This latest development strengthens our view that Vicente is the clear frontrunner to take over the presidency (see Business Monitor Online, November 4 2011, ‘Challenges Ahead For Ruling Party Beyond 2012 Election’) at some point during the next presidential term following the September 2012 parliamentary election. BMI believes that the selection of Vicente is a shrewd political manoeuvre, as he already reportedly belongs to the president’s close decision-making circle. This would appear to rule out the prospect of an outright shift in policies and allow for dos Santos, who has been in power since 1979, to continue influencing decisions behind the scenes.

Burma (Myanmar): Political Reform Is Key

We’ve been saying for years that Myanmar has the potential to become a ‘second Thailand’, if only the military-dominated regime would liberalise its political system and reform its economy. During 2011, the new president, Thein Sein, appeared to embark on this path. These are very small steps, but, as the saying goes, ‘every journey has a first step’. US Secretary of State Hillary Clinton’s landmark visit last year has helped spark a sort of Myanmar mania at the present time.

Yoma Strategic Holdings, share price (SGD)

The best example of this has been the trebling in the share price of Singapore-listed Yoma Strategic Holdings – a company which is involved in real estate development, agribusiness, and truck distribution in Myanmar – to a four-year high of SGD0.40 since last December. It’s hard to tell how far Yoma’s share price can keep going, especially after languishing so low for so long. However, broader investor sentiment will remain constrained by Myanmar’s complex multiple exchange rate system, high levels of corruption, and weak infrastructure.

Ultimately, political developments will be crucial. Veteran opposition leader Aung San Suu Kyi is running in by-elections in April, and any further sign of liberalisation thereafter would boost Myanmar’s international reputation and long-term prospects.

Laos: Quietly Humming Along

Laos is arguably the most ‘normal’, politically, of the BLANK states. True, it is a one-party communist state, but it has not shown the level of hostility towards the outside world as Myanmar and North Korea, and it is not at war like Afghanistan. Laos is actually experiencing rapid economic growth, thanks to demand for its natural resources and hydroelectric power. The country inaugurated its stock market in early 2011, which initially surged, but has since fallen sharply (see chart below, click to enlarge).

Laos Stock Exchange Index

Going forward, Laos looks likely to be caught up in a geopolitical struggle between neighbouring China and Vietnam (and possibly Thailand). However, if Laos can skilfully play off its bigger neighbours, it can maximise concessions from Beijing and Hanoi.

Afghanistan: Western Exit To Prove Colossal Challenge

Afghanistan is probably the worst off among the BLANK economies, since it is in the grip of civil war and is in worse shape, physically, than North Korea. Over the last 24 hours, the United States announced that it would seek to wind down combat operations in Afghanistan in 2013, one year before the withdrawal of virtually all Western troops from the country. The news coincided with the leaking of a US military report stating that the Taliban, backed by Pakistan, will retake control of Afghanistan once NATO forces leave. If this prognosis is accurate, and indeed it seems to make sense, then Afghanistan’s economic prospects will remain bleak. Optimists could argue that once the Taliban regains control, the war would be over, and ‘moderates’ could still seek to attract foreign investment, but this is a long shot to say the least.

North Korea: Convergence With South Decades Away, But Upside Potential Is Vast

If Myanmar is potentially a ‘second Thailand’, then surely North Korea is potentially a ‘second South Korea’. There is no reason why the North shouldn’t eventually catch up with the South. The trouble is, this will cost trillions of dollars and probably take decades. This also assumes there won’t be war or state collapse. The death of Kim Jong Il last December at least opens the possibility of change, but so far, the signs are not good. His son and successor Kim Jong Un, although educated in the West, is maintaining the status quo, and even if he were a zealous reformer, he surely lacks the power to enact them. Kim Jong Un’s exiled elder half-brother Kim Jong Nam has been calling for reform, but there’s little he can do from his isolation in Macau.

It’s quite possible that North Korea’s powerful military leaders will eventually promote change, but so far they appear to be years behind their counterparts in Myanmar. Still, if Myanmar’s transition proves successful, it is just about conceivable that generals in Pyongyang will follow suit. According to a Bank of America-Merrill Lynch report cited by the South’s Yonhap News Agency, if the North opens up its economy, it could grow by 10-12% annually. This would make North Korea a significant investment destination.

In Business Monitor Online today, we have published two key articles on Japan and Italy.

In the first, we assess the global impact of a potential Japanese sovereign debt crisis. We outline which countries would be most vulnerable to a withdrawal of Japanese direct and portfolio investment, and the impact on US Treasuries. Although a Japanese blow-up does not appear imminent, we warn that a crisis in confidence, rather than a sudden deterioration in fundamentals, is all that is needed to spark disorder in the bond markets.

Our Italy article is a fully updated version of our long-term political forecast (2012-2021). We discuss the enduring  impact of Italy’s fiscal austerity drive on the country’s political system, social fabric, and regional geography.

More broadly, BMI publishes long-term political forecasts for 100 countries, outlining the main challenges and threats to national stability, and scenarios for how the polity may evolve over the coming decade. These complement our full-range of 10-year economic forecasts for individual states. All are available on Business Monitor Online.

In the case of Croatia, we retain our view that the government will seek IMF backing of some sort this year, which will help avert a full-blown crisis in the economy. This is predicated on the increasingly difficult conditions for Croatian financial markets as a result of tightening liquidity and a persistently weakening macroeconomic backdrop.

The precipitous slide of the kuna against the euro in recent months has prompted the Croatian Central Bank (HNB) to raise reserve requirements (RRs) to 15.0% from 14.0% previously (RRs were last raised by 1 percentage point (pp) in September). The central bank governor, Zeljko Rohatinski, stated that tightening liquidity in the domestic market – which will withdraw an estimated HRK3.1bn from the system – is preferable to running down the country’s foreign exchange reserves as that would be ‘a clear signal to the financial markets that Croatia is facing growing problems with external liquidity’. Full analysis is available in our online service.

Elsewhere, South Korea’s economic growth decelerated for a third successive quarter in Q4 2011. We expect this slowdown to persist in 2012, with net exports acting as the main drag. We anticipate that much of the deterioration in economic activity is likely to come in H1 2012 and we harbour expectations of a modest cyclical recovery in the second half of the year. Consequently, we have revised our 2012 growth forecasts downwards from 2.4% to 1.9%, which still puts us below government projections of 3.7% and a Bloomberg consensus of 2.3%.

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Gingrich’s remarks came in a speech he made while campaigning in Florida, from which the US used to launch the space shuttle, prior to its retirement last year. Gingrich has long had an interest in space exploration, and he emphasised that an enhanced space programme would bring substantial technological benefits. He compared the space programme to efforts to build a transcontinental railway across the US in the 1800s, or the early developments of airlines in the 1930s. He added that it was in America’s interests to acquire so much space experience that China and Russia would never come close to matching it. On this front, Gingrich happily accepted the charge that he was being ‘grandiose’, and that being ‘grandiose’ is ‘American’.

Gingrich’s speech was dramatic, but it is hard to see how an enhanced space programme or lunar base will be a priority for Americans in 2012 or for some time beyond this. Although US economic growth accelerated to an annualised rate of 2.8% in Q4 2011, up from 1.8% in Q3 2011, unemployment remains well above 8%, and the budget deficit and debt burden remain painfully high. It is difficult to see the US channelling substantially more money into the heavens, when there are so many problems on earth.

Nevertheless, Gingrich’s speech raised the possibility of a renewed space race, or more specifically, a race for the moon. At the end of last year, China also announced an ambitious five-year programme for enhanced space exploration that would include more manned spaceflights, and an eventual moon mission. Given that China’s space programme is run by its military – unlike in the US, where there are separate military and civilian space programmes – Washington fears that Beijing could be moving to challenge its dominance in space – something that is crucial for broader US military superiority on earth.

Meanwhile, Russia is not sitting still. Russia, too, announced in January that there should be a permanent moon base – although rather than being a solo effort, the Russian space agency said that it would seek to boost cooperation with the United States’ NASA and the European Space Agency (ESA).

Going forward, it is difficult to tell how much of all this is rhetoric, and how much is sincere. The costs of space exploration are substantial, meaning that the issue will not be a high priority for voters in the US, Europe, and Russia. In addition, China’s economy is at risk of a ‘hard landing’ in 2012 or thereafter, which, if followed by a period of substantially slower growth, could stunt its space ambitions.

Nonetheless, precisely because of its military applications, we would expect the world’s major powers to enhance space capabilities over the coming decade (See our blog post of September 25, 2008, for further background). There is also the prestige factor – which is why India and Japan will maintain space programmes.

However, the fact that Iraq has not been in the headlines belies the very substantial political risks that the country faces in 2012. In an article published on Business Monitor Online on January 26, we discuss the dangers faced by Iraq in the near term:

• Iraq faces rising tensions between the Shi’a majority and the Sunni minority.
• Prime Minister Nouri al-Maliki (a Shi’a) is increasingly seen as an authoritarian figure, raising fears about Iraq’s democratic credentials.
• Iraqi security forces may not be strong enough to prevent a new sectarian conflict.
• A renewed conflict in Iraq would affect the interests of Iran, Saudi Arabia, Turkey, and several other MENA states, and would probably drag them in as proxy players.
• One scenario we outline would be simultaneous civil wars in Iraq and Syria, which would be highly destabilising for the heart of the region, and lead to refugee flows.
• Iraq’s Kurdish region could take advantage of Shi’a-Sunni strains to increase its autonomy from the central government in Baghdad.
• Any protracted political crisis or renewed violence could interfere with the oil sector’s development and deter prospective investors.

The situation is looking precarious. If Syria and Iraq descend into full-blown civil war, and Israel or the US attacks Iran, then the entire region between the Mediterranean and the Afghanistan-Pakistan border will be in conflict. A scary thought.

The key themes for Africa’s oil and gas sector are as follows:

• Total oil production is set to recover quickly in line with Libyan volumes and higher output from Ghana, Angola and Nigeria.
• Gas output is also likely to rise significantly over the next five years to 2016 as new sources emerge and governments attempt to harness previously flared gas for domestic power generation.
• We forecast a rise in oil consumption on the back of steady economic growth. This is likely to necessitate further investment in the downstream sector, with Chinese development loans most likely to be the principal source of investment.
• The main investment opportunities are likely to be upstream, with West African subsalt and East African gas plays among the most exciting projects. High fuel prices are likely to incentivise further exploration and appraisal over the next decade.

We analyse the above issues in more detail in Business Monitor Online.

China: With the economy heading towards a ‘hard landing’, we believe it will become increasingly difficult for the central government to report strong growth figures. While the headline GDP figure is as much a political issue as an economic one, a greater focus on redistribution and rebalancing could be seen as a means to frame weaker overall growth. Consequently, we maintain that China’s economy will grow by less than 8% annually over the coming years. We do caution, however, that there are significant upside risks in the near term, as the forthcoming change in leadership this autumn could compel Beijing to pull out all the stops to prevent growth falling significantly.

North Korea: New leader Kim Jong Un’s exiled elder half-brother Kim Jong Nam has made a number of comments highly critical of the younger Kim and the system over which he presides. In particular, Kim Jong Nam criticised the country’s third dynastic succession, saying that Kim Jong Un is too young and inexperienced to be more than a figurehead, and that the economy needs reform. This has led to speculation that Kim Jong Nam is either positioning himself as a rival to Kim Jong Un, or seeking to force the issue of reform. Nonetheless, there is little that Kim Jong Nam can do from exile, because most of his domestic supporters were ‘purged’ some time ago. It’s possible that China is cultivating Kim Jong Nam as an alternative leader of North Korea, but it is also possible that someone else will emerge, if Kim Jong Un falters.

VIX Index

Equities worldwide have made a strong start to the year. One market that could potentially be nearing an inflection point is China’s. As we previously argued on Business Monitor Online, the Shanghai Composite Index stands to benefit, if we are correct in our expectations of further monetary policy easing by the People’s Bank of China through the coming months as growth cools and inflation moderates further. Downtrend resistance comes in at 2,350.

Shanghai Composite Index

Although the US dollar has strengthened against the euro over the course of the Q4 2011-Q1 2012 rally in global equities, with euro strength still expected to be fleeting in the face of ECB easing, many other currencies appear primed for further upside against the greenback.

One example is the Australian dollar, which remains in a multi-year uptrend and has recently pushed through resistance at US$1.04/AUD. This break points to a retesting of the top end of the Australian dollar’s trend channel – at US$1.20/AUD.

Singapore – Exchange Rate, SGD/US$

The Singapore dollar also looks robust from a technical perspective. After a dramatic sell-off in September 2011, the currency is now rolling over and looks set for a run towards SGD1.2350/US$.

The euro is poised to rally to resistance at US$1.3250/EUR, although we would be cautious at that stage.

Interestingly, the euro has rallied as anticipation has grown surrounding ECB (European Central Bank) and multilateral assistance to embattled sovereign bond markets. This suggests that monetary easing is helping rather than hindering appreciation, as the market is more concerned for now about the structural integrity of the eurozone than about inflation.

The euro’s move higher against the dollar has been accompanied by the Dow Jones breaking through resistance at 12,500. This development suggests that US equities could be set to retest their 2011 highs in the weeks ahead.

Therefore, the euro and equities may be set to recouple and move higher in lockstep in the short run. This would run contrary to a view we have held since October, for divergence between equities and the euro. However, with continued easing by the ECB to be expected, our medium-term conviction remains for divergence, with the euro declining as global equities rally. A break of US$1.3250/EUR would force a reassessment, however.

Main Themes And Trends For Oil Prices In 2012

• Supply-side concerns will continue to provide the main upside risk to oil prices. We expect a supply deficit to ease during the course of the year, but a lack of spare production capacity is likely to make oil markets extremely sensitive to supply-side shocks.
• Saudi Arabia will continue to be the market’s supplier of last resort. Riyadh’s response to Iranian sanctions and the return of Libyan volumes will therefore be critical.
• Stricter sanctions on Iran are set to cause a reorientation in crude flows – a ‘substitution effect’ could push Brent crude higher versus other benchmarks, depending on the severity of an EU ban.
• Demand concerns will provide the main downside risk to prices. Our forecasts indicate robust global demand despite lower growth in China and the eurozone.
• A further downside risk could come from reform to Chinese oil subsidies.

The full article includes our forecasts for oil prices (Brent, Urals, WTI, Opec basket, and Dubai) out to 2016 and is available to subscribers at Business Monitor Online.

• What will be the choices on offer to the Scottish electorate?
• When will the referendum be held?
• Who will vote in the referendum?
• How will the campaign be run?
• What outcome do opinion polls suggest?
• What will be the impact of the referendum on UK politics?
• What would a Yes vote mean for Scotland?
• What would an independent Scotland mean for the UK’s ‘great power’ status?

Overall, with only around 30% of Scots solidly in favour of independence, the referendum will probably fail. Nevertheless, despite the defeat of the Quebec independence referendum in 1980, the separatists regained momentum and came within a whisker of succeeding in the 1995 vote. If the Scottish nationalists lose by a narrow margin, they could eventually try again.

But even if they succeeded, would they really gain ‘independence’? Sovereignty is a hazy concept these days. Several eurozone countries have lost their economic policymaking powers to supranational institutions over the past year. Elsewhere, South Ossetia and Abkhazia seceded from Georgia in 2008, only to become de facto Russian protectorates, which virtually no one recognises. Clearly, Scotland should not be compared to those two statelets, but an independent Scotland would probably join the EU and eurozone (provided the latter still exists!), meaning that considerable political power would be wielded in Brussels and Frankfurt, rather than in Edinburgh.

In many ways, the Republican candidate should be a shoo-in for the White House. Unemployment remains elevated by historical standards, Washington’s fiscal deficit remains eye-popping, and crucially, Obama’s approval ratings are hardly robust (at 46% in the daily Gallup poll, versus 48% disapproving of his performance). Furthermore, the rise of the ‘Tea Party’ movement suggests that the Republican Party base could be re-energised to turn out to vote this year, much as Democrats came out in droves in 2008.

However, we think that Obama should still be considered the favourite to win in November 2012. First, and most importantly, White House incumbents have a natural advantage, so long as the economy is improving by the time the election is held, which we expect to be the case this time around. Second, the Electoral College map is relatively favourable for Obama in our view, with Romney having to make up significant ground in several major swing states such as Ohio and Pennsylvania (we will provide a more thorough analysis as November approaches). As usual, it will come down to a short list of vote-rich states: Colorado, Florida, Iowa, Michigan, Nevada, New Hampshire, North Carolina, Ohio, Pennsylvania, Virginia, and Wisconsin. Given that a majority of these states has traditionally been considered Republican-leaning, and given that Obama has maintained significant support in most, it appears that the Republican candidate will be as much on the defensive as on the offensive. It is very difficult to see a path for a Republican candidate to the presidency without winning North Carolina, for example.

It is certainly unlikely that Obama will win as many electoral votes as he did in 2008 (365 of the 538 available), but it is more likely than not that he will reach the 270 required to win re-election. Of course, this election should be on a knife’s edge, not least because the reallocation of electoral votes as part of the 2010 Census population findings has shifted 14 or more electoral votes to traditionally Republican-leaning states. If Romney can tap into the groundswell of voters who are dissatisfied with the state of the economy, he stands a very reasonable chance of being elected.

In our US 2012 preview article, we also discuss what policies may be expected under a Romney presidency or a re-elected Obama. In a separate article also published on Business Monitor Online today, we also outline Obama’s main foreign policy challenges in 2012.

It was an unlucky Friday the 13^th for France, which lost its AAA credit rating from Standard and Poor’s. Among other things, the downgrade is likely to be prompt a reassessment by investors and the electorate of the Franco-German relationship in ongoing eurozone rescue plans, in which France is increasingly looking less like an equal partner. We cannot rule out the possibility that the change in this dynamic may prompt French President Nicolas Sarkozy to adopt a new tactic in ongoing negotiations, acutely aware that any suggestion of subservience towards Germany is likely to pour salt on France’s wounds, while opening the door for his rival presidential candidates (the election is in April) to manipulate this by adopting a populist strategy. National Front presidential candidate Marine Le Pen has employed this tactic with some success, accusing Sarkozy of selling out to ratings agencies while pushing her neo-mercantile economic policy, which has seen her make gains in the polls. Indeed, we now cannot rule out the possibility that Le Pen makes it through to a second-round runoff election.

That said, the downgrade is not as calamitous as some have posited. Fitch Ratings has affirmed France at AAA for the time being, meaning that technically France maintains AAA-status, although this is unlikely to remain so for long. Secondly, we do not envisage that the additional 100 basis points or so demanded on French sovereign securities will create an unsustainable burden on France’s public financing requirements; they imply an additional cost of US$4bn or so in 2012 – significant, but by no means disastrous.

Far across the world in Taiwan, President Ma Ying-jeou was comfortably re-elected, and his KMT party retained its majority in the legislature. We thus expect to see a continuation of the KMT’s cross-Strait economic integration policies. Indeed, Ma’s election campaign focused on the economic benefits that Taiwan has gained since he assumed office in 2008, touting the Economic Cooperation Framework Agreement (ECFA) signed with China and the resumption of direct air, sea transport, and postal links, as well as the surge in mainland tourist arrivals, as crowning achievements during his tenure.

Ma will now engage in further cross-Strait cooperation, which, in our view suggests brighter growth prospects for Taiwan in the medium term. Beijing has persistently dangled the economic carrot as a means of achieving its final aim of reunification with the island. While such an end-game is unlikely to materialise for a great many years (if ever), we certainly expect a proliferation of deeper integration policies, which should boost businesses on both sides of the Taiwan Strait. China’s share of Taiwan’s exports has surged from just over 2% in 2000 to almost 30% presently, with bilateral trade amounting to approximately US$145bn in 2010. Taiwanese investment in China has totaled almost US$100bn in the last two decades, with almost US$40bn coming during Ma’s first term. Following the conclusion of the ECFA in 2010, free trade negotiations with economies such as Singapore, Indonesia and the EU have either resumed or are likely to commence in the near future.

Similarly, German equities are breaking higher, building on the recovery they have staged since early October. While we anticipate further near-term gains for such assets, we remain very sceptical about the health of the Chinese economy, and we believe a collapsing property market will ensure a ‘hard landing’ in 2012.

Agribusiness Themes For 2012

Earlier this week, BMI’s Commodities Team published its list of agribusiness themes for 2012. In brief, the five themes are:

1. Tightening ethanol supplies
2. Supply shocks due to the La Nina phenomenon
3. Outperformance by food manufacturers’ share prices
4. Risks to commodities trade finance
5. Chinese import fluctuations

We discuss these in greater detail in Business Monitor Online.

There are three channels through which Southern African economies could be hurt, if the region experiences the wrong kind of weather:

Economic Activity: With agriculture making up a sizeable proportion of many Southern African economies, lower harvests would have a detrimental effect on GDP growth. In additon, the number of people who rely on agriculture for income in Southern Africa is disproportionately high when compared to the sector’s overall contribution to GDP. Weaker harvests would therefore have negative ramifications for private consumption. Furthermore, investment would also be impacted by reduced purchasing power and higher borrowing costs as inflation rises and monetary policy is tightened.

Inflation: Food prices make up a large proportion of consumer price baskets in the region. This being the case, food price increases resulting from supply shortfalls could drive inflation higher at a time when almost all Southern African economies are enjoying a period of single-digit price increases. Although high dam levels mean that the risk remains relatively remote at this stage, a prolonged period of poor rains would also hamper hydroelectricity production at the Kariba and Cahora Bassa dams, which would add to inflationary pressures. Located on the Zambezi River, these are important sources of power for Mozambique, South Africa, Zambia and Zimbabwe. Higher inflation in South Africa in particular would be negative for the region, as it would spill into many of its neighbours, given the strong trade linkages.

Monetary Policy: Higher inflation would likely move monetary authorities into tightening mode at a time when domestic and international macroeconomic conditions would otherwise call for loose monetary policy. Indeed, amid growing concerns about the health of the global economy and external demand, the bias in the region is currently to loosen policy in the case of Zambia and Mozambique or maintain interest rates at historically low levels in the case of South Africa.

In our article, we analyse how the above factors will affect the economies of Malawi, Mozambique, South Africa, Zambia, and Zimbabwe.

How Did We Get Here?

Hungary’s economic problems are well documented. Legacies from the previous crisis, namely a large stock of foreign currency-denominated debt and an overleveraged banking sector, have been exacerbated as, respectively, the forint has come under severe pressure and Western parent banks have hinted that they are seeking to limit credit exposure to the weakest economies in CEE.

Compounding matters, Hungary is – by some measures at least – the CEE economy that is the most heavily exposed to trade and investment with the eurozone. This supports our view that Hungary’s economy will be the only one in CEE to contract over the course of 2012.

On the political front, the situation has been no better. The government has been branded as increasingly authoritarian and erratic by both investors and credit rating agencies alike. Legislation to change the nomination structure within the central bank has been likened to a curbing of its independence, while there have also been attempts to diminish the influence of the judiciary and the independent media. As a result, the three major credit rating agencies have dropped Hungary to junk status, and investors have flocked out of all major asset classes.

How Will It All Play Out?  

There is no question that Hungary’s only real escape from its current economic mess rests with a new IMF/EU deal. But there is potential for negotiations to prove volatile and protracted in the meantime, given that Hungary will prove loath to give into external demands. In the meantime, should markets continue to come under duress, we cannot rule out the central bank aggressively hiking interest rates to help stem capital outflows, by as much as 100-200 basis points, as it did back in late 2008.

Ultimately, with the economy heading back into recession, and Fidesz likely to lose face as it is forced to backtrack on major legislative moves, public support should begin to shift away from the centre-right party, potentially yielding a rise in the far-right’s popularity. At the same time though, financial markets could offer attractive entry points as terms of the IMF deal become more concrete. The forint and government bonds in particular look ripe for a bounce.

In a special feature published on Business Monitor Online and in Emerging Markets Monitor this week, we discuss threats to Hormuz shipping. Although my colleagues and I do not believe that Tehran will carry out its threat, we at BMI periodically carry out thought experiments in which negative situations play out. In our special feature, we analyse:

• Reasons why Iran might close the Strait
• The impact this would have on oil markets
• How shipping routes may be disrupted
• The alternative shipping routes from the region
• The reaction of the US and its allies to the closure
• The impact of the closure on the Iranian economy

Even if Iran refrains from closing the Strait, the possibility will keep the oil market on edge. The bigger risk is that a limited skirmish between the Iranian and American militaries at sea could be a prelude to Washington waging a wider war against Iran to neutralise its nuclear programme. This in turn could escalate into a regional conflict, posing yet another danger to a global economy already roiled by the eurozone crisis and the spectre of a ‘hard landing’ in China.

As it happens, a week before Kim Jong Il’s death, I finished reading a book that offers fascinating insights into where North Korea may be heading. The Man With The Baltic Stare is the fourth and latest instalment of the ‘Inspector O’ series of novels featuring the eponymous Korean detective. The books were written by James Church, the pseudonym for a 65-year old former Western intelligence operative with decades of experience in Asia.

The story begins in 2016, with our protagonist being summoned to Pyongyang after having retired from the Ministry of People’s Security in 2011 and having spent the past five years living in seclusion in the mountains. During Inspector O’s five-year absence, Pyongyang has changed dramatically, with new buildings, new lighting, new etiquette, new babies in prams, and the stirrings of an emerging middle class society. Even more surprising for O is that North and South Korea are now cooperating quietly with one another to maintain stability on the Peninsula and have exchanged special liaison officers. O is quickly caught up in the intrigues of South Korean and Chinese agents, who are actively competing against each other to maximise their influence in the North. The South fears that the North could become a de facto Chinese province, while Beijing fears that Seoul is seeking to turn North Korea into a gangster state aimed at causing problems for China.

This web of intrigue soon takes Inspector O to Macau, which has long been a base for North Korean external intelligence and economic activities. There, he investigates the mysterious murder of a prostitute at a luxury hotel, which was apparently committed by the man designated as successor to Kim Jong Il (although neither Kim nor his son are mentioned by name), and who has himself gone missing. Naturally, there are competing foreign interests seeking to discredit or bolster Kim’s chosen successor.

O subsequently journeys to Prague, where some shadowy figures from his previous adventures elaborate on foreign plans for the Korean Peninsula, before sending O back home for a final showdown with his opponents. Who exactly O’s enemies are is often unclear. He does not trust his former employers in the Ministry of People’s Security, but he can hardly trust the South’s ambitious and manipulative point man, Major Kim. Meanwhile, there is more than one Chinese faction at work in this drama. Moreover, although O is a critic of the Pyongyang regime, he is still a patriot, and does not want North Korea to merely become a South Korean or Chinese puppet state.

Inspector O is not a North Korean James Bond. He does not shoot people, jump out of planes or trains, or seduce women. He is 68 years old and does most of his fighting with words. Despite the fact that he is a nuisance to his enemies, none of them make much effort to kill him; instead they are content to manipulate him in their power games. Yet O is surprisingly resilient and has a penchant for witty and acerbic comebacks. Indeed, perhaps because of his advanced age and his lack of family and close friends, O doesn’t seem too concerned about his own fate. This makes it harder for his former employers, and South Korean and Chinese agents, to intimidate him.

Overall, The Man With The Baltic Stare is an unusual spy story with an unusual protagonist living in an unusual country facing an unusual future. This alone makes it an intriguing read.

The Man With The Baltic Stare, by James Church, was published by Minotaur Books in 2010. ISBN 978-0-312-56941-9

Further Reading

Under The Loving Care Of The Fatherly Leader by Bradley K Martin is probably the most comprehensive English-language book ever published on North Korea and the Kim family, although at 800+ pages, it’s one for serious Pyongyang watchers.

Pyongyang: A Journey Into North Korea by Guy Delisle is a highly insightful graphic novel about a Canadian cartoonist’s experiences working in North Korea.

Nothing To Envy: Real Lives In North Korea by Barbara Demick won the BBC Samuel Johnson Prize for Non-Fiction in 2010.

We noted that the definition of ‘hard landing’ varies considerably. Our China analyst provided a qualitative definition, characterised by the following symptoms:

• a sustained contraction in manufacturing PMI (Purchasing Managers’ Index)

• a contraction in services sector PMI
• a sustained fall in imports
• double-digit (%) house price declines
• elevated banking sector stress
• growing expectations of currency weakness

We reiterated that it is very difficult to forecast a hard landing, because aside from the timing issue (for example, it could be 2012, or 2013, or 2014, etc…), there is the data reliability issue. China observers have long questioned the accuracy of official data. In light of this, we essentially have to forecast what we think the Chinese stats bureau will report. Quarterly Chinese GDP data still only reflects year-on-year (y-o-y) changes, and not seasonally adjusted annualised rates. Attempts to calculate the latter from official data series lead to nonsensical numbers.

It was pointed out that investment banks are lowering their China 2012 forecasts, and we are already below consensus. For all we know, actual growth could already be well below official GDP figures.

Beyond 2012, our macroeconomic forecasts for subsequent years, ie 2013-2020, already reflect our expectations of lower growth.

We discussed policy options for the Chinese government, such as interest rate cuts, higher bank lending, and tax cuts, but noted that many options could exacerbate circumstances. Indeed, more lending to state owned enterprises (SOEs) would hurt small and medium sized enterprises (SMEs), in an environment where capital is already drying up. The private sector is at risk.

So how does it all end?

The future of China’s export- and investment-driven growth model is up in the air. It could end with a bang or whimper, and one analyst raised the possibility of a ‘Japan scenario’ of a sharp slowdown, followed by years of lackluster growth.

Another analyst noted that China’s economic liberalisation has slowed, and that the government could become more entrenched in the economy as a result of a hard landing.

We also discussed yuan (CNY) devaluation risks, but felt that depreciation rather than devaluation was more probable. China’s famously humongous foreign currency reserves have already been falling, and there has been capital flight.

Furthermore, we noted that banks could still need a further bailout.

5-10 year view

Much depends on the government’s policy response to a slowdown.

China’s demographic changes alone could trim 1-2 pps off headline growth.

It was noted that despite everything, China’s exports to the US are at an all-time high.

Probable explanations include:

1) China gaining market share from competitors

2) Chinese exports include substantial re-exports

The best-case scenario for 2012-2013 would see a recovery of US growth, and a stabilisation of the eurozone crisis. It involves the continuation of global imbalances and ‘business as usual’.

It was noted that China’s political transition in late 2012-early 2013 means that the government will do everything it can to minimise the risk of macroeconomic instability. Nonetheless, we also acknowledged that policymakers may not be able to prevent a hard landing, despite political pressure.

China is unlikely to see an uprising against the central government unless the economy collapses. There are tens of thousands of incidents of unrest every year, but these tend to be focused on very specific local issues, rather than clamouring for systemic change.

We discussed the international environment. China could become a bigger election issue in the US if American unemployment fails to decline. In Europe, the probable defeat of French President Nicolas Sarkozy in April-May could break the Sarkozy-Merkel axis. Clearly, a further weakening of the eurozone would be bad news for China.

A senior BMI official also noted that there are upside risks to our China outlook, and we need to be cognisant of them.

Over the longer term, even if Chinese growth slows to a much lower average over the coming years, China still offers tremendous potential, in the sense that it’s still a very poor country with room for catch-up with developed states. China is nowhere near as developed as Japan in 1989-1991, when the asset bubble burst. Rather, it is more akin to the US in the 1920s.

Spot Platinum, US$/oz (Monthly Chart

Platinum has failed to break through support-turned-resistance at US$1,450/oz, creating a particularly bearish technical pattern. It has been our view since October 2011 that platinum prices have topped out, and with no significant levels of support until around US$1,000/oz, platinum prices look precarious. Furthermore, as platinum is increasingly being used as an investment tool, we expect significant volatility in the coming months. Platinum ETF holdings have come off the boil in recent months, but remain elevated by historic standards. Additional financial market weakness in the coming months could catalyse a sharp unwind of ETF holdings, which could place significant downward pressure on platinum prices.

Although there is potential for a small short-term bounce for platinum as oversold momentum unwinds, we expect this to be short-lived and unlikely to break through resistance at US$1,450/oz. On the fundamental side, we forecast weak growth in autos demand in Europe, the main component of global platinum consumption. This will weigh on platinum prices and help keep them subdued over 2012.

We expect the spread between gold and platinum ratio to remain positive (in gold’s favour) as gold prices remain elevated due to the metal’s safe haven appeal. The spread is near multi-decade highs and we do not expect it to return to negative territory until a normalisation in global monetary policy causes gold to lose its attraction. As we expect the US Federal Reserve to keep interest rates low until 2014 at the earliest, we anticipate the medium-term uptrend for gold to remain in place.

Palladium looks more attractive than platinum on a technical basis, as the multi-year uptrend remains in place. However, we have stopped short of being outright bullish towards palladium, especially as it has yet to break resistance at US$700/oz. Indeed, we are not yet expecting the ratio between platinum and palladium to resume its multi-year downtrend in palladium’s favour. A key reason for this is that over the long term, our below-consensus view on Chinese economic growth and Chinese autos production in particular do not bode well for palladium. As China accounts for a greater share of palladium demand compared with platinum, it is likely that palladium will be harder hit by a ‘hard landing’ in China.

Global Manufacturing PMIs

The US ISM manufacturing PMI reached 53.9 from 52.7 in November, the highest in six months; Chinese PMI was just above the 50.0 expansionary line following a dip into contractionary territory (though we expect it to falter again); while UK and eurozone PMIs were below 50.0, but came in above analysts’ expectations. Looking at the chart of US manufacturing PMI plotted alongside real GDP growth, we reiterate our general view that the US economic recovery will continue in 2012, though with increasing headwinds from Europe. One of the big risks to this view dissipated somewhat when the US government in December approved an extension of 2011′s payroll tax cuts through February 2012 (a reversion to previous tax rates would have cost the typical household around $1,000 per year).

US Manufacturing PMI And Real GDP Growth

Against this backdrop, the technicals for equities are looking increasingly positive. As the accompanying chart shows, the Dow faces significant resistance at 12,500. A break through this level would offer a further suggestion that the underlying macro fundamentals are continuing to improve as we expect.

Dow Jones Industrial Average

On that note, my colleagues and I recently published ‘Our Key Themes For 2012’, which can be found on Business Monitor Online and in the latest edition of our monthly Global Macro Monitor magazine.

In many ways, our 2012 preview is a continuation of our 2011 outlook. At the end of 2010 we believed the upcoming year would be characterised by heightened political risk, a Chinese economic slowdown, and a culmination of the eurozone crisis. As it turns out, there remains much unfinished business from last year. We expect 2012 to offer answers to some of the really big questions, such as whether the Chinese growth model is doomed, and whether Europe can finally get its act together to save the eurozone. Our macroeconomic growth forecasts are below-consensus, but not dramatically so. However, we are very concerned about the negative tail risks, with a deflationary scenario potentially arising from a combination of deleveraging and a reduction in global demand. No matter how we look at it, 2012 looks set to be at least as interesting – and as challenging – as 2011.

In our 2012 preview, we discuss the following topics:

• Rising global political risk
• China’s hard landing
• The ongoing eurozone crisis
• Gridlock in Washington
• Ongoing global economic imbalances
• Further monetary easing
• Risks of a new European credit crunch

Obama goes to Tehran: Almost everyone (in the risk analysis business) is talking about the prospects of war against Iran in 2012, and certainly the outlook for Western world-Iran relations isn’t particularly good. In light of this, the real surprise would be a major diplomatic breakthrough. What if, somehow, the US and Iran were to reach a ‘Grand Bargain’ over their outstanding disputes, paving the way for President Barack Obama to visit Tehran for handshakes with Mahmoud Ahmadinejad? This would be a truly extraordinary event, greatly reducing tensions in the Persian Gulf and radically transforming regional and potentially global geopolitics.

US third party presidential victory: The US presidential campaign usually begins at least a year before the election, and many pundits believe that it is probably too late for a new candidate to enter the fray. However, even though the weak US economy has hurt Obama’s ratings, the Republicans have failed to find someone with both the credibility and popular appeal to pose a formidable challenge to the incumbent. Against this backdrop, there have been growing calls for a third-party candidate. Recall that Texan billionaire Ross Perot won 19% of the popular vote in 1992, even though he was a late entrant and pulled out of the presidential race during the summer of that year. Perot was able to capitalise on widespread uncertainty at a time when the US was exiting recession and felt outcompeted economically by Japan. It is too difficult to say who would be a third-party candidate in 2012, but the idea merits considerable attention.

China announces democratic transition: The big event to watch in China in 2012 will be the five-yearly Communist Party of China (CPC) congress in the autumn, which will result in the transfer of power to the ‘fifth generation’ of leaders. The congress may also outline some new ideological phrases or mantras for the new era. No surprises there. But what if the CPC does something really surprising, such as outline a timetable for the transition to a fully democratic and competitive political system? Conventional wisdom holds that the CPC will not do this unless faced with ‘Arab Spring’-style unrest. Yet, wiser heads in the party could argue that an elite-led transition would be the best way to head off mass unrest. A democratic China could dramatically change the way the country and economy are run.

Greece-Israel Vs Turkey war in Eastern Mediterranean: Conventional wisdom holds that if Israel gets drawn into a military confrontation in 2012, it would be against Iran, or possibly a more radicalised Egypt. However, Israel’s relationship with Turkey saw noteworthy strains in 2011, and Israel has been quietly boosting military cooperation with Turkey’s arch-rival, Greece. Meanwhile, the Eastern Mediterranean has emerged as a potential flashpoint, due to its gas deposits, the ownership of which is disputed. It’s not inconceivable that Turkey and Israel could come to blows, leading to a limited military confrontation at sea or in the air.

‘Spring’ in the Steppe: The ‘Arab Spring’ of early 2011 put authoritarian leaders around the world on notice that they could be vulnerable to sudden outbursts of people power – four long-time Arab rulers were toppled by the end of the year. Just before Christmas, Kazakhstan saw its worst unrest in the post-Soviet era, when sacked oil workers clashed with police in the west of the country. Kazakhstan has generally been stable since independence, but the political system is completely dominated by President Nursultan Nazarbayev, who has led the country since the late Soviet era. Yet, there has been speculation about his health, and he does not appear to have a clear succession plan. Thus, a key risk is that he could pass away, triggering a destabilising power struggle, whose outcome could lead to mass unrest. And if that were to happen, similar uprisings could take hold in Uzbekistan, Turkmenistan, and Tajikistan (Kyrgyzstan is already democratic), potentially radically transforming the region.

That’s enough to think about for now. I should mention that we also list more ‘mainstream’ ‘wild card’ risks at the end of our latest Global Political Outlook 2012, which was published in Business Monitor Online on December 16, 2011.

On that note, Business Monitor International wishes all its readers a happy new year, free of a ‘hard landing’.

Total Available Credit, % chg y-o-y

Source: BCB, BMI

The main issue with Brazil’s credit boom over recent years has been the nature of bank financing, with loans backed more by debt issuance – much of which has been in the form of external debt – than deposits. This has led to a rapid increase in commercial banks’ loan-to-deposit ratio, one of the highest globally, and has created a system where many lenders, particularly smaller-sized banks, are heavily reliant on expensive, government-backed loans.

Brazil’s monetary authorities had initially stated that they wanted to end this system of state-guaranteed lending in 2012, but concerns about a significant contraction in credit has now prompted them to extend it. In addition the central bank recently announced new regulations to make it easier for larger banks to purchase loan portfolios of their smaller rivals. This should help keep credit flowing for a while longer, and is in line with a period of consolidation in the commercial banking sector in 2012, something Riskwatchdog has expected for some time now. But if the external environment takes another turn for the worse, which is entirely possible given the eurozone’s ongoing sovereign woes, the authorities may struggle to prevent a credit crunch.

Warning Signals

Precisely what would spark a liquidity crisis is not clear, but there are a couple of indicators which would suggest that the banking sector is coming under much greater stress. The most obvious signal would be a surge in non-performing loans (NPLs), something which the central bank is clearly trying to avoid through the recent removal of several so-called ‘macroprudential’ measures – initially implemented to cool credit growth – and the decision to embark on a rate cutting cycle despite inflation being well above target. Although NPLs have been rising in recent months, with the default rate on consumer loans currently standing at 7.3%, compared to 5.7% in December 2010, I believe that the combination of regulatory and monetary policy measures should see this level moderate, if not fall, as we head into 2012.

BRL/US$ Exchange Rate

Source: Bloomberg, BMI

Much more of a risk, in my view, would be an uncontrolled sell-off in the Brazilian real, as this would not only make bank financing more expensive, but it would also hamper consumer spending by significantly raising the cost of imported goods. For this reason I’m watching closely to see whether the real can hold technical support at the key BRL1.9000/US$ level. If we do see the currency sell-off aggressively, the relatively optimistic medium-term outlook for the Brazilian banking sector, and consumer story, could become a lot less favourable.

The MENA region is just beginning its transition to democracy, and the journey could be a long and bumpy one. Meanwhile, Syria is at risk of descending into further chaos, and the risks of an Israeli airstrike against Iran’s nuclear programme are rising. At the same time, relations between Russia and the West look set to cool next year, over a variety of European security issues.

The year 2012 will also see important elections held (in chronological order) in Taiwan, Russia, Iran, France, Mexico, Venezuela, Ukraine, the United States, South Africa, and South Korea, some of which are expected to result in a change of leadership. Furthermore, China will hold its quinquennial Communist Party Congress in the autumn of 2012, during which it will anoint its ‘fifth generation’ leadership.

Amid considerable global uncertainty, one thing is certain: the old saying ‘may you live in interesting times’ is sure to be fulfilled.

Kim Jong Il’s Death: Key Implications

Also in Business Monitor Online today, we discuss the implications of the sudden death of North Korean leader Kim Jong Il. Our Global Political Outlook mentioned this as a possibility in 2012, and back in September, we outlined various succession scenarios. Our broad take is that his son Kim Jong Un can indeed assume the helm, but he will only be a figurehead for a military-dominated collective leadership. Quite simply, Kim Jong Un, aged around 29, has not had the time to be fully trained up to govern the country, and he will need all the help he can get from North Korea’s 60- to 70-something generals and party apparatchiks.

With Kim Jong Il no longer around, there is also a rising risk of a power struggle, which will worry North Korea’s neighbours, for it would raise concerns about who controls the 1.1 million strong Korean People’s Army and all its weapons (including nukes). The new regime’s top priority will be maintaining stability, and thus we expect no major policy changes in the near term. However, we see scope for gradual change over the longer term.

Kim Jong Il was the third major opponent of the West to perish in 2011, after Osama bin Laden in May and Muammar Qadhafi in October. And yet, is the world a safer place? Not necessarily.

This would bode ill for emerging European currencies – the Czech koruna and Polish zloty have already moved sharply lower, but we doubt the sell-off has fully run its course. Of course, Federal Reserve policy is also crucial in determining the dollar’s direction. The Fed has every reason to remain dovish, thanks to low inflation and lingering high unemployment. However, US economic data have been relatively solid through H2 2011, and this may mean further easing is off the agenda for now.

A clear signal that this is the case from the Fed would add to the dollar’s positive momentum, and likely mean that gold will have to hold uptrend support around US$1,550/oz before it can continue its multi-year bull run.

The technical pattern of the Chinese yuan 12-month non-deliverable forward (NDF) outright is extremely bearish. Despite overwhelmingly bullish sentiment towards the currency over the past few years, the 12-month NDF has been unable to appreciate beyond its 2008 high.

While our view of Chinese yuan NDF weakness and our warnings of a potential devaluation may confound those who point out how undervalued the currency is versus the US dollar, we note that on a real effective basis, the Chinese yuan is at its most expensive level since 1994, just prior to the 50% devaluation. The price of a basket of goods in China is still much cheaper than it is in the US, which is why many observers believe the yuan is undervalued. However, according to the IMF (and our projections for 2011), this ‘undervaluation’ is now no longer so large. We estimate the yuan to be just 34% undervalued relative to the greenback, which is the most expensive it has been since 1985, making it less undervalued than the South Korean won or the Taiwan dollar. Considering the much lower GDP per capita is in China, this places the currency well in the expensive category in our valuation model.

Credit Crunch Could Leave Few Options Open

The Chinese property market is in free fall at present, according to anecdotal and private sector sources, and there is a growing risk that the banking sector could experience a widespread credit crunch as the shadow banking system freezes up and non-performing loans soar. Should this highly plausible domestic scenario be combined with a negative shock on the external front (trade flows have thus far held up well in spite of the economic troubles in Europe, but we expect deterioration ahead), then the Chinese government may be compelled to weaken the yuan to help reflate the economy. According to the latest reserves figures, the central bank is acting to prop up the currency in response to capital flight. We see no reason why this capital flight (of both foreign-owned and domestic-owned capital) should not intensify in line with economic weakness.

1. Weak external demand, due to a slowdown in the US and a recession in the eurozone.
2. The growing risks of a ‘hard landing’ in China, which would reduce demand for African commodities, and lessen Chinese investment in Africa.
3. Divergent inflation and interest rate trends across the continent.
4. Question marks about the future of the Central African Franc, in view of its peg to the euro and the eurozone’s woes.
5. A rebasing of Nigeria’s nominal GDP, which is expected to show that the country is Africa’s biggest economy, ahead of South Africa.

For more coverage of Africa’s economies and political risks, please also visit our Africa Monitor website.

In fact, the debate over centralisation and localisation of power in Europe has been around for decades, and is not really new. The problem is that the more power is centralised in Brussels, the more the EU will be seen as an empire. In addition, because the EU’s leadership is not directly elected (like the US president), there is a risk of a backlash against an increasingly powerful federal centre.

The centralisation versus localisation debate is not unique to Europe. Rather, it is an issue for all large countries, and even small countries. We expect the issue to gain greater prominence in Russia, China, India, and several other countries over the coming decade.

Russia: During the presidency of Boris Yeltsin (1991-1999), Russia experienced a wave of decentralisation. Yeltsin himself urged regional leaders to ‘take as much sovereignty as you can handle!’ Direct elections were introduced for the presidencies of Russia’s titular ethnic republics and the governorships of large territories. However, this backfired. The southern republic of Chechnya attempted to secede, leading to a brutal war. And when Russia defaulted on its debt in 1998, regional leaders became increasingly assertive, taking economic policy into their own hands. In the late 1990s, many observers wondered if Russia itself might fragment.

Under Vladimir Putin, Russia has experienced a recentralisation of power. One of Putin’s first acts of office in 2000 was to divide Russia into seven federal super regions, each administered by one of his appointees. Putin further downgraded local autonomy by abolishing elections for regional leaders in 2004. Yet, Russia is a vast country, and many feel that in addition to being undemocratic, the lack of local democracy has left Russia’s regions less able to manage their economic affairs in line with local requirements. Thus, if Putin is to modernise Russia, he may need to rethink the way that the country is governed.

China: China is a highly centralised state, at least on paper, with all matters of national importance determined by Beijing. However, in practice, regional officials do not always adhere to the central government’s directives, which is one of the reasons why China has found it so difficult to rein in fixed-asset investment and cool its economy.

Chinese leaders have good reason to fear devolving power to the provinces, some of which are the size of large countries in their own right (four provinces have more than 80mn people each). China has experienced several periods in its history during which the central government has been so weak that true power was held by warlords. In addition, China has two large separatist regions, Tibet and Xinjiang, and Beijing still claims the island of Taiwan as a breakaway province. Beijing does not want to see China break up like the Soviet Union.

Nonetheless, managing a country as large as China from Beijing is no easy task, and we believe that if China ever moves towards a more democratic system of government, the issue of devolving more power to provincial authorities will rise up the political agenda.

India: India often seems less centralised than other mega-states, and Indian states have their own elections, which can influence politics at the federal level. Yet even with considerable state autonomy, there are those who feel that local power should be devolved further. For many years now, and since 2009 in particular, a debate has been raging over whether the Indian state of Andhra Pradesh should have a new state, Telangana, created from it to satisfy local demands. More recently, India’s largest state, Uttar Pradesh, with a population of 200mn people, has become subject to a proposal for its four-way division. Several other Indian states also have separatist movements, which could gain momentum if Andhra Pradesh and Uttar Pradesh are split up.

Other countries: Mega-states are by no means the only countries subject to decentralisation tendencies. Most medium-sized countries face the same debates. For de-centralisers, greater regional autonomy is considered more democratic, and greater control over the local economy can improve management. However, opponents of decentralisation fear that the process could lead to state disintegration. The debate will surely continue for many years to come, especially in countries where authoritarian leaders are removed from power.

What do the Russian people want?

Although Russia’s economy experienced strong growth in the 2000s, many ordinary Russians have failed to benefit from this, due to a heavy concentration of wealth in the politically well-connected elite, and because of high inflation. At the same time, corruption remains endemic.

Nevertheless, Russia is still far better off in 2011 than in 1999, when Vladimir Putin first became prime minister.

Many Russians will have vivid memories of the depression and chaos that followed the collapse of the USSR, and the shock of the country’s default in 1998 (that said, the younger protestors won’t have clear memories of these events). Although Russia was arguably more democratic then than it is now, Putin has at least brought a semblance of stability. He has also helped restore national pride. In 1999, Russia was still humiliated by geopolitical retreat from Central Europe, the 1998 default, defeat in Chechnya in 1994-1996, and the Kosovo War. Now, Russia is once again a strong power and a BRICS economy (although arguably its revival rests on shaky foundations).

Despite United Russia’s setback in the latest election, the party remains far more credible than the second-placed Communist Party, the third-ranked A Just Russia party, and the fourth-ranked ultranationalist Liberal Democratic Party. Other parties that contested the election did not win any seats. Putin himself remains a far more credible candidate for the presidency than the leaders of these four parties. Furthermore, there is virtually no one with the national stature of Putin (although Putin himself was an unknown when he rose to power). We also discussed whether Putin would dispose of Dmitry Medvedev as his prime minister, and whether Russia could return to ‘revolving door’ premiers, as was the case in the late Yeltsin era. This was highly unsettling for investors.

One significant factor is that the growth of alternative media has given Russians other viewpoints, thus challenging the state’s monopoly of the media sphere. This should at least promote a more diverse political, economic, and social discourse.

Although the protests on Saturday December 10 were the biggest since the Soviet collapse, involving tens of thousands of people, they were far smaller than the hundreds of thousands (or even million plus) of people in Egypt’s Tahrir Square in January-February 2011. In other words, popular protests in Russia are nowhere near big enough to threaten the Medvedev-Putin administration. Nevertheless, they are likely to have sent a clear message to the Kremlin that it will no longer be unchallenged.

Putin will still win the 2012 presidential election. However, a weaker victory on a lower turnout could undermine his strength.

We also discussed potential flashpoints in and around Russia over the coming years:

• What if tensions between ethnic Russians and Latvians in Latvia rise dramatically?
• What if Russia experiences a new financial crisis?
• What if a provincial city in Russia experiences a revolt?
• What if we see major clashes between Putin supporters and anti-Putin protestors?
• How will Russia react if Belarus’ economic crisis topples the regime of Alexander Lukashenko?
• How will Ukraine’s October 2012 parliamentary elections affect its relationship with Russia?

And lastly, we pointed out that 2014 will be a key year for Russia, because of its hosting of the Winter Olympics in Sochi. This will be a showcase event, one which Islamist militants in the North Caucasus will surely seek to disrupt. In addition, the native Circassians are likely to use the games to highlight the 150^th anniversary of the alleged genocide against them.

On Thursday, December 8, the European Central Bank cut rates by 25bps for the second time in as many months, and we expect that continued macroeconomic deterioration will prompt further easing in the months ahead. We now forecast the ECB’s refinancing rate, which currently stands at 1.00%, to be slashed by a further 50bps next year. We also believe that de facto quantitative easing will be necessary in order to restore stability to the eurozone sovereign debt market, despite the bank’s continued protestation against such action.

In response to slowing global growth, many emerging market central banks have already begun reversing the policy tightening delivered since the 2008 global financial crisis. Most significantly, China joined the easing club on December 1 by cutting the reserve requirement ratio for banks by 50bps. The dramatic decline in consumer price inflation that has occurred over recent months, with CPI today coming in at 4.2% y-o-y for November, from 6.5% in July, has further to run – as indicated by the dynamics of global food prices. Such disinflation will allow the Chinese authorities to shift their policy focus from inflation-fighting to supporting growth. With external demand faltering and the domestic property market clearly weakening, it is likely that the People’s Bank will ease policy further over the coming months.

Essentially, there are five basic types of break-ups we can envisage: a two-tiered euro area; a ‘core’ (German) exit; a ‘small peripheral’ exit (Greece/Portugal); a ‘large peripheral’ exit (Spain/Italy); and a full blown break-up. One common thread runs through all of these scenarios: the costs would be extremely high, whether a full-blown break-up occurs or individual countries peel away. For each scenario, we outline the advantages and the disadvantages, and our assessment of its likelihood.

I emphasise the word ‘could’. US Secretary of State Hillary Clinton’s recent trip there is merely a first step in rehabilitating Myanmar, and the journey could be a long one. Nevertheless, if Washington is successful, and Myanmar embarks on a reformist course, it could – say within 10 years – follow in the footsteps of Vietnam in achieving ‘frontier market’ status.

In fact, BMI identified Myanmar’s potential to become a ‘second Thailand’ as far back as November 2007 in our online service. At that time, we noted that the country has a large population of 50 million, considerable oil and gas reserves, and vast potential for agriculture, low-cost manufacturing, and tourism. More recently, our coverage of Myanmar’s economy has focused on the country’s timber, gem, and metals, its high literacy rate (85%), and real estate sector. However, one of the biggest economic problems right now (besides the obvious) is Myanmar’s dilapidated exchange rate system, in which the kyat officially trades at MMK6.4/US$ but in practice trades at MMK776/US$ in the black market. The IMF has been assisting the government to harmonise the system, but this will take time.

Going forward, the key to unlocking Myanmar’s potential lies in the lifting of US and EU sanctions, and this will depend on political reforms in the country. My colleagues and I freely acknowledge that Hillary Clinton’s landmark trip to Myanmar could be a false dawn. Recall that the then-US Secretary of State Madeleine Albright’s historic visit to North Korea in late 2000 failed to deliver a breakthrough, even after the passage of more than a decade.

Nonetheless, we think that the regime in Myanmar is increasingly cognisant of the need to liberalise the country (at least in part) in order to survive and pre-empt an ‘Arab Spring’-style uprising. In addition, Naypyidaw seems keen to reduce its dependency on China. For its part, Washington views Myanmar as a geopolitical counterweight to Chinese influence in Asia.

Three years ago, my colleagues and I crafted the acronym BLANKs to refer to Burma, Laos, Afghanistan, and North Korea – all isolated or quasi-pariah states that have considerable economic potential, if only political circumstances would improve. Laos has done reasonably well so far, but Myanmar, owing to its large population, may well have the greatest potential.

There were initially five rival plans vying for Shah Deniz-II’s gas. These include: Nabucco, Interconnector Turkey-Greece-Italy (ITGI), the Trans-Adriatic Pipeline (TAP), the recently proposed South East Europe (SEE) pipeline, and White Stream. Socar has now finally stepped forward to make its own proposal – the Trans-Anatolian gas pipeline. The declaration comes just a few months before the Shah Deniz consortium is due to make a final decision. The announcement was made after Turkey and Azerbaijan ratified agreements for the purchase and transit of gas from Shah Deniz-II, ending months of negotiations and occasional tension between the two parties.

According to a report by Bloomberg citing Socar’s Vice President, the proposed Trans-Anatolian gas pipeline has an estimated cost of US$6bn-US$7bn and a capacity of 21bn cubic metres (bcm). The only route details available are that it will travel through Turkey. BMI’s Oil and Gas Team believes that a portion of the gas (possibly even half of the total 21bcm) could be earmarked for the domestic Turkish market (hence Botas’ crucial involvement), thus leaving about 10-11bcm for Europe – the same capacity proposed by the BP and Statoil routes.

We believe that the real contenders will now be the projects backed by Shah Deniz consortium members – BP (25.5% stake), Statoil (25.5% stake) and Socar (10% stake) – as, naturally, they will have more leverage over the decision.

Following Socar’s proposal, we do not consider Nabucco, or the ITGI to be frontrunners any more. The former is too big a project (in terms of costs and proposed capacity) and thus the risks associated with its construction and long-term feasibility are also significant. The heavily politicised nature of Nabucco is also muddying the outlook with regard to its long-term commercial viability. ITGI is a direct rival to Statoil’s proposed TAP pipeline, which we believe – primarily on the basis of its main sponsor’s stake in the Shah Deniz project – has a better chance of succeeding.

Last but not least, we have to consider Turkey’s role and specifically the function that Botas, the state-owned gas pipeline operator, will perform. Botas has already terminated a gas purchase agreement with its long-term supplier Gazprom because of a price dispute, leaving it free to find another partner to help it meet a portion of its gas needs. By bringing Botas on board its project, Socar can build upon its recently-inked gas supply purchase agreement with the company, if its proposed pipeline is selected.

• Shale oil has much stronger prospects than oil shale, as the technology and economics of production are far more favourable for the former.
• Shale oil is on the cusp of taking off on a global level, with Argentina already making the first strides.
• Global oil supply forecasts therefore face strong upside risks, while we see associated downside risks for the price of oil.
• Where acreage covers both gas-prone and liquid-prone basins, we believe that – geological conditions permitting – shale oil exploration is going to follow shale gas exploration around the world.
• Oil shale is better suited for power generation than crude oil production; therefore we believe that the future of the technology lies with the power sector, especially in smaller markets highly dependent on fuel imports.

The full feature is available to subscribers at Business Monitor Online.

If you wish to request a copy of this latest oil industry analysis please contact us at enquiry@businessmonitor.com.

The US Federal Reserve’s surprise move on November 30 to cut dollar swap line rates is a rare bit of good news, but it may ironically ease some of the pressure from European policymakers to make a deal to save the euro at the December 9 EU summit. While we have no strong view on what to expect at the meeting, we note that previous summits have disappointed.

It would require quite a positive announcement – involving a plausible fiscal union framework, supported by ECB financing – for us to believe that the worst of the eurozone crisis is behind us. There are hints of a positive outcome emerging, but things may yet have to get worse before they get better, in order to give European policymakers enough impetus and political cover to broker a deal. This probably will not happen until the New Year.

Meanwhile, our Asia team cautions that the People’s Bank of China’s reserve requirement ratio cut is no silver bullet for China’s economic growth prospects. Although this move plays into our view that emerging market monetary easing is set to go into full swing, benefiting local yields, further easing is likely to go hand-in-hand with further economic deterioration. So despite signs of policy accommodation, we remain cautious on risky assets globally.

Russian Parliamentary Elections To Test Putin’s Support

The upcoming elections for the Russian State Duma on Sunday are unlikely to produce any surprises, and the ruling United Russia party is widely expected to maintain a strong majority. However, in the weeks running up to the poll, there have been increasing signs that the Russian authorities are growing uncomfortable with a sense of voter apathy. In addition to pressure on independent election monitors, such as ‘GOLOS’, there have been numerous incidents suggesting that United Russia is looking to persuade citizens to go out and vote over the weekend, with one video published on the internet showing the mayor of Izhevsk in the Ural Mountains telling an audience of Russian war veterans that the state money allocated to them will be directly proportional to the number of people voting for United Russia.

Latest polling data and incidents of booing at public events in which the Kremlin attempted to promote United Russia suggest that the government may have reason for concern ahead of the presidential election in March 2012, in which Prime Minister Vladimir Putin is expected to return to the presidency. The share of people who would vote for Putin has dropped from 42% at the end of September/early October to 31%, according to a poll by the Levada-Centre. Although we refrain from interpreting growing voter dissatisfaction with the government and the incumbent prime minister as a sign of major political changes to come, we note that a prospective lower voter turnout on Sunday and in March 2012 could have significant long-term implications on government policy.

Real GDP growth came in at 6.9% y-o-y in the second quarter of the current fiscal year (FY2011/12, April-March), down significantly from the 7.7% growth rate achieved in the previous quarter. The latest data clearly demonstrated the pronounced domestic nature of this ongoing slump, with private consumption and gross fixed-capital formation growth falling to 5.9% and -0.6% (from 6.3% and 7.9%) respectively, as the Reserve Bank of India (RBI)’s aggressive tightening continued to choke off domestic demand. Furthermore, the Q3 2011 reading clearly suggests that India will not be able to export its way out of this current soft patch, nor will expansionary fiscal policy be of any substantial support.

True, exports grew by a spectacular 27.4% y-o-y last quarter, the fastest pace in three years. But, while recent figures have undoubtedly impressed, the performance of the sector has been unable to spur a pick-up in investments. Net inflows of foreign direct investments have been on a secular downtrend since the global financial crisis in 2008. The strong export growth of late has only served to prevent a much faster collapse of the Indian economy. However, with external trade expected to decline as global headwinds mount, this last pillar of support should soon give way.

Meanwhile, although government consumption growth ticked up to 4.0% y-o-y in the same period, we continue to believe that New Delhi is in no position to enact a fiscal stimulus large enough to jumpstart the economy. Indeed, in contrast to the four quarters after the global financial crisis hit in Q3 2008 when public consumption averaged 26.7% y-o-y growth, government spending has only increased at an average rate of 3.2% in the last four quarters. If the government wanted to push through aggressive stimulus, it would have done so already.

Taking into account the faster-than-expected deceleration of the Indian economy, we have downgraded our FY2011/12 and FY2012/13 real GDP growth forecasts to 6.8% (from 7.4%) and 7.3% (from 7.5%) respectively, on the back of weaker outlooks for private consumption and investment expenditure. Our newly revised 6.8% projection for the current fiscal year indicates a lower rate of growth than the one recorded in FY2008/09.

The immediate future of the Indian economy remains dim. For further in-depth analysis on this topics, and the impact of the global economic crisis, please visit Business Monitor Online.

Since then, we have seen an important uptick in Japanese bond yields, with the 10-year paper piercing through eight-month trendline support at 1.05%. From a fundamental perspective, Japan’s fragile sovereign debt position is built upon the unstable foundations of low yields. If these start to rise across all tenors, the impact on the government’s repayment capacity would be severe, triggering a vicious cycle of deteriorating creditworthiness and higher yields. As the eurozone crisis has shown, confidence underpinning sovereign bonds can evaporate very quickly.

The whole world is talking about the eurozone debt crisis. But Japan’s public debt stock is comparable in size to that of the entire eurozone. People keep asking, who will save the eurozone. We ask, who will save Japan?

Postscript: Rumble In Osaka

One of Japan’s biggest problems since the bursting of the bubble economy in 1989 has been the lack of strong leadership to tackle the country’s woes. The exception was Junichiro Koizumi, who served as prime minister in 2001-2006. Even the defeat of the long-ruling Liberal Democratic Party in 2009 failed to end Japan’s cycle of weak, revolving door premiers. In this respect, last Sunday’s mayoral and gubernatorial elections in Osaka could be a harbinger of change. The continued ascent of Toru Hashimoto as Osaka’s mayor appears to reflect growing support for younger, populist leaders who are unaffiliated with the two main political parties. Hashimoto campaigned on administrative reform in the Greater Osaka region, which he sees as essential to boosting the local economy. If he is successful, he could use Osaka as a platform to enter national politics.

There is a widespread belief that the eurozone will survive, because “there’s no way that German Chancellor Angela Merkel, French President Nicolas Sarkozy, and other European leaders will let 60 years of European integration efforts collapse during their watch”. These leaders will take decisive action at the last minute to save the eurozone, so the argument goes.

The trouble with this line of reasoning is that it assumes a great deal of faith in policymakers. Perhaps even too much faith. This is the same sort of faith that assumes that “there’s no way Chinese leaders will allow a ‘hard landing’ under their watch”. Yet, many assumed that “there’s no way Soviet officials will allow the USSR to disintegrate” back in early 1991. True, there are big differences between the eurozone, China, and the Soviet Union, but the broader argument is that there comes a point when systemic crises develop a momentum of their own, and it becomes too late for policymakers to save whatever it is that they are trying to save. The eurozone may well be nearing such a point.

In light of this, my colleagues and I have been discussing the political and geopolitical consequences of the collapse of the eurozone. We discussed these issues on Risk Watchdog back in July, but are revisiting the topic. What follows below is not an official BMI forecast, but reflects our worst fears:

• Any country that quit the eurozone would probably have to leave the EU. This means that a major fracturing of the eurozone could mean the end of the EU as we know it. In its place, we could see a new ‘curtain’ separate Europe.
• The dire economic conditions in any state leaving the eurozone could bring to power ultranationalist or extremist parties. Indeed, the newly impoverished post-EU states could feel that they have been subjected to Treaty of Versailles-style austerity. If this were to happen in several European states, international (i.e. intra-European) tensions could rise dramatically, especially if the ‘extremist’-governed states turned against the rump eurozone/EU core states.
• Even without the collapse of the eurozone and EU, the high levels of youth unemployment in Europe threaten to create a ‘lost generation’ of young people whose prosperity and livelihoods will be impaired. Although incidents such as the England riots of 2011 do not appear to have been politically motivated, they could be a harbinger of things to come. If economic conditions do not improve, then the various ‘Occupy’ movements could gain momentum, and potentially become more aggressive.
• If the EU collapses, then the less developed member states such as Romania, Bulgaria, and the former Yugoslav states would no longer have a policy anchor to converge with Western European economic, financial, legal, and social norms. This could even pave the way for a return to ethnic violence in Bosnia, Kosovo, and Macedonia.
• Turkey would also lose a key policy anchor. Turkey has identified itself with the Western world since 1923, and has aspired to EU membership for decades. Although the Islamist government of Recep Tayyip Erdogan has been moving the country along a more independent trajectory in recent years, it is still nominally aiming to join the EU. Yet if the EU ceases to exist, there would be very little reason for Turkey to adopt European economic, political, and social norms. This could lead to a reversal of the pro-EU reforms enacted since the early 1990s, and hasten Turkey’s shift away from the West. This in turn could make Ankara more assertive towards Greece and Cyprus, and the Middle East.
• If the EU collapses, then Russia would surely be tempted to reassert its influence in Central and Eastern Europe. Russia’s geopolitical ‘revival’ under Vladimir Putin has largely focused on rebuilding a sphere of influence in the former Soviet Union, but the Kremlin could subsequently seek to meddle in the affairs of Poland, Slovakia, Romania, Bulgaria, etc.
• A collapse of the EU would also raise new question marks about NATO’s survivability. The Alliance has already been strained repeatedly by disagreements over its wars against Serbia, Iraq, and Libya. Most NATO states have been slashing defence budgets, due to fiscal austerity, and the US has long bemoaned that European states aren’t spending enough on defence. With Europe in disarray, the US would no longer be able to rely on Europe as a security partner.
• Other regions of the world experimenting with greater economic or political integration could be put off such initiatives by a collapse of the eurozone/EU. Perceptions of the EU would quickly shift from role model to bad example.
• The net result would be a sharp decline in Europe’s global influence. How could rising powers, including ‘troublemakers’, take Europe seriously if European countries are constantly bickering among themselves?

The above outcomes are far from inevitable. The eurozone and EU may well survive, and severe economic dislocation need not result in extremism. Economic collapse in post-Soviet Russia (1992-1998), South Korea (1997-1998), Indonesia (1997-1998), Argentina (2001-2002), and Latvia (2008-2009) did not lead to extremist takeovers. Also, European countries are far more prosperous, materially, than they were during previous crises. Furthermore, European states have no major territorial disputes, and Russia has limited means with which to stir up trouble.

Nonetheless, much is at stake.

One more thing to add: Even if the eurozone survives the current economic crisis, there is no guarantee that these issues will not re-emerge later in the 2010s.

In the first feature, we explain why Brazil’s economic growth will significantly outperform Mexico’s over the next 10 years, despite the substantial underperformance of the Brazilian manufacturing sector. There is an increasing chance that Mexico will undergo the necessary shake-up of its energy sector to put it on a stronger growth path beyond the 2012 elections, but even if this happens, it would still be playing catch-up with its South American counterpart.

Elsewhere, Thailand’s worst flooding in more than 50 years has finally started to subside, but the ripple effects on the country’s macroeconomic prospects, industry performance, and international competitiveness will be felt for some time to come. Government officials have put the cost of flood damage at THB300bn, or roughly 3% of GDP, although we reckon the final sum could be significantly higher given the worse-than-expected impact on Bangkok (whose output accounts for 25% of the economy), and given that rainfall is forecast to remain above normal for a few more months. As one would expect, we have made some sizable forecast revisions across the board following the floods. We outline some of these changes, as well as the possible implications for the financial markets.

The US and Western Europe traditionally have the world’s largest tractor fleets, given the size of the sectors and the historical wealth of the countries. However, the decrease in combined annual sales in these two markets over the past decade is at least partly a function of their maturity.

Unlike Western Europe, sales in key emerging markets have been consistently strong in recent years. In particular, annual sales in Brazil and Mexico have showed a significant increase, largely on the back of rising soft commodity prices and the availability of credit. Indeed, sales of tractors on a yearly basis have more than tripled since 2005, the result of a significant increase in the area dedicated to crop production and high average prices since 2007. Russia is another example of an expanding market driving greater machinery sales. Russian tractor purchases have increased from roughly 1,900 units per month in June 2009 to over 4,000 units per month in April 2011 and have remained elevated ever since. Similar to Brazil, Russian agricultural production has been significantly expanding in recent years, as export demand has driven a surge in investment in the sector. In Russia’s case, wheat is the main export, while for Brazil soybeans, sugar, and corn are the main items.

In the coming months, we expect the current trend of emerging market sales outperforming developed market sales to continue. Firstly, greater credit availability in places like Russia and Brazil will provide farmers with greater access to the capital required to increase purchases.

Secondly, base effects suggest that there is more potential for growth in emerging markets. For example, as late as 2007 (the last year of available data), the US had double the capital intensity (quantified by number of tractors per 100 square kilometres) as Brazil, which had just 129. Russia was even lower at just 29 tractors per 100 sq km. Given the large area dedicated to farming, this implies significant potential for sales growth over the medium term. We believe this should mitigate our expectations for lower average agricultural commodity prices in 2012. For the developed states, a combination of weak economic prospects, tight credit conditions, and expectations for lower average prices should keep new tractor sales subdued in the coming months.

Although there are, for the time being, fewer demonstrators on the streets than were present in late January and early February, the events of the past several days are nevertheless eerily reminiscent of what unfolded in the run-up to the resignation of Mubarak. Egypt’s interim military ruler, Field Marshal Mohammed Hussein Tantawi, is increasingly being likened to his predecessor – which is hardly surprising, since he was previously Mubarak’s defence minister for 20 years.

As of November 23, reports have indicated that three dozen protestors have been killed, and thousands have been injured. In an apparent concession to protestors, the cabinet has resigned, the military-led transitional government (the Supreme Council of the Armed Forces, SCAF) has declared that a new government of ‘national salvation’ would be appointed, and that presidential elections would be moved forward from early 2013 to June 2012. As is evident from the tens of thousands of protestors who remain on the streets, such concessions have not gone far enough, with many continuing to call for the resignation of Field Marshal Tantawi (who heads the SCAF), and a swifter transition to civilian rule. Essentially, Egyptians are facing a once-in-a-lifetime opportunity to build a democratic system, and will not easily let this opportunity pass.

In Business Monitor Online today, we discuss Egypt’s near-term political outlook in more detail, and the impact of the political crisis on the economy and financial markets.

Confidence is collapsing in the private sector, and investors are starting to shun even core eurozone debt outside Germany. In Business Monitor Online yesterday, we flagged the spread of the French 10-year government bond yield over the German bund equivalent, which has more than doubled since the beginning of August and is currently at 160bps. We believe this is symptomatic of the enormous uncertainty surrounding the future of the eurozone. Indeed, with uncertainty over the future value of the euro and even whether the currency union itself will survive, even the more stoic economies in the region are now under threat from speculative pressure.

Tying in with the theme of confidence destruction, we highlight the surge in bank deposits held at the ECB as providing further cause for concern. Overnight deposits have surged to levels not seen since the first half of 2010 (when the debt crisis in Greece was gathering full steam) and the collapse of Lehman Brothers in 2008.

In a deflationary environment, banks locking up cash at the ECB rather than lending it out will choke off growth momentum altogether. If it were not for the ECB’s liquidity provisions, the interbank market would likely have unravelled long ago. While we have been arguing for a while now that time is running out for policymakers to come good on a resolution – which at this stage has to be nothing short of ‘shock-and-awe’ – there may just be weeks left before a major ruction occurs.

Given the dallying thus far, it is not implausible to think that Europe’s politicians will try to drag out a solution into the new year, by which time a full-blown ECB monetisation of sovereign debt may be unavoidable. Market-wise, we expect downward pressure on the euro to intensify, non-German eurozone bonds to succumb to further hard selling, and European bank stocks to get caught in the crossfire. We have revised down our 2012 average euro-dollar forecast to US$1.3400/EUR from US$1.3800/EUR previously, simultaneously projecting a 0.2% contraction in eurozone output next year.

The clear margin of victory secured by the PP was widely expected, given that the PSOE was blamed by a significant part of the population for presiding over Spain’s worst recession in living memory, and then making matters considerably worse by pursuing one of the toughest fiscal consolidation programs in the region. By tightening the screws on the fiscal front, the PSOE had been able to deliver an impressive budgetary improvement. However, at the same time, unemployment has surged to beyond 21% (the highest in the European Union), while youth unemployment is closer to 50%. Given the current economic malaise facing Spain, the massive shift in support towards the PP should therefore be thought of less as an ideological swing to the right, and more a protest vote against the previous administration’s policies.

As we have discussed previously in Business Monitor Online, with the yield on 10-year Spanish debt trading at around 6.5% as of November 21, the incoming administration is unlikely to relent on fiscal tightening. If anything, with the fiscal deficit target of 6.0% this year looking increasingly unlikely to be met, and the PP having already pledged to meet the previous deficit targets agreed to with the EU stability programme, even deeper cuts are on the cards. This will undoubtedly hit the PP’s popularity. Recently elected PP-led regional governments have already been forced to make aggressive cuts after deficits in a number of cases were found to be larger than previously thought.

The new administration will also need to pursue further labour market reforms, as Spain remains one of the least competitive economies in the eurozone. Given the PP’s absolute majority in parliament as well as at the regional level, the likelihood is that these reforms will come sooner rather than later, and could go some way towards addressing some investor concerns over the Spanish labour market – namely the existence of a dual contract system whereby those on temporary contracts were hit hard as soon as the global economic downturn hit in 2007.

Going forward, we emphasise that there is no quick fix to Spain’s problems. Having hardly grown at all since it began to recover in early 2010, the economy now looks as if it is heading back into recession, as a deteriorating external picture compounds an already stagnant domestic outlook. In turn, unemployment is unlikely to come back down below 20% before 2013 at the earliest. At the same time, house prices continue to fall, putting increasing pressure on banks to further write down the value of the assets. This raises the spectre of further state-led capital injections in the banking sector – a development that would place even more pressure on the government to cut spending elsewhere.

Irrespective of what the new administration manages to achieve, Spain’s funding difficulties are unlikely to improve while a lasting solution to the region’s sovereign debt crisis remains lacking. The Eurozone sovereign debt market remains in disarray, with concern spreading from the profligate peripheral states to core states such as Austria, the Netherlands and even Finland – the only country to still be in compliance with the Maastricht criteria.

Essentially, the US is seeking to ‘deal’ itself ‘back’ into Asian geopolitics after a decade spent fighting wars in Afghanistan and Iraq. The US is scheduled to withdraw the last of its troops from Iraq at the end of this year (contrary to our expectations, I might add), and is eyeing an exit from Afghanistan by 2015. All this will free up more diplomatic energies and military power to focus on Asia – assuming, of course, that Washington does not get drawn into a new war against Iran.

I should emphasise that despite the Afghanistan and Iraq wars, the perception that the US has neglected Asia is somewhat exaggerated. The US retains tens of thousands of troops in Japan and South Korea, continues to arm Taiwan, and in 2004 designated the Philippines and Thailand as ‘major non-NATO allies’ – a status that confers enhanced defence cooperation. In addition, the US has been moving to resume military cooperation with Indonesia, and has boosted relations with Vietnam. Furthermore, the US’ outreach to Myanmar actually kicked off in 2009.

Nevertheless, there is a perception that China has increased its influence while the US has been busy elsewhere. Certainly, Chinese economic influence has grown stronger, and the People’s Republic is now the biggest trading partner of a growing number of Asian states. However, when it comes to the region’s security, the US is still the premier partner of choice.

Essentially, China’s increasing assertiveness in pursuing its maritime claims in the South China Sea and East China Sea since 2010 has been counterproductive, in the sense that it has made many regional states wary of Beijing’s intentions. This is turn has driven these countries into closer relations with the US.

The US is also moving to shore up its economic influence in the region via the Trans-Pacific Partnership, which if fully implemented, would become the world’s biggest free-trade zone – one that would for the time being exclude China.

Page-Turner In Burma

Washington’s efforts to bring Myanmar out of the cold merit close attention. Myanmar is of great geopolitical significance, because of its extensive coast on the Indian Ocean (which is itself emerging as a zone of ‘Great Power’ competition), which guards the approach to the crucial Malacca Straits waterway, and because it serves as a buffer between China and India. Beijing has been seeking to develop Myanmar as a key transport corridor for its landlocked inner provinces, for the purposes of giving them improved access to world markets. For its part, the regime in Naypyidaw has leaned towards China for many years, but mainly because it has been isolated by the US and EU. This could slowly be changing.

If the US can successfully drag Myanmar out of China’s orbit, then this would be a significant diplomatic victory. A pro-Western and liberalised Myanmar would also stand to benefit economically. Myanmar, with 50 million people and extensive resources, is the last Asian state of significant size not to have emerged as a ‘tiger’ economy. In time, probably decades rather than years, we believe the country could evolve along the lines of Thailand – provided, of course, that political liberalisation does not lead to state disintegration, which temporarily befell Indonesia in 1998.

The Greatest ‘Game’ Will Intensify In The 2010s

Where does all this leave China? Not very happy. Beijing’s strategic planners are right to view US moves as ‘containment’ or ‘encirclement’, even if Washington has no hostile intentions. For the time being, China does not have the strength to challenge the US’s dominance of the region’s security arrangements. However, by the mid-2020s, China will probably have an economy almost the size of the US, and its military power will have increased substantially. At this point, it will be in a better position to challenge the US.

Over the coming decade, my colleagues and I expect to see an intensification in competition between China and the US for influence in the Asia-Pacific region, with Japan, Vietnam, India, and Australia most closely aligned with Washington. In general, though, we expect most countries in the region to carefully balance their relations between the two powers.

Is there a risk of military conflict? We believe that no-one has an interest in this, but when push comes to shove, things can spin out of control quickly. For example, there is certainly the risk of Chinese, American, and South Korean intervention in North Korea, should that country collapse. Also, there is a risk that increasing military activities in the South China Sea could lead to naval stand-offs, armed skirmishes, and even aerial confrontations. Recall that in early 2001, a Chinese fighter jet collided with a US spyplane, which was forced to make an emergency landing in southern China. Beijing detained the 24-strong crew for about a week, in a diplomatic stand-off with Washington. No lasting harm was done to bilateral relations, but new incidents like these would certainly make investors nervous.

The Global Mines Database is an interactive tool, allowing users to search for mines and mining projects by country, commodity, and/or company. Search results can then be further refined using a number of the included fields including ore grade, output, and phase of mine. All data can be exported to Microsoft Excel.

The addition of the Global Mines Database provides a significant enhancement to BMI’s Mining Service by adding substantial value to existing industry analysis. The data is now available via an online interactive platform, enabling users to tailor the results to their specific requirements.

Subscriber Benefits

The Global Mines Database contains key information on mines that are operational or planned, in 60 of the countries covered by BMI’s Mining Service. Mines for six commodities are currently included – these are copper, bauxite, zinc, lead, tin, and nickel – with more metals set to be added in the future. Clients can view mine information including output (current and projected), phase of mine, ore grade, and companies involved. For projects, it is also possible to see anticipated operational dates and planned capital expenditure.

The database is a valuable tool for a variety of users. By listing mines and projects by company, it provides insightful company intelligence, allowing users to keep an eye on competitor activity. For service companies in the mining industry, or those downstream of mining companies, the database also aids in strategy planning, by enabling users to identify the most dynamic sectors and countries.

The data can be filtered by region and country, by commodity, and by company, allowing users to custom-build fully-exportable databases. Beyond this, a comprehensive search bar allows results to be filtered to the most precise requirements, e.g. a specific mine or company, or more broadly, by mine type (operational, new project, expansion, idled, or restarted). Furthermore, the user can choose how to view the information by sorting columns alphabetically or through highest or lowest value. The ability to export data to Excel allows for further manipulation of the data.

Content Details

The new data is available from the Mining page on Business Monitor Online. The database covers 60 countries and more than 750 mines (including over 300 projects), each containing 11 columns of mine description (where data is available). BMI’s Mining team plans to roll out the Global Mines Database to include more commodities in due course. The data contained in the Global Mines Database will be updated on daily basis, with new projects added and status updates provided where available.

The countries covered are as follows:

Africa: Algeria, Botswana, Burkina Faso, Cameroon, Eritrea, Ethiopia, Ghana, Guinea, Kenya, Madagascar, Mauritania, Morocco, Namibia, Sierra Leone, South Africa, Tanzania, Zambia, Zimbabwe.

Americas: Argentina, Bolivia, Brazil, Chile, Colombia, Cuba, Ecuador, Guatemala, Guyana, Honduras, Jamaica, Mexico, Panama, Peru, Venezuela, Canada, United States.

Asia: Afghanistan, Australia, China, India, Indonesia, Iran, Laos, New Caledonia, New Zealand, Pakistan, Papua New Guinea, Philippines, Saudi Arabia, Thailand, Uzbekistan, Vietnam.

Europe/Eurasia: Bulgaria, Finland, Ireland, Kazakhstan, Mongolia, Poland, Portugal, Romania, Russia, Serbia, Spain, Sweden, Turkey.

• China’s engagement with Africa is about more than natural resources.
• A relatively high level of risk-tolerance has enabled China to finance much-needed long-term investments, especially in infrastructure.
• Substantial amounts of Chinese investment are flowing into manufacturing and construction.
• There is little evidence that China has significantly worsened governance on the continent, but we see political risk stemming from potential anti-China sentiment.

Of course, China’s increasing role in Africa means that the continent will become more vulnerable to a Chinese ‘hard landing‘, which is arguably growing in likelihood. The main channels would be lower commodity prices, and reduced access to Chinese capital.

Two key factors underlie BMI’s optimistic outlook on Qatar. Most important is the country’s massive store of hydrocarbon wealth. Despite having a population of little more than 1.5 million people, Qatar has the world’s twelfth-largest proven oil reserves and its third-largest proven gas reserves. While even countries like Saudi Arabia – set to become the world’s largest oil producer over the coming years – will have to accelerate efforts to diversify their economies over the next decade, for Qatar this problem is much further down the line. The income Qatar earns from energy exports has allowed the government to embark on a massive capital investment drive, while still leaving it room to hand out cash to its citizens in the form of subsidies and wages (a 60% increase in public sector salaries was announced in September). Barring a sudden drop-off in demand for Qatari oil and gas, none of this is likely to change in the medium term.

Further bolstering the country’s reputation as a highly stable polity, Qataris display few outward signs of discontent with their government, primarily because per capita GDP is amongst the highest in the world, but also because the emir – by announcing that the first-ever elections to his advisory council will be held in 2013 and by attempting to position himself as a champion of the Arab Spring – has been more proactive than most in reacting to the demands of the Arab public.

All this bodes well for the economy in the years ahead. Not only can the large investments in energy, transport and education be expected to continue over the next decade, but the country’s ‘safe haven’ reputation is likely to continue attracting business away from a number of its more precariously-positioned neighbours, such as Bahrain. Tourism and financial services stand to benefit most in this regard. Although long-term questions relating to over-capacity and hydrocarbon-dependence remain unanswered, for the foreseeable future, at least, the Qatari growth story is likely to go on.

Given that politicians are often held in low esteem in many countries (and especially at the present time in Greece and Italy), there will naturally be those who welcome the appointment of non-politicians to high office, at least for the time being. Technocrats with no obvious political ambitions are best placed to make painful decisions for the long-term good, insulated from populist demands that would benefit the short-term ‘bad’ – or so the argument goes.

To some degree, the same argument is used to justify central bank independence: far better to leave monetary policy to unelected ‘experts’ who are insulated from the existing political cycle. Now, in Greece and Italy, fiscal policy is being handed over to unelected ‘experts’.

The troubling aspect of technocracy is that it goes against democracy. Perhaps Greece and Italy need such leaders at the present time to make unpopular decisions, but that hardly means that the public will accept this. Those who oppose spending cuts will continue to oppose them, regardless of whether the decisions are being made by politicians or technocrats. Also, the fact that Papademos and Monti are both ‘European’ technocrats could give the impression that Europe’s supranational institutions now have direct control over policymaking in Athens and Rome.

Technocrats may win short-term support, but these ‘neutral’ figures could eventually face rising opposition. On the other hand, neither Papademos nor Monti could last that long. Greece is expected to hold a fresh general election in early 2012, and Italy could also go to the polls next year, well before they are due in mid-2013. The politicians will soon be back.

Given that only two troubled Western European states have succumbed to technocracy, it is still too soon to say that the ‘technocrats are taking over’. Indeed, many economically troubled nations have managed to avoid such governments. Nonetheless, the possibility of more technocratic governments coming to power over the next few years is at least worth considering.

Consider a starting point of ‘Greece Default: Yes or No?’ Going down the ‘yes’ path, several questions emerge, including whether it is a unilateral disorderly default, or one made in cooperation with its creditors; going down the ‘no’ path, does it involve a Greek departure from the eurozone, stronger growth lifting Greece out of the fiscal danger zone, etc.

Then the question moves on to other states, and a multitude of permutations. Will Italy have difficulty rolling over some EUR350bn in debt next year – and if yes, will the solution be a restructuring, ECB intervention, both (as we suspect), or an Italian withdrawal from the currency union?

Will civil society in Spain tolerate 50% youth unemployment through the next few years of weak growth? Will German politicians soon begin to recognise the severity and urgency of the situation, and realise that perhaps only an epic crisis can deliver? And then, even if we get a fiscal union, how long will it be before sclerotic economic growth begins bringing governments down, to be replaced by populist politicians demanding exit from the bloc?

We are also pondering the external (i.e. global) economic climate, and the difficult if not impossible arithmetic of the eurozone’s periphery and core alike seeking to export their way to growth at the same time that the US is thinking the same way, and the biggest emerging markets’ economic models are likewise oriented toward exports. The equilibrium that this creates is far from optimal, and nearly ensures weaker global demand and growth ahead.

Even under the most naïve and wildly optimistic assumptions, we cannot see how the Italian economy can be turned around in time to avert disaster. Italy’s predicament is as much the result of an enormous debt load as it is an anaemic economy. Even during the global economic boom of the last decade, the Italian economy languished. Over the course of Q2 1995-Q2 2011 the Italian economy mustered average real growth of just 0.2% q-o-q, half the rate achieved by the eurozone, despite an unprecedented global credit boom and favourable global trade dynamics.

Economic Overhaul Would Take Decades

With the Italian economy already in recession, and, given the vast obstacles to growth, we cannot see how Italy can escape its malaise. Even if a new technocratic cabinet immune to the political fallout of fiscal retrenchment could miraculously overhaul various impediments, the impact would not be instantaneous, but would likely take several years to affect households and businesses. Indeed, it could take decades to modernise the economy. However, during this time Italy’s demographic outlook will be worsening, and this will prove almost impossible to tame without mass immigration (which wouldn’t be popular). This leaves an enormous debt default and restructuring, or full-blown monetisation by the European Central Bank (ECB), as the only options left on the table.

Regular readers will recall that we have been warning of a catastrophic debt crisis for Italy since September 2010, with the caveat that the government had a little more space to manoeuvre than the Greeks – providing an opportunity to avert the worst-case scenario.

We have now turned decisively more bearish. In light of a number of adverse political developments (particularly crumbling policy cohesion over the euro) and the government’s inability to overhaul Italy’s economic deficiencies fast enough to restore confidence, we believe that the game is now up.

A day of reckoning is looming, particularly in light of around EUR300bn in debt (excluding interest) refinancing coming up in 2012.

For the last 18 months, my colleagues and I have noted that despite the weak and fractured nature of the opposition, as well as Berlusconi’s previous ability to come back to power, his time in frontline politics is drawing to a close.

Although previous attempts to oust Berlusconi from office have failed, we believe that the bond market will prove more successful. It has become clear that investors will not have confidence in Italy as long as Berlusconi remains prime minister. Even if the government survives today’s vote, which we do not rule out, the markets appear to be siding against Berlusconi, which ultimately could precipitate his departure.

If he steps down, then a technocratic government would most likely follow, which would increase confidence in the short term. However, even if all prescribed reform measures aimed at improving labour productivity and reducing red tape in the economy are pushed forward, we see little to suggest that Italy’s economy will be on track to recover, particularly in light of a rapidly deteriorating economic outlook in Germany.

In the recorded webinar Saket Vemprala and Justin Jacobs from BMI’s Oil and Gas team highlight the opportunities and examine the risks of shale gas development, including:

• World shale gas resources
• Incentives to invest in shale gas development
• Europe: gas resources, gas import forecasts to 2020, CEE Upstream risk/reward ratings
• Assessment of the market potential: Poland, France and United Kingdom
• Asia Pacific: gas resources, gas import forecasts to 2020, risk/reward ratings
• Assessment of the market potential: China, Australia and India
• Africa: gas resources, gas import forecasts to 2020, risk/reward ratings
• Assessment of the market potential: Egypt, Algeria, Libya, Tunisia and South Africa
• Latin America: gas resources, gas import forecasts to 2020 and risk/reward ratings
• Assessment of the market potential: Argentina and Brazil

If you wish to view this presentation please contact us at enquiry@businessmonitor.com

For several years now, there have been recurring periods of intense speculation in the international media that the US and/or Israel is gearing up for a military strike on Iran’s nuclear facilities. The past fortnight or so represents the latest such period. During the previous ‘Iran War fever’ last autumn, we published a major article in which we argued that the US and Israel would refrain from attacking Iran before the end of 2012 (see Business Monitor Online, November 16, 2010, ‘Iran War: The Risks And The Consequences’). Our main reasons for arguing this included the US being bogged down in Afghanistan and Iraq; President Barack Obama’s apparent reluctance to order an attack; a general desire to give sanctions more time to work; Israeli logistical challenges and doubts about the success of a strike; the possibility that a successful strike would leave Iran even more dangerous; and, of course, the fact that Tehran’s devastating response could trigger a regional war. Overall, while we are inclined to retain our core view, we acknowledge that the risks of an Israeli attack on Iran are rising. We also reiterate that Israel has more reason to strike Iran than the United States.

What Has Changed Since Last Autumn?

Speculation concerning a US/Israeli air attack on Iran waned in early 2011, as Iran’s nuclear programme suffered technical difficulties as a result of the ‘Stuxnet’ virus (which is believed to have been the result of Israeli cyberwarfare), several Iranian nuclear scientists were mysteriously assassinated, Israel pressed ahead with building an anti-missile shield, and attention turned to the ‘Arab Spring’. However, we subsequently argued that geopolitical changes as a result of the ‘Arab Spring’ could increase Israel’s sense of vulnerability, thus increasing the chances of an attack on Iran.

Several other developments have created conditions supportive of air strikes on Iran. The revelation of an alleged Iranian plot to assassinate the Saudi Arabian ambassador to the US has reinforced notions of Tehran as a reckless and dangerous actor on the world stage. In addition, the US has confirmed that it will withdraw all of its troops from Iraq on schedule by the end of 2011, meaning that they will no longer be in harm’s way of potential Iranian retaliation. Also noteworthy is that the overthrow and death of Libyan leader Muammar Qadhafi is likely to have strengthened Iran’s resolve to develop nuclear weapons, so as to deter a future Western attack aimed at ousting the country’s rulers. Furthermore, there has reportedly been a narrowing of differences between senior Israeli officials, with a shift in favour of military action. Finally, the International Atomic Energy Agency (IAEA) is expected to release a report this week outlining the military dimensions of Tehran’s nuclear programme, thus potentially providing an official casus belli.

Constraints On War Still Powerful

Despite the above factors, we still believe that there are strong reasons why US and Israeli policymakers will hold off on an air strike for the coming year, although we emphasise that if there is military action, it will probably be initiated by Israel rather than the US, because the former views Iran’s nuclear programme with a greater urgency. Yet if Tehran’s retaliation threatens the wider region, as seems likely, Washington could quickly be drawn into the fray.

The US has greater reasons than Israel to avoid going to war. Firstly, with President Obama facing re-election in November 2012, American voters are much more concerned about the domestic economy and the jobs situation, rather than on foreign conflicts. It would be very risky for Obama to wage a potentially lengthy air war whose outcome may prove inconclusive. The conflict would probably not boost Obama’s standing among Republicans, but it could sap support from Democrats. Secondly, and on a related note, American voters are unlikely to favour going to war against Iran immediately after the US winds up a costly nine-year war in Iraq, while still being heavily engaged in Afghanistan. Thirdly, Iran’s leaders are clearly involved in a power struggle, and with the Iranian economy looking weak, the country is arguably at risk of a popular uprising. An attack on Iran would probably end up boosting the regime, and strengthen the hand of hardliners, especially ahead of presidential elections in mid-2013. This would be contrary to the West’s long-term interests, which favour a liberal-democratic regime in Iran.

As I write this post, confusion surrounds the fate of Greek Prime Minister George Papandreou, whose office has denied his imminent resignation. But it’s clear that the crisis is not necessarily to Greece’s advantage.

In fact, the political crisis has become so severe, that speculation swirled through the international media the other day that Papandreou’s dismissal of the heads of the general staff, army, navy, and air force earlier this week was a move aimed at pre-empting a coup d’etat.

There’s no doubt that Greece is facing a critical moment in its post-World War II history, one that could define the nation for at least another generation. Thus, speculation of a coup is hardly surprising. Although Greek officials have portrayed the latest military reshuffle as routine, the timing cannot help but raise eyebrows.

Coup Fever Tends To Wane Quickly

Generally speaking, military coups do not necessarily bring long-term stability. For example, many Pakistanis initially welcomed General Pervez Musharraf’s coup in 1999 amid hopes that he would clean up the political system and reform the economy. Although Pakistan did indeed experience strong growth during his nine-year rule, this was probably because of overwhelming US financial support for Islamabad, post-9/11, and a strong global economy. Within a few years of Musharraf’s coup, he was already facing a backlash, especially because of his pro-American policies.

Similarly, in 2006, many initially welcomed Thailand’s military coup against Thaksin Shinawatra after months of street protests. Yet, the Thai coup arguably polarised the country even further between the ‘Red Shirts’ (pro-Thaksin forces) and the ‘Yellow Shirts’ (anti-Thaksin forces). Thailand went on to experience more years of instability, which was resolved temporarily by Thaksin’s sister’s clean victory in the July 2011 elections.

Bangladesh, too, experienced a de facto military coup in January 2007, which was initially welcomed to clean up the political system amid fears of civil unrest. However, before long, supporters of the country’s traditional leaders managed to prevent a wholesale purging of the old guard.

More recently, the Egyptian military takeover following the popular uprising against Hosni Mubarak has already prompted a backlash, and has led to fears that the army doesn’t want to let go of the levers of power.

Power Is A Poisoned – Nay Toxic – Chalice

When Russia defaulted in August 1998, there was heightened speculation that the military would seize power in a last-ditch attempt to stabilise the country. As it happens, the Russian military was too demoralised after years of budget cuts and defeat in Chechnya. No coup took place.

The same was true of Argentina in late 2001 and early 2002, in the wake of its default. The country was reduced to poverty and saw the rapid turnover of five presidents within a few weeks, but the army stayed in its barracks. This was probably wise, given that memories of military rule from 1976 to 1983 were still fresh in most people’s minds.

The reality is that by seizing power, the Greek military would be inheriting a toxic chalice (similar to the false Holy Grail that the evil American drinks from at the end of Indiana Jones and the Last Crusade). The generals would not necessarily know how to run the country, and they would be blamed for any subsequent mismanagement or policy errors.

Furthermore, a Greek acquaintance of mine told me that he doesn’t think that Greek generals would have the full backing of the military to proceed. The lower ranks would not be up for it. This would raise the possibility of a fragmentation of the armed forces – which could be a prelude to civil war.

Greek Coup Could Lead To Massive Backlash

Even if a military coup in Greece succeeded, it would be a particularly dangerous development, given that many still recall the period of military rule from 1967 to 1974. If a coup were to take place now, I would expect mass demonstrations against the military, which could easily lead to violent crackdowns and even greater unrest. Perhaps civil war would be too harsh to describe this scenario, but it would have the hallmarks of it.

Greek Coup Would Set Bad Precedent

A military coup in Greece would be psychologically damaging, too, in the sense that a reasonably ‘mainstream’ European country would increasingly resemble an old-school Latin American state – although in financial ways, Greece already does.

It would also look terrible for the EU and NATO if one of their members saw a coup. True, NATO members Greece and Turkey saw military coups in the 1960s and 1970s, and NATO member Portugal was under authoritarian rule until well into the 1970s, but that was another era with lower standards of acceptable political behaviour within the Western alliance.

I think it would be wrong to rule out a coup in Greece. But the costs would probably outweigh the benefits.

 KES/US$

The shilling has reacted extremely positively to the news rallying by some 2% to trade at KES96.50/US$ at one point on November 2, taking out six month resistance in the process. For several reasons, I think that it could have further to run yet. From a technical perspective, the shilling is still deep in oversold territory on the monthly relative strength index. Furthermore, in addition to the rate hikes, the CBK has taken several other measures to support the currency. The cash reserve ratio has been increased by 50bps to 5.25% to mop up shilling liquidity and commercial banks’ permitted foreign currency exposure has been halved to 10% of core capital in a bid to restrain banks’ demand for dollars. The authorities are also in the final stages of negotiating a US$250mn increase to a US$500mn IMF extended credit facility to boost Kenya’s foreign exchange reserves.

Admittedly, there is still a lot of uncertainty emanating from a precarious balance of payments position and this could very well keep the currency from embarking on a meaningful rally. But even then, I don’t see the shilling heading back to historic lows and I think that sideways trading is probably the worst case scenario. With overnight deposit rates spiking to over 20% after the hike, I think that the shilling is a great place to be from a carry trade perspective at the moment.

Overnight Deposit Rate, %

Time for the caveats. There can be no doubt that there are still lots of risks for the shilling. As I alluded to above, a gaping current account deficit and only US$3.7bn in foreign exchange reserves (enough to cover a mere 3.4 months of imports) mean the balance of payments is in a shaky position. Political risk can also not be discounted. Not only are what are sure to be hotly contested elections (scheduled for August 2012) fast approaching, but the country has also recently launched an incursion into neighbouring Somalia to deal with rebels. An escalation of one or both of these could hamper the inflow of foreign capital and this would hurt the shilling potentially negating the gains made from high Kenyan interest rates.

A referendum has likely been called for two reasons. First, in an attempt to refresh its mandate and confront persistent riots, a vote would give the go ahead for the government to continue down the path of austerity. Second, the referendum was a shock for European politicians and even members of Papandreou’s own party. As such, the move is likely intended to secure additional concessions from eurozone policymakers beyond the potential 50% haircut.

Although a date has yet to be set, a potential vote in January has been touted. A delay of several months would heighten uncertainty among investors and underpin pronounced market volatility at a time when the eurozone economy is at risk of tipping back into recession. Before that time, the PASOK government faces a vote of no confidence in parliament on Friday (November 4), with the party’s majority previously weakened to just three seats. Even if the government manages to cling on to power for now, a referendum would be even more pivotal as it would effectively be both a confidence vote in the government and on Greece’s membership in the euro area. Voting down the referendum would mean that Greeks refuse to accept the rescue package which could feasibly presage a disorderly default- the worst outcome for the stability of the eurozone. In this scenario all bets would be off and abandonment of the euro altogether would seem far more likely.

However, we would stress a number of points at this stage. First, the prime minister may not be able to secure a referendum as intended. As we understand it, there are two ways that a referendum could be called, but only one is relevant in this instance (the second has a clause which excludes matters of fiscal policy). The cabinet must go to parliament to seek backing for a referendum as a matter of national urgency, which would then need approval by at least 151 members before the president can call it. With the majority of PASOK party members not consulted on the referendum, and with many politicians likely to fear the consequences of such a vote, it is still not a done deal at this stage. Even if it were to go ahead, eurozone policymakers – under pressure from markets and the uncertainty posed by the referendum – could intervene in an attempt to ward off the threat of an adverse vote. Specifically, instituting an even deeper haircut and more favourable restructuring on outstanding debt (from Greece’s perspective), as well as a plan to revive the Greek economy, could tip the balance in favour of supporting the rescue programme. Moreover, although voters themselves may have indicated that they do not approve of the rescue package, the fear of the unknown – what would happen in the event of a disorderly default and potential eurozone exit – could be sufficient to quash a referendum.

Despite these uncertainties, one thing is clear: the Greeks have reached the limits of austerity. Politicians have been fighting tooth and nail over the bailout package, but there has been little talk of how to revive the economy. With no silver lining, no credible plan to create jobs and paint a brighter future, support for further austerity has hit a wall.

Key Views On The Intervention:

1) The BoJ is heavily defending the JPY79.20/US$ level, suggesting a peg may be imposed.

2) We remain neutral on the currency given the large tail risks, even if the immediate peg is relaxed.

3) Despite official rhetoric, a stronger yen does reflect the fundamentals.

4) Japanese government bonds are a massive sell.

JPY/US$ Peg Could Be A Lasting Measure

Looking at the price action of US$/JPY, the BoJ appears to have pegged the unit at JPY79.20/US$, and there have been reports of heavy selling at this level. While it is too early to suggest that the BoJ will look to defend this level for an extended period, it is plausible that the BoJ follows in the footsteps of the Swiss National Bank and aggressively steps up intervention efforts. Unlike the Swiss franc, though, which looked to have ended its bull market of its own accord prior to the intervention, the JPY could be a tougher beast to tame without a capitulation move higher.

Remaining Neutral Due To Tail Risks

Despite the potential for further gains, we refrain from adopting an outright bullish stance, even if the immediate peg is relaxed, given the risks of a fiscal crisis in the country. Indeed, while the yen may gain a further 10-20% as the bull market grinds on, a fiscal crisis could see the currency lose 50% should a surge in bond yields force the government to default or ramp up the printing presses, triggering domestic savers to flee the country en masse. While such a move would most likely need to be preceded by a stronger yen, the risk remains.

Fundamentals Call For A Stronger Yen

Finance Minister Jun Azumi has repeatedly blamed speculators for the rise in the yen, which he said did not reflect the fundamentals of the slow-growth Japanese economy. While speculators are clearly driving the currency higher, they are doing so for a reason – the strong current account surplus, which neither the US, the eurozone, or many of the commodity currencies can offer, and the fact that interest rate spreads have been narrowing as global bond yields have fallen in line with the those in Japan. In fact, it is slow growth, both domestically and globally, that are the main supportive factors driving the yen, as locals see fit to repatriate their external assets from overseas under such conditions. Until Japan runs a current account deficit, it will be difficult to convince us that it is ‘speculators’ driving up the yen, given that there is a fundamentally greater demand for JPY by the world than there is demand for US dollars in Japan, slow growth or otherwise.

Japanese Government Bonds Are A Massive Sell.

While the risk/reward ratio on the JPY leaves us neutral, the same does not apply to local bonds. With the 10-year JGB yielding 1.05%, it is a fundamental sell, given the minimal risk of further material gains and the major downside that would prevail in a fiscal crisis. With support giving way, we believe the odds favour further weakness in the near term, and much further weakness over the long term. If the bond market loses the support of a strengthening yen (for example if the BoJ does peg the unit) this will add further upward pressure on bond yields.

While the newly implemented capital controls are likely to alleviate devaluation pressures on the official exchange rate in the short-term, through reducing foreign currency reserve depletion which has seen the central bank sell around US$2.7bn of reserves in August and September, we are not convinced of their medium-term effect. As elevated capital flight levels reached around US$9.8bn in H111 we believe concerns about a devaluation are likely to persist, leading to a larger use of the country’s unregulated black market exchange rate, where the peso will continue to weaken further.

Indeed, our view that the new Fernández government sees little benefit in devaluing the currency is reinforced by this immediate post-electoral response to capital flight. The president’s newly introduced measures also reinforce our view that the government will need to begin adjusting the current expansionary fiscal and monetary policy stance in order to cool inflation in the longer term, to allow currency depreciation in real terms, regain competitiveness and eventually regain confidence in the Argentine economy. 

However, in order for these longer term targets to be achieved, we expect the operating environment for international companies and investors to become increasingly precarious. In the short-term, the adjustment in government policy is likely to cool growth, towards our 2012 real GDP growth forecast of 4.1%. While the continued government intervention and the increased use of capital controls, bodes ill for the nation’s business and investment environment – particularly in extractive industries.

Key highlights of the emergency summit agreements include:

• A voluntary haircut of 50% on Greek debt by creditors, with the aim to reduce the public debt-to-GDP ratio to 120% by the end of this decade.
• Using the EFSF to insure new issuance of government bonds and setting up a special purpose vehicle (SPV) to attract foreign funding to boost the fire power of the facility. The EFSF will be increased to EUR1trn of guarantees, though details on how this will be achieved are still scarce.
• Raising capital for euro area banks by EUR106bn with guarantees for bank bonds.
• The IMF will play a bigger role, with the EU and IMF set to inject an additional EUR130bn into the Greek economy.
• The Italian government has pledged to initiate debt reduction measures.
• The European Central Bank (ECB) will continue to purchase government bonds on the secondary market.

Although we believe that the picture is currently conducive for a continuation of the ongoing rally in the near term, we note that structural issues of the European Monetary Union (EMU) remain unaddressed. Indeed, the announced plans remain very thin on concrete details, such as how the EFSF will be leveraged up and how big a portion of new government bond issuance in the eurozone will be insured by the rescue fund. Moreover, we believe that the proposed measures, such as a 50% voluntary haircut on Greek debt falls short of a realistic write-down given our view that Greece remains insolvent.

The rules put in place by the CFTC may have some justification. In particular, commodities have become an increasingly large target for speculators in recent years, mainly because they have become a popular vehicle through which to play global growth (specifically copper and oil) or a hedge against inflation, (especially gold) particularly since most of the major commodity contracts are denominated in US dollars.

Another indicator of rising interest in grain speculation is the correlation between speculative positions for grains and actual grain prices, as measured by the 40-month rolling percentage variation in prices compared to rolling variation in speculative positions, both commercial and non-commercial. In recent years, (aside from during the price collapse in 2007) the correlation has strengthened, and is now roughly 0.8, indicating a high degree of correlation.

Although regulatory changes by the CFTC could help reduce the degree of speculation, it is debatable whether this would have the intended effect, whether it is fully enforceable, and whether the changes in prices are not part of broader trends that mitigates the need for specific regulations. More specifically, to what degree are speculators even the problem? Furthermore, to what extent will international co-operation be required to make the regulations effective. Finally, what kind of unintended consequences could result from the implementation of these regulations? Find out more on BMO online under the commodities and agribusiness sector.

Following EUR54.3bn worth of fiscal austerity measures introduced in September, which are expected to eradicate the fiscal deficit by 2013, Italy’s executive has come under increasing pressure to pass a set of measures to boost economic growth. The resulting ‘decreto sviluppo’ was supposed to be presented on October 21, ready for eurozone scrutiny, but the need to pander to various political forces, in a run up a vote of confidence on October 14, has kept the most fundamental measures off the cards.

A preliminary draft of the ‘growth bill’, presented on October 18, sparked even further concern in financial markets as the government seemed once more involved in window-dressing rather than actually tackling growth. Although most of the measures included in the draft would help to modernise the country, none seems on the scale necessary to significantly bolster the long-term growth path. The European Central Bank, the EU Commission, and EU partners have been calling, among others, for a substantial liberalisation of closed professions (public notaries, lawyers, pharmacists, etc.), an increase in the pension age, a privatisation of local utility companies. On the other hand, with the present ‘growth bill’, the government was offering a progressive move to introduce electronic bus tickets, liberalisation of the margarine-producing sector, and cut down regulation concerning the disposal of beauty-salon utensils, to name the most peculiar.

In the aftermath of the cold shower received in Brussels, we expect Berlusconi to push further on the reform agenda, with an increase in the retirement age from 65 to 67 already being hinted at. However, in doing so, the Italian prime minister will clash with the populist Northern League, its junior coalition party, which is now proposing itself to the electorate as the last defender of workers’ and pensioners’ rights. As we had previously highlighted, although winning yet another confidence vote, Berlusconi now has a slim and fragmented majority which is kept together mainly by the desire to avoid early elections that would punish the governing coalition (see Business Monitor Online for more). Furthermore, a jaunty opposition does not seem inclined to help the government out, now that it sees it close to the brink. It will therefore prove very hard to pass the far-reaching reforms the market and international partners are pushing for, unless the situation in financial markets was to escalate, at which point it could be too late to prevent a major debt crisis.

All in all, we expect Berlusconi’s coalition to partially yield to international pressure, as the spread between Italy’s 10-year BOTs and Germany’s 10-year bunds is fast approaching the 400bps level. However, we expect most of the fiscal consolidation to come from temporary measures like the sale of state property or a potential tax amnesty, in an effort to avoid a clash with interest groups.

Brazil, Russia, Indonesia, and Israel have already partially reversed prior rate hikes and since August the number of countries still tightening policy has dwindled to a mere handful – India and some frontier markets in Africa. The global economy is slowing whilst global inflation appears to be rolling over.

On a GDP-weighted aggregate basis, consumer price inflation in Brazil, Russia, India and China slipped to 6.9% y-o-y in August from what may well prove a cyclical high of 7.2% in July. With commodity prices showing clear moderation (the S&P GSCI Grains Index was up just 1.6% y-o-y as of October 20), emerging market inflation looks set to continue cooling, providing central banks with greater scope to adopt accommodative policy heading into 2012.

By our forecasts, countries representing at least 60% of global GDP will be easing monetary policy outright by the end of 2011, up from approximately 43% at present. Notable emerging markets for which we anticipate a shift to monetary policy easing in the months ahead include China, South Korea, Mexico, and Poland.

I am aware that people said this after 9/11, and after the collapse of the USSR in 1991, and in the early 1980s when the Cold War was at a particularly dangerous phase, and in the 1970s after the oil shocks, etc… etc. But rarely has so much uncertainty been faced by so many countries at the same time, and rarely has so much of that uncertainty been negative, particularly with regard to economic indicators.

Multiple Moving Parts… Not All Turning In The Same Direction

All of the world’s major economic engines are faltering, or at risk of doing so. The US economy is weak, and dogged by high unemployment. The eurozone continues to face question marks about its survival, as Greece is convulsed with unrest. China is at greater risk of a ‘hard landing’, even if there isn’t another global recession. Japan is still reeling from the earthquake-tsunami-nuclear disaster of March 2011, and could face a fiscal crisis before this decade is out. Brazil, Russia, and India are too small, economically, to lead the world out of the doldrums, and in any case, none of them are immune to US or Chinese weakness. Meanwhile, the Middle East is in the midst of a once-in-a-generation transformation, which could take the region in all kinds of directions, some welcome, and some less so.

What is particularly concerning right now is that most of the major economies have run out of room to loosen monetary or fiscal policy, because interest rates are already so low and budget deficits and debt burdens so substantial.

The geopolitical landscape is also highly uncertain. The US is down, but not out. China is rising, but is not powerful enough to displace the US as the global hegemon. The EU’s weaknesses could embolden Russia on Europe’s periphery, but Moscow is not as powerful as it was 20 years ago. Meanwhile, Turkey is moving in new directions, while Syria is at risk of civil war, and tensions are rising between Iran and Saudi Arabia. In addition, the Afghan war is far from over.

Not only have the world’s major powers run out of monetary and fiscal ammunition, but it seems that they have in many ways run out of military momentum. The US is weary after a decade of wars in Afghanistan and Iraq. Meanwhile, the European NATO states struggled for five months to overthrow Libyan leader Colonel Qadhafi, whose country was not a formidable military power. All this begs the question of how the West would fare against more dangerous opponents such as Iran and North Korea.

Beware Linear Pessimism

Against this backdrop, it would be tempting to feel pessimistic about the future, at least for the next few years. However, it would be wrong to assume that the US, eurozone, or even Greece are in irreversible long-term decline. The US has emerged stronger from several periods of self-doubt, and we believe the eurozone will survive the current crisis. It may be difficult right now to see Greece avoid a lost decade, but both Russia and Argentina avoided coups and civil wars after their defaults and regained economic poise within a few years (although global economic conditions were generally much more conducive to their recoveries back then). As for China, even if there is a ‘hard landing’ or meltdown, this would not mean the end of the country’s long-term ascent. Indeed, an economic crisis could be the trigger for much needed reforms that actually increase the quality (as opposed to speed) of China’s growth.

Almost Anything Is Possible Over A 10-Year Timeframe

The bottom line is that while it is easy to project today’s circumstances and trends into the future, the world seldom moves in a linear fashion. Consequently, even events that seem unthinkable (for better or for worse) can transpire over a 10-year timeframe. Clearly there are mathematical and physical limitations to this. For example, Iran has no chance of becoming the world’s number one economy by 2021, and Suriname is not going to build a fleet of aircraft carriers to dominate the world. But solid regimes and institutions can crumble with surprising speed, while seemingly strong or weak economies can experience dramatic reversals of fortune.

Another reason for the positive investment outlook is the urgent need for these projects to go ahead. The region’s massive infrastructure deficit means that even if private sector investors are not tempted, many regional governments may well go it alone, or at least sweeten the tenders to make them more attractive. Yes, this will boost public sector debt levels, but for the time being most sovereigns in the region can afford it, given their low levels of public sector debt when compared to their developed world counterparts.

The third, and perhaps most important reason for the buoyant fixed investment outlook is the role that Asia, and particularly China is playing. Not only does Chinese investment in Latin American energy, mining and infrastructure sectors ensure access to much-needed resources for years to come, but it also allows China to diversify its massive foreign reserve holdings out of US dollars, solving some of the more pressing problems caused by its vast holdings of dollar-denominated paper.

Yet here lies the risk. Slower growth in China probably won’t see these investments dry up, but if it turns into a ‘hard-landing’, then these reserves are likely to be needed domestically, either for import cover or to shore up the domestic banking sector. While a hard landing in China is still not the global consensus view, BMI believes that the risks are substantial. In such a scenario, Latin America may well have to cope with a major infrastructure deficit for some time to come.

Turning then to the longer-term outlook, Singapore, along with Taiwan, boasts an excellent net international investment position (NIIP) relative to Indonesia and South Korea. Excluding reserves, Singapore runs a surplus of US$416.1bn, an enormous 154.1% of GDP, while Taiwan runs a US$256.6bn surplus, constituting 51.3% of GDP. By contrast, Indonesia runs a substantial NIIP deficit of US$413.8bn, or 50.6% of GDP, and South Korea runs a deficit of US$231.8bn, amounting to 20.6% of GDP. We view the NIIP ex-reserves as a very important indicator of a country’s vulnerability to external macroeconomic conditions, and the exclusion of reserves allows us to more accurately depict net exposure to capital outflows. In the short term, we see better prospects for the Singapore dollar and the Taiwan dollar in light of their robust NIIP ex-reserves positions, while in the long term, Asian currencies as a whole are likely to strengthen in part because of largely positive NIIPs.

We interpret US President Barack Obama’s decision to send 100 military advisers to Uganda to fight the Lord’s Resistance Army as part of a broader trend aimed at increasing the United States’ military commitment to Africa over the longer term, in light of the continent’s growing importance to the global economy. China, and to a lesser degree India, have been expanding their economic influence in Africa over the past decade, raising speculation in the West that the latter have been beaten in the race for Africa’s extensive natural resources. Washington’s growing awareness of Africa’s rising geopolitical importance was evident when it established the United States Africa Command (AFRICOM) in October 2007 (The US military divides the world into several regional ‘commands’). AFRICOM continues to be headquartered in Stuttgart, Germany, because key African states have been reluctant to host a large US military presence. Nonetheless, the US has been maintaining a low-key military presence in the continent for some years. Although Djibouti accounts for the bulk of the US military presence in Africa, with around 3,500 troops, the US also has 200 trainers in Kenya and Ethiopia, and is also involved in training the armed forces of the Democratic Republic of Congo (DRC).

For its part, Uganda could emerge as a key US ally in the region. Uganda has already taken a leading role in the UN-backed AMISOM (African Union Mission in Somalia) military force, which has been assisting the Somali government in fighting al-Shabaab Islamist fighters. Uganda has already paid a price for this, having suffered a deadly twin bomb attack by al-Shabaab in July 2010. Other countries in the region also feel threatened by al-Shabaab, which is nominally allied with al-Qaeda. The US military presence in Uganda, however limited, is a sign of Washington’s growing interest in that country in particular and Africa in general. This should boost foreign investor confidence in Uganda, especially at a time when it is continuing oil exploration.

Hollande Well Positioned To Win Elysee Palace

Meanwhile in France, following a comfortable victory in a second-round run-off in party primaries on October 16, François Hollande has become the Socialist Party’s candidate for the presidency, with elections due in April/May 2012. While the race is set to prove tight, we nonetheless expect Hollande to defeat incumbent President Nicolas Sarkozy, who continues to trail in the polls and faces a tough domestic economic environment. That said, irrespective of who wins, we see little room for the next government to ease back on the current government’s fiscal austerity plans.

We believe the risks are evenly weighted between continued yuan appreciation and a move to meaningful depreciation. Perhaps the most salient upside risk comes from the possibility of Beijing continuing to adjust the CNY stronger in a bid to assuage US political concerns. However, even if the US were to deem China a ‘currency manipulator’, we do not think this would result in Beijing strengthening the yuan. The main downside risk comes from large-scale capital flight in the event of an economic crash, which could be triggered by a bust in the property market and a potential banking crisis, as we explore in detail in our most recent special report, China 2012: From Miracle To Meltdown.

Aside from the Chinese yuan, BMI publishes regular currency forecasts for more than 60 currencies, including those for frontier markets, in our online service and print publications.

The key risk to our outlook for expansion of the European Union remains ‘enlargement fatigue’ among existing member states. Indeed, with the eurozone debt crisis worsening, many of the fundamental principles of the European ‘project’ have been thrown into question. Enlargement fatigue is already evident when discussions of the Schengen visa-free travel zone come to light. The most recent meeting on this matter saw a block on granting Romania and Bulgaria access to the EU by key member states, and suggestions from a number of member states that the Schengen agreement be re-visited. In this context, we see scope for the EU bloc to become less open to further expansion.

Outside the EU, in the Balkans, we do not see enthusiasm to join the bloc dissipating to the point of a rejection of the accession process. However, we can see scope for public fervour to wane as problems in the bloc dampen the appeal of the Union. This is already the case in Iceland, and also Turkey. With accession treaties having to pass a national referendum before gaining the final approval from all EU member states, there is scope for candidate members’ populations to reject joining the EU in future.

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1) The US dollar will remain weak.

2) Oil prices will not rise too greatly, and real US demand for imported oil will continue to decline.

3) Export competitiveness should improve.

4) US domestic consumption will remain relatively weak.

5) The trade deficit with China will narrow (as a proportion of US GDP).

6) US income receipts will remain much higher than income payments.

7) US net savings will remain high, obviating the need to import foreign capital.

Risks To Outlook

If Chinese demand collapses as a result of primarily domestic factors (e.g. not due to a drop in US/European demand for Chinese exports), we would expect to see the Chinese trade surplus increase as imports fall much more quickly than exports. This would exacerbate the US trade deficit with China. Higher oil prices than we are currently forecasting would put major pressure on the trade balance. A renewed push for fiscal stimulus would increase the propensity to borrow from abroad, and could potentially fuel domestic consumption, widening the trade gap. If there is a buyers’ strike on US assets, particularly for low-yielding government bonds, this could cause the current account deficit to narrow – but for the negative reason that foreigners are no longer willing to finance excess US consumption.

The greatest focus of Chinese investment in Africa is West Africa, due to the region’s substantial iron ore reserves. Already, companies such as Chinalco and Hanlong are developing projects which will revolutionise Guinea’s and Cameroon’s mining sector, respectively. Looking ahead, I expect greater interest in the iron ore reserves of Liberia, the Republic of Congo, and Gabon given that their governments are seeking to improve infrastructure and encourage investment in their substantial iron ore reserves.

In Southern Africa, Zambia and the Democratic Republic of the Congo are particularly of note, as they contain high-grade copper deposits. However, investment in these countries opens Chinese companies up to a range of risks. In DR Congo, political and security risks as well as a lack of power and transport networks could hinder Chinese operations in the country. In addition, the recent election of Michael Sata in Zambia will worry Chinese companies as Sata’s campaign was centred on opposition to Chinese mining investment. Whilst we expect Sata’s stance to moderate, BMI expects higher taxes and greater government control over the mining sector in the country, as well as more scrutiny of Chinese investment to ensure that it benefits Zambia.

With regards to Nigeria, we believe that at some point, the positive economic growth story will be reflected in the stock market. With so much uncertainty surrounding the naira at the moment, we see little likelihood that foreign investor interest will provide the impetus for a turnaround in the market. Instead, we believe that it will be a change in local investor sentiment – which has not really recovered since the great crash of 2008 – that will rescue the index from the doldrums. It is difficult to say what the trigger for such change in sentiment could be. Reform of the banking sector is certainly a necessary but not necessarily sufficient condition for equity market revival. There are also growing calls for some of the NGN2trn held by Pension Fund Administrators to be allowed into the equity market. This, if it were to happen, could set the rally in motion.

Room For Improvement In Nigerian Equities

Turning to Kenya, the decision on October 5 to hike the central bank rate by 400 basis points to (11.00%) is an indication that policymakers have finally begun the aggressive monetary tightening that is necessary to fight rampant inflation and support a plummeting currency. Although it will take time for these measures to feed through, we think that inflation is near a peak and the currency is near a trough, and Kenyan local debt could become very enticing if and when this is confirmed. There will almost certainly be further monetary tightening ahead, and we therefore do not think the time for a turn is right just yet. But we will be keeping a close eye things.

A major concern we have is that there has been little in the way of substantial financial and economic reforms since the global financial crisis. Indeed, the economic imbalances that underpinned the crisis are still present, and in some respects have worsened. This owes in part to the differing demands of deficit and surplus states. While both were content with the relationship during the previous cycle in which the developed world borrowed and consumed and the emerging world produced and saved, deficit economies are now seeking to reverse this dynamic at a time when the surplus states want to maintain the status quo.

For the full article, please visit our website, or read it in our weekly Emerging Markets Monitor magazine.

Beyond 2012, if Obama is re-elected, he may well be tempted to pursue a more activist US foreign policy, as he seeks to secure his legacy by claiming a foreign policy success to compensate for America’s economic weakness. That said, the US is moving to cut its overseas aid budget sharply, which will decrease its influence abroad. In addition, with the White House having reached agreement with Congress on a deal that could cut defence spending by up to US$1trn over the next 10 years, the US can ill afford new conflicts. Meanwhile, if a Republican wins the presidency, then he (or conceivably she) would feel pressured to concentrate on domestic economic issues. In a global emergency (for example, a new 9/11-scale terror attack or conflict in Korea) of course, overseas events beyond the US’ control could force either president’s hand in terms of intervention. Nonetheless, with the American economy weak and the country weary after more than a decade of war, we see a reasonable possibility that the US will focus more on domestic affairs over the next few years.

Amazon’s highest-end tablet is the Kindle Fire, which includes a touchscreen, with the display strengthened to be 30 times harder than plastic. But, more importantly, it offers free storage in the Amazon Cloud and access to the company’s growing range of music, videos, books, and an app store. While the more basic Kindle devices maintain their function as e-readers, the Kindle Fire is the closest to a conventional tablet and is being regarded as the main competitor to Apple’s device.

Certainly, the market seems to think that Amazon’s new range has potential, with the company’s share price rising on the back of the launch. While analysts are contemplating the device’s ability to compete with the iPad, Apple’s share price remained unaffected. Instead, fellow e-reader supplier Barnes & Noble saw a sharp drop in its share price, and BMI suspects that Amazon’s new range will hit the retailer hard.

As a media device, the Kindle Fire has a large range of content that should help attract customers, and BMI believes that it is the range of content that will create the competition between Apple and Amazon. Amazon seems unconcerned with selling the device as a loss-leader, instead relying on its wide range of available content to drive revenues. One of Apple’s major strengths is the range of content available to subscribers in its online store, giving access to films, music, and TV content, as well as the largest applications store currently available.

However, Amazon’s own content could rival Apple’s store, reducing the competitive advantage in the tablet market from the look and capability of the devices to the media available to customers. In this regard, BMI believes that Amazon stands a strong chance against the current market leader, although it is not being promoted as a business tool, but rather a leisure device with all content available in one space.

The price of the new Kindles should make them attractive. The Kindle Fire will cost US$199 and the basic Kindle US$79. The cost of the basic device in the UK will be GBP89 (US$139), which may put off some potential customers.

BMI is encouraged by Amazon’s focus on cloud storage for the Kindle Fire, although security and connectivity are key for cloud computing to succeed, and so the product may be a slow grower. Additionally, the current version of the Kindle Fire only has a Wi-Fi connection and no 3G version yet announced. The Kindle Touch 3G, which is an e-reading-only device, has free 3G included in the price, but expected downloads per device will be small. Considering the exceptional demand for data on comparable devices such as smartphones, and the higher sized files that can be accessed on Amazon’s top-end device, it seems unlikely that a free 3G network would be a viable option. Reliable streaming for video and music content could be difficult, and storing all files in the cloud would require constant download capabilities which would add strain to the network. Nevertheless, in an increasingly mobile-connected world, BMI expects a 3G or 4G version of the Kindle Fire would gain attention in future, as networks gear up to cope with the higher data capacity needed.

There is no indication that the Kindle Fire is being sold outside the US in the company’s press releases. BMI believes there will be demand for services outside the North American market, particularly in Western Europe, but also in other emerging markets in the Middle East, Asia, and Europe, where there is a growing demand for new content. The price of the Kindle Fire also makes it a more affordable tablet device, opening up a new market among customers in emerging and frontier economies.

I must admit that, unlike some of my colleagues, I’ve avoided reading books about the global economic crisis. Part of the reason is that I am sceptical about the benefits of ‘instant books’ – that is to say, books about current events published during the event or too soon after it is concluded. When I say ‘events’, I don’t mean mega-trends such as the rise of China and India. In any case, depending on the scale of the event, it can take many years to objectively assess its causes and consequences. To quote former Chinese Premier Zhou Enlai on the impact of the 1968 French student riots on world history, “It’s too early to say”.

One book about the global economic crisis that I actually have read and recommend is Gary Shteyngart’s Super Sad True Love Story, which is set in a dystopian post-collapse America of the near future. The love story in question is between Lenny Abramov, the 39-year old son of Russian Jewish immigrants, and Eunice Park, a 24-year old Korean American from California. The two meet in Rome, where Lenny is on sabbatical, and Eunice is escaping her oppressive Korean family. Lenny works for ‘Post Human Services’ (basically the rejuvenation and immortality industry) at the powerful Staatling-Wapachung Corporation, where he identifies High Net Worth Individuals (HNWI) who might be interested in life extension, while Eunice is a recent graduate with a major in Images and a minor in Assertiveness. The two quickly move to New York City, where the bulk of the story takes place.

The story is told from both characters’ perspectives, with Lenny’s version of events recounted in his personal diary, while Eunice’s narrative takes the form of emails to her best friend Jennifer Kang (AKA ‘Grillbitch’) in California and her mother Chung-won, and instant messaging with her sister Sally.

The future Shteyngart portrays is scary, but the author manages to make it amusing and entertaining to the reader. The US has experienced an economic and social collapse, and is now a quasi-police state run by the Bipartisan Party and the American Restoration Authority (ARA). The President, Jimmy Cortez, is weak and ineffectual, and the real power is the Henry Kissinger-esque Defense Secretary, Rubenstein. The US is meanwhile bogged down in a military quagmire in Venezuela, and soldiers returning home are organising protests because their bonuses aren’t being paid.

China has become the dominant global power, and is now known as China-Worldwide. Other countries’ names reflect aspects of their polity, e.g. SecurityState-Israel, HolyPetroRussia, Stability-Canada, and HSBC-London. The Chinese yuan has become the world’s dominant currency, and the US itself uses two currencies – ordinary dollars and yuan-pegged dollars. This system is never fully explained, but we are later told that the exchange rate is US$4.90 per yuan, and US$8.64 per euro. Surprisingly (from today’s perspective), the euro still exists, although there is later a reference to the northern euro.

American companies seem to have been consolidated into super-giants, too. For example, Lenny flies back to New York from Rome on a UnitedContinentalDeltamerican airliner, while the main bank is called AlliedWasteCVSCitigroupCredit. There’s also a company called ColgatePalmoliveYum!BrandsViacomCredit. Also noteworthy is that many American universities have been twinned or merged with their Asian counterparts, e.g. Brown-Yonsei.

The world that Lenny and Eunice inhabit is a hyper-connected version of today’s one. Mobile phones (known as äppärät, and resembling pendants) can now be used to scan everyone’s personal details, ranging from their wealth and sex appeal, and to track their real-time movements. In fact, there are credit poles all over New York City that display personal credit ratings when an individual walks past them. Yet despite America’s economic woes, consumerism is still big, and has been taken to ever cruder levels, judging by the names of some of the retailers – AssLuxury, TotalSurrender underwear, and Onionskin Jeans. At one stage, Lenny and Eunice visit the United Nations Retail Corridor – the UN has been moved elsewhere, and has been replaced by something resembling a North African bazaar. Yet, retailing is a highly sought-after job for American female graduates such as Eunice.

Before long, Lenny and Eunice get caught up in the upheavals of New York, which has become highly militarised with armoured personnel carriers and tanks on the streets. In fact, Eunice’s mother remarks in an email that America increasingly resembles South Korea in 1980, when protesters resisted the military coup, and wonders if the Park family should return to Korea, which is now richer than the US. Ex-US military personnel and the homeless have built shanty towns in Central Park; Venezuela veterans are marching for their bonuses in the Mall; old apartment complexes (including Lenny’s) are being torn down and being replaced by new luxury condominiums solely for non-US nationals; and China pushes the US closer towards the abyss by dumping US Treasuries. All the while, Lenny and Eunice are trying to continue their romance, overcoming suspicions towards Lenny from Eunice’s conservative Christian parents, Eunice’s dislike of Lenny’s self-obsessed ‘Media’ friends, Eunice’s increasing involvement with the protestors in Central Park, and Lenny’s hyper-rejuvenated boss’ growing infatuation with Eunice.

It’s hard to characterise Super Sad True Love Story. To some degree it’s almost as if Philip K. Dick had returned from the dead and written a romantic comedy – a combination that might well alarm some potential readers, but it actually works very well.

The style of writing is extremely witty and insightful, and both Lenny and Eunice are well crafted and well defined characters (although Lenny sounds like he might be Shteyngart’s alter ego). The observations of immigrant life (in this case Jews and Koreans) are also nicely done.

Although I hesitate to call this book sci-fi, it does share in common with sci-fi the fact that it says more about today’s world than the probable future (see my previous post on this subject – The World In 2500). I for one doubt that China will become a global hegemon, as many believe. In fact, I’m certain Shteyngart’s Chinese counterpart could just as easily write a similar book about a post-bubble-collapse China.

Nonetheless, Super Sad True Love Story is a tremendously enjoyable book, and certainly one of the more memorable ones I’ve read in recent years.

PS: Hardly anyone in Shteyngart’s America reads books anymore. At one stage Lenny starts reading a book on the plane, and a fellow passenger complains about the smell.

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In this recorded webinar Cedric Chehab, Head of Americas Research and Richard Hamilton, Head of Latin America Analysis examine global risks to Latin American growth, including:

•    Global GDP growth expectations, US recessionary pressures
•    Developed versus emerging markets
•    Recovery risks and the impact of government policies
•    Positive growth outlook for Latin America
•    Divergence amongst the region’s countries
•    Latin American vulnerabilities to the slowdown in global growth
•    Trade and capital flows, policy responses and risks

Sata’s win poses important questions for Zambia, since his long political career has often been characterised as antagonistic towards foreign investors and operators, with particular vitriol aimed at the Chinese. Sata has at various times threatened to nationalise Zambia’s all-important copper mines, reintroduce windfall taxation on mining revenues, and get tough on Chinese mining companies who he has criticised as irresponsible and abusive.

Despite the heated rhetoric that Sata has used in years past, it should be noted that in his latest campaign he made a conspicuous attempt to draw support from more ‘moderate’ voters. He has shied away from the idea of mine nationalisation, and in the closing days before the election, he even told reporters he would not bring back a mining windfall tax. My colleagues and I do actually believe that there will be some tax increases in the mining sector, but BMI’s Mining Team does not believe that this should constrain investment to a significant degree, since mining taxes are quite low at the moment, and Zambia’s high-grade copper mines will very likely remain profitable. Global dynamics – particularly the price of copper – will play a much greater role in the sector than domestic policy in the months and years ahead.

Under the previous government, there were huge strides in Zambia’s business environment – the country was named a top reformer by the World Bank – and we expect that Sata will prudently keep in place many proven policies. For example, the popular Farm Input Subsidy Programme, which has seen maize harvests soar in recent years, will be preserved. Sata has softened his tone towards foreigners as well. In an olive branch that could double as a big stick, in his inaugural address he said that Chinese investors were ‘welcome in the country’, as long as they ‘adhere to labour laws’. He also said that the income gap between the rich and the poor would need to be addressed.

Incidentally, the Zambian elections represent an encouraging step forward for African democracy, and outgoing President Banda gave an exemplary concession speech, calling for unity and respect from all parties. He immediately accepted the poll results, and urged his supporters to help Sata to build a ‘more prosperous Zambia’. He wished the new president well and said that he hoped that the Patriotic Front’s policies bear fruit, and that the country is able to flourish.

There are also suggestions that a coordinated recapitalisation of eurozone banks will be instigated in order to contain the contagion of such a Greek debt writedown. If eurozone policymakers are able to agree upon such steps, essentially eliminating the risk that the crisis will spiral into regional financial meltdown, it would be a very positive development. As such, it is understandable that European equities, in particular eurozone banks, are enjoying some relief from the carnage of recent weeks.

Of course, nothing has yet been agreed, and several weeks of political wrangling may yet lie ahead. A final plan of action may even have to wait until the next meeting of the G20 in six weeks time, and in the meantime, contradictory statements on what action will be taken would not be surprising as politicians play to their domestic electorates. The enlarged EFSF still needs to be ratified by the German parliament on September 29. Nevertheless, the prospect of concerted action to stem the eurozone crisis should lend support to risk assets globally for the days ahead.

Putin remains Russia’s most popular political figure, and with approval ratings above 60%, he is one of the most popular leaders in the world. Therefore, it is virtually impossible to see him losing the 2012 presidential election. The 2018 election is more difficult to call, but so long as Russia avoids economic or geopolitical disaster, Putin should remain secure in power.

Oil Prices Key To Putin’s Success

The key to Russia’s economic success, at least in the near term, is high oil prices. Costly oil was the main reason why Putin’s first eight years in power (2000-2008) were a period of robust growth. However, if oil prices were to experience a sustained downturn – as a result of a secondary global recession, or a prolonged period of substantially slower growth in the US, Europe, China, etc – then Russia’s economy too would come a cropper. In fact, Russia’s GDP contracted sharply (by 7.8% in 2009, one of the worst-hit countries) as a result of the global recession.

If Russia’s economy were to weaken for a prolonged period, Putin could lose some of his sheen. It is difficult to see an Arab Spring-like popular uprising against Putin, especially since anti-government protests in the wake of Russia’s 1998 default (which came after a lost decade following the Soviet collapse) largely fizzled, but then again, the Arab Spring caught everyone by surprise. Thus, such a scenario in Moscow cannot be ruled out.

Three Challenges: Diversification, Demography, And Caucasus Insurgency

Arguably, Putin’s biggest economic challenge between now and 2024 is to reduce Russia’s dependency on hydrocarbon exports by generating new industries – e.g. hi-tech. This will probably require foreign investment. However, foreign investment is deterred by weak institutions and rampant corruption. Many feel that Putin failed to tackle these during his eight years as president and three years as prime minister. Outgoing President Dmitry Medvedev is apparently to be appointed prime minister, to signal to investors that his more business-friendly policies will continue, but doubts about Russia’s commitment to reform will linger.

Besides the economy, Russia’s other big challenges are reversing the country’s demographic decline, and pacifying the violent North Caucasus region. The UN forecasts Russia’s population shrinking by 12% to 126mn by 2050, which is far less severe than anticipated a few years ago (down 25% to 108mn), but Russia is nonetheless the only BRIC economy and only major emerging market actually losing people. Russia does attract migrant workers from Central Asia, but ethnic Russians fear that they are changing the character of the nation – which explains the rise of far-right groups. As for the North Caucasus, the Kremlin has tried virtually everything – brutal wars and billions of dollars’ worth of investment – to stabilise the region, but without lasting success.

A failure by Putin (or anyone else) to tackle these issues would leave Russia a depopulating and ageing country susceptible to commodity-induced downturns and vulnerable to internal fragmentation. This would raise questions about Russia’s status as a global power or leading economic power, for that matter.

• The Fed’s decision to buy longer-dated Treasuries in favour of short-dated ones should accomplish the goal of reducing long-end interest rates, including for mortgages.
• While this will assist with private-sector balance sheet repair, it is not likely to have a major positive impact on economic activity. The main problem in the economy remains not the price of credit, but the lack of demand for it. The yield curve flattening could also hurt banking sector profitability at a time when financial institutions are already struggling to rebuild from the 2007-08 crisis.
• The growing dissent within the FOMC is worrying, as is the increasing amount of political pressure, which is beginning to cast doubt on the Fed’s independence.
• The threshold for enacting a further round of quantitative easing is clearly very high. Judging from market reaction, this is positive for the dollar.

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We have highlighted on several occasions in our online service the significant impact La Niña had on the world’s grains and soft crops in 2010/11. Indeed, La Niña was responsible for severe rains in Australia, which followed years of droughts and disrupted the country’s wheat and sugar production. Even though this was less severe than expected – as we estimate wheat production to be up 20% year-on-year (y-o-y) in 2010/11 – we estimate Australian sugar output to be down 20%. Unusual wetness in Indonesia has meanwhile affected coffee and cocoa crops, which decreased respectively by 6.3% and 14.7% in 2010/11. In particular, humidity encouraged the spread of diseases in cocoa beans. Elsewhere, droughts in Latin America reduced yields for corn and soybean crops in Brazil and Argentina. For instance, BMI forecasts Brazilian corn production to decrease by 0.9% in 2010/11 because of lower yields. Argentinean corn and soybean crops are set to decrease respectively by 6.6% and 7.0% in 2010/11.

Even though industry sources expect the return of La Niña at the end of 2011 to be milder than it was during the first half of 2011, we believe more extreme weather conditions could significantly impact crops in 2011/12. In this context, we underline both upside and downside risks to our outlook depending on the region.

Firstly, we believe a repeat of the droughts in Latin America could reduce yields for corn and soybean crops. This could result in both markets remaining tight at global levels, as Brazil and Argentina are the world’s second-largest exporters of soybean and corn respectively. Secondly, increased but not severe wetness in South East Asia is likely to help a recovery in yields in wheat in Australia and softs in Indonesia and Vietnam.

Ultimately, we see potential for increased scarcity in corn and soybean markets, while wheat and softs (excluding coffee) markets should remain relatively well supplied. Indeed, without taking into account the effects of La Niña in 2011/12, we forecast the global corn market to return to a slight surplus of 4.6mn tonnes in 2011/12, while the soybean market will have a small deficit of 630,000 tonnes. Also, we forecast prices to moderate to USc1,300/bushel for soybeans and to USc600/bushel for corn in 2012. Therefore, we highlight a major upside risk to our price forecasts for soybean and corn if La Niña’s return results in tighter supply for both commodities in 2011/12.

Israel arguably has the most to lose from Turkey’s transformation. Until a few years ago, Turkey was Israel’s closest ally in the Muslim world, and the two enjoyed strong military cooperation. However, as my colleagues and I explained in our podcast last Friday, all this has changed. Indeed, for the first time in decades, all three of the Middle East’s biggest powers – Egypt, Iran, and Turkey – are either hostile towards Israel or becoming increasingly confrontational towards it.

Turkey’s turn against Israel and its support for the Palestinians are turning up the pressure on the Jewish state. Turkey is not Iran, but in some ways, Ankara’s more subtle approach (at least compared to Tehran) complicates life for Jerusalem. It is easy for Israel to mobilise international public opinion against Iran, when its president called for Israel to be wiped off the map, when it routinely suppresses the opposition and has a dreadful human rights record, and when it continues to pursue a suspected nuclear weapons programme. By contrast, Turkey is a parliamentary democracy, a member of NATO, a candidate for the EU (at least officially), and a major emerging economy. All this means that a more hostile Turkey is far more difficult for Israel to criticise.

Oddly enough, although Turkey’s recent behaviour in some ways dovetails with Iran’s geopolitical outlook, Tehran is unlikely to be pleased with Ankara’s growing assertiveness. If anything, Iran is likely to be concerned that Turkey is stealing its thunder on the Palestinian issue (in a far more ‘professional’ manner) and pulling the rug from beneath Tehran’s feet as far as regional influence is concerned. Turkish Prime Minister Recep Tayyip Erdogan has just been on a tour of ‘Arab Spring’ states, extending the hand of friendship. Moreover, Turkey, with its vibrant economy, is much more capable of offering economic rewards to countries such as Egypt, Libya, and Tunisia, than Iran. Furthermore, Turkey’s democratic system is a more appealing model for Arab Spring states than Iran’s theocratic regime. What can Iran offer these countries, realistically?

Admittedly, the Arab nations do not want to fall under Turkish dominance, as was the case during the Ottoman Empire. At the same time, they do not want to fall under the Persian thumb. Therefore, neither Turkey nor Iran will emerge as the regional hegemon. Ultimately, Egypt is in many ways the natural leader of the Arab world, but until it sorts out its post-Mubarak political system, it will remain somewhat introverted. However, in time Egypt can be expected to enjoy a strategic revival, potentially heralding a tripolar Middle East.

For full in-depth coverage of these issues, please visit Business Monitor Online.

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The euro can therefore be expected to remain under pressure after last week’s relief rally, and I see little reason for optimism on the currency at present levels. Rather than decisive action from European politicians, the only development that may provide significant support to the euro against the greenback would be US Federal Reserve policy easing in excess of that currently anticipated to be announced on Wednesday. A move below US$1.3500/EUR would portend further losses for the euro.

In similar fashion, German equities remain vulnerable after the DAX Index failed to close above the key 5,640 resistance level we flagged on Friday. For the days and weeks ahead, the market will be very much a hostage to the policy choices (or lack thereof) on either side of the Atlantic.

A more meaningful rally is almost certainly off the agenda whilst the eurozone debt issue goes unresolved, with procrastination still the default setting (if you excuse the phrase) in Berlin and elsewhere. And the longer the situation continues, the more likely a unilateral Greek default becomes. Greek Finance Minister Evangelos Venizelos’ comments yesterday that Greece is being ‘blackmailed and humiliated’ certainly raise questions over how much longer the current situation can continue.

For market stability to return, eurozone leaders must agree to provide Greece with further funding and also acknowledge that a coordinated forgiveness of more Greek debt will be needed. Without such action, the prospect of an unmanaged unilateral Greek debt default will grow, a development that would imperil other sovereigns of the European periphery and by extension the entire European banking sector.

However, this could be premature.

One of the charts that has intrigued me since Q4 2010 is the ratio of the MSCI World Index (eg Developed Market equities) to the MSCI EM (Emerging Markets) Index. A higher ratio suggests ‘DM’ equity outperformance over EM, and vice-versa. Looking back to the early 1990s offers a roadmap to recent economic history, with Developed Markets outperforming through the Asia and Russia crises in the late 1990s, until the dot-com bust in 2000-01. This was followed by newly resurgent Emerging Markets driving equity outperformance. The same chart now suggests to us that, technically, at least, the EM story may have run its course for now. If there is a reversal in favour of DM outperformance, it would be a secular shift that nobody is talking about, especially with sentiment towards Europe and the US at extreme lows.

Ratio of MSCI World over MSCI EM

To be frank, it seems hard to envisage significant outperformance by developed states at a time when they seem to be in their greatest crisis since the 1930s. But things can change quickly.

The turning point for Emerging Markets came in 2001-02 when Argentina posted the biggest default in history, and Brazil was on the brink of the same, only for President Lula to turn the ship around; expansionary Chinese economic policy (WTO entry, etc) also helped. At this moment in time, EM sovereign balance sheets are relatively solid, but we recall that as late as 2001, the US was forecast by the Congressional Budget Office to run fiscal surpluses for the ensuing decade, culminating in virtually zero federal debt by 2011.

Conditions today are hardly suggestive of significant DM performance – by way of historical contrast, EM countries had cleaned up their act significantly following the Asian and Russian crises of 1997-98, and the Latin debt crises of the 1980s. But what if the eurozone gets its act together, allows for debt restructuring and defaults within a framework designed to avoid systematic financial disaster, and emerges as a stronger, leaner bloc more along the German than the Club Med model? And looking at the US, total debt as a percentage of GDP has been declining for the past three years, despite soaring federal debt, and the government is in a position to borrow extremely cheaply and spend it on stimulus. Meanwhile, our Asia team remains sceptical about the Chinese growth model, and the potential for some sub-par years of growth does not seem completely far-fetched.

And even if global growth turns out to be just fine, large multinational firms listed in developed states may be a better risk-adjusted way of playing it. It’s just an idea…

In the first article, we discuss Turkey’s motivations for its recent actions, the Israeli perspective on the crisis, and the geopolitical and economic issues at stake. We also outline three scenarios for how the present tensions could affect Turkey-Israel relations for the foreseeable future.

In the second article, we analyse how Israel’s geopolitical realities have changed – mostly negatively – since the onset of the ‘Arab Spring’ in early 2011. Not only is Turkey becoming increasingly assertive (as outlined above), but Egypt is likely to adopt a more critical stance towards Israel following the removal of long-time president Hosni Mubarak in February. Meanwhile, the possible collapse of Syria’s regime raises the spectre of a civil war in close proximity to Israel.

All this is happening at a time when the US – which has close relations with both Turkey and Israel – must increasingly focus on domestic economic matters. Against this adverse backdrop, we also outline how Israel can strengthen its relations with other countries – in Asia and the Caucasus – to bring long-term benefits.

Despite significant declines over July and August, commodity markets have remained far more resilient than equities. Although this outperformance could continue, a deteriorating macro picture, combined with a more bullish outlook for the US dollar, leaves us wary of a fresh leg lower by commodity markets.

The risk of a fresh slide in metal prices would rise significantly should key levels of support give way for markets such as copper. Three-month copper is testing medium-term trendline support around US$8,700/tonne and a decisive break below this level would be a worrying technical signal for the metals complex as a whole. Such a move would suggest that the secular uptrend in prices that has been in place since Q109 was at an end.

Metals have held up far better than equities since mid-year. In our view, this is because underlying supply and demand fundamentals for metal markets have remained supportive of prices, despite wider financial market turbulence. However, a break below key levels of support in bellwether markets such as copper and aluminium would suggest that investors are starting to price in a marked global slowdown. Should underlying fundamentals show significant signs of weakness in the coming months, this would affirm investor fears and would leave metal prices vulnerable to significant additional declines.

• Although 9/11 was a tremendous shock to America and the world, leading directly to the war in Afghanistan and indirectly to the Iraq War, the bigger ‘event’ over the past decade in terms of global transformation was the rise of China in particular, India to a lesser degree, and emerging economies in general. Billions of people have seen their living standards and opportunities improve. This would have happened regardless of 9/11.
• Al-Qaeda is down, but not out. The Arab Spring largely marginalised al-Qaeda, which also suffered the loss of Osama bin Laden in May 2011. Nonetheless, al-Qaeda is still a threat to the West, and has become a much more diffuse menace.
• Al-Qaeda has failed to achieve its strategic goals of overthrowing Arab leaders and replacing them with Islamist ones, and of merging putative Islamist states into a global caliphate. The latter ambition remains as distant as ever.
• The West’s war on Islamist militancy is unlikely to be the defining geopolitical feature of the first half of the 21st century, unless Pakistan becomes radicalised or collapses, potentially allowing its nuclear weapons to fall into terrorist hands.
• The West is not the sole target of Islamist terrorism. Russia, India, and several Muslim countries, including Pakistan and Indonesia, have been major victims, having suffered more attacks than Western countries.
• The United States is also down, but not out. Clearly, a decade of war in Afghanistan and Iraq, and the global economic recession of 2008-2009 have taken a severe toll on the US’s global standing. Nevertheless, the US will remain the world’s strongest individual country for the foreseeable future, if only because its main competitors are in an even weaker position.
• The US’s present weaknesses and its distractions in Afghanistan and Iraq have arguably emboldened North Korea, Iran, and Russia and China in their dealings with the US.
• Europe is down, and out. In the decade since 9/11, Europe (or at least the eurozone) has gone from being a confident, fledgling currency union to a financial crisis zone. Although we believe the eurozone will survive, the various sovereign debt crises and the unexpectedly long war against Libya have cruelly exposed Europe’s financial and geopolitical weaknesses.
• The major risks to look out for over the coming decade include China’s economic and political evolution, the future of the Korean Peninsula, Japan’s rising debt burden, Russia’s shaky revival, the uncertainty over the long-term direction of the Arab Spring and Iran, Mexico’s ongoing drug war, and cyber-warfare, among others.