As the West tightens the sanctions knot around Iran, the United Arab Emirates (UAE) is giving a significant extra pull by stemming its extensive trade and financial relations with its neighbor.

A major regional trade and finance entrepôt, the UAE has long given Tehran breathing room by serving as a conduit for goods and money. But analysts say that the UAE has begun cracking down on the business as relations between Iran and Gulf Arab states grow more strained. The biggest change has occurred in Dubai, the UAE’s leading commercial center.

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“You’ve seen in Dubai changes in its attitude toward Iranian banking and other activities,” Theodore Karasik, director of research at the Institute for Near East and Gulf Military Analysis, told The Media Line. “The Iranians in Dubai are starting to feel that pinch in a sharp drop in remittances transfers. No one wants to be associated with Iranians because it can raise a red flag and people don’t want to be investigated.”

A confederation of seven tiny emirates just across the Gulf from Iran, the UAE serves as one of the Islamic republic’s most important windows to the outside world. Iran is the UAE’s second-largest re-export market, accounting for about 17% of total volume, while the UAE is one of Iran’s top sources of imports, accounting for more than 15% of the total. Two-way trade between them reached $10.4 billion last year.

Just as importantly, banks and other financial service firms in the UAE have allegedly enabled Iran to circumvent financial sanctions. Bank Saderat and Bank Melli, two Iranian lenders flagged by the US and the European Union as helping Iran's nuclear program, both operate in the UAE.

Underscoring the UAE’s key role in enforcing the sanctions, David Cohen, the US undersecretary for terrorism and financial intelligence, visited the confederation last week after a new round of tougher measures against Iran were announced by Western powers.

“Iranian businesses operating in Dubai and serving the Iranian market by routing business to Europe through Dubai are finding it difficult to get trade finance instruments such as letters of credit and guarantees. With the new round of sanctions, getting shipping insurance will be harder,” Ayesha Sabavala, UAE analyst for the Economist Intelligence Unit (EIU) in London, told The Media Line.

The Iran sanction regime is growing tougher, although it is being imposed on a one-by-one basis by mainly Western countries, rather than the United Nations, after the International Atomic Energy Agency last month released a damning report on Iranian nuclear ambitions.

Two weeks ago, the US, Britain and Canada announced a new round of sanctions on Iran's energy and financial sectors. Britain went the extra mile, saying it would cut all financial ties with the central bank as well. Last week, the US Senate defied the White House and passed legislation penalizing foreign financial institutions that do business with Iran's central bank while the European Union added 180 Iranian officials and companies to their sanctions list and promised measures against Iranian oil exports, banks, transportation and the Revolutionary Guard Corps.

While the IAEA report and increased US pressure have played a role, analysts say that heightening sectarian tensions in the Gulf may be the biggest factor of all.

They have caused the UAE and other Gulf Arab governments to look with increasing suspicion at the minority Shiite communities in their midst and begun to crack down on their activities, including commercial dealings with their coreligionists in Iran. Gulf leaders are convinced Iran in stirring up their Shiite populations. When a small explosion occurred near the British Embassy in the Bahraini capital of Manama on Sunday, the Interior Ministry was quick to blame it on “the inciting rhetoric in Iran.” 

Bahrain called in Saudi and UAE security forces last spring to quell a largely Shiite rebellion against the Sunni royal family. Saudi Arabia, which in home to a substantial Shiite minority, has had to put down mass protests in a strategic eastern province. The UAE has been quiet, but some 450,000 Iranians or people of Iranian origin live among a population of just over five million and are responsible for most of the trade and financial ties with the country.

Analysts say another factor is the changing balance of power inside the UAE confederation since 2008. That was the year Dubai’s real estate-powered economic boom fizzled, prompting its wealthier, oil-rich neighbor to help bail it out with $10 billion in aid.

Abu Dhabi has traditionally taken a harder line on Iranian ambition compared to the business-minded Dubai. But, Karim Sadjadpour, a researcher at the Carnegie Endowment for International Peace, said in a study entitled The Battle of Dubai: The United Arab Emirates and the U.S.-Iran Cold War that Dubai’s financial woes have enabled Abu Dhabi to take firmer control of the combined UAE foreign policy and impose its views.

“The UAE has become an increasingly reliable partner for the United States, but both fear and economic expediency prevent it from taking a stronger public stand against Iran,” Sadjadpour wrote in the July report. “It has thus tried to walk a fine line between satisfying its ally and protector, the United States, and accommodating its looming neighbor, Iran.”

Since United Nations sanctions were first imposed in June 2010, the UAE has increased restrictions on Iran-related business with tighter custom inspections, freezing bank accounts and blacklisting of some Iranian banks. Fear of running afoul of the broadening US restrictions, even indirectly through the UAE clearing system, often causes UAE banks to take even sterner measures on their own.

Tightening sanctions come at a challenging time for the UAE economy and its trade sector. The UAE's purchasing managers' index (PMI), a composite indicator of the performance of the non-oil private sector published by HSBC Holdings Plc and Markit Economics on Monday, declined in November, a sign they said that the economy is “struggling” to maintain momentum.

But Sabavala of the EIU said that tougher policies on Iran haven’t yet bitten into bilateral trade, which grew by more than a third in the first quarter of 2011 from a year earlier. She speculated that the rise was due to increasing small-scale trade in traditional dhows, which isn’t as closely monitored, as well as increased demand for consumer and other goods not covered by sanctions.

“Demand from Iran is still very, very strong,” she said. “There are a lot of high net worth individuals in Iran. Their spending power is tremendous. The economy in Iran for them is still quite strong. There is a lot of demand from them for consumer products.”

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