006 0 250 112 53 583 697

2007 0 295 157 63 688 822

2008 0 386 208 82 901 1,076

2009 0 262 141 56 612 731

YearGCCTotal

SaudiShare

UAEShare

1995 481 12% 56%

1996 500 12% 62%

1997 518 13% 65%

1998 522 13% 62%

1999 1,983 4% 88%

2000 631 16% 50%

2001 668 18% 52%2002 619 15% 59%

2003 696 17% 55%

2004 924 30% 47%

2005 1,382 35% 42%

2006 1,694 34% 41%

2007 2,024 34% 41%

2008 2,652 34% 41%

2009 1,803 34% 41%

Source: International Monetary Fund, Direction of Trade Statistics, June2010. Trade data as reported by GCC Countries to the IMF.

Figure 3. Iran-Saudi Trade as Reported by Saudi Arabia(in millions of dollars)

Source: International Monetary Fund, Direction of Trade Statistics, June2010

In order to assess the relative significance of Iran-GCCtrade, Figure 4 shows the relative shares of Europe, Chinaand the GCC in Irans goods imports. As can be seen, theGCCs share of Irans total imports grew steadily between1998 and 2007, while European countries shares remained

relatively stable. China has emerged as one of Iransleading trade partners in recent years; Figure 4 showsthat its share began to increase after 2004. The increase inChinas share after that year is associated with the declinein the European Unions share. Overall it is clear that inrecent years Irans imports origins have shifted from otherregions to China and the GCC. As will be explained in thenext section, both increasing international sanctions andstrategic considerations have played important roles in thisreorientation of Irans trade patterns.

Figure 4. Shares of Major Trade Partners in Irans Total Imports

Source: International Monetary Fund, Direction of Trade Statistics, June

2010

The Sanctions ImpactThe economic and financial sanctions that the internationacommunity has imposed on Iran, with various degreesof intensity for more than two decades, have had twodistinct impacts on Irans foreign trade. First, the unevenparticipation of various nations in these sanctions forcedIran to shift its trade from countries that had joined inthe sanctions to others. Germany was Irans largest trade

0

100200300400500600700800900

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Saudi exports to Iran Saudi imports from Iran

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GCC China European Union


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partner in the 1990s, for example, but the sanctions havehad an adverse effect on Iran-German trade in recent years.In 1990 Germany accounted for 14.4% of Irans imports,but its share gradually declined to 11.4% in 2007 and 8.9%in 2008. The increasing difficulties entailed in trading andconducting financial transactions with Germany and otherEuropean countries after 2006 have forced many Iranianfirms to look for other sources of needed imports.9 As aresult, Iran has expanded its imports and exports with some

Asian countries, at Europes expense.Second, Iran has used trade and investment incentives todiscourage some countries from joining in the sanctions.This proactive trade diplomacy was applied with respectto Europe in the 1990s when the Iranian governmentdeliberately expanded its trade and investment ties withGermany, France, Italy, and the UK to increase the coststo them of joining the U.S.-sponsored sanctions initiatives.These economic incentives in turn contributed to the strongpreference on the part of the Europeans for settling thenuclear dispute through negotiation. In recent years Iran

has offered even stronger economic and trade incentives toRussia and China for the same purpose.Both of the aforementioned factors have influenced Iran-GCC economic relations since 1995. In the earlier phasesof the U.S. sanctions against Iran the restrictions appliedprimarily to U.S. corporations and their internationalsubsidiaries, and because of its long history of trade withthe U.S. before the 1979 revolution, Iran was in need ofsome U.S.-made spare parts and electronic products thatwere subject to sanctions. Iran was forced to obtain theseproducts in the black market or to purchase them indirectlythrough intermediaries. The liberal trade policies and freetrade zones of Dubai offered Iran a valuable opportunityto procure sanctioned goods, such as popular computersand software, through Dubai re-exporting arrangements.It is noteworthy that the sanctioned products representedonly a portion of Irans total imports from Dubai; ordinaryconsumer goods and nonsensitive products were alsocommonly traded via Dubai.

The ease of travel to, and investment opportunities in, theUAE (mostly in Dubai) has allowed many Iranian businessentities to establish branches there; in 2008, as many as9,500 businesses in the UAE were partly or completelyowned by Iranians. The largest concentration of these firmsis found in the Jebal Ali free trade zone. (One hundredpercent foreign ownership is allowed only in free tradezones; outside them, foreign partners can own only up to49% of an enterprise.) These firms have played an importantrole in facilitating trade and investment relations betweenDubai and Iran.10 The large number of Iranian tourists whovisit the UAE have also contributed to enhanced traderelations. There are on average 300 commercial flights perweek between the two countries.11

Overall, the adverse impact of sanctions on Irans directtrade with its traditional trade partners is responsible forthe reorientation of Irans trade toward the UAE in recentyears. The growth in Iran-Oman trade volume is also partlydue to the sanctions. Iranian firms that faced difficultiesand long regulatory delays in direct dealings with Europewere able to avoid these difficulties by setting up UAE-based firms that were not identified as Iranian entitiesThese firms not only facilitated indirect imports from other

countries to Iran via Dubai; they also allowed some Iranianproducers to export their products and services to foreignpartners who would have been reluctant to deal withIranian firms. This practice has been particularly popularwith some Iranian software companies.

Irans growing trade and economic reliance on Dubai inresponse to the European sanctions has not gone unnoticedby the United States. In recent years the U.S. has urged theUAE government and financial institutions that operatethere to reduce their ties with Iranian entities. Despite itsislands dispute with Iran, the UAE federal government has

been reluctant to go beyond the UN-sponsored sanctions bycooperating with unilateral U.S. sanctions. This reluctanceis on account of the economic benefits that accrue to theemirate of Dubai from its widespread trade and investmentrelations with Iran.12

In 2008, however, the United States began to pressureUAE-based financial firms to cut back on their tradefinance services for Iranian businesses, by warning thatviolators would lose access to the U.S. market. Severalfinancial institutions that are concerned about theirbusiness interests in the United States have voluntarilycomplied with this demandand mounting evidence eversince suggests that their actions have had an adverse effecton Irans trade relations with Dubai and with the rest ofthe UAE. The government of the UAE, on the other handlike other GCC governments, has been reluctant to openlysupport the unilateral U.S. sanctions but has been willingto comply with UN-approved sanctions against IranAccordingly, it responded swiftly to the latest round of UNsanctions that were approved in June 2010. Only a few daysafter UN approval of these sanctions, the UAE Central Bankordered its banks to freeze the assets of forty-one Iranianentities in compliance with the new sanctions.13

Irans concerns about the sanctions also partly explainthe growth in Iran-Saudi trade volume during 2001-8. Aspart of its efforts to improve its diplomatic relations withSaudi Arabia and discourage the Saudi government fromsiding with the United States, Iran sought to expand itstrade and investment ties with the kingdom. This strategicconsideration was visible in the middle years of MohammadKhatamis presidency (19982004), when Irans importsfrom Saudi Arabia grew by some 315%, to $274 million. Theupward trend continued during Ahmadinejads presidency


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with Irans imports from Saudi Arabia rising to a record$901 million in 2008. In addition, Iran made a strong effortto promote bilateral investment vis--vis Saudi Arabia,and in 1998 the two countries signed a comprehensivecooperation agreement which had a strong economicdimension. During this period the Saudis generallyadvocated a negotiated settlement of the Iran-U.S. nucleardispute, and on occasion it tried to help improve U.S.-Iranrelations.

Economic relations between Iran and Saudi Arabiacontinued to expand during President Ahmadinejadsfirst term, and Saudi Arabia continued to publicly expressskepticism with regard to sanctions and about the wisdomof a military strike against Irans nuclear installations. Butthe Saudi position has shifted away from Iran and closer tothe United States since 2009. Angered by Ahmadinejadsmilitant Middle East policy and concerned about theapparent progress of Irans nuclear program, in recentmonths Saudi Arabia has cooperated more closely with U.S.sanctions initiatives.

It also appears that along with Saudi Arabia, the UAE andother, smaller GCC countries are also showing a greaterwillingness to support U.S. sanctions, which are morerestrictive than the UN sanctions. Thus, the Kuwaiti oiltrader IPG ended its gasoline sales to Iran in January 2010 inresponse to warnings from the United States.14 In early July2010 an Iranian official claimed that Kuwait had joined theUAE and Germany in refusing to supply jet fuel to Iraniancommercial airplanes, but this claim was later denied by theIranian government.15

As was mentioned earlier, there has been a disconnectbetween the UAEs diplomatic and economic relations withIran which requires explanation. This disparity is primarilydue to disagreements between the ruling families of Dubaiand Abu Dhabi with regard to Iran. Dubai, which benefitsheavily from trade and investment ties with Iran, attemptedto downplay the islands dispute and to discourage the UAEfederal government from joining in the U.S. sanctions. TheAbu Dhabi ruling family, by contrast, is less friendly towardIran and more willing to side with the United States. Sincethe UAE constitution gives each emirate considerableindependence in its conduct of economic and trade policy,Dubai has expanded its economic ties with Iran. Yet at thesame time the occasional tensions between the UAE federalgovernment (which is dominated by Abu Dhabi) and Iranhave continued, and the islands dispute has remainedunresolved.The recent shift away from Iran in the attitude of the UAEis partly a result of the diminishing relative economicand financial power of Dubai within the broader UAEframework. Dubais economy suffered a major setbackin 2009 when the real estate market collapsed and the

government-owned conglomerate Dubai World failedto repay its debt obligations in November of that yearforcing Dubai to turn to the wealthy emirate of Abu Dhabfor financial assistance. This economic setback reducedDubais political power within the federal government of theUAE, enabling the Abu Dhabi ruling family to distance theUAE from Iran and increase its cooperation with the U.Ssanctions in 2010.

In addition to directly cooperating with the UN sanctionssome GCC countries have played an important role inhelping the United States persuade China to cooperate withthe efforts to apply effective sanctions against Iran. Duringseveral rounds of intense diplomatic efforts in the first halfof 2010, the U.S. asked Saudi Arabia and the UAE to offeradditional oil sale assurance to China and encourage it to join in the latest round of UN-sponsored sanctions, whichwas approved in June 2010. While there have been no formadeclarations, it appears that these GCC countries havecomplied with this U.S. request, and their promise to supplymore oil to China in case of disruptions in its imports from

Iran has played an important role in convincing China tosupport the June 2010 UN sanctions. Iran accounted for11% of Chinas crude oil imports in 2009, but the volumeof imports in the first half of 2010 was smaller than in thefirst half of 2009. During the same period, Chinas crude oilpurchases from Saudi Arabia, Brazil, and Angola increased. 1

Saudi Arabia supplied 14% of Chinas crude oil imports in2009.

Overall it appears that Irans various initiatives todiscourage the GCC from joining in the U.S.- and UN-sponsored sanctions, while successful in the past, havefailed in recent months. In addition to Dubais declininginfluence on UAE foreign policy, two other factors havecontributed to this failure. First, in order to deter GCCcooperation with military operations against Iran, theAhmadinejad government has taken a carrot-and-stickapproach toward the GCC states. On the one hand, Iranis trying to improve economic and diplomatic ties withits GCC neighbors. On the other hand, in the past twoyears Iranian military leaders have repeatedly warnedthat, if attacked, they will retaliate by closing the Strait ofHormuz and by targeting countries that host U.S. forces orprovide logistical support to the U.S. Army. This threat wasprimarily meant to increase the cost to the United Statesof an attack against Iran, but it was also directed at GCCcountries that might offer logistical support for such anattack. This frequently repeated Iranian threat resulted ina development that Iran did not intend: Worried, the GCCgovernments sought closer security cooperation with theUnited States.Second, the success of Irans uranium enrichment programin the past two years has taken GCC countries bysurprise and has convinced them that Iran might be closer


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to developing a nuclear weapons capability than theyexpectedand this fear contributed to their willingness tooffer greater cooperation with anti-Iran sanctions. In Juneand July of 2010, the official and semi-official Iranian mediasharply criticized Saudi Arabia and the UAE for cooperatingwith these sanctions.

It must be added, however, that for most GCC states thetilt toward the United States will likely remain limited, and

they will try to maintain a posture of neutrality if possible.While they have shown a willingness to comply with UNsanctions, they are likely to cooperate only cautiously withthe unilateral sanctions applied by Europe or the UnitedStates, in order to avoid further complications in theirrelations with Iran.

Sanctions and SmugglingAlong with the formal trade between Iran and GCCcountries, a large volume of goods are exchanged between

Iran and two GCC countriesthe UAE and Omanthrough smuggling. Most of the smuggled goods are shippedfrom the GCC region to Iran. Smugglers use small boatsto transport commodities from Dubai and from the smallOmani enclave of Madha at the southern shores of the Straitof Hormuz. For a small boat it is only a few hours ride fromDubai to Irans shores on the northern edge of the PersianGulf. The boat ride from the small port city of Khasab in theOmani territory to the Iranian island of Qeshm takes onlyfifty minutes, and some smugglers are even able to make twosuch trips per night.17 While most of the products that aresmuggled into Iran from these areas are low-tech consumer

goods with no strategic value, the same routes are also usedto transport small-size strategic goods such as aircraft parts,computer chips, and sophisticated electronic equipmentthat can be carried on small boats.18

Profit-motivated smuggling between Iran and GCCcountries is not a new phenomenon; local smugglers havetransported goods in both directions for centuries. Therecent economic and commercial sanctions against Iran,however, have added a new dimension to this practice. Thesanctions have forced Iran to smuggle in some strategicgoods that it can no longer purchase on open markets.

Not surprisingly, the government of Iran has supportedthese smuggling activities by establishing front companies(primarily in the UAE) and providing logistical support forthe navigation of smuggling boats in Iranian waters.

In 2002, Mehdi Karrubi, then Speaker of the Iranianparliament who is currently one of the main oppositionleaders in Iran, claimed that the Revolutionary Guards(IRGC) were actively involved in smuggling operations.According to one of his aides, the Guards had built somesixty jetties on the southern shores of Iran and on the

islands of Kish and Qeshm to facilitate their clandestineimports. This claim has been more recently confirmed byMohsen Sazegara, a founder of the IRGC, who currentlylives in exile in the United States. 19 The jetties allow theIRGC to smuggle large volumes of goods into Iran for bothcommercial and strategic purposes.The smuggling of goods from Dubai and other GCC areas toIran has caught the attention of U.S. officials, who are now

likely to put additional pressure on the UAE government tolimit such activities. However, since most of the smugglingis carried out by small boats and often at night it will bevery difficult for the UAE government to completely endthese operations.

A sizeable volume of goods is also smuggled across theIran-Iraq border. Most of this smuggling, which has beengoing on for decades, takes place in the mountainousKurdish regions with the participation of Kurdish villagerson both sides of the border. Since June 2010, when bothU.S. and European sanctions focused more intensely on

Irans gasoline imports, Kurdish smugglers have been busytransporting refined oil products to Iran.20

At the same time, as a result of Iraqs liberal trade policiessince 2004 the volume of trade between Iraq and the UAEhas sharply increasedexceeding $5 billion in 2009when Iraq became the UAEs second largest Arab tradingpartner.21 If direct smuggling of products from Dubai to Iranbecomes more difficult, it is likely that some smugglers willfirst send their products legally from Dubai to Iraq and thensmuggle them through various land routes into Iran.The Islamic government of Iran maintains good relationswith the regional government of Kurdistan (in Iraq) as welas with many Shiite factions in southern and central regionsof Iraq. Consequently it will not be very difficult for Iran toset up a Dubai-Iraq-Iran smuggling network. In response tothe escalating sanctions, the Iranian smugglers have alreadyestablished transport networks in several neighboringcountries, including Turkey.22

If the current sanctions continue and become morecomprehensive, the volume of goods smuggled into Iranis bound to increase (as long as Irans oil exports and oirevenues are not targeted for sanctions). The Dubai-Iran andDubai-Iraq-Iran smuggling routes, in particular, are likely tosee a sharp increase in the volume of transported goods.One factor that is likely to facilitate this smuggling activityis the favorable opinion of a large segment of people in mostArab countries toward Iran. The 2010 Arab Public OpinionPoll, conducted by Shibley Telhami of the University ofMaryland and Zogby International, is revealing. Conductedin June and July 2010 in six Arab countries includingSaudi Arabia and the UAE, the survey shows that 77% of


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the respondents believed that Iran had a right to developits nuclear program. Even among the Saudi and UAErespondents who believed that Iran was seeking nuclearweapons, 50% and 16%, respectively, believed that Iranshould be allowed to complete its nuclear program.23 Theserespondents did not believe that Irans nuclear program,even if it was for military purposes, posed a threat to theircountry. Consequently, in addition to many smugglerswho will be motivated by profit, some GCC citizens and

residents might also assist in this activity out of politicalsympathy for the Iranian regime.

Summary and Conclusions

Irans nuclear dispute with the West in conjunction withthe escalating economic sanctions against that country havehad a profound effect on Iran-GCC economic relations. Asthe leading European economies (Germany, Italy, France,and England), which were Irans largest trading partnersin the 1980s and 1990s, imposed more restrictive sanctions

in the past decade, Iran was forced to reorient its foreigntrade toward the GCC and Asia. Among GCC countries,the United Arab Emirates (UAE) has emerged as themain beneficiary of this change. The volume of formal andinformal trade between Iran and the UAE grew sharply after2003, and the UAE (along with China) has become one ofIrans leading trade partners. Concern about the cooperationof other GCC countries with U.S. sanctions also motivatedIran to seek closer economic and diplomatic relations withSaudi Arabia, which led to a boost in Iran-Saudi tradevolume as well. Overall, had it not been for the escalatingsanctions imposed by other nations, Iran-GCC trade wouldhave increased at a significantly slower pace during 20002008. This is particularly the case given that Irans tradewith the UAE (which consists primarily of re-export tradewith Dubai) accounts for more than 80% of the Iran-GCCtrade.

The United States is well aware of the growing reliance ofIran on the UAE (and on Dubai in particular) as a meansof evading sanctions. In recent years the U.S. has workedhard to persuade the UAE and other GCC governmentsto curtail their trade and investment relations with Iran.However, these efforts have been only partially successful.Doing business in Dubai has become more difficult forIranian firms as a result of the voluntary cooperation ofsome UAE banks with the financial sanctions against Iran;the UAE government has also increased its inspection ofgoods bound for Iran. These steps have increased the cost ofimports and have made it more difficult for Iran to importlarge items that cannot be smuggled on small boats. Still,the overall volume of Iran-UAE trade has not suffered asubstantial decline, and smuggling activities have increased.There is also no evidence that the flow of Iranian tourists

and travelers to the UAE has been adversely affected by thesanctions.

What lies ahead for Iran-GCC economic relations in thecoming years? From a purely economic perspective, bothIran and the GCC countries will have an incentive toexpand their trade relations. However, diplomatic andstrategic concerns are likely to play an important role aswell. As long as the United States continues to rely on

sanctions as the primary means of putting pressure on IranGCC countries will feel pressured to cooperate with thesesanctions. Given the U.S. resolve to stop Irans nuclearprogram, these sanctions are likely to intensify, and greatercooperation will be expected of the GCC countries.The United Arab Emirates in particular is likely to comeunder considerable diplomatic pressure from the UnitedStates. Since its strategic ties with the U.S. are far moreimportant to the UAE than are its economic ties with IranUAE leadership is likely to accommodate to this pressureOman and Saudi Arabiawhich, along with the UAE

account for more than 95% of GCC exports to Iranwilllikely also cooperate for the same reason. Another factorthat can be expected to encourage more GCC cooperationwith the sanctions is GCC leaders fear of a nuclear IranThese governments are worried that if Iran acquires nuclearweapons, it might pursue a more aggressive foreign policy inthe Persian Gulf and undermine their political stability.Consequently, we expect the volume of trade betweenIran and the GCC to grow at a slower pace than it hasover the last several years, and it might even diminish. Thevolume of illegal trade (smuggling), on the other hand, islikely to increase, but this increase will be smaller thanthe reduction in formal trade, and it will also be far morecostly for Iranian importers. Trade with GCC countries hasbecome crucial for many Iranian businesses and producersthat have lost access to European markets and are nowfacing more sanction-related difficulties vis--vis their Asianpartners.24 Given that the United States is also aggressivelyencouraging Asian countries to impose more severesanctions on Iran, it is unlikely that Iran can easily find anew trade partner to replace the UAE.The current factional divisions within the Iranian regimehave motivated some political leaders, such as formerpresident Rafsanjani, to openly acknowledge the heavyburden imposed on the Iranian economy by the tighteningsanctions. Rafsanjani has also warned that the sanctionsare likely to intensify in the near future. If, as predicted, theGCC countries (the UAE in particular) go beyond the UN-approved sanctions and adopt more severe unilateral tradeand investment restrictions with respect to Iran, the cost onthe Iranian economy could be severe.


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Endnotes

1 Several definitions of economic diplomacy are available; forpurposes of this Brief, it is defined as a set of economic incentivesthat a country offers another in order to influence that countrysdomestic or foreign policy on a specific issue.2 One of the issues that still worried the moderate GCC rulerswas that Iran continued to support Islamic movements in various

Arab countries. Irans support for Hezbollah in Lebanon inparticular posed a challenge to Saudi efforts to strengthen themoderate Sunni factions in that country.3 Crown Prince Abdullah of Saudi Arabia attended thisconference and met with Irans Supreme Leader, AyatollahKhamenei, and with President Khatami.4 In February 2009, Bahraini media reported that a high-ranking Iranian official had suggested a territorial claim onBahrain by noting that Bahrain was Irans fourteenth provincebefore it gained independence in 1971. Although the Iranianofficial later explained that he was simply referring to a historicalfact in the context of eighteenth-century conditions, thegovernment of Bahrain reacted angrily and froze Iran-Bahrain

diplomatic relations for several weeks. Bahrain also convincedthe GCC to issue a warning to Iran about making territorialclaims on Bahrain. See Ghazanfar Ali Khan, GCC Warns Iranagainst Making Hostile Remarks,Arab News, February 23, 2009.*5 For more details on this dispute, see Abraham S. Kurts, IranSpars with Kuwait over Arash/Al-Durra Offshore Oil Field, OilField (January 2004).6 Up until 1993, Iran and Sharjeh had partitioned the Abu Musaisland under a 1971 agreement. In 1993, Iran occupied the entireisland and required foreigners who wanted to enter the Sharjehsection of the island to have an Iranian visa. (Sharjeh citizens arestill allowed access to their section of the island.) Irans action,which intensified the tensions between Iran and the UAE, was

motivated primarily by Irans fear that the UAE was planning tostation foreign troops in Abu Musa, which is strategically locatednear the entrance to the Strait of Hormuz.7 For a detailed account of Saudi-Iran competition for influencein the region, see Frederic Wehrey, Theodore W. Karasik,Alireza Nader, Jeremy Ghez, Lydia Hansell, and Robert A.Guffey, Saudi-Iranian Relations since the Fall of Saddam:Rivalry, Cooperation, and Implications for U.S. Policy (RandCorporation, National Security Research Division, 2009).*8 Haseeb Haider and Martin Croucher, UN Sanctions to HitUAE-Iran Trade, Khaleej Times, June 29, 2010.*9 The share of the four largest European countries (Germany,France, Great Britan, and Italy) in Irans goods imports declinedfrom 32% in 2002 to 19.3% in 2008. (Source: IMF, Direction ofTrade Statistics, 2010.)10 Sanctions Slow Irans Trade, but not Stop, InternationalHerald Tribune, August 18, 2008.11 Ibid.12 The UAEs foreign policy is dominated by the oil-rich emirateof Abu Dhabi, but the emirate of Dubai also exerts influence asthe second richest emirate in the UAE federation. Traditionallythe leader of Dubai has served as UAE prime minister, whilethe presidency has been reserved for the ruler of Abu Dhabi.The emirate of Abu Dhabi has been more willing than Dubai tocooperate with the U.S. sanctions against Iran.

13 UAE Freezes 41 Iranian Accounts,Press TV, June 28, 2010.*14 Shell, Vitol Suspend Gasoline Sales to Iran, Market Watch,March 10, 2010.*15 Iran Claims Kuwait, Others Refusing Fuel to Its Planes,Kuwait Times, July 6, 2010.*16 Chinas Imports from Iran Decline (Reuters), Gulf News,

June 22, 2010.*17 Noueihed, Lin, Smuggling to Iran Rife in Dangerous GulfWaters, Reuters, May 12, 2008.*

18 Kambiz Foroohar, Dubai Helps Iran Evade Sanctions asSmugglers Ignore U.S. Laws, Bloomberg, January 25, 2010.*19 Babak Dehghanpisheh, Smugglers for the State: WhySanctions Wont Hurt The Revolutionary Guards, Newsweek,

July 10, 2010.*20 Oil Smuggling to Iran Stokes Tension in Iraq, Gulf News,

July 14, 2010.*21 UAE-Iraq Trade Exchange Exceeded $5b in 2009, TodayMagazine, June 28, 2010.*22 Jiyar Gol, Travelling the Smugglers Route from Turkey toIran, BBC News: Middle East, August 2, 2010.*23 2010 Arab Public Opinion Poll (Washington, DC: BrookingsInstitution, 2010).*

24 In September, South Korea announced that it will imposenew unilateral sanctions on Iran that will go beyond the latestround of UN-approved sanctions.

* Weblinks are available in the online version found atwww.brandeis.edu/crown
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The Impact of Sanctions on Iran-GCC Economic

Relations

Prof. Nader Habibi

Recent Middle East Briefs:Available on the Crown Center website: http://www.brandeis.edu/crown

Dr. Saeid Golkar, The Ideological-Political Training of Irans Basij, September 2010, No. 44

Naghmeh Sohrabi, Is Nothing Sacred in the Islamic Republic of Iran? July 2010, No. 43

Kanan Makiya, The Iraqi Elections of 2010and 2005, June 2010, No. 42

Yezid Sayigh, Hamas Rule in Gaza: Three Years On, March 2010, No. 41

Nader Habibi, The Impact of the Global Economic Crisis on Arab Countries: A Year-EndAssessment, December 2009, No. 40
http://www.brandeis.edu/crownhttp://www.brandeis.edu/crown/publications/meb/MEB40.pdfhttp://www.brandeis.edu/crown/publications/meb/MEB40.pdfhttp://www.brandeis.edu/crown/publications/meb/MEB40.pdfhttp://www.brandeis.edu/crown/publications/meb/MEB40.pdfhttp://www.brandeis.edu/crown/publications/meb/MEB40.pdfhttp://www.brandeis.edu/crown/publications/meb/MEB40.pdfhttp://www.brandeis.edu/crown

The Impact of Sanctions on Iran-GCC Economic Relations

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