IRAN TRADE - CHANCELLOR MERKEL'S MORAL SUASION

S E C R E T SECTION 01 OF 03 BERLIN 000772 SIPDIS, P, T, E, ISN, EUR, NEA/IR, EEB NSC PLEASE PASS TO ADAM STERLING AND EMILY HARDING TREASURY FOR LUKAS KOHLER AND TFI - COLLEEN EDDY E.O. 12958: DECL: 06/10/2018 TAGS: ETRD PREL ETTC KNNP MNUC EFIN EPET IR GM SUBJECT: IRAN TRADE - CHANCELLOR MERKEL'S MORAL SUASION CAMPAIGN REACHING ITS LIMITS REF: A. BERLIN 333 ¶B. BERLIN 628 ¶C. 07 BERLIN 1792 ¶D. BERLIN 664 Classified By: DCM John M. Koenig for reasons 1.4 (b) and (d). ¶1. (S) SUMMARY: Chancellor Merkel's moral suasion campaign -- along with UN/EU sanctions and a host of other factors -- has convinced major German banks and big business to curtail trade and financial ties with Iran. The result will be a further downward trend in German exports to Iran, according to German government officials and industry associations. Moral suasion has been markedly less successful with small and medium-sized exporters (the "Mittelstand"),over whom the Government holds much less sway. While Mittelstand exporters have refrained from engaging in trade that is strictly prohibited, they have refused to voluntarily curtail what they see as "legal trade" with Iran. Economics Ministry officials expect German exports to Iran will decline during the course of 2008. Significant cuts in trade with Iran, however, will require a new round of UN/EU sanctions and/or further tightening of German export controls on a case-by-case basis, to include what is now considered legal commerce. Providing Germany with detailed information on how Iran's oil/natural gas revenues support its proliferation programs could convince German export control officials of the need for tighter restrictions on the export of certain extraction and refining equipment. Absent new sanctions or tougher export controls, it will be difficult for Germany to press the Mittelstand to voluntarily reduce exports not specifically subject to export controls. END SUMMARY. MORAL SUASION HAS WORKED WITH BIG BANKS AND INDUSTRY ¶2. (C) Despite Chancellor Merkel's strong support for increasing political and economic pressure in response to Iran's continued refusal to fulfill its international obligations on suspension of enrichment, she faces increasingly vocal challenges from the German business community, particularly small and medium-size exporters, who fear the permanent loss of market access in Iran to competitors in China, Russia, and other countries. Notably after the Crawford summit in November 2007, Merkel was a driving force behind the German government's efforts to press big German companies -- as represented by the German Federation of Industries (BDI) -- and banks to reduce ties with Iran. Measures included sharply reducing new export credit guarantees (Hermes) to Iran, encouraging German banks to withdraw from Iran, a slower and more careful scrutiny of export licenses (ref A),and utilizing "moral suasion" with German exporters to convince them to curtail trade. The result, according to Economics Ministry officials and representatives of two major business associations, has been a clear downward trend in German business ties with Iran. LIMITED IMPACT WITH SMALLER EXPORTERS ¶3. (C) The consensus view within the Chancellery and Economics Ministry, as well as the major German business associations, however, is that moral suasion with German industry has reached its limits. Major banks and big business -- i.e., those who, in the words of one Economics Ministry official, "listen to what the Chancellor says" -- have sharply curtailed their exposure in Iran. On the other hand, small and medium-sized exporters (the much-vaunted "Mittelstand"),who have actively traded with Iran for decades and tend to focus exclusively on one or two markets, have paid less attention to the "policy debate" in Berlin. These companies, most of which are too small to have an in-house legal department and have limited resources to undertake extensive due diligence, indicate they will refrain from engaging in trade that is forbidden by law but refuse to take voluntary action to curtail "legal trade," especially when such cuts threaten their bottom line and might ultimately force them to shut down operations as Iranian customers look elsewhere. "As long as it's legal," a representative of the Association of German Chambers of Industry and Commerce (DIHK) told us, "rules-based" Mittelstand companies will continue to export and even look for "innovative, legal ways to keep business running." ¶4. (C) Further complicating the German Government's efforts to increase economic pressure on Iran is the persistent outcry -- widely reported in the German media -- from the business community and even some German parliamentarians BERLIN 00000772 002 OF 003 (from coalition and opposition parties alike) against sanctions. (Bundestag discussions to be reported septel.) German business continues to complain about a lack of new export credit guarantees and the slow pace of government decision-making on Iran-related applications for export licenses and "zero-notices," a government-prepared certificate indicating that goods or technology proposed for export are not prohibited or subject to German export controls (ref A). According to BDI representatives, new contracts with Iran have dropped dramatically, with sales of complete factory plants, electronic parts, and machine tools most heavily affected. GERMAN BUSINESS - TRADE CUTS HAVE NO IMPACT ON IRAN ¶5. (C) Despite their own considerable economic losses, German exporters argue, reductions in trade have had little effect on Iran. Exporters, as well as media commentators and some politicians, insist that competitors in other countries -- not just China, India, and Russia, but also Malaysia, Pakistan, and Turkey -- have experienced double-digit growth in exports to Iran. (NOTE: Iranian officials have played upon these concerns in their interactions with German business, government and Bundestag representatives by underscoring the gains of competitors in Iran's markets. END NOTE.) Rumors also continue to circulate that U.S. products are widely available in Iranian markets and that U.S. companies are intentionally circumventing U.S. sanctions by working through foreign-owned subsidiaries, although a concerted Embassy campaign has sharply reduced the incidence of these complaints. GERMAN BUSINESS COMPLAINING MORE LOUDLY ¶6. (C) Economics Ministry and BDI interlocutors insist that the business community's loud complaints are evidence that targeted sanctions and moral suasion -- along with Iran's misguided domestic economic policies -- have had a significant impact on German exports to Iran. Germany's exports to Iran declined by 13 percent in 2007. Although exports increased by 13.6 percent year-on-year in the first quarter of 2008, Economics Ministry and BDI representatives cautioned against projecting a trend from the Q1 statistics, pointing out that German trade with Iran is a small part of Germany's world-wide trade and that deliveries on one or two major projects might have skewed the statistics. They also note that Iran's surging oil revenues have resulted in an overall boom in spending and, as a result, Iranian imports overall are on the rise. Meanwhile, BDI representatives told us that, while a few new export credit guarantees are still being issued, they are prohibitively expensive and are only considered on a case-by-case basis in a limited number of sectors. (NOTE: Germany cut export credit guarantees for Iran-related exports by more than half from nearly 1.6 billion euros in 2006 to 503 million euros in 2007. The German Government also reduced its total outstanding liabilities from 5.6 to 5.2 billion euros. END NOTE.) Widespread German skepticism -- particularly within the CDU/CSU -- about the effectiveness of sanctions presents a further challenge. ONLY NEW TRADE RESTRICTIONS WILL PROMPT FURTHER CUTS ¶7. (C) While Economics Ministry officials expect German exports to Iran will continue to decline in 2008, BDI and DIHK contacts argue that significant reductions in Mittelstand companies' exports -- which constitute the bulk of exports to Iran -- will require a clear, legal framework that provides "black-and-white guidance" to exporters. Mittelstand companies "need government transparency," rather than subtle, "political pressure," one DIHK interlocutor insisted. If exporters do not fulfill their contracts, they will have to pay penalties to their customers for non-delivery. The only way exporters can avoid such penalties, a BDI contact told us, is if they have an official reason (i.e., legal cover) to terminate or curtail business. Currently, however, there is little sign that the government has the stomach to press the Mittelstand more than it already has. COMMENT - FOCUS ON EXPORT CONTROLS, TOO ¶8. (S) There are two ways to further restrict trade with Iran: additional UN/EU sanctions and further tightening of German export controls could pave the way for further cuts by sending the Mittelstand clearer legal guidance to curtail trade in certain types of products. Chancellor Merkel and BERLIN 00000772 003 OF 003 Foreign Minister Steinmeier have both publicly called for increased international pressure -- including additional UN and EU sanctions -- on Iran, and Germany is working closely with the UK and France to push for robust EU implementation of UNSCR 1803. In addition, providing Germany with detailed information about the link between Iran's oil/natural gas revenues and its proliferation programs could convince German export control officials of the need for tighter restrictions on the export of extraction, refining, and other equipment. ¶9. (S) Our experience shows that German export control officials are willing to take action to tighten export controls if they feel they have a sufficiently strong legal justification. Two examples are the May 2008 decision to require export licenses for heavy truck exports to Iran and Syria (ref B) and restrictions on the export of printing presses to the DPRK imposed in July 2007 (ref C). Another example is Germany's decision, in anticipation of an EU near-term designation on Bank Melli, to prohibit the Bank Melli Hamburg office from directly or indirectly transferring funds, capital, or assets to Bank Melli Iran or other institutions outside the EU (ref D). All three moves were the result of extensive and prolonged advocacy by the Embassy and by visiting State and Treasury high-level officials. German officials repeatedly presented us with detailed questions, not necessarily because they doubted our conclusions, but because they were anticipating questions that might be posed by parliamentarians or the business community. For that reason, we should be as forthcoming as possible in our initial presentation, but also be prepared to patiently answer questions. While this will likely be a difficult and often frustrating undertaking, the results could yield significant benefits and possibly even point the way forward for action within the EU. TIMKEN JR