Iran-China relations

On 21 May, United States Secretary of State Mike Pompeo delivered a speech outlining the US policy toward Iran in the aftermath of US withdrawal from the Iran nuclear agreement (Joint Comprehensive Plan of Action - JCPOA).

• Pompeo's speech makes clear that the US seeks a fundamental change in Iran's behaviour, emphasising that Iran's failure to do so has the potential for internal collapse, not least given widespread public dissatisfaction with the Islamic Republic's economic performance.
• Although there is domestic consensus in Iran to avoid provocative actions that could jeopardise securing sanctions relief from Europe, Russia, and China, strengthening US sanctions will reduce Iran's available options, contribute to expanding divisions within the political establishment over economic management and foreign policy, as well as embolden economically driven protests.
• Iran will probably become increasingly reliant on China, its largest trading partner; Chinese companies will likely be supported by the Chinese state in legally obviating US sanctions for Iranian business deemed strategically important.

In his speech, Pompeo reiterated President Donald Trump's willingness to negotiate another agreement with Iran, and also outlined 12 US requirements before a 'new' deal could be implemented including, Iran agreeing to never pursue plutonium reprocessing, halting all development of nuclear-capable missile systems, essentially giving the International Atomic Energy Agency (IAEA) unrestricted access to verify implementation, as well as retracting all support for US-designated 'terrorist' groups in the Middle East region, which includes Iran's most capable proxy non-state armed group (NSAG), the Lebanese militant group Hizbullah. In exchange for meeting these demands, the US would end its web of sanctions, which drastically narrow Iran's access to the global financial system, as well as allow the Iranian government to re-establish normal diplomatic and commercial relations with the rest of the world, and receive financial and other support to modernise the Iranian economy, including liberalising the transfer of advanced technology.

Pompeo also made clear reference in his speech to the potential for internal collapse if Iran's leadership failed to take appropriate action, and urged the "Iranian people" to hold their government accountable. This was likely in reference to growing pressure on the Iranian state from localised but nevertheless unprecedented anti-government protests focused on perceived government corruption and economic mismanagement, which have recurred in Iran during 2018.

Pompeo additionally stated that the "timeline" for the US accomplishing its objectives would be determined by the "Iranian people", and also made reference to the inevitable death of Supreme Leader Ali Khamenei, likely to signal the opportunity for the Iranian elite to change course.

Narrowing Iranian options
Despite ongoing divisions among Iran's elite over economic management and the direction of domestic and foreign policy, there remains consensus over the need to avoid provocative actions that could jeopardise sanctions relief from the remaining signatories to the JCPOA for as long as possible. The French and Chinese foreign ministers both indicated commitment on 21 May to implement the JCPOA provided Iran abides by its terms.

Failure to do so, in addition to increasing pressure on the Iranian currency and the economy, would risk further emboldening economically driven protests and increase government instability risk in Iran. Broadening anti-government protests would also risk exacerbating divisions between hardliners who are committed to expanding the Islamic Republic's revolutionary ideals and therefore, the current foreign policy course in Syria, Lebanon, Iraq, and Yemen on the one hand, and centrists, led by President Hassan Rouhani, who seek to prioritise domestic investments over funding foreign military intervention and other regional commitments on the other.

Given the strength and effectiveness of US sanctions, Iran is likely aware that European commitment to the JCPOA would probably wane in the event that the US pursues a policy of maximising pressure on any party attempting to do business with Iran and with exposure to the US financial system over the coming year. China and Russia however, both have an interest in giving Iran the opportunity to circumvent US sanctions by increasing its dependency on them, with the aim of improving their negotiating position with the US over broader trade and security-related matters - but mainly to support their own national strategies. For China, Iran is an important node in its Belt and Road Initiative land route, in which it is envisioned as a future trade hub and gateway to Europe. Iranian oil imports are also likely to be an increasingly important part of China's energy mix, as it diversifies away from coal under President Xi's ambitious 'new era' targets. Iran accounted for about 7% of China's imports of crude oil in 2017 and China National Petroleum Corporation (CNPC) has publicly stated on 19 May that it will remain engaged in Iran and will take over French company Total's stake in Iran's South Pars Phase 11 project.

In light of the new US demands, Iran will now have the options of agreeing potentially to permanent restrictions on its ballistic missile and nuclear programmes to secure a new deal acceptable to the US, negotiate separate agreements with European countries, or accept increased dependency on Russia and China in particular.

In all cases, Iran's powerful Islamic Revolution Guards Corps (IRGC) will in coming months probably prioritise expanding commercial networks and alternative funding channels using local affiliates in Iraq, the Caucuses, Turkey, Lebanon and Russia, to improve Iran's capacity to circumvent US sanctions.

Outlook and implications
Iran will probably expand its exports of crude oil to China over the coming year, and more generally offer incentives to Chinese firms, with the hope of securing more reliable and systematic mechanisms to offset the impact of US sanctions. China has already established a bank that can process transactions with Iranian entities without violating the planned secondary US sanctions. Iranian entities would be able to import most Chinese goods and settle payments, probably in renminbi, through this channel. The new rail link connecting China to Iran, which has been in operation since 2016, will further facilitate opportunities for trade in goods and services with countries along that route.

Although Chinese companies with US interests will officially fall under US sanctions on Iran if they are fully enforced from November, the Chinese government would tacitly support Chinese state-owned enterprises and national champions' attempts to structure strategically important transactions with Iranian entities so that they obviate US banks and are settled in renminbi. (Indeed, this is in line with the People's Bank of China's objective to internationalise the currency). This is likely to widen the scope for Iran's deepening trade with China while ensuring that ongoing US-China discussions remain focused on the more immediate issues of trade tariffs and IP protection between the world's two largest economies.