With this in mind, we have decided to introduce a bearish view on the 12-month CNY non-deliverable forward outright in our regional asset class strategy, as expectations of depreciation start to gain traction. Currently at CNY6.2270/US$, we are targeting a medium-term move back to CNY6.5000/US$.

A Political Shift In Argentina?

Elsewhere, we continue to believe that 2013 will be a turning point in Argentine politics, signaling the beginning of a shift away from the unpredictable and highly interventionist style of government practiced first by the late President Nestor Kirchner and now by his wife and successor, President Cristina Fernández de Kirchner. As a sputtering economy increasingly discredits the ‘Kirchnerite’ governing model, we believe the balance of power will shift towards more moderate members of the Peronist coalition. A key test will be this October’s mid-term elections. However, we acknowledge a number of risks to our outlook, not least of which is that Fernández is an adept politician and has managed to reverse public opinion in the past, a scenario that could ensure that interventionist policies remain the norm over the next several years. More detailed analysis is available to subscribers in our online service.

This Week’s Trivia Question

Last week’s question concerned the Philippines, which held mid-term elections earlier that week, has the second-best performing stock market in Asia this year, and has received investment grade status from credit ratings agencies. Our question was, which 1950s science fiction novel, made into a Hollywood blockbuster in the late 1990s, featured a Filipino protagonist? (Hint: in the film the hero was played by a fair-haired Caucasian actor. In both the book and the film, Buenos Aires is destroyed.) And, since the new Star Trek film was released recently, which major character was named after a body of water in the Philippines?

The answer to the first part is Robert Heinlein’s Starship Troopers. The novel is told by a first-person narrator, Juan Rico, and the reader only discovers that the protagonist is Filipino when he mentions to a colleague, towards the end, that his native language is Tagalog. The answer to the second part is Sulu, who was named after the Sulu Sea in the Philippines.

This week’s question is as follows: which 1980s American soap opera had a season cliffhanger in which all the characters appeared to perish in the massacre of the royal family of a quasi-fictional European country, and what was that country? (Incidentally BMI‘s Senior Economist is currently visiting the country in question, and I hope he writes a blog-post about it when he gets back.) And what is the connection between this fictional ‘massacre’ and the former Serbian royal family, and, surprisingly, the film version of Starship Troopers?

Overall, there is a long-term risk to the autos sector in developed states, and particularly the US, that car ownership is no longer the priority it once was. Below are a couple of key points:

Licenced drivers in the US fell from 90% of the driving age population in 1992 (the peak) to 86% in 2011.

Within that total, only 67% of 16-24 year-olds held a licence in 2011, the lowest since 1963. This is the biggest worry for carmakers, as it is the future market.

Reasons For The Decline

The cost of car ownership is rising, although this has been a steady increase in comparison with the drop-off in miles driven per person and the number of licences.

There has also been a 7% increase in the urban population over the same time period, which suggests that more people are turning to public transport, car sharing, bike schemes, etc.

For younger people, technology is becoming more of a priority. They would rather own smartphones and computers than a car; hi-tech goods are becoming the new symbol of independence. People may also have less need to see their friends face to face, which would involve a car journey.   

How The Car Industry Is Responding

It’s a tough one, as they need to change the consumer mindset. One strategy is to increase the level of technology in cars to appeal to the younger age group – but this comes with associated costs, which are out of reach for many younger drivers looking for their first car.

Another possibility is to offer new ‘fun’ smaller cars – such as the Fiat 500, and Citroen DS range – but again, these are not cheap.

One of the best opportunities for US automakers could come from the contraction in transport infrastructure spending forecast by our Infrastructure team. If developments in transport cannot keep up with urbanisation, this will provide a window for carmakers.

Further analysis of the global autos sector is available to subscribers at Business Monitor Online.

But is this optimism justified? Regular readers of this blog will recall that I have generally sounded a pessimistic note about Japan, having warned that the country is at risk of a ‘lost eternity’. More recently, I have warned that Abe’s combination of extreme QE and fiscal stimulus could accelerate Japan’s debt crisis. I still hold these views.

What If We Are Wrong About Abe?

Nonetheless, I must also recognise the possibility that Abe might in fact succeed in reviving Japan. By ‘revive’, I mean putting the Japanese economy onto a sustainable growth path that allows for a reduction in the budget deficit and debt burden, and causes it to regain some of the ‘edge’ that it has lost to countries such as South Korea and China.

Abe’s sense of mission is encouraging. It is better that Japan has a leader who at least tries to shake it out of its slumber than one who does nothing, or very little. (Some could argue that a do-nothing approach is better than accelerating the inevitable bust.) The fact that Abe is Japan’s first prime minister since the late 1940s to be given a second stint in the job suggests that he could have more staying power than before; i.e. he may have learned the mistakes of his previous premiership.

There is also the possibility that Abe may be able to channel his nationalism towards a new agenda for economic reform. In general, there are two kinds of economic nationalism. One is parochial and protectionist, designed to keep the economy (of any country, not just Japan) relatively closed to foreign competition and to preserve the country’s business culture (and thus its broader culture and social system). This model is tied to vested interest groups.

But there is also a second kind of economic nationalism, one that recognises that in order to revive Japan’s economy and make the country strong, a broad restructuring is needed that will transform its business model via the adoption of foreign ideas and practices. In the late 19^th century, Japan’s leaders adopted this policy for the purposes of strengthening the country against possible Western colonialism. In the early 21^st century, China, not the West, is Japan’s most formidable rival.

Shinzo Abe is a strong nationalist, and wants to make Japan militarily powerful. The question is, which economic model will his nationalism embrace? In his first period as premier (2006-2007), Abe favoured the first kind. However, Abe’s apparent desire to take Japan into the Trans-Pacific Partnership (TPP) free-trade grouping suggests that he could indeed be a reformer this time. Nonetheless, no-one should underestimate the strength of Japan’s vested interest groups.

July’s Upper House Election Is Key

Abe is due to unveil a new economic growth strategy (his ‘third arrow’) in June, and investors are hoping that he will outline reforms to a variety of sectors, including agriculture, healthcare, utilities, and the labour market, amongst others. Then, in July, Japan will hold elections to its Upper House, where Abe’s Liberal Democratic Party (LDP) lacks a majority. If the LDP wins a majority, which is a distinct possibility given Abe’s overwhelming popularity, he would be Japan’s strongest prime minister in many years and should have a solid hand with which to carry out economic reform.

There is, however, a danger that once he secures an Upper House majority, Abe could lose interest in bold economic reforms and instead focus on issues closer to his heart, such as amending Japan’s constitution to reduce constraints on the use of its Self Defense Forces (SDF). Recall that one of the reasons Abe lost popularity during his first stint as prime minister in 2006-2007 was because he championed ‘patriotic’ and defence-related matters at a time when voters were more concerned about ‘bread and butter’ issues. If Abe backtracks on his commitment to reforms or Japan’s inclusion in the TPP, then investors could lose faith in Japan once again.

There is also a possibility that excessive focus on defence issues on the part of Abe could worsen relations with China and South Korea, which oppose Japanese rearmament and deeply resent Tokyo’s relatively unapologetic attitude to its Imperial past.  

Possible Game-Changers

Regardless of the Upper House elections and the durability of Abe himself, there are several possible game-changers for the Japanese economy over the long term.

The first is a colossal debt crisis. Naturally, this would be viewed extremely negatively. However, it is quite possible that such a visible systemic failure could serve as the trigger for genuinely radical reform, as was the case in South Korea after its 1997-1998 financial crisis. Some have argued that Japan’s ‘lost decade’, and even the 2011 triple disaster, were not painful enough to galvanise the country into reform. On a positive note, Japan, like South Korea, probably has the social cohesion to rally behind reform, rather than slip into Greece-style mass unrest.

The second is a new resource bonanza. Japan has actively been researching ways to develop its considerable reserves of offshore methane hydrates, a topic my colleagues in BMI‘s Oil and Gas team has been tracking closely. If this proves successful, then this could be a substantial boost for Japan’s economy, which imports most of its energy. Japan could also tap rare earth metals from its sea bed. These are in high demand for a variety of hi-tech goods, and the world’s major economies are keen to break China’s virtual monopoly (97%) on its production.

The third would be a new immigration strategy, which the LDP proposed in 2008, but quietly dropped later. It is my contention that immigration is the real key to Japan’s revival – the country needs newcomers to top up and rejuvenate its population, and introduce new ideas and ways of thinking. However, Japan remains resistant to immigration for fear that it would change the culture. In any case, immigration is not a panacea, and Japan still needs to implement some of the above-mentioned reforms.

A fourth possibility is the rise of a new political force, if the LDP stumbles once again. This could include the Japan Restoration Party (JRP) of former Tokyo governor Shintaro Ishihara and Osaka mayor Toru Hashimoto, possibly in cooperation with other parties. (Sadly both men have made some highly inflammatory comments, which have been condemned in China and South Korea.) Although the JRP has lost some of its momentum since its establishment in 2012, it is now the third-biggest party in parliament and could even move to second place. However, it is unclear if the party’s highly nationalistic leaders can deliver reform.   

No Easy Path To Recovery

Overall, Japan’s road to revival will be bumpy. As the population ages, its society will probably be less disposed towards change. In addition, Japanese prime ministers come and go with alarming speed, and it is not clear if any of Abe’s putative successors would continue ‘Abenomics’.

Much is at stake. The coming years will determine if Japan regains its lost edge and remains among the world’s most important economies, or slips further down the rankings of global powers.

The proposed facility is designed to eventually handle 150mn passengers per year, and its first phase is due for completion in 2016. The contract to build and operate the EUR22bn (US$29.5bn) project was awarded to a five-company consortium led by Limak Holdings earlier this month. BMI‘s Infrastructure team has been following the Turkish airport sector for a while, and notes that there is a slew of airport projects underway. For example, the second runway at Istanbul’s Sabiha Gokcen Airport – which Limak is also involved in – underpins our bullish long-term average real growth forecast for Turkey’s airport infrastructure industry value of 8.3% up to 2022. Meanwhile, Turkish Airlines, which will be the main operator of Istanbul’s new airport, is seeking to position itself as a global carrier on a par with Emirates.

Despite the prestige that this project holds for Istanbul and the will of the Turkish government to see its completion, there are a number of hurdles which need to be overcome:

As mentioned above, the price tag on this project is a huge burden. Project financing in Turkey has been a real problem in recent years as a result of erratic government policy and tight conditions in the eurozone. Indeed, three members of the winning consortium recently failed to secure financing for a US$1.96bn electricity grid project they had been awarded. The airport contract states that companies will pay the full EUR22bn sum over the 25-year concession, but even so, the success of Turkey as a regional air hub is not guaranteed, and thus traffic and revenues may not permit the winning companies to meet their financial obligations.

Then, there is the competition that Istanbul’s third airport is putting itself up against. Gulf states, notably Dubai and Abu Dhabi in the UAE, are already established regional hubs with recognisable national carriers. Despite an impressive advertising campaign and sponsorship deals, Turkish Airlines is not yet perceived as the global carrier that it wishes to be.

Furthermore, the construction of the new six-runway giant airport will take place on a site which is currently a quarry. Preparation of the site for construction is likely to be an extremely technically difficult and costly exercise, and will require the felling of over half a million trees, thus raising environmental opposition.

More detailed analysis of Turkey’s ambitions of becoming an east-west economic and logistics hub is available to our subscribers at Business Monitor Online.

Among emerging markets, the Philippines, Thailand, and Turkey (upon which we have a bullish asset class strategy view) have climbed to new all-time highs too. The fundamental outlook is solid, with earnings near their pre-crisis peak, valuations at reasonable levels, dividend yields outstripping government bond rates, and positive earnings surprises outstripping the negative.

And, incredibly at this stage, retail investor sentiment continues to be minimal, with net mutual fund inflows by US investors into equities still negative on aggregate since the rally began in 2009. This stands in stark contrast with the 1990s and 2000s equity bull runs, in which there were major net inflows into equities and outflows from bonds. As such, there is no reason to believe that stocks are entering a bubble due to sentiment alone.

Our full range of equity market views is available to subscribers at Business Monitor Online.

BMI Updates Latin America Sovereign Risk Ratings

Meanwhile, BMI‘s Americas Research team has just completed its quarterly update of our sovereign risk ratings, which cover 19 Latin American and Caribbean countries. For each country, we have scores for ‘ability to pay’ and ‘willingness to pay’, out of 100, which are used to create an aggregate national score. Countries that score 80 and above are rated ‘A’; 70 and above are rated ‘B’; and so on. Each country also receives a market outlook score of 1 to 5, with 1 being the most bullish, to reflect our expectations of the performance of that country’s 5-year credit default swap. Overall, BMI rates 86 countries worldwide. Our sovereign risk ratings are published in our online service and in our weekly Emerging Markets Monitor magazine.

This Week’s Trivia Question

In last week’s question, we asked, which famous British actor played Pakistan’s founding father in a late 1990s biopic, having earlier in his career played a James Bond villain, and subsequently in the 2000s powerful sorcerers (one of which was committed to capitalism) in two epic film sagas? The answer is, of course, Christopher Lee, who played Francisco Scaramanga in The Man With The Golden Gun (1974), as well as Saruman in The Lord Of The Rings trilogy and Count Dooku in the second and third Star Wars prequels. The latter character was a separatist leader ‘committed to capitalism’.

This week’s question concerns the Philippines, which held mid-term elections earlier this week, has the second-best performing stock market in Asia this year, and has received investment grade status from credit ratings agencies. Our question is, which 1950s science fiction novel, made into a Hollywood blockbuster in the late 1990s, featured a Filipino protagonist? (Hint: in the film the hero was played by a fair-haired Caucasian actor. In both the book and the film, Buenos Aires is destroyed.) And, since the new Star Trek film was released recently, which major character was named after a body of water in the Philippines?

• Transpacific shipping rates are still doing relatively better than Asia-Europe rates, but are down in year-on-year (y-o-y) terms.
• Asia-Europe freight rates are down on lack of demand (due to continued economic woes in the eurozone) and over-supply of vessels (there are more vessels and vessels of a larger size that can only operate on the Asia-Europe trade route).
• A rate war has erupted in the Asia-Europe rote, which has forced rates down below the US$1,000 per TEU (twenty-foot equivalent unit) level, as operators fight for market share.
• Ships are now sailing at a loss – a container can be shipped between Shanghai and Rotterdam for just US$740.
• All this is very bad for shipping lines, and could see them post losses this year if the rate war continues. Trust has been lost, so the rate war could continue for a while yet.
• Low freight rates are good for shippers; auto parts manufacturers, retailers, food and drink suppliers, ICT producers, and also potentially pharmaceutical makers, could benefit from these really low freight rates, which have slashed their transportation costs.
• When will overcapacity end? 2015 is being floated as the year that supply and demand will reach equilibrium, but that was prior to the launch of the mentality of ‘my ship is bigger than your ship’, which will see even bigger vessels placed into service in the medium term.

Full coverage of the global freight transportation sector is available to subscribers at Business Monitor Online.

Six-Month Equity Market Performance, %

In Business Monitor Online today, we discuss the reasons for the ASE’s outperformance, and the market’s prospects over the coming months and years.

What explains Russia’s behaviour? The most basic reason is that Moscow has, or has had commercial or military interests in these countries that could be jeopardised by a change of regime.

However, there is a bigger reason, namely that the ‘Great Powers’ still view world politics as a ‘zero-sum game’. In other words, the fall of a Russia- or China-friendly regime is regarded as a ‘gain’ for America, and vice-versa. This explains why China is concerned about Myanmar’s rapprochement with the US, and why Beijing continues to prop up North Korea. This ‘zero-sum’ perspective is a holdover from the Cold War.

Russia has valid reasons for its present worldview. During the 1990s, Moscow generally adopted a highly cooperative attitude towards the West, as reflected by its green-lighting the US-led 1991 Gulf War against Iraq (a well-established Soviet ally), dissolving the Warsaw Pact, withdrawing all of its troops from Central and Eastern Europe in the early 1990s, and eventually pressuring Yugoslavia to acquiesce in NATO’s entry into Kosovo in 1999. Yet despite its cooperation, Russia regards itself as having received relatively little in return from the West, with NATO expansion taking place over Moscow’s objections, the alliance subsequently attacking Russia-friendly Yugoslavia, and the US pressing ahead with plans for a missile defence shield. Russia did receive considerable economic assistance from the West, but this only added to its sense of wounded pride.

All of the above happened at a time when Russia was very weak as a result of the post-Soviet economic collapse. Following the ascent of Vladimir Putin as Russia’s leader in 1999, and thanks to the country’s economic revival due to rising oil prices in the 2000s, Moscow is now much more willing and able to defend its perceived interests abroad.

Let us suppose that Russia abandoned Bashar al-Assad, or took active steps to remove him from office. It is difficult to see what Moscow would gain from this. Possibly a few words of gratitude from the US, but very few tangible rewards, if any. Meanwhile, the Kremlin’s influence in the Levant would have been weakened, as the new Syrian regime would be highly unlikely to view Russia favourably. Furthermore, there would be no guarantee that Syria would be last occasion where the West and Russia found themselves on opposing political sides. There is still Belarus, and probably several other Soviet republics.

Ethiopia’s Rationale For Hydropower

Ethiopia’s desire for hydropower stems from the following goals:

• To ensure energy security and support economic development.
• To become less reliant on expensive imported oil for electricity generation and improve its trade balance.
• To raise capacity, both for domestic generation, but more interestingly, to export surplus electricity to its neighbours – particularly Kenya – and establish itself as a regional energy hub.

Can Ethiopia Succeed?

Ethiopia has huge estimated hydropower generation potential of 45,000 MW (second only to the Democratic Republic of Congo in Africa, according to the World Bank).

Ethiopia has already inaugurated a 283km transmission line that has enabled Djibouti to import up to 60 MW of electricity. Ethiopia is currently earning a small amount of income from the deal and has gained access to Djibouti’s ports as a result.

Kenya is the main target of electricity exports, and its economy is growing quickly, thus generating demand for Ethiopian electricity.

China is stepping in to build transmission lines and infrastructure between industrial centres and to other countries.

Threats To Ethiopia’s Ambitions

Geopolitics: Egypt is very unhappy with Ethiopia having control of Nile water resources. The populations of Sudan and Kenya have also voiced concerns – but, equally, their governments are keen to import the electricity.

Environment: There are major concerns about the effects of damming rivers on the ecologically sensitive Lake Turkana in Kenya.

Financing and China: Because of concerns about environmental impact, the World Bank and African Development Bank (AfDB) have been wary about financing some of the latest large-scale projects. China has no such qualms and wants to expand its global influence through involvement in Nile resources. Interestingly, China is not in Ethiopia to tap natural resources (Ethiopia doesn’t really have any), but mostly for political gain. Ethiopia is strategically positioned, with a population of 90mn, and is the home of the African Union.

Further coverage of the renewable energy sector is available to subscribers at Business Monitor Online.

Similarly, the Japanese yen recorded sharp weakness overnight, breaching the important JPY100/US$ level. This presages a move towards JPY110/US$, a break of which would even bring JPY125/US$ into focus. The sharp currency move suggests that foreign investors are becoming increasingly concerned about Japan’s fiscal situation, a key risk for the Japanese economy that we have highlighted repeatedly.

The ongoing rise in Japanese Government Bond (JGB) yields is a key indicator of these looming risks, and hence, we maintain our bearish call on 10-year JGB. Yields on the instrument have spiked to 0.67% this week, helping to confirm our view that the market has put in a structural top. We expect the 10-year yield to head higher over the coming months, and retest the six-year support level at around 0.90%.

This Week’s Trivia Question

The theme of our question last week was missing American soldiers in South East Asia. We asked, which long-running American TV series has a major character who turned out to be impersonating a US soldier lost in Vietnam? (Hint: the character was a school teacher.) The answer is Principal Seymour Skinner from The Simpsons, who was somewhat abruptly revealed in one episode to be an impostor named Armin Tamzarian.

Our question this week is as follows: Which famous British actor played Pakistan’s founding father in a late 1990s biopic, having earlier in his career played a James Bond villain, and subsequently in the 2000s powerful sorcerers (one of which was committed to capitalism) in two epic film sagas?

The incumbent president, Mahmoud Ahmadinejad, has generally pursued a confrontational policy towards the US and Israel, but he is not eligible for a third consecutive term, so there will be a new president. In Iran, the president is much less powerful than the Supreme Leader, Ayatollah Ali Khamenei, so we do not expect a major policy shift after the election.

However, the president is still important in representing Iran abroad, managing the economy, and setting the general tone of political discourse. The post therefore matters a great deal.

Candidates must register by this Saturday, May 11. Prominent names being bandied about include former foreign minister Ali Akbar Velayati, current Tehran mayor Mohammad Bagher Qalibaf, former nuclear negotiator Hassan Rowhani, former parliament speaker Gholam Ali Haddad Adel, former vice-president Mohammed Reza Aref, former president Hashemi Rafsanjani, and former Revolutionary Guards commander Mohsen Rezaei. Ahmadinejad favours his former chief of staff, Esfandiar Rahim Mashaei, but it is unclear whether the latter’s candidacy will be accepted.

The candidates will be vetted by the Council of Guardians (a body of clerics) for their loyalty to the regime or religious political system, and their general reliability, which in practical terms means their ability to work with the Supreme Leader. Ahmadinejad had the Supreme Leader’s support in the controversial 2009 election, but he subsequently moved to challenge Khamenei’s authority. The regime will want to avoid such schisms in the next presidential term.

The election is thus bound to be dominated by conservative candidates, but some of them may have more reformist leanings than others.

What To Look Out For

There is a risk that the liberal opposition, whose leaders have been sequestered since challenging Ahmadinejad’s re-election in 2009, will boycott the election, or be forced to support their least disliked conservative figure.

We will be watching closely for signs of unrest. The regime will be particularly fearful of the possibility of a repeat of 2009, when mass protests followed the disputed result. Iran’s economy has worsened since 2009, due to tighter sanctions over its nuclear programme, which have led to the sharp depreciation of the rial currency and double-digit inflation. In addition, the Arab Spring could serve as a possible inspiration for Iranians.

That said, Iranians may be fearful to take to the streets in large numbers, due to the freshness of memories of the severity of the regime’s crackdown in 2009, and the chaos that has hit some Arab countries as a result of their own uprisings.

Implications For The Nuclear Dispute

We have held the position that neither Israel nor the US would attack Iran before the June 2013 presidential election, with all parties adopting a ‘wait and see attitude’.

Regardless of who becomes Iran’s president, the country’s nuclear programme will continue in some form.

If a relatively moderate or at least non-firebrand conservative figure becomes president, then this could set the scene for a reduction in tensions with Israel and the West, and continued negotiations. Israel would come under further pressure to refrain from an attack on Iran.

However, if an aggressive conservative figure becomes president, and maintains Ahmadinejad’s inflammatory rhetoric while appearing uncompromising on the nuclear issue, then this would increase the risk of an eventual Israeli attack on Iran.

Full coverage of Iran’s domestic politics, economy, and nuclear dispute is available to subscribers at Business Monitor Online.

The report looks beyond the current uncertainty surrounding the mining industry and outlines the case for further frontier mining investment, given our forecast for lower mineral prices in the coming years. The report provides analysis of countries with key growth potential, such as Mozambique, Myanmar, and Vietnam, and it also assesses real threats to frontier mining, including resource nationalism, infrastructure problems, and commodity prices.

Customers can use BMI’s core views on frontier mining, which are comprehensively backed up by data and forecasts, to understand the risks and opportunities to their operations and to enhance their investment decision-making. The report answers key questions, such as:

The special report draws on BMI’s 30 years of experience to critically evaluate the prospects for mining investment in the frontier markets over the long-term, helping you assess the role it could play in your company’s growth strategy for 2013 and beyond.

Global Asset Class Strategy: Several multi-year charts continue to point to a major shift underway in the global economy, in which we expect the US dollar to come back (it probably bottomed in August 2011, in our view), and developed market equities to continue outperforming those of emerging markets. These are the major trends that drive our multi-year asset class strategy.

Macro-Industry Update: Our Global Macro-Industry Strategy views are unchanged this week. One potential new view that we explore is communications tower companies, given BMI‘s forecast for a surge in global demand for data, the spread of data demand into rural areas, the ongoing emergence of new technologies, and fact that the continued release of wireless spectrum will necessitate an increase in infrastructure capacity.

Global Assumptions: Our global real GDP growth estimates for 2013 have been revised down to 2.8% from 2.9% since our last Global Assumptions update, with our 2014 forecast also falling by one-tenth of a percentage point to 3.3%, from 3.4%. The primary reason for our reduced global forecast is a reduction in our expectations for eurozone growth in both 2013 and 2014, which in turn is due primarily to a downgrade of France’s outlook.

Our full coverage of the global economy, including our Global Assumptions and our investment and asset class strategies, is available to subscribers at Business Monitor Online.

Although the market had been positioning for a refi rate cut, with European equities rallying over the preceding days, the Governing Council’s decision has come a year (or more) too late. Peripheral eurozone economies continue to flounder, while even German growth has looked vulnerable this year after a long run of relative strength.

We see a further 25bps rate cut in the coming months, which will put the ECB’s rates more in line with other major central banks. Over the long term, the euro still appears overvalued and is set to weaken versus the US dollar. Yen weakness due to explosive quantitative easing in Japan will only pile the pressure on European exporters.

Our forecast of an average exchange rate of US$1.34/EUR in 2013 is still looking pretty good, but we are looking for depreciation towards US$1.20/EUR in the coming years with downside risks, as the US economy picks up.

This Week’s Trivia Question

In last week’s question, we asked, which historical figure’s lock of hair was sold for EUR13,720 at an auction house in Vienna that week? The answer is former Austro-Hungarian emperor Franz Joseph. For this week’s question, something totally different, inspired by reports earlier this week that an American soldier believed to be missing in action in the Vietnam War was found living in that country – although the reports were quickly debunked, and he was said to be an impostor. Our question is, which long running American TV series has a major character who also turned out to be impersonating a US soldier lost in Vietnam? (Hint: the character was a school teacher.) The answer will be revealed next Friday.

While this downgrade is substantial, it reflects the importance of Russia’s public sector in determining the shape and pace of domestic demand. It is hard to say exactly what has prompted the change of tone from the president, who had until recently been pressuring the central bank to loosen monetary policy, although Putin’s public criticism of Prime Minister Dmitry Medvedev’s economic management has prompted speculation that he is using the recent slowdown as a pretext for political advantage, rather than reflecting a genuine concern about fiscal and monetary stability.

Regardless of his motive, with Putin now apparently willing to accept a growth rate of below 3.0% this year – the economy ministry recently cut its 2013 GDP forecast from 3.6% to 2.4% – we find it hard to identify significant drivers of growth, given the weak external backdrop and slowdown in consumption.

Although our 2013 growth forecast for Russia is now some way below Bloomberg consensus estimates of 3.1% (which we also expect to be revised down following recent developments), we see risks of further downward revisions to our projections over the coming months. It is still unclear what damage the Cyprus bank bailout will have on Russian banks, and by extension domestic loan growth. We also see potential for increased political uncertainty over the next few months, as ongoing tensions between Putin and Prime Minister Medvedev increase speculation of a change in government.

Our full analysis of the Russian economy and political scene is available to subscribers at Business Monitor Online.

Syria Less Pressing Than Iran And North Korea

Another probable reason why the US wishes to avoid war in Syria is that it needs the flexibility to respond to a new crisis involving Iran or North Korea, which would arguably be more dangerous than the situation in Syria. Although Syria’s civil war has resulted in tens of thousands of deaths and substantial refugee flows, and has become a proxy conflict between pro-regime Iran on the one hand and pro-rebel Saudi Arabia and Turkey on the other, it is still relatively contained. By contrast, a new crisis with Iran or North Korea could escalate into a full-scale regional war. Although Iran’s nuclear programme and speculation about Israeli airstrikes against it have faded from the headlines lately, the matter could gain greater urgency once Iran’s June 14 presidential election is out of the way. This will especially be the case if a vocal hardliner is elected president of Iran, and the new administration fails to adjust Tehran’s nuclear stance in current negotiations with the ‘Great Powers’.

As for North Korea, the shrill rhetoric from Pyongyang seems to be subsiding somewhat, and it is a little surprising that the country refrained from carrying out new missile tests in April, as many had anticipated. However, we expect tensions on the Korean Peninsula to linger at least until July 27, when the two Koreas will mark the 60^th anniversary of the end of the Korean War (1950-1953). No doubt, the North, which regards itself as the victor of that conflict, will use the occasion to play up its military strengths, and this could entail a new rocket or nuclear test. As ever, we warn that the real danger lies from a skirmish with the South escalating to a limited war as a result of miscalculation. Since the US is committed by treaty to South Korea’s defence, it must be ready to deploy hundreds of thousands of troops to the country in the event of war.

Yet whenever the US undertakes major military operations, it reduces the amount of domestic and international political capital and military resources available elsewhere. The ‘strange’ thing is that although Russia and China vigorously oppose US intervention in Syria, Moscow and Beijing would probably benefit from seeing Washington getting stuck in a new quagmire. China, in particular, would probably interpret US involvement in Syria as distracting Washington from its stated intent to ‘pivot’ towards Asia, something that Beijing – correctly in my view – regards as being aimed at counterbalancing China itself.

In addition to the above, the Senkaku/Diaoyu islands dispute between Japan and China is far from resolved. It remains a key flashpoint in East Asia, one that could drag in the US, since America is also committed by treaty to Japan’s defence.

Overall, events in Syria, Iran, and North Korea are all connected. Iran is Syria’s main ally in the Middle East, and maintains a degree of military cooperation with North Korea. The dynastic regimes in Pyongyang and Damascus have also developed friendly relations over many decades. If any of the three regimes were to collapse, for whatever reason, then it would be a psychological blow to the other two.

Olympus Has Fallen

On the subject of North Korea, this writer saw the film Olympus Has Fallen last night. When I first saw the poster of this film on the side of a London double-decker bus, I was adamant that I would not see it. The image of the White House aflame seemed clichéd to say the least. However, when I heard about the North Korean angle, it piqued my curiosity.

Olympus Has Fallen is essentially Die Hard in the White House, with elements of Air Force One thrown in. Basically, North Korean terrorists storm the White House during the US President’s summit with the visiting South Korean premier, and hold the US President as well as senior cabinet officials such as the Secretary of Defense hostage, while demanding that the US withdraws its forces from South Korea and handover codes for America’s nuclear weapons. The terrorists’ leader, Kang Yeonsak, wants to reunify the two Koreas, although it is somewhat unclear if he is acting independently of the North Korean government. Fortunately, a member of the President’s secret service team who knows the White House’s secret passages exceptionally well manages to ‘take out’ the terrorists one by one, a la Bruce Willis in Die Hard.

The film is entirely unoriginal, clichéd, outrageous, and preposterous (not to mention violent), and for these reasons I feel somewhat guilty for often finding it entertaining. Naturally, there are absurd moments, such as when a rogue US secret serviceman who has assisted the North Koreans in the siege tells the president that he was motivated by a hatred of ‘globalisation and Wall Street’. There are at least two bloopers, such as when chief terrorist Kang calls upon the US navy to withdraw from the Sea of Japan (Koreans refer to it as the East Sea), and when a television news banner states that ‘Southeast Asia on the brink of war’ when it means Northeast Asia. It is also fair to say that the characters lack… character. For example, both the hero and the chief villain lack the wit or personality of Bruce Willis and Alan Rickman in Die Hard. The film has also been criticised for its allegedly anti-Asian tone – indeed, there aren’t any sympathetic Asian characters.

Olympus Has Fallen is, by my count, the fourth big-release Western film to feature North Koreans as villains after Die Another Day (2002), Team America: World Police (2004), and the remake of Red Dawn (2012). It would be interesting to hear of how the regime in Pyongyang reacts to the film. Clearly, the film would be seen as an extreme form of American propaganda against North Korea (even though the Kim regime isn’t named). Nonetheless, the film also ‘credits’ North Koreans with remarkable operational capabilities, and thus, in a way, flatters them.

Postscript: The North Korean raid on the White House had a precedent, namely the North Korean attempt to attack the Blue House (South Korea’s presidential residence) in 1968. It failed, but dozens of people were killed in the incident.

It is evident to us that the Obama administration does not wish to get drawn into another major war in the Middle East, especially since North Korea and Iran are more pressing geopolitical issues. Also, there still appears to be a lack of consensus within the US intelligence community on whether chemical weapons were used. However, Obama may still come under pressure from US politicians to adopt a tougher stance towards the Assad regime, given that ‘American credibility may be on the line’, so to speak.

At this stage, it is unclear whether Syria is actually testing the US’s resolve or has made a conscious decision to pursue the use of chemical weapons as a matter of policy. Another theory is that a local commander may have acted on his own initiative (although this too would be worrying, since it would represent loss of centralised control). Either way, the situation merits closer attention.

Some opponents of US intervention argue that the only beneficiaries would be radical Islamist forces among the Syrian rebels, who would not in any way be grateful for American air support. Others argue that US (or Western) intervention is necessary precisely to bolster the secular-nationalist rebels vis-à-vis the radicals.

If the US were to intervene, then its ‘safest’ course of action would be to provide lethal weaponry to the rebels. The second-safest option would be to establish a no-fly zone over Syria or carry out airstrikes on the Assad regime’s pillars of support. This would certainly be safer than sending in tens of thousands of ground troops. However, even an air campaign would probably take a long time to deliver results. The NATO alliance bombed the Federal Republic of Yugoslavia for 78 days in 1999 before a political agreement to end the Kosovo conflict was reached. A lighter NATO air war in Libya in 2011 took much longer to overthrow Colonel Qadhafi. Furthermore, we reiterate that even if Assad is overthrown or killed, there would be no reason to expect peace in Syria. The country’s different groups could keep fighting for some time. Speculation that Syria could become a ‘new Afghanistan’, ‘new Iraq’, or ‘new Lebanon’, should not be dismissed.

While we remain broadly neutral towards Spanish stocks, which have been in a downtrend for the past five years, we believe a break above resistance at 8,400 for the IBEX index could signal an important change in investor sentiment towards Spain. On the other hand, a failure to break through would imply that investors’ fears over the country’s perilous macroeconomic position are still significant.

In similar fashion, German equities are signalling that the country’s economy could be facing a key inflection point, but we are not yet clear in what direction the next major move would be. Over the last month or so, the DAX has flirted with long-term resistance around 8,000, a break of which would send the index to record highs and represent a strong bullish signal for Germany’s medium-term growth and export story. However, the DAX may also be forming a triple-top formation pattern, which, if it plays, out would send it back towards 7,200 in the first instance, with plenty of potential for a move even lower. On balance we believe the story for a move lower is the most compelling, although we do not yet rule out the bullish scenario.

This Week’s Trivia Question

Last week’s question was fairly straightforward. We asked, which city’s police force recently added a Lamborghini to its patrol car fleet? Hint: it is a generally wealthy place currently recovering from a major property market-induced financial crisis a few years ago. And, which country was the previous one to add a Lamborghini to its police car fleet? The answer to the first part is of course Dubai, which has also just added a Ferrari to its police force. The answer to the second part is Italy. Unfortunately, the Lamborghini had to be written off after a collision.

Our question this week is as follows: which historical figure’s lock of hair was sold for EUR13,720 at an auction house in Vienna this week?

• We expect a consolidation in oil and industrial metal prices over the coming weeks. Further gains from recent lows are likely for commodities such as Brent crude, copper, and aluminium, as underlying macroeconomic fundamentals will remain relatively supportive for now.
• We retain our bearish medium-term outlook on industrial commodities and have revised our 2013 and 2014 average copper price forecasts to US$7,300/tonne (from US$7,700/tonne) and US$7,000/tonne (from US$7,300/tonne), respectively.
• Gold prices will be volatile in the coming months, and we do not rule out a temporary rally towards US$1,500/oz. Nonetheless, the recent collapse confirms our view that gold has peaked.
• Grain prices will trend lower over the coming quarters, although soybean prices will outperform.
• We expect a temporary bounce in several soft commodity prices in 2013, before the long-term downtrend resumes.

Our price forecasts for individual commodities, such as oil, natural gas, coal, various industrial and precious metals, and agricultural products, are available to subscribers at Business Monitor Online.

Our latest Afghanistan article is an opportune time to consider the ‘BLANK’ group of ultra-frontier economies – Burma (Myanmar), Laos, Afghanistan, and North Korea – we identified some years ago. As things stand, Myanmar probably looks the most promising, especially with the EU having lifted the last of its sanctions the other day. Laos is the least controversial BLANK economy, even though it is a one-party communist state. The latest news from there is that it appears to be proceeding with a high-speed railway that will connect it with China – although as we mention in our online service, the US$7.2bn cost will probably outweigh the benefits.

Among the remaining two BLANK economies, it is hard to say which is in a worse position – Afghanistan or North Korea. North Korea at least has a semblance of stability, an educated and disciplined workforce, and considerable homogeneity (which means less risk of interethnic conflict), but if or when it collapses, it could land very hard. Yet, once North Korea lands hard, it would probably receive massive financial assistance from South Korea, Japan, the US, China, and Russia, paving the way for its long-term revival and eventual convergence with the South (albeit after decades). It is hard to see Afghanistan being that successful.

Naturally, it is tempting to be very downbeat towards failed or semi-failed states. However, Somalia – arguably the world’s most consistently chaotic state over the past 20 years – has shown signs of improvement of late, with money pouring in from abroad. In fact, the shilling currency has appreciated sharply, threatening the recovery. If even Somalia can show a semblance of recovery, then other war-torn states could too.

Full coverage of frontier economies, including the ones listed above, is available to subscribers at Business Monitor Online.

We continue to believe that global rebalancing pressures will cause a secular shift in the export dynamics of the major Latin American economies in the coming years.

The metals producers in the region are, by and large, set for a painful readjustment. Indeed, in the last decade, Peruvian, Chilean, and Brazilian export growth was buoyed substantially by robust Chinese demand. With China’s growth story winding down, this will feed through to weaker export growth for the major metals producers.

Elsewhere, despite Venezuela’s devaluation of the bólivar, and our expectation that Argentina will devalue the peso this year, we do not believe this will be sufficient to head off a moderation in their export growth over the long term. In Venezuela, the devaluation will have little effect, given that dollar-denominated oil exports comprise the vast majority of the country’s total outbound shipments and given the underinvestment resulting in falling production. In Argentina, while the peso’s anticipated devaluation will see exports recover somewhat, grains prices will remain below the past decade’s highs, and the effects of major erosion of productive capacity will linger.

By contrast, Mexican exports look set to surge in the coming decade. Rising wages in China have seen Mexico’s manufactured goods become increasingly cost-competitive in the last year. Combined with a fairly attractive business environment and recently passed reforms, this will bolster export growth over a multi-year timeframe.

Our full article on Latin America’s export prospects over the coming decade, as well as broader political, economic, financial market, and industrial sector coverage of Latin America, are available to subscribers at Business Monitor Online.

The epidemic is likely to have an impact on China’s soybean demand and imports in the coming months, putting downward pressure on global soybean prices. Indeed, China typically imports almost two thirds of the world’s traded volume of soybean and is a key driver of prices. The spread of the virus amongst the country’s poultry farms could prompt the government to swiftly step up its measures to contain the disease and order massive culls, dragging down livestock production prospects and ultimately reducing soybean demand and imports in 2012/13 and 2013/14. In fact, soybean consumption and import growth slowed in 2003/04 and 2006/07, following outbreaks of the H5N1 virus in 2004 and 2006. More specifically, a severe epidemic in early 2004 that hit the whole Asia region saw an aggressive response by the Chinese government, which ordered the culling of 120mn chickens (or around 1.5-2.0% of the total domestic chicken headcount) and the quarantining of farming areas.

Even if the virus is quickly contained, lower consumer confidence in poultry products is likely to reduce poultry meat consumption, prompting farmers to reduce headcounts. The overall impact on China’s feed demand could be all the more significant for soybean prices given that the bird flu outbreak follows an incident in March in which thousands of dead pigs were found floating in Shanghai’s main river. This has already reduced Chinese consumers’ trust in domestically produced meat and sent pork prices down 14% in less than a month.

Fundamentally, the soybean market remains the tightest among other grains. As a result, we believe soybean prices will remain supported in the medium term in spite of potentially lower than expected imports from China. Depleted stocks and delays to the South American harvest reaching export markets are likely to maintain the global market in a very small surplus of 300,000 tonnes in 2012/13. Beyond that season, subdued production growth in major soybean producers and the rebound in China’s soybean demand resulting from the recovery in the livestock sector will prevent the market from returning to significant surpluses, dragging down stocks-to-use ratios in the coming years. This underpins our view for prices to average higher in 2013 compared with 2012, at USc1,480/bushel, and to remain elevated in 2014, averaging USc1,450/bushel over the year.

Further analysis of Asia’s agricultural sector is available to our subscribers in our Commodities service in Business Monitor Online.

This Week’s Trivia Question

Our previous trivia question was about Somalia. Our questions were, which relatively famous Somali played a character that tried to kill Captain Kirk in one of the later Star Trek films? And, on a semi-related note, which short-lived US TV series of recent years had an episode in which one of its main characters, who was played by an actor who plays a colleague of Captain Kirk elsewhere, visits a remote region of Somalia? (Hint: the actor was born in a country that is currently being threatened with war by its much poorer neighbour.)

The answer to the first part of the question is the model Iman, who was born in Somalia, and played a shape-shifting alien in Star Trek VI. The answer to the second part is the ill-fated TV series FlashForward. In one particular episode, several characters visit Somalia to investigate some mysterious pylons believed to be able to cause mass blackouts of crows and people. One of the main characters was played by John Cho, a South Korean-born actor who plays Mr Sulu in the new Star Trek films.

This week’s question is much more straightforward: which city’s police force recently added a Lamborghini to its patrol car fleet? Hint: it is a generally wealthy place currently recovering from a major property market-induced financial crisis a few years ago. And, which country was the previous one to add a Lamborghini to its police fleet?

But why would Chechens want to target the US?

The Chechen war for independence from the Russian Federation began as a nationalist struggle in the 1990s, but because Chechens and many other ethnicities in the North Caucasus are Muslim, the movement gradually attracted the support of radical Islamists from the greater Middle East. As the Russian onslaught on Chechnya intensified, and the Chechens became more desperate, it is thought that many became radicalised.

Although President Vladimir Putin’s administration was eventually able to subdue Chechnya, mainly by co-opting Chechen fighters who had become disgruntled with the Islamisation of their struggle, the Kremlin never really managed to restore peace in the North Caucasus. In fact, other republics in the region such as Dagestan, Ingushetia, and Kabardino-Balkaria have succumbed to a low-level Islamist insurgency in recent years.

If the Boston marathon bombing was indeed caused by individuals from Chechnya or the North Caucasus, they were likely radicalised by globally-minded Islamists inspired by al-Qaeda.

Aside from the US tightening its domestic security arrangements, Russia will also be more vigilant. The next Winter Olympic Games are to be held in Sochi in early 2014, and Sochi is in the region of the North Caucasus. It is highly likely that Islamist militants will seek to disrupt the event, which is a major prestige project of President Putin himself.

The potential of geothermal is undeniably huge and, if successfully developed, it could significantly boost economic growth and help ensure long-term energy security in East Africa.

That said, although the geothermal industry is receiving a great deal of support from development banks and other international organisations, we believe funding insecurity remains a key risk and could hinder the sector’s development in the short to medium term.

East African Geothermal Energy Potential. Lighter/Darker shading = Lower/Higher potential.

Full analysis of the global renewable energy industry is available to subscribers at Business Monitor Online.

Prior to the election of Mrs Thatcher’s Conservative government in 1979, the UK telecommunications system was in much the same condition as in every other country around the world. Part of the century-old postal service, it was a state-run utility, financed by tax- and bill-payers, operated via ageing infrastructure that had last benefited from investment and modernisation during the mid-1960s. The utility was an inefficient, over-staffed, loss-making operation that was more of an economic drain than a boon.

Under Thatcher’s watch, the telephone business was spun off as BT in 1981 and privatised in stages between 1984 and 1993, while the international cable company Cable & Wireless was also privatised in 1981 and given a licence to provide fixed telephony services in competition with the incumbent. Despite the opportunities, C&W’s Mercury had a short life, but the lessons learned from its short existence informed the thinking of other governments worldwide, when contemplating the dismantling of a state monopoly and the introduction of competition. Japan deregulated its telecoms in 1985, the US Bell System was broken up in 1984 and Hungary’s Magyar Posta was privatised in 1989. The list goes on.

The mobile phone turned 40 earlier in April, but it was not until 1982, when Racal Vodafone was awarded the first commercial mobile network operator licence in the UK – to compete with BT, naturally – that the impetus to refine and develop the technology for mass market purposes came about. The model of licensing competition, establishing fair business practices such as open access and separate and transparent retail/wholesale service models, governed by an independent regulatory body, has its foundation in Thatcherite policies. And it has been replicated globally since then. There are now well over 1,000 notable mobile operators worldwide.

It is estimated that there were 6.4 billion mobile phone subscribers worldwide at the end of 2012 (nearly one phone for every person in the world), up from 700 million in 2000. Of that number, 1.6 billion were mobile-broadband users, up from almost zero (depending on the definition of what constitutes mobile broadband) in 2000. Meanwhile, the number of fixed telephone lines is generally declining, although numbers are being propped up by voice over broadband accesses, often provided by the kind of cable TV operators that were first allowed into the telecoms sector towards the end of the Thatcher era.

To reach the largest possible audience, services increasingly have to be affordable, devices need to be more multifunctional, and service providers need to be increasingly competitive, yet still answerable to dedicated regulatory and competition watchdogs. All the while, governments can benefit through increased income taxes from operating companies, and increased business and efficiencies derived from the application of modern communications systems.

The Thatcher modus operandi, which centred on aggressive privatisation, had – and still has – its critics in political, economic and business circles. But with frontier markets in Asia (Myanmar), Europe (Kosovo), the Middle East (Lebanon, Libya, and Syria) and Africa (Eritrea) still beginning to open up to competition, it is a template that is still being followed.

Without the pioneering efforts of the early Thatcher government, it is possible that it would have taken longer to turn a dull utility service into the cutting-edge, consumer-driven industry that we have today.

Raw Deal

As things stand, it is far from clear that Maduro will be able to serve out his six-year term to 2019. He will inherit a highly dislocated economy marked by the recent devaluation of the bolívar, above 20% inflation, high levels of goods scarcity, and a record high government fiscal deficit. Maduro’s narrow lead was based on his close association with the late President Hugo Chávez before and after his death in March. I expect this factor to be gradually replaced by Maduro’s handling of Venezuela’s severe economic challenges. Consequently, Maduro’s popularity will probably decline significantly.

Red Heat

This increases the probability of an internal struggle for power within the ruling PSUV party, particularly between Maduro and the hardliners headed by National Assembly President Diosdado Cabello, who holds significant influence over the armed forces. Any indication that Maduro’s declining support would jeopardise the continuity of the PSUV’s dominance could trigger an intervention by Cabello’s faction.

Total Recall

Capriles’s demands for a full vote recount, if successful, would likely reveal an even closer presidential race than the preliminary results show, as votes from abroad are incorporated and electoral irregularities are exposed. We believe this would further motivate the opposition to demand a recall referendum, an option the opposition pursued in 2004 against Chávez, albeit unsuccessfully. Indeed, under article 72 of the constitution, once the first half of the presidential term elapses, the opposition may petition a recall referendum with signatures from 20% of registered voters. While the probability of a successful recall referendum by the opposition has increased significantly since 2004, under such scenario, we would not rule out an intervention by the PSUV hardliners to negate the possibility of an opposition presidency.

Full coverage of Venezuela’s political scene, economy, financial markets, and key industries is available to subscribers at Business Monitor Online.

The dramatic sell-off since last Friday, April 12 has been catalysed by a break of key technical support at US$1,520/oz.

Gold Prices, US$/oz

We expect that trading will be volatile, but the key point is that gold has peaked. We revised down our average gold price forecast for 2013 to US$1,575/oz on April 12, but could be forced to lower this further in the coming weeks, once the dust settles.

This bolsters our constructive view towards the US dollar.

From a sectors perspective, we see significant risk to the capital expenditure plans of major mining firms that had been pencilled in for the coming years. For areas such as Central America, where significant gold mining investment had been planned, expectations will likely have to be tempered.

Similar charts can be seen for JPY/US$ and JPY/GBP, although the relative balance sheet move is slightly more pronounced for the ECB, whose assets have been contracting for months, as some of its liquidity assistance programmes recede. While a large move has already occurred, the BoJ’s doubling of monthly purchases beginning in May (to JPY7.5trn) suggests that this ratio can go further, and potentially much further.

This led us to look at long-term yen crosses, which are showing staggering potential for further upside, and the sky is the limit for yen weakness, technically at least. Sterling-yen looks like it can go to JPY200.00/GBP in the quarters to come, from JPY153.00/GBP at present. Absent a move lower in sterling versus the US dollar, this would imply a dollar-yen exchange rate of JPY133.00/US$. While this is hard to imagine at this point, the technical outlook seems bleak for the yen indeed. Beyond JPY200.00/GBP, there is little support until JPY250.00/GBP. We will be watching these charts closely for future direction, as they may be spelling a severe dislocation in Japanese (and by extension global) markets.

Mozambique Emerging As Regional Power Player

Elsewhere on Business Monitor Online, we examine Mozambique’s role as an emerging power hub for southern Africa. The country is looking well positioned for this role, owing to its already high total installed capacity (relatively speaking compared with its African peers), the projected robust growth in power demand over the coming decade, and the reasonably strong coal, gas, and hydropower plant project pipeline. That said, there are still a number of risks that are likely to delay these expansion plans, such as the government’s unwillingness to fully liberalise the power sector, and feedstock-related issues. There are also security risks. The first week of April 2013 saw attacks blamed on rebel group-turned-opposition party Renamo, which could threaten recent political stability.

This Week’s Trivia Question

Last week, we asked, which currency has apparently doubled in value against the US dollar over the past six months, due to a big influx of funds from expatriates? The hint was that the country is recovering from a long period of conflict. The answer, interestingly enough, is the Somali shilling, as explained in this Al Jazeera clip.

This week, we are sticking with the theme of Somalia. Our questions are, which relatively famous Somali played a character that tried to kill Captain Kirk in one of the later Star Trek films? And, on a semi-related note, which short-lived US TV series of recent years had an episode in which one of its main characters, who was played by an actor who plays a colleague of Captain Kirk elsewhere, visits a remote region of Somalia? (Hint: the actor was born in a country that is currently being threatened with war by its much poorer neighbour.)

Europe: We continue to see a massive divergence between the outlooks for Western and Eastern Europe’s steel sector over the coming years. Germany, France and Italy will see subdued growth in steel demand due to negligible or weak GDP growth rates and a lack of construction activity, while production will remain muted on the back of low steel prices. The situation is almost diametrically opposite in Russia and Turkey, as the two countries embark on significant infrastructure and construction projects. Regarding production, both countries have major projects on the horizon, and despite the availability of cheap imports of Chinese steel, domestic producers are best placed to benefit.

Americas: In the Western hemisphere, major Latin American steel producers in Brazil and Mexico should see strong steel demand growth as infrastructure and construction growth rates exceed those of North America. Both countries will also see strong automotive production growth rates, particularly Mexico. The US and Canada will meanwhile see tepid demand, although we still expect positive real growth this year and the next. Performances among US steelmakers have diverged in recent years, with some firms hurt more by higher input costs and cheap Chinese imports than others. We expect this gap to continue during our five-year forecast period.

Next week, we will be publishing our outlook for the Asian steel industry.

But, the election of Margaret Thatcher as Britain’s prime minister in May 1979 was one of a series of transformational events that year that have a lasting significance to this very day.

China: One of the biggest questions the world faces today is whether China will reform itself, economically and politically, to become an advanced nation. The year 1979 was pivotal for China for several reasons: 1) it was the first year in which China embarked on free market reforms under ‘Paramount Leader’ Deng Xiaoping; 2) it was the year that China established diplomatic relations with the US; and 3) it was the year that China adopted its one-child policy. These three developments shaped the Chinese economy for the next 30-plus years. How the new administration of Xi Jinping handles these three issues – economic policy, relations with the US, and demographics – will determine whether China succeeds or fails.

Iran: The Iranian Revolution of 1979 was a pivotal event for the Middle East, turning a once reliable ally of the West into a fiercely anti-Western state. The American embassy hostage crisis that began in November that year contributed heavily to the defeat of Jimmy Carter in the 1980 US presidential election. International concerns about Iran’s nuclear programme largely stem from the revolutionary zeal with which Iranian leaders condemn Tehran’s enemies. The Islamist regime has repeatedly defied its critics’ expectations of its imminent demise. Nevertheless, we find it hard to believe that the regime will continue in its present form for another decade. Eventually, Iran will change, and when this happens, it will transform the Middle East.

Iraq: In July 1979, Saddam Hussein formally assumed the presidency of Iraq (previously he was vice-president, but de facto president). His ascension would set the scene for three major wars, the third of which resulted in his overthrow. Iraq today is still recovering from Saddam’s legacy.

Egypt-Israel: 1979 was also the year that Egypt signed a peace treaty with Israel, thereby reducing the threat of more Arab-Israeli wars. Israel would still face significant security threats, but the treaty with Egypt effectively broke the back of the radical Arab nationalist camp led by Cairo. The durability of the peace treaty is one of Israel’s biggest concerns today, along with the prospects of a nuclear Iran.

Afghanistan: In July 1979, US President Jimmy Carter initiated a campaign to support forces opposed to the Communist regime that had seized power in Afghanistan the previous year. Carter’s action prompted the Soviet Union to invade in December 1979. This led to a decade of war (1979-1989), a decade of chaos (1989-2001), and a further decade of war (2001-present). Although the Afghan war has faded somewhat from the newspaper headlines, the country’s future after the US withdrawal in 2015 will have a significant impact on the development of Pakistan and Central Asia.

Although many individual years seem ‘pivotal’ in retrospect, we are hard pressed to think of years in the late 20^th century that have had such a big impact as 1979 (the obvious other one being 1989).

• What would a limited war look like?
• How far would the North be willing to go in the event of war?
• Would the US come to South Korea’s defence?
• Would the US and South Korea counter-invade the North?
• How strong is morale in the North Korean People’s Army (KPA)?
• Would nuclear weapons be used in conflict?
• How would China react to a new Korean conflict?
• How would Russia respond?
• How would Japan respond?
• What would be the economic consequences of a Korean war?
• How would a second Korean war end?

Our 2,900-word article is a must-read for anyone even remotely affected by rising tensions on the Korean Peninsula, and interested in the implications of a new conflict for the wider region.

We outline the reasons for this in more detail in Business Monitor Online.

At this juncture, the spot gold price offers up such a chart. Gold is likely to find technical support in the short term in the US$1,520/oz area. However, any break below this level could well trigger a major correction, leading to a medium-term unwind of many of the gains witnessed over the past decade.

The potential downside for gold would tie in with a very strong upward move in the US dollar in the months and years to come, as suggested by the historic record of dollar bull runs (1980-1985 and 1995-2001), which occurred alongside weakening gold. Therefore, should this move happen, it would very coincide with our ongoing and long-held bullish view of US equities, which recently broke to all-time highs, as well as our positive stance towards the US economy and the dollar. This would also correspond with our long-held view that developed market stocks will continue to outperform emerging market stocks over a multi-year horizon.

Myanmar Currency Depreciation Ahead

Meanwhile, BMI has published its latest forecasts for the Myanmar kyat currency in our online service and in our weekly Emerging Markets Monitor magazine. The kyat has weakened by 2.8% since the beginning of 2013, and we see little reason for this trend to reverse itself in the near future. Indeed, the kyat remains a somewhat expensive currency in view of prices within Myanmar’s key economic hubs (particularly Mandalay and Yangon), and government and central bank officials have repeatedly issued statements indicating their preference for the unit to weaken further. We therefore expect the kyat to end 2013 slightly weaker at MMK904/US$, compared to MMK880/US$ today.

As we saw in other countries that witnessed a rapid and sudden increase in foreign direct investment (FDI) after opening their doors to the global economy (such as Vietnam in the early 2000s and Mongolia in 2007), Myanmar’s current account will likely fall into deficit over the coming years as capital and consumer goods imports soar on the back of strong economic growth.

While much of this deficit will be financed by FDI, the net effect on the kyat will nevertheless be negative. As such, we are forecasting moderate depreciation of the currency, averaging 3.0% per annum through to 2018.

Risks to this forecast are to the downside. In the event of a global economic shock, Myanmar would likely witness a substantial retrenchment in FDI inflows, while the current account deficit would likely remain stubborn. Furthermore, Myanmar is still fraught with considerable political risks, and a misstep by the government in the management of these risks could prove catastrophic for the country’s nascent economic reform drive.

Investors who are looking to enter the Myanmar market but are unsure of the interplay between the country’s political and economic risk environments should find our article useful. Further analysis of Myanmar can be found in our Cambodia, Laos, and Myanmar Business Forecast Report and in our online service.

BMI Forecasts Other ‘Exotic’ Currencies Too

BMI has a long history of tracking and forecasting ‘exotic’ currencies, that is to say, the currencies of frontier markets. On our website, subscribers can access forecasts for currencies such as the Armenian dram, Guatemalan quetzal, Haitian gourde, Iranian rial, Mozambican metical, Ugandan shilling, and Uruguayan peso, among others, as well as more ‘mainstream’ emerging market currencies and, of course, the majors. We kid you not.

This Week’s Trivia Question

Our previous trivia question had an Easter theme. We asked, which prolific spy thriller author wrote a novel in the 1970s that ends with the revelation that Jesus did not die on the cross, but was in fact substituted by another prisoner? And, along similar lines, which Asian country has a small town that claims to have the ‘Tomb of Christ’? The answer to the first part is Robert Ludlum (best known for The Bourne Identity and follow-ups, and the book in question was The Gemini Contenders (1976). The answer to the second part is, intriguingly, Japan.

For this week’s question, we are sticking with the theme of obscure currencies. Which currency has apparently doubled in value against the US dollar over the past six months, due to a big influx of funds from expatriates? Hint: the country is recovering from a long period of conflict.

In a special feature published in Business Monitor Online this week, we examine the position and prospects of Mexico’s central states within the broader economy. There are two key points we think are worth highlighting:

1: The manufacturing sector is set to boom in Central Mexico: Northern Mexico has long been the manufacturing heartland of the country, benefiting from proximity to the US market. However, we believe that the central region is set for substantial manufacturing sector growth in the coming decade for several reasons:

• First, it has increasingly strong transport links, allowing for easy export of goods to both US and other foreign markets.
• Second, given the higher population density and proximity to the wealthy Federal District, manufacturers are likely to want to set up in the region to take advantage of a growing Mexican domestic consumer market.
• Third, the central region is cost-competitive, with wages tending to be lower than the north, and a number of the central states having aggressively been offering incentives (such as tax breaks) to manufacturing firms to set up shop.
• Finally, we have already started to see the beginning of a clustering effect in some of the country’s larger industries, especially autos and auto parts. This in itself is likely to draw other firms, so that by the end of our 10-year forecast period, we believe the centre of Mexico could be a manufacturing hub to rival the north, bolstering growth in the region.

2: Southern Mexico will remain economically stagnant: In contrast to our more sanguine view for Mexico’s central region, the south looks set to continue struggling economically.

Mexico has long had a substantial divide between the wealthier north and poorer south, with the southern states lagging their northern counterparts in almost all indicators measuring socioeconomic and human development.

This phenomenon looks set to continue over the coming decade, given the region’s limited political sway and considerable structural obstacles to greater foreign investment, such as a poorer population, less educated work force, and weaker infrastructure.

But does North Korean leader Kim Jong Un really want war?

Despite the extreme rhetoric, most observers, including BMI, do not believe that Kim actually wants war. Although the North Korean People’s Army (KPA) is the fifth-largest in the world with 1.1mn troops and is very heavily armed, most military experts deem its equipment to be outdated and qualitatively inferior to the US supplied and supported South Korean armed forces. The general consensus is that while the KPA could cause severe devastation to the South in the event of all-out war, the South, backed by the US, would repel the North and then go on the offensive against Pyongyang, ultimately overthrowing the regime.

We subscribe to this consensus.

However, we also caution that while North Korea may not wish for war, it will occasionally seek to carry out provocations against the South, such as the sinking of the Southern warship Cheonan in March 2010, and a barrage on the Southern island of Yeonpyeong in November of that year. The two incidents caused the deaths of 50 South Koreans.

Amid current tensions, we see a realistic possibility that Pyongyang may carry out a similar deadly attack, and that unlike previous occasions, Seoul would respond militarily. From our point of view, the South’s retaliation could cause the North to counter-retaliate. This could lead to a major battle on land or at sea that causes hundreds or even thousands of deaths before both sides backed down.

Extreme Rhetoric Mainly Aimed At Home Audience

In our view, North Korea’s extreme rhetoric is mainly aimed at domestic audiences, and is designed to boost Kim Jong Un’s credentials as a military leader. The official state media’s report on a March 29 half-past-midnight meeting between Kim and top generals would seem to confirm this. Moreover, Washington and Seoul have stated that they have seen no signs of unusual military activity in the North to suggest a move to war footing.

We consider Pyongyang’s threats to launch nuclear-tipped intercontinental ballistic missiles against US targets as highly unrealistic, because the KPA is not believed to have perfected the miniaturisation of atomic warheads and the missile technology capable of delivering them across such distances. In any case, the US would retaliate with its own nuclear weapons.

Finally, if North Korea were serious about carrying out a major attack or general war, it would not have raised its rhetoric so dramatically, for it would have lost the element of surprise by making the South and the US even more vigilant than usual.

Nevertheless, we also believe that the extreme rhetoric currently emanating from the North is intended to intimidate South Korea, the US, and Japan, to signal its displeasure at tightened UN sanctions and military exercises. By raising its rhetoric to such levels, Pyongyang is putting its enemies on edge, making them wonder whether it might indeed be serious ‘this time’.

Economic Reform Plans Still Unclear

Against this backdrop of heightened tensions, the annual session of the North’s Supreme People’s Assembly on April 1 appointed ex-premier Pak Pong Ju to his old post, and replaced two vice-premiers and several cabinet ministers. The reshuffle is interpreted as presaging an acceleration of economic reform, because Pak is associated with the North’s tentative free market experiments in the early 2000s during his previous stint as premier (2003-2007).

However, because all key policy decisions rest with Kim Jong Un and his immediate circle, which includes his uncle Jang Song Thaek, aunt Kim Kyong Hui, and top generals, Pak is unlikely to enjoy a free hand at reform. Although BMI strongly believes that the North wishes to modernise its economy, the country has so far failed to meet three minimum conditions for this: firstly, the regime must sharply reduce military spending so that more resources can be diverted to the civilian sector; secondly, the North must reduce tensions with the South and the US so that economic ties with them improve; and thirdly the regime must show a willingness to pursue and stick with reforms even if they prove to be destabilising. As things stand, none of the three conditions are close to being met.

Economic reform is still possible through small, gradual steps enacted over a long period of time. However, given that most emerging economies are modernising much faster than North Korea, there is a risk that the country will fall further behind Asia’s frontier markets, all of which have superior business environments.

Full coverage of the Korean crisis is available to our subscribers at Business Monitor Online.

As we enter the second quarter of 2013, the immediate political risks facing the world are renewed concerns about the eurozone in light of Italy’s political deadlock and Cyprus’s financial crisis, a possible clash on the Korean Peninsula, and, to a far lesser degree, the presidential election in Venezuela.

As the year progresses, we expect attention to turn to several key elections, with September being an especially busy month due to voting in Australia, Germany, and Austria in quick succession.

Other countries holding important elections include Iran (presidential), Japan (Upper House), Argentina (legislative), and Azerbaijan and Georgia (presidential).

As regards international conflict risks, we remain vigilant towards the possibility of an Israeli attack on Iran in the second half of 2013 if Iranians elect a hardliner as president in June and if Tehran shows no flexibility over restraining its nuclear programme. We are also keeping a close eye on the Sino-Japanese territorial dispute over the Diaoyu/Senkaku islands in the East China Sea, the situation in Mali, and of course the civil war in Syria, which could intensify as the rebels close in on Damascus.

Our Global Political Outlook covers hotspots such as:

The eurozone, Korean Peninsula, Iran, Syria, and Asia’s maritime disputes

It also includes commentaries on the political outlook for the following countries:

Americas: The United States, Venezuela, Argentina, Chile, and Brazil

Europe: Italy, Germany, Austria, Bulgaria, Turkey, Russia, and Georgia

Middle East and North Africa: Egypt, Iran, Tunisia, and Yemen

Africa: Mali, Nigeria, DR Congo, Kenya, Zimbabwe, and South Africa

Asia: China, Japan, the Philippines, Malaysia, Pakistan, Australia, and India

We also include a list of potential ‘wild card’ events.

Finally, our global outlook also features a table listing most major countries’ elections between now and the end of 2014, including their dates, main political parties and contenders, BMI‘s expected outcome, and BMI‘s short-term political risk ratings. Our full Global Political Outlook, which is 8,700 words, is available to subscribers at Business Monitor Online.

The Rationale For A ‘BRICS’ Bank

There are three main factors:

• The World Bank and IMF were created in 1944, before World War II ended, and they remain Western-dominated. China, Russia, Brazil, and India want a greater say in global financial institutions, and if the existing ones do not accommodate them sufficiently, these countries will set up their own.
• BRICS countries can now afford to set up a new global development bank, with US$4.4trn of foreign currency reserves (US$3.3trn of which is owned by China). Most of them also have experience dealing with financial crises (their own).
• BRICS states are generally becoming more assertive in defending their interests, and perceive themselves to be emerging or re-emerging world powers.

Reports suggest the proposed BRICS Bank would be focused on infrastructure development. However, there is speculation that there will be a pool of foreign currency reserves for the purposes of rescuing countries from financial crises. Assuming a BRICS Bank gets going, it is unclear whether it would impose the same tough criteria on borrowers as the World Bank and IMF.

Potential Obstacles To BRICS Bank’s Management

The biggest challenge will be determining which country has the greatest say in how the bank is run. The main obstacles to collective action by BRICS states are as follows:

• Geopolitics: Russia and China are geopolitical rivals, as are China and India.
• Divergent economic interests: The BRICS states vary hugely in their wealth, development levels, financial resources, trade dynamics, etc.
• Lack of ideological coherence: The BRICS states also differ considerably in their politico-economic systems.

All of the above means any BRICS Bank would be riddled with internal tensions, which could limit its cohesion and effectiveness. In any case, countries like China and Russia could still provide direct assistance to other states outside the framework of a BRICS Bank.

• From the beginning of the conflict in Syria, Assad’s regime has maintained a much higher proportion of military forces in Damascus, the west, and the south, than in Syria’s northern or eastern provinces. This force disparity has resulted in the contraction of territory held by the regime, which has accelerated in recent months.
• The regime’s inability to control all of Syria originates from Assad’s strategy of deploying only the most trusted military units in combat. What remains of the Syrian army is comprised mostly of committed regime supporters. If the regime loses Damascus this year, which is certainly possible, key units are unlikely to surrender to the enemy, and would maintain control of vast areas in the west and the south.
• We are sceptical that the opposition has the capabilities to take over the entire country any time soon. Barring a dramatic increase in the inflows of offensive weapons to the insurgents, their firepower will likely remain inferior to that of the regular army. Moreover, divisions within the opposition remain deep-seated, undermining its ability to undertake coordinated military action.

We see two major potential game changers at this stage:

• Chemical weapons: Rocket strikes hit Aleppo and Damascus last week, which appear to have involved chemical weapons. Syria’s government and opposition have blamed each other, and both sides called for an inquiry into the attacks. Under a scenario whereby the international community believes that the strikes involved chemical weapons, and such accidents become more frequent, the potential for direct Western intervention could increase.
• Uptick in foreign military aid: Indirect support to the opposition has increased significantly in recent months, with the US saying for the first time in March that it would provide direct, non-lethal aid, while Britain and France declared that they are prepared to arm Syrian rebels even without unanimous EU support. If there is a dramatic uptick in military aid, involving lethal and non-lethal weapons, the opposition could gain the upper hand. However, it is worth remembering that the regime will continue to receive support from Russia and especially Iran.

Our medium-term core view on the Syrian conflict is as follows:

• The regime will remain resilient, even if Damascus falls.
• A divided opposition will be unable to effectively manage the political transition in the territories it controls.
• The civil war will continue, with increasing involvement of Iran, Hizbullah, Turkey, Western and Arab countries, and Russia as proxy players.

To be fair, markets appear to have largely shrugged off concerns about the broader eurozone implications of Cyprus’ financial crisis. The euro has weakened, but it is holding onto key support around US$1.28-1.29/EUR. In addition, there has been a relative lack of panic in eurozone periphery sovereign bond markets, with Spanish and Italian 10-year yields actually looking as if they could head lower after a brief spike in the aftermath of the Cyprus bailout announcement.

All these trends suggest investors believe potential contagion from Cyprus’ banking crisis is minimal. This chimes with our own view that, while indicative of bureaucratic inertia at the eurozone level, the bewilderment created by the Cypriot bailout has limited implications for how policymakers are likely to deal with future bailouts.

We believe that, rather than Cypriot banks, the current political deadlock in Italy represents the biggest near-term threat to eurozone stability and the medium-term euro trajectory. We therefore remain sceptical of the sustainability of the peripheral debt rally.

This Week’s Trivia Question

Last week’s question connected the Yugoslav and Chechen conflicts. We asked which American actor starred in both an early 2000s Hollywood film about the rescue of a downed American airman from Serbian-controlled Bosnia and a 1990s fictionalised portrayal of a US-Russia nuclear stand-off over the former’s support for Chechen separatists. (Hint: the actor’s character had a similar occupation in both films.)

The answer is Gene Hackman, who played an American admiral in Behind Enemy Lines (2001) and a nuclear submarine captain in Crimson Tide (1995).

This week’s question has an Easter theme. Which prolific spy thriller author wrote a novel in the 1970s that ends with the revelation that Jesus did not die on the cross, but was in fact substituted by another prisoner? And, along similar lines, which Asian country has a small town that claims to have the ‘Tomb of Christ’?

Accelerating consumption: Brazil and Colombia

In Brazil’s case, the acceleration in private consumption is mostly due to base effects following a weak 2012. However, Colombia offers a much more compelling consumer story, driven by robust macroeconomic fundamentals, rising disposable incomes, and a strong currency.

Moderating, yet robust consumption: Chile, Peru and Mexico

Chile and Peru will see private consumption growth moderate this year. Weaker growth in China in H2 2013 will mean a fall in metal exports, and this decline will feed through to Latin consumption. In Mexico’s case, monetary easing will support consumption, and strong macroeconomic fundamentals paint an attractive consumer story for the next few years.

Weakened consumption: Argentina and Venezuela

In Venezuela, the devaluation of the bolívar currency in February will weigh on purchasing power. In Argentina, we expect a currency devaluation later this year, which will have a similar impact on the consumer as in Venezuela.

Full analysis of Latin American economies is available to subscribers at Business Monitor Online.

A similar situation played out – unchecked – in the Netherlands last year. KPN suspended dividends while Vodafone and T-Mobile’s share prices were hit badly, too. Already there is talk of passing costs on to the consumer in order to ensure adequate return on investment. Dutch operators may forego extending services into rural areas. This runs counter to the aim of increasing competition and consumer choice. That’s why the Czech government stopped the bidding. They will have another go at auctioning the spectrum once they figure out what went wrong and what tools can be used to prevent irrational bidding.

The spectrum in question – mainly the 800 MHz and 1,800 MHz frequencies – is highly desirable because signal propagation is better at lower bandwidths than the higher frequencies already auctioned for 4G purposes. The better the propagation, the fewer transmission towers you need to build and the better your profit margins.

Governments want to get as much as they can from spectrum sales as this is a cash windfall that can prop up an ailing economy. Witness the disappointment that UK operators bid conservatively in the recent 4G spectrum auction, leading to a shortfall in the government’s planned income for the year. While we are encouraged that the Czech authorities had the courage to intervene, it does bring into question the way in which spectrum is priced. The problem is that existing players already own spectrum in varying amounts and in diverse bands: acquiring additional resources to ‘fill the gaps’ means their valuations will vary considerably, and it is imprudent for regulators to decide what is a ‘safe’ limit on pricing.

This is a hot topic at the moment, and we have covered spectrum auctions nearly every day in Business Monitor Online over the past fortnight. Many investors are concerned about the spectrum allocation processes and resource valuations. They understand the need for operators to future-proof their businesses to cope with projected growth of non-voice (data) traffic but, they also fear that excessive investment in spectrum will weigh on profitability for years to come. And they’re right to be worried, given that there is then the additional cost of building networks to support the new services.

However, not playing the bidding game is equally foolhardy from a business development perspective. That’s why we expect strong interest in upcoming spectrum auctions in Slovakia, Slovenia, Austria and other markets, despite tepid market growth expectations.

The Iraq War was a landmark event for the US and the Middle East, and the tenth anniversary of its commencement is an opportune time to assess its legacy.

It may be still ‘too early to say’ what that legacy is, to paraphrase former Chinese premier Zhou Enlai in 1972 with reference to the Paris riots of 1968. Nevertheless, in a special feature published in Business Monitor Online today, we identify the biggest consequences of the Iraq War as things presently stand. We also identify ‘winners’ and ‘losers’. We use quote marks, because these terms are subjective and potentially ephemeral.

One of the greatest difficulties in assessing the legacy of a historical event is that the observer must not only compare the present world with the status quo ante, but also the world as it would have been had the event in question not taken place. In other words, like the characters in the American TV drama ‘Lost’ in Season Six, we must ‘flash sideways’.

This is not an easy task.

Below are some of the takeaways from our feature article:

US (loser): Although the US swiftly overthrew Iraqi President Saddam Hussein, the war has taken a heavy toll on America in terms of thousands of troops and contractors killed, tens of thousands injured, and many suicides. There has also been a tremendous financial cost, and a loss of US prestige and popularity – at least initially. The US has also proved unable to set Iraq on a firmly pro-Western path. Although the US remains the world’s only superpower, it is war-weary due to wars in both Iraq and Afghanistan, and now far less able and willing to go to war in the event of a major global crisis.

Iraq (loser): Although Iraq is free of the tyranny of Saddam Hussein, this has come at the cost of at least 100,000 Iraqi lives, a quasi civil war between Shi’as and Sunnis, a multi-year long insurgency (there was a major terrorist attack in Baghdad today), and the devastation of the economy and public services. Moreover, critics say the country is drifting back to authoritarianism under Prime Minister Nouri al-Maliki. Although the Iraqi economy is rebounding, the country’s future looks highly uncertain. That said, Iraq’s Kurds have benefited by becoming more autonomous and more prosperous.

Iran (winner): Iraq was a traditional counterweight to Iran in the Gulf region, and the weakness of post-Saddam Iraq has allowed Tehran to bolster its influence in its neighbour. Iran’s geopolitical strength rose over the past decade, overall. However, Iran’s ‘victory’ rests of fragile foundations, because its rising power and alleged nuclear programme could increase the likelihood of Israeli airstrikes against it – especially if a hardliner is elected president of Iran in June. Furthermore, tighter sanctions against Iran are taking a heavy toll on its economy.

Turkey (winner): Turkey opposed the war, but has been able to take advantage of the new reality by developing close commercial ties with Iraq. It has also developed amicable relations with the Kurdistan Regional Government (KRG) in northern Iraq.

Arab world (neutral): The importance of the Iraq War for the Arab world has been superseded by the Arab Spring, which is still a work in progress. In our view, the Arab Spring would have happened regardless of the Iraq War.

Russia and China (winners): Russia and China vigorously opposed the Iraq War, mainly because of their concerns about state sovereignty and the fact that Saddam was sympathetic to their interests. Nevertheless, both countries have benefited geopolitically from seeing the US bogged down in long wars in Iraq and Afghanistan. These wars have left the US less willing and able to challenge Russian and Chinese interests in the former Soviet Union and Asia-Pacific realms, respectively. The Obama administration’s professed ‘pivot towards Asia’ is an acknowledgement that it perceives itself to have neglected Asia during a decade of involvement in Iraq and Afghanistan.

What Does The Future Hold?

Despite this sober assessment, we caution against assuming a negative future for the US and Iraq. The US was able to recover strategically after defeat in Vietnam in the 1970s and went on to win the Cold War in the 1980s and see off the Japanese economic challenge in the 1990s. It can recover geopolitically, in time.

Meanwhile, although Iraq is in a precarious position, this is hardly unique. Countries as diverse as Cambodia, Colombia, Indonesia, and the former Yugoslavia have all recovered from years of strife to achieve greater prosperity.

Burdened by an overleveraged and outsized banking system, on March 16 Cyprus took the unprecedented step of announcing a levy on bank deposits in order to secure a bailout from the troika (IMF, European Commission and European Central Bank).

The terms of the bailout have not yet been finalised, and the course of events is evolving quickly. In Business Monitor Online today, we outline our immediate response to this weekend’s developments and answer some of the key questions which have arisen. In particular, we discuss:

• The specific bailout terms
• Why Cyprus is ‘exceptional’
• The role the ECB has played
• The role Germany has played
• The meaning of Cyprus’ crisis for the broader eurozone

The eurozone has ventured into uncharted territory. Although bank deposit levies are not completely without precedent – Italy introduced a tax on deposits in 1992 – the size of the charge and its potential to override the EU-wide deposit guarantee scheme are major developments with far-reaching implications. Even if the Cypriot government were able to shift more of the burden onto larger deposits, the mere announcement of the government’s intentions could trigger a mass withdrawal of funds in the coming weeks. A pledge by new President Nicos Anastasiades to compensate savers for any losses with bank shares and reward savers who kept money in their banks for two years with securities tied to national gas revenues may not be sufficiently persuasive.

Depositors across the eurozone will also be on tenterhooks. There remains enormous uncertainty surrounding Spain and Italy and the potential for further state bailouts. If Cyprus sets the precedent of taxing deposits, it risks setting off capital flight across southern Europe. This in turn could restart the polarisation of funding markets which threatened to pull apart the eurozone in 2012.

The Cypriot bailout could mark another inflection point for burden sharing, which has shifted from banks to governments, to future taxpayers, to bondholders, and now potentially to current taxpayers and pensioners. We stress that while Cyprus appears to be an exceptional case, once such a precedent has been set, it is entirely feasible that similar policies could be rolled out in future bailouts.

Venezuela: On March 8, Venezuela’s Vice-President Nicolas Maduro was sworn in as acting president, following the death of former president Hugo Chavez. Given Venezuela’s vast oil reserves, and its role as a key pillar of the ‘global left’, the evolution of the country’s politics and economy will have importance far beyond its borders. We expect Maduro to win the April 14 presidential election and continue Chavez’s policies. However, Venezuela under Maduro could well prove more unstable going forward.

Greenland: On March 12, Greenlanders voted out Prime Minister Kuupik Kleist’s socialist Inuit Ataqatigiit (Community of Nations) party and elected the opposition social democratic Siumut (Forward) party, whose leader, Aleqa Hammond, is set to become the new premier. Kleist had been eagerly courting foreign investment to tap Greenland’s vast natural resources, but voters, fearing a big influx of low-cost foreign labourers for new mining projects, pollution, and changes to their way of life, chose Siumut, which is more cautious towards foreign companies. Further coverage of Greenland is available to subscribers at Business Monitor Online.

Vatican: On March 13, white smoke appeared above the Vatican, signaling the election of a new Pope, who was revealed to be Jorge Mario Bergoglio, Archbishop of Buenos Aires, and who swiftly took the name Francis. He is the first non-European pope in more than 1,200 years, and the first Latin American pope. Given that Latin America accounts for the largest share of Catholics in the world, his selection makes sense from a demographic point of view. And given the tremendous social influence that the Vatican has worldwide, the direction that Pope Francis takes the Catholic Church will be of great significance. The selection of a Latin American pope will also reinforce the perception that ‘global power is shifting south’ – or at least away from Europe.

China: On March 14, China’s National People’s Congress named Vice-President Xi Jinping as president, concluding a once-in-a-decade power transition, in this case to the ‘fifth generation’ of leaders. The Chinese presidency is largely symbolic, with Xi deriving his powers from the posts of Communist Party of China (CPC) general secretary and chairman of the Central Military Commission, which he had inherited at the CPC’s congress last November. Nonetheless, other important state posts such as the premiership and cabinet ministers are being filled. How Xi leads China will be of paramount importance to the world. The big questions are: can Xi rebalance China’s economy away from an export- and investment-led growth model towards one driven by private consumption in an orderly fashion? Can China improve its environmental problems? Will China experience rising pressure for democratisation? Will China’s rise be peaceful? Xi’s expected decade in power will provide the answers.

Japan: Also on March 14, the Japanese Diet approved Prime Minister Shinzo Abe’s nominee, Haruhiko Kuroda, as the next governor of the Bank of Japan. Given that Abe is adopting much more aggressive quantitative easing and a looser fiscal policy to revive Japan’s economy, the identity of the BoJ governor and his relationship with the premier will be crucial. It’s also quite likely that Kuroda will be at the helm longer than Abe. The BoJ governor gets a fixed five-year term, whereas most Japanese prime ministers in recent years have struggled to last more than a year in office. How Japan fares economically and politically over the coming years will be of tremendous importance to the balance of power in Asia.

Naturally, there are other important power transitions approaching. Among other countries, we are closely watching moves to form new governments in Israel and Italy, and the change of presidency in Kenya.

This Week’s Trivia Question

Last week’s trivia question was about the 10^th anniversary this week of the last time that a European prime minister was assassinated. We asked who that individual was, and also, who was the last European president to have met a similar fate. (Note: we exclude conspiracy theories here.) The answer to the first part is former Serbian prime minister Zoran Djindjic, who was shot in Belgrade on March 12, 2003, in a plot masterminded by a former Yugoslav special forces commander. The answer to the second part is, alas, also a Serb, namely former Serbian president (1986-1987) Ivan Stambolic, who was the political mentor of the late Yugoslav president Slobodan Milosevic. Stambolic disappeared in August 2000 and his fate was only revealed three years later – he had been murdered on the orders of Milosevic. The last time an incumbent European president was assassinated was 2004, when Ahmad Kadyrov, the pro-Kremlin president of Chechnya, was killed in a bomb attack. Chechnya’s unrecognised president, Aslan Maskhadov, was also killed the following year.

This week’s question connects the Yugoslav and Chechen conflicts. Which American actor starred in both an early 2000s Hollywood film about the rescue of a downed American airman from Serbian-controlled Bosnia and a 1990s fictionalised portrayal of a US-Russia nuclear stand-off over the former’s support for Chechen separatists? (Hint: the actor’s character had a similar occupation in both films.)

Neutral US versus eurozone stocks: We had maintained a US over eurozone equities strategy for nearly two years prior to December 2012, before going neutral. At this stage, we remain neutral, given how far US equities have come in such a short space of time. However, we would look to renew our relative bullish US over Europe view should the US market pull back.

Macro-Industry Strategy: Our key Macro-Industry Strategy views remain unchanged this week. Despite recent share price stagnation, we remain bullish towards German real estate, with the fundamentals that underpin our belief in the long-term investment story still firmly in place. While not outright bullish on either sector at present, we have also been looking closely at the US banking sector and global data centre infrastructure market this week.

Italian elections: The slow trend higher in 10-year Italian sovereign yields in the past few days suggests that markets are in ‘wait-and-see’ mode ahead of March 15, when parliament convenes and official negotiations on forming a new government begin. We see three realistic scenarios for Italy’s political trajectory over the next few months, only one of which is likely to offer any support to investor confidence. However, even in a best case scenario we see little hope of significant economic reform.

US nonfarm payrolls: Following last Friday’s data showing an above-consensus 236,000 nonfarm payroll jobs created in February, the change in NFPs has remained above the 25-year average of 102,910 new jobs per month in 22 of the last 24 months. We expect businesses to continue to add jobs at a faster-than-average rate over the next several quarters, and remain above-consensus on US growth.

Our full Global Macro-Industry Strategy views and broader financial market views are available to subscribers at Business Monitor Online.

First, Elba Esther Gordillo, head of the 1.5mn-strong teachers’ union, was arrested on charges of embezzlement on February 26. Given that she was long considered ‘untouchable’, we believe this served as a calculated message that the government is serious about cracking down on the power of various entrenched interest groups – including unions and monopolies – to push through reform.

Second, at the ruling Institutional Revolutionary Party (PRI)’s annual conference in early March, the party passed a number of rules to bring it more into line with President Peña Nieto’s reform agenda. It also now allows the president a greater role in internal party decision making.

We have long highlighted that one of Peña Nieto’s main challenges would be ensuring the full support of his own party. While these changes to the PRI’s internal statutes do not guarantee full party support for the president’s reforms in the legislature, they represent an important step forward.

That said, while these changes encourage us to take an increasingly optimistic stance on the passage of a number of key economic reforms, not the least comprehensive fiscal reform, we remain more cautious on energy sector liberalisation.

At present, we anticipate a piecemeal reform process. President Peña Nieto’s own rhetoric has focused more on side issues, such as highlighting the need to reduce Pemex’s tax burden and even drawing the need for alternative energy sources in the debate. While these are useful points, they won’t reverse a decade of declining oil production. Moreover, when the issue of increasing private capital into the energy sector is raised, it comes with the heavy caveat that the state will continue to control Mexico’s oil.

We are not ready to completely rule out energy sector liberalisation, and we acknowledge that the administration may be downplaying the controversial elements of its planned energy sector reform in an effort to tackle a number of other, less contentious reforms early on. Moreover, we note that recent events suggest Peña Nieto may have the political capital he needs to push through full-scale liberalisation. However, until the president indicates willingness to move forward with such a bill, we maintain a more tempered view.

Telecoms Sector: Dial ‘R’ For Reform

Meanwhile, in recent weeks we have taken a more optimistic stance on the potential for the Mexican government to push through legislation to introduce greater competition into the telecoms sector.

While our telecoms team has long been cautious about the potential that regulatory change may prompt substantive improvement in the sector – particularly since regulatory developments have been blocked by lengthy legal disputes in the past – there have been a number of positive steps in recent months.

Not only have the three main parties showed a far greater willingness to cooperate than in the past, but a bill is currently before the Senate that would prohibit companies holding public concessions to use court injunctions as a delaying tactic. This would remove one of the key obstructions used by the large telecoms firms.

Combined with the arrest of Gordillo, which we see as a signal of the government’s seriousness about cracking down on entrenched interests, we see increased scope for greater competition in the telecoms sector.

• What does the passage of the 2013 election portend for Kenya’s political development?
• What does the election mean for Kenya’s economy and financial markets?
• What are the implications of defeated candidate Raila Odinga’s challenge of the election results?
• What are the implications of Kenyatta’s upcoming International Criminal Court appearance?

BMI also offers full political, economic, and sector-specific coverage of sub-Saharan African countries to our subscribers.

For some time now, we have heard that the eurozone crisis will lead to mass social unrest and a rise in extremist parties, with some commentators warning of a return to 1930s-style political conditions. Certainly, it is very ominous that youth unemployment is around 50% in Spain and Greece, and it is true that we have seen mass protests against austerity in several European countries. It is also true that some anti-establishment parties, such as Beppe Grillo’s Five-Star Movement in Italy, have made strong gains.

Nonetheless, in all European countries, mainstream political parties remain the dominant political forces.

Considering the present economic backdrop, Europe remains relatively peaceful. For example, there has not been a return to 1970s-style urban terrorism in Europe. (The Norway massacres of 2011 appear to be an exception.) Labour unrest has also been relatively contained. Furthermore, assassinations are very rare.

What explains this? One part of the reason is that the youth bracket (age 15-24) represents a diminishing proportion of the population in most European countries, most of which are ageing rapidly. Second, many unemployed people are working in the shadow economy, suggesting that headline jobless figures may exaggerate the true social picture. Third, people are generally far better off in material terms than they were in the 1930s. And fourth, there is an absence of ideological clarity in many of the ‘extreme’ political parties or movements that have emerged. Being ‘against the system’ must be complemented with a well articulated alternative vision. Voters in many European countries may be too cynical to believe in credible alternative parties and their ability to win power.

Perhaps if present economic conditions in Europe worsen or fail to improve over the next few years, then we will see greater radicalism, but for now it would appear that establishment forces have the upper hand.

Arab Spring Demonstrated Potency Of Discontent

Of course, we have witnessed tremendous upheaval in the Middle East and North Africa over the past two years, including terrible civil wars in Libya and Syria, and a deterioration of the state in Yemen. Yet so far, in the countries where we have not seen civil war, such as Egypt and Tunisia, we have not seen anything comparable to the 1979 Iranian Revolution in terms of ideological extremist fervour and purges. Iran itself has avoided a counter-revolution despite a collapsing currency and deteriorating economy brought about by UN sanctions. Further east, Pakistan has avoided systemic change despite having all the ingredients for a state collapse.

In Japan, two lost decades and the worst natural disaster since the 1920s did not foster extremism. It is true that a new third force made gains in the last election, but the biggest winner was the Liberal Democratic Party, which ruled Japan for 54 years.

China Is The Biggest Unknown

China is perhaps the biggest unknown. Despite a sharp economic slowdown, not to mention rising inequality, public anger about environmental pollution and corruption, and a host of other issues, the Communist Party of China (CPC) remains entrenched in power. Given the mass upheaval seen in China in previous decades, and clear memories of the 1989 Tiananmen Square crackdown, many Chinese are presumably unwilling to jeopardise more than 30 years of rapid economic growth with a concerted effort to oust the CPC. Nevertheless, it would be unusual if China does not move towards greater political liberalisation before this decade is out.

Known Unknowns

Overall, with the exception of the Taliban in Afghanistan, various Islamist militant groups in Africa and the government of the Democratic People’s Republic of Korea, there are no truly anti-systemic political forces in power or close to coming to power in any major country.

Yet, precisely because of this seeming ‘absence’, we must be vigilant. Extremist politicians rose to power surprisingly quickly in the former Yugoslavia in the late 1980s; the apocalyptic Japanese cult Aum Shinrikyo seemed to come out of nowhere in 1995 when it gassed the Tokyo metro; and hardly anyone was paying attention to an international terrorist group called al-Qaeda on September 10, 2001.

This suggests risk perceptions have improved significantly, to a point where we are actually bullish on the prospects of Spanish debt in the very near term. In turn, this points to continued risk appetite within the eurozone, and by extension, on a global basis.

However, we remain cautious towards eurozone periphery debt over a longer horizon. The macro fundamentals in these countries are dire, and the European Central Bank simply does not have the flexibility to intervene in the sovereign debt markets before a full-blown crisis has emerged. While the euro has stabilised around US$1.30/EUR area, and may head higher over the coming months, we continue to expect weakness in H2 2013, particularly as we expect renewed US economic strength as the year proceeds.

This Week’s Trivia Question

Last week’s theme was religious succession, which is currently focused on the identity of the next Pope. Our question was ‘which church elected its new head on March 1, 2013?’ The answer is the Ethiopian Orthodox Church, which chose Abune Mathias as its new patriarch.

This week’s question is as follows: next week marks the tenth anniversary of the last time a European prime minister was assassinated. Who was that individual? And who was the last European president to have met a similar fate? (Note: we exclude conspiracy theories here.)

If North Korea does carry out a provocation, the South will certainly be tempted to respond. President Park’s defence minister-nominee, Kim Byung-kwan, stated on March 7 that Seoul would sternly punish the North by employing all means available, including psychological warfare. Another Southern general, Kim Yong-hyun, also warned that it would retaliate against the North’s ‘command’, which is believed to refer to its corp commanders.

After the North’s provocations in 2010, which resulted in the deaths of 50 South Koreans, the South took no military action – for fear of triggering a wider conflagration. This may have sent the message to Pyongyang that Seoul does not have the resolve for a fight. Now that the South has given a strong warning, it may have to follow up on its rhetoric in the face of a Northern provocation. There is thus the risk that a Northern provocation against the South will lead to retaliation, resulting in a skirmish that costs dozens of lives.

In the event of a clash that risks escalation, we would expect the US and China to exert tremendous pressure on all parties to prevent matters from spiralling into a bigger conflict. A fuller version of this article is available to subscribers at Business Monitor Online.

• A new presidential election will be held within 30 days, and we expect Vice-President Nicolás Maduro, Chávez’s chosen successor, to win. His most likely opponent is Henrique Capriles Radonksi, who was defeated by Chávez last October. The opposition doesn’t really have time to find someone new.
• We expect Maduro to continue Chávez’s legacy of high social spending and interventionist economic policies.
• Social tensions will remain elevated, fuelled by a polarised electorate and political uncertainty.
• Now that Chávez is dead, we do not rule out internal fragmentation within the ruling Partido Socialista Unido de Venezuela (PSUV) party. This could see the military faction, led by National Assembly president Diosdado Cabello, seek to increase its influence, resulting in a destabilising power struggle.
• Chávez’s death will pave the way for the next president to gradually move away from his predecessor’s more hardline policies. In other words, there is scope for modest reform.

Opposition Has Its Work Cut Out

At this point, the opposition’s best bet is to mobilise as quickly as possible for the forthcoming presidential election. The opposition will need to work hard to bolster its support, given its heavy losses in last December’s regional elections. Beyond the presidential poll, the opposition will also be eyeing municipal elections, which are scheduled for July 14. Then, there will be legislative elections in 2015. This will be a key test for whether the opposition can win the presidency in 2019.

Overall, we expect Venezuela to remain unstable for some years to come.

Chávez’s Death Removes Key Ideological Pillar

Also significant is that Chávez’s death removes a key pillar of the global anti-imperialist left. Chávez provided strong support for left-wing leaders in Latin American countries such as Argentina, Bolivia, Cuba, Ecuador, Nicaragua, Peru, and elsewhere, and he forged ties with anti-American leaders such as Iranian President Mahmoud Ahmadinejad and Libya’s late Muammar Qadhafi. There are no obvious figures with Chávez’s ideological convictions, motivation, and experience to replace him.

1. The deteriorating security situation. The Congo is still recovering from a series of wars that killed about five million people. While a return to the anarchy of the late 1990s in unlikely, we expect tensions to remain high.

A recent peace deal, in which neighbouring Rwanda and Uganda promised not to support armed groups in the DRC (something they currently deny doing), is unlikely to change this.

While fighting is likely to remain contained in the east of the DRC, this still deters investment and diverts government spending away from dealing with pressing developmental challenges (the government has spent over US$400mn since April 2012 in its failed attempts to contain the M23 rebellion).

2. A difficult business environment. The DRC is an incredibly difficult place to do business, and is ranked among the most corrupt countries in the world. In 2012, the IMF cut off aid over a deal whereby the government gave prime mining land to an Israeli diamond billionaire who has close ties with President Joseph Kabila.

The government has promised to release a new mining code, but has yet to produce a draft. Meanwhile, investors are shying away from new projects.

Most of the DRC is impassable jungle, and the country has some of the worst infrastructure in the world. Land travel across the DRC is said to be less efficient than at the time of independence, making business dependent on expensive rental flights and exporting goods via neighbouring countries.

3. China’s economic rebalancing. The DRC’s post-war boom has been largely based on surging copper exports, which have mostly gone to China – the People’s Republic accounts for 48% of Congolese exports.

As the Chinese economy slows and the construction sector’s demand for copper falters, the DRC will look less attractive as an investment opportunity.

Full coverage of the global renewable energy sector and sub-Saharan African economies is available to subscribers at Business Monitor Online.

Momentum is picking up in the industry, as political commitment to the renewables agenda strengthens and investment appetite increases.

• Although it is one of the most talked about renewables markets in the world, Saudi Arabia only has 10MW of solar capacity installed, a relatively insignificant amount.
• The government’s decision to develop a solar power market is sensible. It will free up more oil for exports; it suits the climate (Saudi Arabia has the second-highest insolation potential in the world); and it fits with the population’s power consumption patterns, such as high daytime use of electricity.
• Political commitment is strong and momentum is building behind the solar industry. The government’s white paper outlining the ‘renewables roadmap’ set a target of 24,000 MW by 2020 and 54,000 MW by 2032, principally made up from solar technology.
• We maintain our bullish outlook for the sector, and believe that the Saudi market presents some of the most exciting and rewarding investment opportunities for renewable energy developers in the world.  This view is based primarily on Saudi Arabia’s promising track record for infrastructure and power projects and the government’s strengthening conviction towards solar power.

That said, we believe the government’s current targets are too ambitious, and it is unlikely these goals will be realised so quickly. Solar power expansion could also be hindered by the lack of experience developing this kind of large-scale renewable projects, as well as the government’s keenness to promote domestic, rather than international, production of related equipment.

The sovereign risk situation in Latin America is as follows:

• While our latest Sovereign Risk Ratings show no change in the average overall score for the region since our last update in October 2012, we continue to see 2013 as a challenging year for several economies.
• Our ratings highlight a number of themes which we believe will be key in 2013, such as economic underperformance in Argentina and Venezuela, the impact of slowing Chinese growth on Latin America’s industrial metals exporters, and continued robust economic expansion and fiscal consolidation in Mexico and Colombia.
• Although Chile (rated B with a score of 76/100) retained the top spot in the region, its score has declined significantly in recent months, as we expect that China’s rebalancing away from an investment-led growth model will erode Chile’s current account position significantly, weighing on the country’s ‘ability to pay’ score.
• In addition, we have seen a broader shake-up at the top of our regional rankings in recent quarters, with Brazil (C+) and Chile losing their luster, while Colombia and Mexico (both rated B, and both economies we have liked for a long time) have climbed towards the top.
• Another major theme we have long highlighted is that 2013 will be a turbulent year for Argentina and Venezuela (both rated E), which hold the bottom two spots in our regional table. In particular, Argentina now scores lowest in the region in the ‘willingness to pay’ category, which chimes well with our view that the country is highly likely to enter technical default as a result of an ongoing court case with a group of ‘hold-out’ investors.

Our full Sovereign Risk Ratings reports are available to subscribers at Business Monitor Online.

This Week’s Trivia Question

Last week’s question was about currencies. We asked, apart from the Brazilian real, what other existing currencies’ names are derived from the same root word as the real? And which currencies in the world have a value greater than one US dollar?

The answer to the first part is the rial currencies of Iran, Oman, and Yemen, the riyal currencies of Qatar and Saudi Arabia, and the Cambodian riel. The answer to the second part is the Kuwaiti dinar, Bahrain dinar, Oman rial, Latvian lat, UK pound, Jordanian dinar, the euro, Azerbaijani manat, Cayman Islands dollar, Swiss franc, and from time to time the Australian and Canadian dollars, which are currently close to parity with the US dollar.

This week’s theme is religious succession, which is currently focused on the identity of the next Pope. Our question is, which church elected its new head on March 1, 2013?

These are all lofty goals, especially since many observers believe that Japan has experienced two ‘lost decades’ of economic growth and has become less relevant to the world.

Abe is indeed back, but for how long? Japanese premiers have notoriously short tenures, with Abe the seventh incumbent in less than six years. The main reason for the rapid turnover is that prime ministers come under pressure to resign if their approval rating falls below 25%; this usually happens within a year of taking office, due to disappointment with each leader’s handling of the economy.

Abe may last longer this time – he is the first Japanese PM since the late 1940s to be given a second chance – but can his mix of ultra-loose monetary policy, a weaker yen, and higher spending (dubbed ‘Abenomics’) really revive Japan?

Is Japan Really ‘Back’?

My colleagues and I are sceptical. It’s true that the Nikkei index has surged by 32% since late last year thanks to ‘Abenomics’, but these stimulants appear to be only a short-term fix. There are several key reasons why Japan’s economy has performed poorly since the early 1990s, but one of the major factors is demographics.

Japan’s population is shrinking (notwithstanding the fact that the average Japanese resident has gotten bigger in recent decades) and ageing rapidly. The government reckons that the population could fall by 32% to 87mn by 2060. Meanwhile, the percentage of the population aged 65 and above is forecast to rise to 35-40%. These dynamics point to fewer producers, fewer consumers, and higher expenditure on health and welfare, as opposed to investment.

In our view, the surest way Japan can overcome these problems is to allow greater immigration to rejuvenate and ‘top up’ its population – something that Abe’s Liberal Democratic Party acknowledged in June 2008, when a group of legislators argued for the country to take in 10mn immigrants and become a multiethnic society by 2050.

However, no action has been taken on this front. In fact, Japan’s foreign population peaked at 2.2mn in 2008 and has declined slightly since then, due to the severity of the 2008-2009 downturn and the Tohoku earthquake-tsunami-nuclear triple disaster of 2011.

In a special feature on immigration and the Japanese economy published in Business Monitor Online this week, we outline:

• The reasons why Japan’s population dynamics are negative for its economy and global influence
• Possible ways in which Japan can offset the above dynamics, in the absence of mass immigration
• The ways in which the economy could benefit from immigration
• The main obstacles to seeing greater immigration in Japan, and how they are being challenged

The Relevance Of Japan’s Demographics For The World

The future of the Japanese population has relevance for the world for three key reasons:

First, Japan is still the third-largest economy in the world. Its fate matters to Asian countries and the global economy, particularly in terms of trade and investment.

Second, Japan is the most indebted mainstream economy in the world (public debt is 220+% of GDP, far more than any eurozone country). The ageing of the population could bring forward a fiscal crisis of catastrophic proportions in Japan.

Third, many countries are following in Japan’s demographic footsteps, albeit still some way behind. South Korea, Taiwan, Hong Kong, Singapore, and even China will experience the same ageing phenomena as Japan, and so too will many Central and Eastern European states. Even ‘younger’ countries such as Mexico, Turkey, and Iran will eventually see their populations age. Therefore, how Japan deals with this issue will be closely watched by governments worldwide.

The stakes are high for Japan. If it fails to enact a sustainable economic revival, it risks falling further behind other developed and emerging nations in global significance.

Water plays a vital role in the successful operations of mining projects as it is used in virtually all steps of the mining process. Most of the water at a mine site is used for the separation of minerals from host rocks, the cooling of drilling machinery, and the control of dust particles. The level of water consumption varies greatly depending on a range of factors such as weather conditions, ore mineralogy, and mine management and practices, as well as the commodity being mined.

In general, hard rock mines such as those for gold, copper, nickel, diamonds, and platinum are the most water-intensive as they are often associated with low-ore grades. With a much lower concentration of ore being embodied in waste rock, these minerals require higher quantities of water and greater energy usage to separate the ore from the rock. As such, we believe the competition for water resources will intensify as many mines around the world are grappling with declining ore grades, a problem that will persist in the years ahead.

In a special feature published on Business Monitor Online, we discuss the impact of water scarcity on mining. In particular, we outline:

• The water risk framework for the mining sector
• The countries facing the greatest scarcity risks
• The challenges for mining in frontier markets
• The operating costs involved
• The ways in which miners can mitigate water scarcity problems

Full analysis of the global mining sector is available to subscribers of our online service.

This deadlock is the last thing that eurozone policymakers and investors want to see. Monti’s technocratic administration, in place since November 2011, has won plaudits from financial market players for implementing fiscal reforms, but Italians are clearly fed up of these measures, which they see as prolonging the country’s recession. From a market point of view, a weak government will mean a waning commitment to tackling Italy’s debt woes. This explains why Italy’s 10-year bond yield jumped 45 basis points to a 2½ -month high of 4.94% at one stage on February 26.

Italy – 10-Year Bond Yield (%)

Attention To Focus On Coalition Building In The Near Term

Parliament will convene on March 15. Over the coming days and weeks, we expect the PD to attempt to form a viable coalition so that it can gain the Senate majority needed to govern. However, this will not be easy, and it is unclear who it could join hands with. At present, a grand coalition between Bersani’s PD and Berlusconi’s PdL would appear to be unlikely, given that the parties are bitterly opposed to each other, and a pact between them would probably not last long. Moreover, the bigger the coalition, the more unwieldy it would be, and the higher the risk of extended gridlock. The PD could also attempt to attract the support of M5S, but the movement is reluctant to join forces with a traditional party for fear of compromising its anti-establishment credentials. Yet if M5S chooses to remain completely separate from governance, it would risk losing relevance over the longer term. Thus, M5S also faces a dilemma on how to build on its success.

New Election Likely

Given this backdrop, we believe that Italy may need to hold another general election before the end of 2013 to produce a more decisive result. However, this may necessitate changing the electoral law, which could take time. In the meantime, President Giorgio Napolitano could install an interim government. Therefore, Italy could face months of political uncertainty, which could cause bond yields to rise further and bring concerns about the eurozone’s survival back to the top of the agenda. Finally, even if Italy holds a fresh election, there is no guarantee that this would result in a more durable or market-friendly government.

Chaebol Clampdown To Prove Rhetorical

Many South Korean presidents promise to reduce the power of the chaebol during their election campaigns, and most of them fail. We have repeatedly highlighted that the proposed chaebol clampdown that served as a key plank of both presidential candidates’ campaigns was likely to be merely a populist pitch and that reform momentum was unlikely to gain any meaningful traction. True enough, our view appears to be panning out. In the policy roadmap announced by Park’s transition team on February 22, ‘economic democratisation’ was clearly absent from the list of initiatives Park planned to roll out (although she did mention it in her inaugural speech).

Indeed, Kim Chong-in, a co-chair of Park’s presidential campaign and a strong advocate of chaebol reform, was not assigned any senior position within the government. As we observed during Park’s campaign run, her policies were largely growth-oriented. Consequently, making life harder for the conglomerates (which essentially drive Korea’s export-oriented economy) is too risky a move to make, especially against the current economic backdrop. In our view, any reform measures are, at most, likely to take the form of fairer competition laws aimed at preventing the unchecked expansion of the chaebol into unrelated industries, as opposed to breaking them up. Looking ahead, we thus expect the chaebol to maintain their hold on the economy and we do not envision any radical changes to the export-led economic model.

Other Challenges

Aside from the above issues, Park will need to address several long-term challenges. We outlined some of these in early 2008, not long after Lee Myung-bak took office, but we reiterate the key questions below:

• Can South Korea maintain its edge in manufacturing at a time when China and other lower-cost rivals are emerging?
• Can South Korea really make itself a key economic/financial hub in Asia?
• Can South Korea become a knowledge-based economy?
• How will South Korea deal with a rapidly ageing population?
• How can South Korea best prepare itself politically and economically for dramatic change in the North?

South Korea is undoubtedly one of the world’s greatest economic success stories of the post-World War II era. However, a failure to tackle the above-mentioned challenges could consign it to the fate of Japan.

However, we believe that investors are losing confidence in the government’s ability to reform the public finances as a result of the economy flat-lining and the fiscal and debt targets being pushed back. In addition, a stabilisation of the eurozone as a result of more assertive action from the European Central Bank has reduced the demand for safe haven assets. With these two supports for the pound – fiscal credibility and safe haven status – slowly eroding, and UK economic activity still inert, it is difficult to see how sterling can keep up the façade of strength. We caution that should the pound make a strong push below US$1.50/GBP, a move towards US$1.40/GBP would not be unfounded.

Brazilian Real Forecast Revised Up

Elsewhere, we have revised our forecasts for the Brazilian real to reflect greater strength this year, as we believe inflation will remain a salient concern for the monetary authorities over the coming months. Indeed, in our previous currency forecast update, we highlighted that should inflation spike, we could see the central bank allow for a greater appreciation of the currency, a risk which has played out in recent weeks. January’s rate of inflation came in at the highest level (6.15% y-o-y) in 12 months and both the Central Bank President and Finance Minister have made statements that suggest the real may remain in a relatively stronger trading range in the short term. In order to account for the current rally and potential for a relatively stronger real over the coming months, we have revised our 2013 average forecast to BRL2.0000/US$, from BRL2.0700/US$ previously.

That said, we continue to expect real weakness over the medium term, forecasting the unit to end 2013 at BRL2.1000/US$ and 2014 at BRL2.2000/US$. This is because we believe government policy remains biased towards a relatively weak exchange rate, we forecast domestic interest rates to remain near historical lows, and anticipate that weaker base metals prices will translate into more modest investment inflows into Brazil in H2 2013.

Full analysis of global currency performance, as well as our forecasts for scores of currencies worldwide, including that of frontier markets, is available to subscribers at Business Monitor Online.

This Week’s Trivia Question

Last week’s question was about ancient institutions, and was inspired by the Pope’s resignation.  We asked, the day Pope Benedict XVI announced his retirement, an even older institution than the Papacy marked its 2,673^rd anniversary. What is that institution? And which organisation celebrated its 900^th anniversary over the previous week? The answer to the first question is the Japanese imperial family (and for that matter Japan as a nation, which officially came into existence on February 11, 660 BC). The answer to the second question is the Knights of Malta.

This week’s question is about currencies. Apart from the Brazilian real, what other existing currencies’ names are derived from the same root word as the real? And which currencies in the world have a value greater than one US dollar?

• Correa pledged to deepen his ‘Citizens Revolution’ political agenda in his new term, which encompasses high levels of social spending, but undermines the private sector through high levels of state interference.
• We see this playing out through stringent requirements affecting foreign investment, such as advance payment of royalties and sizeable tax burdens.
• We also highlight a likelihood of greater state intervention in the banking sector. Correa has publicly spoken against rent-seeking lending practices by banks, and a recent tax on banks’ revenues to finance a monthly cash transfer for lower income house-holds points to greater involvement in the financial sphere.

The extension of Correa’s rule also supports our long-held view that the Ecuadorean energy sector will continue to stagnate over the next few years. (Subscribers should refer to Business Monitor Online, February 1, 2013, ‘New Oil Production Targets Are Likely To Be Missed’). That said, we do see some upside potential stemming from the ongoing licensing round, which has on offer 13 new oil blocks for exploration. The government is hoping that the current licensing round will reverse the drying up of foreign investment, although even a best-case scenario in terms of investment is highly unlikely to shift current dynamics.

Good Korea Move For Won

Also in our online service this week, we have updated our 2013 and 2014 forecasts for the South Korean won. Following the recent sell-off in the Japanese yen, and consequently the series of currency depreciations we witnessed across the region, including in Korea, the KRW appears to have topped out. Going forward, we believe that the balance of risks are tilted in favour of won weakness and a move towards support at the KRW1,100/US$ level is likely over the coming weeks. A weaker won will be beneficial for South Korean exporters, especially since many compete against Japan.

South Korea – Exchange Rate, KRW/US$

Full analysis on Ecuador, South Korea, and other emerging and developed economies is available to subscribers at Business Monitor Online.

The majority of the discussion in our new report focuses on shale formations, which is the area that the industry is broadly concentrating its resources towards, and from where we have the greatest pool of data available for a quantitative and qualitative global assessment. Although the report has much on fracking in the US, it also examines developments, obstacles, opportunities and risks affecting the industry worldwide.

Our report answers key questions, such as:

• How do attitudes towards fracking in Western and Eastern Europe differ, and how will this play out for the industry?
• What are the risks to Latin America’s development of the fracking industry?
• How does the picture for shale exploration and production look in Asia, and what are the strategies of the key markets?
• How will infrastructure and fiscal challenges impact efforts to tap Africa’s shale gas?
• What do the exploration activities in the Mississippian Lime hold for the United States’ energy sector?

The special report draws on BMI’s 28 years of analytical experience to critically assess the proliferation of hydraulic fracturing techniques and global energy dynamics.

At stake are whether the sense of stability that Monti brought to Italy can continue, and whether the next government can maintain current austerity measures and enact reforms to boost Italy’s long-term growth prospects. Italy is the third-biggest economy in the eurozone and has the eurozone’s second-largest government debt pile, of EUR1.9trn, or 128% of GDP, which is equivalent to about 23% of the eurozone’s overall public debt. Therefore, if the incoming administration mishandles Italy’s economy or raises further concerns about the country’s debt sustainability, then bond yields could surge, causing a new financial crisis. This in turn could threaten the eurozone’s survival.

Ahead of the Italian election, Business Monitor Online has just published a primer outlining the electoral system and main parties, the challenges facing the next government, and the possible election outcomes.

Which Are The Main Parties?

There are dozens of parties running, but most of them will struggle to win enough support to enter parliament. The biggest parties have formed pre-election alliances with a host of smaller parties. The major parties are as follows:

• Democratic Party (PD): Centre-left, pro-European. Led by former cabinet minister Pier Luigi Bersani. The PD has indicated that it will continue outgoing PM Monti’s austerity measures, but will introduce more pro-growth policies. The party was ahead in the last polls (voter surveys are banned two weeks before the election), with around 30-35% support.
• Party of Freedom (PdL): Conservative. Led by former PM Silvio Berlusconi and Angelino Alfano. The party has criticised Monti’s austerity measures and taken a confrontational attitude towards Germany. The party is second in polls with around 27% support, having greatly reduced the gap with the PD, thanks to Berlusconi’s campaign skills.
• Five Star Movement (M5S): Populist, environmentalist, and eurosceptic. Led by comedian and internet activist Beppe Grillo. The party is a fringe group that has attracted a great deal of support from those who are fed up of Italy’s traditional parties. M5S is third in the polls with around 18% backing.
• Civic Choice (SC): Centrist. Led by outgoing PM Mario Monti, who has decided that he wants to remain in his job. Although he has won praise from investors for his reforms, Monti’s popularity has fallen amid unhappiness with his fiscal reforms. Monti, a technocrat, is also said to lack charisma and campaign skills. SC has around 15% support.

What Are The Main Issues?

Without doubt, fiscal austerity and the state of the economy are the biggest issues, especially with unemployment at a 13-year high of 11.2% and youth unemployment at 37%. Italy’s relations with the eurozone are also a key issue. Corruption is also entering the discourse, especially with the recent emergence of a banking scandal at Banca Monte dei Paschi di Siena, Italy’s oldest and third-largest bank.

What Is The Probable Outcome?

Polls point to the centre-left PD-led alliance winning the election, but it may fail to win the Senate. In Italy, the Senate has equal power to the lower house, and governments need the support of both chambers to function. Thus, the PD bloc could need to form a coalition with Monti’s SC.

A wild card scenario would be a victory by Berlusconi’s PdL party, which would greatly concern investors and cause bond yields to spike.

Our full primer on the Italian election, and in-depth analysis of the eurozone crisis, are available to subscribers at Business Monitor Online.

Selected Countries - Net Grain Exports ('000 tonnes). Note: FSU-12 = former Soviet Union 12; EU refers to member states prior to joining; Grain exports include wheat, corn & soybean; 2012/13 is a forecast; Source: BMI, US Department of Agriculture.

Aside from higher US grain exports due to improvements in production (owing to better weather), our belief stems from three key reasons:

• Even with significant demand destruction (partly due to the closure of ethanol plants), grain prices remain elevated by historical standards, encouraging US farmers to plant more.
• US farms are displaying relatively healthy financial statements despite poor crops in the last two seasons. In particular, farm net income from the 2013 season is forecast to come in at 40-year highs (in constant 2005 US dollars), and relative debt levels at US farms are at 50-year lows, allowing for increased capital expenditure (particularly for seeds and farm equipment) and a greater planted area.
• Although South America will catch up with the US in terms of efficiency, the US will have the more efficient grain sector over the long term (leading to higher yields and superior ability to mitigate lower average grain prices).

Further analysis of global soft commodity markets is available to subscribers at Business Monitor Online.

Despite a more positive outlook for the first half of the year, we maintain our bearish longer-term outlook for industrial commodities. For demand, we believe the current upturn in Chinese economic growth is temporary, and expect some negative surprises as the year progresses. For supply, favourable production prospects from high prices in recent years will result in markets loosening up in the coming quarters. This is particularly the case for oil, and in 2013 we forecast the first global production surplus since 2007.

Gold prices will struggle in H1 2013, and a break of key technical support at US$1,640/oz would prompt us to remove the bullish view from our commodity strategy table. As the global economy gently grows, investors will price in monetary policy normalising sooner than anticipated, causing US Treasury yields to rise and gold prices to fall.  However, we do not expect a sustained bearish reversal in gold prices until 2014.

After two years of broad-based declines, we believe soft commodities such as sugar and coffee have bottomed out, and we expect modestly higher average prices in 2013 than current spot levels. Supply will remain healthy for these crops over the coming months, but the market has priced in an optimal production picture. As non-commercial net speculative long positions are languishing at multi-year lows for these commodities, prices will be very sensitive to any supply disruption. We expect a temporary recovery in prices over 2013, before the long-term structural downtrend resumes. We retain a bullish coffee view in our commodity strategy and have palm oil on our watch list.

For full analysis and price forecasts for a wide variety of commodities, subscribe to Business Monitor Online.

This Week’s Trivia Question

Last week, we asked, which Central London landmark was partly donated to the City of Westminster in the 1980s by Liechtenstein? (Hint: West End cinema-goers will probably have walked past it.) The answer is a set of glockenspiel that stands just off Leicester Square. The bells and moving figures used to adorn the façade of the now defunct Swiss Centre, but disappeared in 2008 when the building was demolished. The bells and figures were restored in 2011. They were jointly donated by Liechtenstein and Switzerland in 1985.

This week’s question is about ancient institutions, and was inspired by the Pope’s resignation. The day Pope Benedict XVI announced his retirement, an even older institution than the Papacy marked its 2,673^rd anniversary. What is that institution? And which organisation celebrated its 900^th anniversary over the past week?

Two years on, the Arab Spring states remain in turmoil. This is hardly surprising, given that it is very difficult for countries where one party or individual has ruled largely unopposed for decades to experience an orderly and peaceful transition to democracy. The countries of Central and Eastern Europe managed this relatively smoothly after 1989, but they had the political, economic, and cultural anchor of the European Union and NATO. Even then, Slovakia, Bulgaria, and Romania became laggards on the road to convergence, while Yugoslavia succumbed to civil war.

Looking around the Arab world, Egypt has made a transition to elected Islamist rule, but the secularists are fighting back. Thus far, nothing that has happened in Egypt has surprised us, except perhaps the identities of the final two presidential candidates in 2012 – the then-little known Mohamed Morsi, and Mubarak’s last prime minister, Ahmed Shafiq.

Elsewhere, Tunisia has just been rocked by the assassination of an opposition leader, while Libya remains unstable following the civil war of 2011. Yemen, too, is looking shaky following Saleh’s departure, although the country has in fact long been more fragmented than many Arab countries. Meanwhile, unrest in Bahrain continues to simmer.

Two Mild Surprises

One thing that has surprised us somewhat is that Syria’s Assad has been able to hold onto power somewhat longer than expected, despite a series of major setbacks. We still believe that he is likely to be toppled eventually, but this could take a while longer. Even if Assad is overthrown, we caution that Syria will not return to a state of calm quickly.

Another surprise is that Iran (which is not an Arab country, but shares several of the socio-economic characteristics of the Arab spring states) has not succumbed to mass unrest. Iran’s economy has been suffering as a result of tighter sanctions aimed at curbing its nuclear programme, and the rial currency has collapsed in value.

Overall, the Arab Spring remains a work in progress. To paraphrase former Chinese premier Zhou Enlai in 1972 in reference to the impact of the 1968 Paris riots on world history, “It’s too early to say”. For a start, we have yet to see mass unrest in Saudi Arabia, despite repeated predictions over the past decade or more.

Indonesia And Pakistan Offer Possible Roadmaps

So what does the future hold?

We recall that when former Indonesian President Suharto was overthrown in 1998, the country became increasingly chaotic, and in 1999-2000, there were heightened concerns that the vast archipelagic nation would fragment into several new states amid civil war. But this did not happen, and since 2004 the country has gradually consolidated its democratic institutions. In recent years, Indonesia has become increasingly favoured by investors.

Unfortunately, Pakistan could also offer pointers as to the direction of Arab Spring states. Pakistan has become almost chronically unstable, lurching from one political or economic crisis to another. Yet, it has managed to muddle through most of these.

Our overall verdict: give the Arab Spring more time. Two years is too soon to expect fully functioning democracies to emerge. However, if these countries still look the same way in eight or 10 years time, it would be somewhat discouraging.

The special report outlines BMI’s core macroeconomic view on the region, analysing seven topical issues that shed light on the nature of Africa’s growth story. In addition, we identify which countries are likely to outperform economically over the long term and we analyse how various nations stand to benefit or lose from ongoing global and regional trends. Furthermore, the report outlines potential risk scenarios for SSA as a whole.

The report answers key questions, such as:

• What are the current and future trends in foreign direct investment in the region?
• How will the relationship between Sub-Saharan Africa and India develop further?
• What are the region’s infrastructure shortcomings, and how are they harming development?
• What is the outlook for Africa’s manufacturing sector?
• How would a potential ‘hard landing’ in China affect Sub-Saharan Africa?

The special report draws on BMI’s 28 years of experience to critically assess the economic trends that will shape Sub-Saharan Africa in the years to come, helping you identify the opportunities and challenges for your business in 2013 and beyond.

BMI has been expecting a new nuclear test on and off for some time now. The timing appears to have been chosen to commemorate the birthday on February 16 of North Korea’s late leader, Kim Jong Il; this is in line with Pyongyang’s history of carrying out grand gestures ahead of dates of national importance.

The timing may also be interpreted as a snub to South Korea’s outgoing president, Lee Myung-bak, who leaves office on February 25. North Korea blames Lee’s hardline stance for a sharp deterioration in inter-Korean relations since he took office five years earlier. In Business Monitor Online today, we discuss several implications of the nuclear test. Some of these are listed below:

• The detonation’s yield was estimated at 6-7 kilotons (kt). This is a ‘bigger bang’ than the first two nuclear tests North Korea has carried out – but is still far less than the 16-21 kt explosions of the bombs dropped on Japan in 1945, let alone the warheads possessed by the world’s major nuclear powers.
• North Korea has ruined any chances of improving relations with South Korea, and incoming president Park Geun-hye, any time soon. This will be to Pyongyang’s disadvantage.
• The nuclear test demonstrated that China – which opposed the move – has very little influence over North Korea’s decision-making.
• The test will bolster the position of Japan’s nationalist politicians, who want a more robust military.
• South Korea’s financial markets were very muted in response, demonstrating that the nuclear test had largely been factored in already. Overall, BMI has observed that the Kospi index and the won currency have been very resilient to Pyongyang’s provocations over the past decade.

What Next?

With the world’s major powers condemning North Korea, Pyongyang is likely to be isolated for the foreseeable future. Hopes have largely faded that leader Kim Jong Un will take his country along a reformist path.

In the 14 months since he took office, there have been mixed signals about Kim’s intentions. He has modernised North Korea’s public image and purged several powerful generals. He allowed Eric Schmidt, chairman of Google, and Bill Richardson, a former US governor of New Mexico, to visit the country in January. In his new year’s address, Kim even sounded relatively conciliatory towards South Korea.

All this seemed to suggest Kim could be a reformer. Yet at the same time, Pyongyang has carried out two rocket launches and now a nuclear test, and retained its official ‘military-first’ ideology. None of this means reform is impossible, but it does suggest North Korea will not change its tune any time soon.

By maintaining its hardline policies, Pyongyang is alienating friend and foe and depriving itself of economic opportunities.

In Business Monitor Online today, we have a special feature on the drone wars.

Why Is The US Increasingly Using Drones?

• Drones are seen as a low-risk tool for the US, because no pilots are put in harm’s way.
• Drones provide the US with a low-key tool for attacking its enemies in places like Pakistan, Afghanistan, and Yemen.
• Drones are much cheaper than manned fighter jets.

The Risks Associated With Using Drones

• The ‘casual’ use of drones lowers the threshold for going to war. Also, wars initiated by drones could escalate to the point where actual soldiers are required.
• Hundreds of civilians have been killed by drones. Drone strikes are seen as particularly cowardly, because the pilots are not in harm’s way.
• Drone usage raises legal questions, and there are growing concerns about the lack of transparency in the US’ policy on targeting, and the apparent lack of judicial oversight.
• US drone strikes in Pakistan and Afghanistan have seriously strained bilateral relations.
• Drone strikes have increased tensions in Pakistani communities, with militants having carried out reprisals on local populations, for fear that local spies have passed targeting intelligence to the US.
• Drone strikes have not brought stability to countries such as Pakistan and Afghanistan.
• Although drone pilots are out of harm’s way, they are known to suffer stresses caused by the contradictions of waging war remotely by day and returning to a normal family life in the evening.

Long-Term Implications Of The Drone Wars

• More countries are developing or purchasing drones, leading to fears of an arms race.
• Although the focus of drones has been on unmanned aerial vehicles, we will soon see more ground- and sea-based unmanned vehicles.
• Drones will increasingly be used for domestic purposes – such as disaster relief, environmental monitoring, and border security, but also for police surveillance, raising fears of a ‘big brother’ state.
• Cyber security will become increasingly important, amid concerns that militant or terrorist groups could hack into drone control systems to sabotage them or turn them against their owners.
• Drone warfare raises serious ethical questions, and images of drones being used to suppress protestors will send chills around the world, raising the spectre of a man-versus-machine conflict.
• Eventually, drone computers may become sufficiently advanced that human decision-making could be removed from their operations. In other words, the drone might ‘decide’ whether to attack targets.

This Week’s Trivia Question

Last week’s trivia question was on cities. We asked, which world city announced this week that it would need to expand its land supply by 8% to accommodate a 30% increase in its population to almost seven million by 2030? The answer is Singapore. We also asked, how long did it take for Rome’s population to return to its Empire-era peak? The answer is around 1,800-1,900 years between the first century AD and the 1930s.

Our question this week is as follows: In view of Liechtenstein’s election last weekend, which Central London landmark was partly donated to the City of Westminster in the 1980s by Liechtenstein? Hint: West End cinema-goers will probably have walked past it.

For now, recent measures by the government suggest it is attempting to delay the devaluation. It is likely buying time until another presidential election, which is likely to be triggered by President Hugo Chávez’s failing health, takes place.

Recent economic measures include a change in the government’s windfall oil tax to channel more US dollars into the foreign exchange system, effectively increasing the supply of dollars to the economy. However, since that measure was implemented, the black market rate (currently VEF18.40/US$, or four times weaker than the official fixed exchange rate) has continued to weaken, suggesting FX shortages are worsening.

While we cannot pinpoint the timing of a new election, Chávez hasn’t been seen in public for two months, since his most recent cancer treatment. Once he officially steps down, an election would have to take place within 30 days, and we anticipate any devaluation would take place soon after.

With a sizeable fiscal deficit, estimated at over 12% of GDP in 2012, a devaluation of the currency would generate more bolívars per petro-dollar for the government, allowing it to narrow the financing gap, and continue spending on social programmes. However, Venezuela’s already high rate of inflation would rise further, bringing with it greater discontent.

Asiacell’s rivals Zain and Korek are required to list up to 25% of their shares on the stock exchange eventually. We expect both operators also to attract considerable interest from investors. At the end of Q312, Asiacell had a market share of 36% in Iraq’s mobile market, compared with Zain’s 50% and Korek’s 14%.

Investor interest in Asiacell shares beat most analysts’ expectations, mainly because of positive fundamentals in the telecoms sector. These include:

• Strong revenue and profit growth, as opposed to flat revenues and declining profits in most markets in the region
• Average revenue per user (ARPU) resilience despite the lack of 3G network services
• Significant growth opportunities for voice and data services, with mobile and broadband penetration rates lagging other countries in the region by wide margins

Iraq is the most attractive frontier telecoms market in the Middle East in terms of market size and macroeconomic fundamentals. The other frontier markets and their challenges are:

• Iran: Closed to foreign investments because of international sanctions and strong government interest, through the Revolutionary Guards, in the telecoms market.
• Lebanon: A small market (less than 5mn people) with total state control of the telecoms sector.
• Syria: Caught in a state of civil war.
• Yemen: Elevated political risks and a poorer population than most other countries in the region.

That said, there are significant industry-specific and political and macroeconomic risks in Iraq. The political and macroeconomic risks are well documented by Business Monitor International (BMI)’s Country Risk team. In terms of industry-specific risks, Iraq’s telecoms regulator is not independent of political interference. This means that key policies, such as the allocation of 3G spectrum, competition in the fixed-line market, and possible award of more mobile licences, are driven by political expediency, as opposed to market forces.

Further coverage of Iraq’s economy and the global telecoms market is available to subscribers at Business Monitor Online.

Regarding Greenland, our article discusses the following points:

• Global climate change is making Greenland’s natural resources more accessible.
• Greenland has extensive resources of oil and gas, base metals, rare earth metals, fish stocks, and freshwater. All these are in general high demand.
• Mining for rare earths and uranium is  banned under Danish law, but the parliament appears to be softening its stance.
• The thinning of Arctic ice is also raising hopes of a permanent, rather than seasonal, Arctic shipping route between Europe and Asia – although this is far from assured).
• Due to the Arctic’s growing importance, the USA, Canada, Norway, and Russia have become more assertive in promoting their territorial claims in the region.
• China, Japan, South Korea, and India are seeking permanent observer status at the eight-member Arctic Council, which consists of Canada, Denmark, Finland, Iceland, Norway, Sweden, Russia, and the USA.
• Greenlanders are divided over how much new investment the country should look for, and how quickly. The main benefits would be increased revenues and infrastructure upgrades. The main risks would be pollution, a major influx of foreign workers (which could prevent Greenlanders getting jobs), and socioeconomic change.
• These issues are likely to be hotly debated in the run-up to the general election scheduled for March 12.

As for Mongolia, mining giant Rio Tinto has hit back at the government’s threat to renegotiate terms of the Oyu Tolgoi (OT) agreement. The government wants to raise its stake from 34% to 50% and receive greater royalties. However, we believe both parties have too much to lose from a prolonged suspension of the project. For Rio Tinto, the commercial viability of the OT asset has never been better and, as such, it would make little sense to back out at this stage. Meanwhile, it is more important than ever for the Mongolian authorities to maintain the confidence of international investors, given the precarious health of the country’s public finances. In our featured article, we examine the origins of the mining dispute and map out the most likely scenario over the coming months.

Full coverage of the global mining sector, including frontier markets, is available to subscribers at Business Monitor Online.

Liechtenstein’s Independents Make Gains

Meanwhile, even Liechtenstein isn’t immune to the anti-incumbent sentiment pervading large parts of Europe at this time. In elections held on February 1 and 3, Prime Minister Klaus Tschuetscher’s liberal-conservative Patriotic Union party saw its popularity fall by 14.1 percentage points from the 2009 election to 33.5%, giving it only eight seats in the 25-member parliament. The conservative Progressive Citizens’ party (FBP) won 40.0% of the vote, down 3.5 pps from 2009, but enough to make it the biggest party with 10 seats, albeit short of a majority. Perhaps the most significant development was the strong performance of a new group of Independents, which won 15.3% of the vote and took four seats, pushing the centre-left Free List into fourth place with 11.1% and three seats. Although Liechtenstein is one of the most prosperous places on earth, the microstate has been suffering from falling government revenues, as tighter financial regulations adopted as a result of international pressure have reduced the principality’s appeal as a tax haven. The 2013 budget envisages a record budget deficit of CHF210mn (US$231mn), implying that local taxes would have to rise to plug the gap.

Argentina’s shale resources are estimated as the third largest in the world. If it invests in these, the country could become a regional and even global gas powerhouse.

Mexico has the world’s fourth-largest shale resources, but is unlikely to make a large-scale investment into production any time soon. Domestic dynamics are against it, and Mexico’s access to cheap US gas means natural gas retrieval is not a pressing issue.

This reinforces our view that the Mexican energy sector will continue to decline despite its significant below-ground potential. Policies around controversial fraccing techniques are under question throughout the region, leading to significant regulatory uncertainty and the risk of popular objection on environmental grounds.

In Business Monitor Online this week, we published a special feature examining the impact of the expansion of fraccing and other unconventional production techniques on Latin American countries, including Argentina, Chile, Colombia, and Mexico. The full article is available to subscribers.

Overall, there are risks to Latin America’s shale resource development outlook, despite the continent’s significant potential resources and growing interest in developing them. Broadly speaking, the risks around unconventional production are similar to those around other methods of resource extraction. They include the insufficient regulation of fraccing and other unconventional techniques and concern about environmental implications, specifically groundwater contamination.

Many Latin American societies have strained relations with extractive industries, and their response to widespread fraccing is likely to be no different. Countries with the strongest environmental opposition to oil and gas, infrastructure, and mining projects are Peru, Chile, Bolivia, Brazil, and Ecuador.

Furthermore, several countries have significant concerns about water supply security, namely Chile, Mexico, and Peru. Mining companies in Chile have already warned they are not able to secure water supplies in the Atacama region, and the conflict over water will only be heightened by the introduction of fraccing methods, which are highly water-intensive.

With these issues in mind, we believe Latin American states will seek to regulate unconventional oil production over the long term. As this kind of production is at an early stage on the continent, Latin American governments will probably take their cues from other parts of the world, including the US and Europe. As such, the evolution of fraccing policies and regulations globally stands to have a significant impact on Latin America, and will determine whether the region’s shale potential leads to a dramatic shift in its energy landscape.

This Week’s Trivia Question

Last week, the theme was anniversaries. The question was: Following the signing of the Paris Peace Accords (40 years ago on January 27) aimed at ending the Vietnam war, what did the North Vietnamese negotiator refuse to accept? And separately, what major literary work marked its 200^th anniversary this week?

The answers are as follows: North Vietnamese negotiator Le Duc Tho refused to accept the Nobel Peace Prize of 1973, which he was awarded jointly with US National Security Advisor Henry Kissinger. Tho argued that there was no peace to celebrate. The answer to the second question is Jane Austen’s Pride and Prejudice.

This week, we change the theme to cities of the world:

Which world city announced this week that it would need to expand its land supply by 8% to accommodate a 30% increase in its population to almost seven million by 2030?

And how long did it take for Rome’s population to return to its Empire-era peak?

The recent slide in the share prices of South Korea’s largest automakers has confirmed our downbeat outlook expressed in July 2012 (subscribers can refer to Business Monitor Online, July 13 2012, ‘Macro-Industry Strategy: Cautious Outlook On Korean Automakers’). The two companies have been hurt by several months of negative news flow, such as the overstated mileage claims controversy in the US in late 2012. However, the biggest headache for South Korean car manufacturers has been the strengthening of the Korean won against the Japanese yen since May 2012, which has seen Kia’s share price slide.

Near-term indicators suggest Korean automakers’ shares are slightly oversold at this point, and we could see a short-term bounce. However, in the medium term, we forecast underperformance in both Hyundai’s and Kia’s share prices. This is because we anticipate continued weakness in the Japanese yen against the Korean won due to Japanese Prime Minister Shinzo Abe’s expansionist monetary and fiscal policy.

Also noteworthy is that both Kia and Hyundai’s US market share reached a cyclical peak of 4.6% and 5.6% of total US car sales, respectively, in May 2011. As the US consumer remained in deleveraging mode, Korean brands benefited from their more affordable and fuel-efficient mass market models, as well as a weaker won. However, going forward, Hyundai and Kia might face a new scenario in the US. BMI has turned more bullish on US 2013 economic growth, and with American households enjoying more secure finances, consumers may be looking to ‘trade up’ and make new auto purchases. This would be another blow to Korean brands, as they seek to arrest their sliding market share.

Ratio of Toyota and Hyundai Share Prices

One chart that portends the shape of things to come for Asia’s auto industry is the ratio of Toyota’s share price to that of Hyundai. From 2007 to late 2012, the falling ratio shows the remarkable outperformance of Hyundai against Toyota. As Japanese automakers struggled with an ever-strengthening yen and a host of product recalls in the past few years, they also had to grapple with the Great Tohoku earthquake and Thailand floods in 2011, which disrupted their supply chain. The outbreak of the Sino-Japanese territorial dispute in September 2012 didn’t help either. Now, without the stranglehold of the strong yen, Japanese automakers could be ripe for a major comeback.

Full analysis of the global car industry, including five-year forecasts for production and sales, is available to subscribers at Business Monitor Online.

Three-Month LME Copper, US$/tonne

With gold prices flat-lining, this suggests that the ratio of copper to gold prices could be heading higher as well. Historically, this has indicated an improving global growth outlook.

Ratio of Copper To Gold

There is a similar picture in the oil-gold ratio, which is testing upside resistance. We recently highlighted an upward break in oil prices and hold a positive near-term view towards the commodity (see Business Monitor Online, ‘Oil Looks Resilient’, January 13, 2013).

Ratio Of Brent Crude Oil To Spot Gold

The upside risk to our neutral view on industrial metals is that the ‘risk on’ trade that began in September 2012 and which has been most apparent in equities will continue well into 2013 and eventually drag commodities higher. Commodities have significantly underperformed equities since November. A break higher by copper versus gold would suggest that commodities may be on the move again, and could prompt upward revisions to our industrial metal price forecasts.

This would also augur poorly for bonds, which are already under upside pressure and have probably bottomed out, in our view (subscribers should refer to our Global Asset Class Strategy Update, 29 January 2013). The copper-gold ratio tracks US 10-year Treasury yields reasonably closely, at least in terms of the direction.

Ratio of Copper To Gold, And US 10-Year Treasury Yield (%)

So putting this all together, if the copper-gold ratio breaks higher, it would lend further credence to our view for improving global economic activity and the bottom of US yields. A significant move higher in both would suggest that a normalisation of monetary policy could occur earlier than we – or the market – currently expect. As such, we maintain our long-held view that we prefer equities to developed world bonds.

Essentially, we see gold prices remaining underpinned by loose global monetary policy conditions over the next 12 months. We expect gold prices to peak around 2014, as by that point investors should increasingly start pricing in a normalisation of US monetary policy (even though we do not expect this until 2016). This anticipation will cause a liquidation of the speculative holdings of gold that have built up in the last few years.

However, we don’t see gold prices collapsing after 2014, and indeed our 2015-2017 forecasts are slightly above consensus. Prices should be held up by the following factors:

• Still loose monetary policy outside the US (e.g. the eurozone and Japan)
• Resurgent traditional physical demand as prices fall (e.g. jewellery in India)
• Continued purchases by emerging market (EM) central banks as a diversification of their holdings away from traditional reserve currencies such as the dollar and euro

Our full gold price forecast, as well as forecasts for a wide range of other commodities, is available to subscribers at Business Monitor Online.

This Week’s Trivia Question

The previous week’s trivia question centred on the 34^th anniversary of the Iranian revolution, and we asked what revolutionary leader Ayatollah Khomeini’s response was when a journalist aboard his flight asked him how he felt about returning from exile to Iran. Khomeini’s response was “hichi” (nothing).

For this week’s question, we stick with the theme of anniversaries. Following the signing of the Paris Peace Accords (40 years ago this week) aimed at ending the Vietnam war, what did the North Vietnamese negotiator refuse to accept? And separately, what major literary work marked its 200^th anniversary this week?

By coincidence, over the weekend I finished reading Saigon, an epic 750-page novel by former British journalist Anthony Grey that covers the period 1925-1975. The novel was first published in 1982 and is now sadly out of print; I only happened to have discovered it by chance at the second-hand book market several months ago. Nevertheless, if you can get hold of a copy, it’s well worth the read.

Saigon is a multi-decade, multi-family saga covering a huge swathe of modern Vietnamese history. Perhaps the easiest way to think of the book is as the ‘Gone With The Wind’ of the Indochina wars, at least in scope. The reader largely experiences the events through four main families: the wealthy and politically influential Sherman family of America; the Devraux family, who are French colonial settlers; the Tran family, who are powerful and pro-French Vietnamese landowners; and the Ngo family, who are servants of the Devraux family, but eventually turn against them and join the anti-colonial rebellion.

The story begins in 1925 with American Senator Nathaniel Sherman visiting Vietnam with his wife and young sons, a trip that would ultimately lead to Sherman’s sons and grandsons being heavily involved in events in Vietnam for the next 50 years. The novel is divided into eight parts, each dealing with a major phase of Vietnam’s struggle for independence, such as the failed anti-colonial uprising of 1930; Vietnam during the Pacific War; the Battle of Dien Bien Phu of 1954, which led to France’s defeat; the early phase of US military involvement in 1963; the Tet offensive and the height of US combat in Vietnam in 1968-1969; and lastly the US withdrawal and the final collapse of South Vietnam in 1972-1975.

As might be expected, the war not only divides Vietnam, but also the main families of the story along political lines, with often deadly consequences. There’s certainly a lot of tragedy going around in this book. Several real life historical figures, such as Vietnamese revolutionary leader Ho Chi Minh, North Vietnamese military commander Vo Nguyen Giap, and South Vietnamese President Ngo Dinh Diem also make brief appearances in the story.

Overall, I would recommend the novel Saigon first and foremost to anyone with even a cursory interest in Vietnam or Asian history, but also to anyone who likes good and highly readable historical fiction involving revolution, war, family drama, tragedy, and political intrigue, all leading to a gripping finale that coincides with a major world event.

Vietnam’s Rising Importance

Almost four decades after the end of the Vietnam War, Vietnam is rising in importance, economically and geopolitically. Vietnam is now recognised as one of the next generation of emerging markets, albeit one whose recent growth has not been as smooth as neighbouring China, with which it is often compared. Meanwhile, the US has been seeking to develop closer relations with Vietnam, in a context where both countries are apprehensive about the rise of China. Hanoi and Beijing dispute parts of the South China Sea, which, along with the East China Sea, is emerging as a zone of geopolitical competition in Asia. Thus, we can expect to hear more about Vietnam over the coming years.

• Debt dynamics: Jamaica’s debt burden, at nearly 130% of GDP, is the largest in the region. With around one third of total revenues going to interest payments, there is no way for the country to rapidly improve its debt profile.
• Balance of payments: In recent quarters, the central bank has been forced to dip increasingly into foreign reserves to fund external account shortfalls on the back of poor goods trade dynamics and weak investment inflows.
• Recession: High unemployment, weak investment and sluggish tourism inflows all weighed on growth and were further exacerbated by Hurricane Sandy, such that the Jamaican economy contracted in the first three quarters of 2012.

While our core view is that the economic picture will slowly improve in the coming quarters, we note that there are a number of potential catalysts – including a substantial rise in commodity prices, rapid increase in violence weighing on tourism revenue, or a spike in bond yields – that could trigger a crisis situation. In Business Monitor Online, we explain further the macroeconomic dynamics of Jamaica, and outline three different scenarios under which the country could be thrown into crisis.

Given Jamaica’s size and importance in the Caribbean, a major crisis in that country would have an impact across the region. Economies that have similarly large debt burdens could see bond yields rise as investors grow nervous, and liquidity could dry up across the Caribbean.

There are several reasons why the Sahel is suitable for terrorist bases. Firstly, the countries of the region are predominantly Muslim, meaning that militants can blend in more easily and draw recruits. Secondly, the sheer size of the Sahel region and the lack of effective border controls mean that militants have vast areas in which to hide and train, and they can cross relatively easily between countries. Thirdly, the collapse of the Qadhafi regime in Libya in late 2011 and the subsequent chaos in that country have allowed weapons and militants to flow into neighbouring or nearby states such as Algeria and Mali.

We have been covering these events in Business Monitor Online, and present a list of frequently asked questions (FAQs) below. More detailed analysis is available to subscribers in our online service.

Who was responsible for the attack on the In Amenas gas plant in Algeria?

Mokhtar Belmokhtar, a one-eyed Algerian fundamentalist who recently broke from al-Qaeda in the Islamic Maghreb (AQIM) and set up his own group, ‘The Brigade of those that sign in Blood’.

What is al-Qaeda in the Islamic Maghreb (AQIM)?

A primarily Algerian terrorist group that rebranded itself with the name ‘al-Qaeda’ in 2007 to gain prestige. It is mostly active outside Algeria because of Algiers’ heavy-handed (but largely successful) counter-terrorism policies. Its links to al-Qaeda ‘global’ seem largely nominal.

What are AQIM’s goals?

AQIM’s precursor (the Salafist Group for Preaching and Combat, GSPC) was active in the Algerian civil war in the 1990s, when it fought for an Islamic state in that country. It still aims to depose local secular governments, but also opposes Western influence in the region, which it believes supports the current regimes and keeps the region poor.

Does AQIM pose a real threat to the region?

Yes. Along with several allied groups, AQIM conquered northern Mali in April 2012, expelling government troops and forcing 460,000 people to flee. The militants are well-armed, well-financed, and have a history of attacking Western interests (mining, etc). They are much more dangerous now that they control part of a country. While attacks in Europe are not necessarily imminent, reports that the militants have begun recruiting operatives within the African diaspora in Europe are worrying.

Will the French-led intervention in Mali defeat the militants?

Probably not, although it is likely to keep them occupied in Mali over the next few months, making attacks outside that country less likely (the In Amenas crisis notwithstanding). Eventually, France is likely to re-take northern Mali, but this will not destroy the militants. An Afghanistan-like stalemate is a reasonable example of what could happen.

Can regional states deal with this threat?

No. Apart from Algeria, the region has some of the poorest and worst-governed countries on earth. The borders between them exist largely on paper, and are completely undefended. Regional militaries are poorly equipped, badly trained, and do not cooperate with one another.

Is British Premier David Cameron right to talk about a ‘multi-decade struggle’?

Yes and no. If the goal is ending instability in the Sahel and transforming countries like Niger into functioning states, then he is correct that this will take decades (if it ever happens). If the goal is preventing instability in the Sahel from harming Europe, then this is more achievable, and will take less time. Overall, the West has lived with a dangerous Sahel for years; European governments are more likely to tolerate the occasional hostage-taking in the region than make an Afghanistan-style commitment to rebuilding a region the size of India.

Britain’s commitment to the entire ‘European project’ has long been half-hearted, at least compared to Germany, France, and several other countries. Previous British governments have shied away from a referendum on Europe (at least since the 1970s), and this has led to frustration among British voters that they have not been consulted about further integration.

Cameron is now offering a referendum in the second half of his putative second term, which would put its timeframe somewhere around 2017. That is still some time away, and much could change between now and then, making the outcome of such a referendum difficult to predict, regardless of what opinion polls today may suggest.

In Business Monitor Online today, we have published a special feature article on the implications of Cameron’s EU referendum pledge. Among the topics we discuss are:

• Cameron’s motivations for announcing the referendum
• The internal dynamics of the Conservative party
• The dilemma faced by the opposition Labour party
• The risk that Cameron may misjudge the public mood
• The impact of Cameron’s speech on other EU states
• The changing economic relationship between the UK and the EU
• The risks of more uncertainty for Britain, and Cameron himself

The Bank of Japan (BoJ) on January 22 decided to introduce a consumer price inflation target of 2.0% year-on-year (y-o-y) into its monetary policy framework, something that new Prime Minister Shinzo Abe has been pushing for. The BoJ’s previous inflation target was 1.0% y-o-y. The central bank has also decided to embark on US-style monetary easing from 2014, setting monthly purchases of financial assets at JPY13trn (without setting any termination date). While the Japanese government seems convinced that the return of inflation is essential for economic growth, we remain cautious towards its implementation given the possibility that these efforts could instead weaken investor confidence in the government bond market.

As regards fiscal policy, the Japanese cabinet recently approved a supplementary budget worth JPY13.1trn, consisting of public works and other social security-related spending. The government’s increasing need for ever more bond sales, at a time when demand from the private sector is likely to decline with the ageing of the population, will likely put upward pressure on Japanese Government Bond (JGB) yields. With few effective tax and pension reforms in the works, investor confidence could be eroded and further stimulus from here on is likely to hasten the arrival of a fiscal crisis in Japan.

Island Dispute Another Big Risk

Meanwhile, Japan faces another major risk in the form of its dispute with China over the Senkaku/Diaoyu islands. Lately, even mainstream news publications and commentators have been raising the spectre of war. Although the idea of a full-scale Sino-Japanese war still seems far-fetched, a limited air and naval confrontation at sea is hardly unthinkable. Even if such a clash is avoided, China-Japan relations are likely to remain tense. In a recent article, we identified several triggers for further deterioration.

The greatest risk is that China and Japan will deploy more aircraft and ships to the East China Sea, resulting in stand-offs, collisions, or ‘incidents’ that cause fatalities. Civilian vessels could also get drawn into the fray. Any deaths could lead to a surge of emotionalism in the country of the victim(s), leading to angry protests, or public demands for retaliation. This would not necessarily trigger outright conflict, but could send relations into deep freeze. In a worst-case scenario, China could use force to seize the islands. If Tokyo failed to respond, it would risk becoming geopolitically subordinate to Beijing.

Other triggers for a worsening of relations are as follows:

• Japan builds new facilities on the disputed islands
• Abe officially moves to further downplay Japan’s wartime legacy
• Japan amends its constitution to bolster its military status and operational remit
• Japan boosts cooperation with Taiwan

Full analysis of Japan’s economy and geopolitical challenges is available to subscribers at Business Monitor Online.

• What are the economic challenges facing Central America in the face of structurally weaker US GDP growth?
• What will Central America’s ‘two-speed’ growth story look like?
• Why is Costa Rica rather than Panama the most promising economy in the region?
• What are the unique opportunities and threats facing the Nicaraguan economy?
• How is Central America faring amid drug- and gang-related violence?

The special report draws on BMI’s 28 years of experience to critically assess the greatest economic and political risks for Central America in the years to come, helping investors assess the opportunities and challenges for their businesses in 2013 and beyond.

The US Dow Jones is only 700 points off its all-time high, and we expect that it will hit this on a break of 13,663. Apart from US stocks, which we believe will perform well, we have several bullish picks among emerging market indices, including Colombia’s IGBC, China’s Shanghai Composite Index, Vietnam’s Ho Chi Minh City Index, Poland’s WIG20, and Nigeria’s Stock Exchange Index.

And of course, we have several macro-industry plays that have performed extremely well and should continue to push higher, from Chinese healthcare to Commonwealth of Independent States (CIS) agribusiness to US midstream energy. There will be obstacles, of course, with complacency setting in over Spanish and Italian debt sustainability that we believe will be shattered at some point, and a renewed Chinese slowdown before the year is out, according to our core view.

However, as long as the recovery remains intact, with corporate profitability being sustained and liquid assets sloshing around, equities remain king.

This Week’s Trivia Question

Last week, the theme was Venezuela’s political transition. We asked, ‘Venezuela’s Supreme Court recently cited the case of which former senior US official being sworn into his position in Cuba as a possible precedent for allowing President Hugo Chavez to take the oath of office for his new term from the island state?’ The answer was former US vice-president William R. King, who took the oath of office in Cuba in 1853 and died shortly after. For this week’s question, we note that last Wednesday, January 16, marked the 34^th anniversary of the departure of the Shah of Iran from his country. He went into exile, never to return, and two weeks later, Ayatollah Khomeini returned from exile to lead the Iranian revolution. On the flight back to Iran, Khomeini was asked by a journalist how he felt about returning. What was Khomeini’s response?

In the scenario below, we outline the consequences of such an attack on a large metropolis.

A major risk to populations and businesses stems from the fact that so much of the modern urban environment is dependent on constant electricity supplies and instant communications. While a loss of power may not necessarily generate panic, a sustained blackout in telecommunications could before long lead to widespread fear, as the public would not know how long the loss of electricity and communications would last.

Let us imagine for scenario’s sake that a cyber attack shut down the electricity grid of a major city in a major economy. This would create immediate problems, as people would lose the use of lighting and power in the first instance, and with it, experience the loss of data. In the second instance, water supplies would be disrupted, because electricity is used to pump water.

At the same time, urban infrastructure would be severely affected, as traffic lights shut down (requiring motorists to drive slowly and much more carefully) and railway systems ground to a halt. Businesses would lose the ability to conduct electronic transactions, and shops and restaurants would stand to lose perishable goods through the loss of refrigeration. If the shutdown lasted days, then the disruption to business activities would take a big toll on the economy.

While a ‘typical’ power blackout in itself is not so unusual in small areas of cities, and would thus not lead to panic, a city-wide blackout could cause fear to spread, if it prevailed for more than a day or so. This would be exacerbated if the power loss was accompanied by a collapse of mobile and fixed-line communications, because citizens would find it difficult to determine how widespread the shutdown was, or how long it would last. Even if the mobile network kept functioning, the power cut would prevent people from recharging their phones, and the networks could be overloaded with phone calls.

Assuming that the cyber attack struck during working hours, most people would presumably go home, although this could take many hours if traffic lights were down and rail services stopped running.

The disruptiveness of a cyber attack on an urban area would depend on the time of day and the time of year that the attack took place, and the latitude of the targeted city. Clearly, if the blackout occurred during rush hours, the disruption would be maximised. A daytime cyber attack would mitigate the problems caused by loss of electrical lighting, but it would exacerbate problems caused by a loss of refrigeration (especially in a hot country). A cyber attack on a temperate zone city in winter could potentially kill thousands of people, especially the elderly, if the power shutdown resulted in people freezing to death in their homes.

We believe that in the event of a cyber attack shutting down major urban infrastructure, the government would be reluctant to admit the origin of the problem (indeed, it might not even know the cause immediately), and would thus cite technical problems for the disruption. Even so, the government might struggle to convey communications to residents of the affected areas, if electricity and communications were down. People with battery-operated radios would be able to receive news reports and official advice, but not everyone has such radios nowadays. Car owners would of course be able to receive radio transmissions in their cars.

As long as a cyber attack-induced blackout did not last more than a day or two, there would be no reason to expect serious public disorder. However, if the shutdown dragged on for several days, then urban residents could start running out of food and water. The authorities could respond by deploying water and food delivery trucks to mitigate civil disorder risks, but there would still be a risk of looting of supermarkets as people helped themselves to food and drink. Other retail outlets would also be at risk of looting, as opportunists took advantage of the shutdown of public video cameras to steal non-essential items such as electronic goods.

Clearly, matters would be worse if the authorities themselves became paralysed by the cyber attack – although we would expect that the government would have contingency plans to keep itself functioning at such times.

Over the past 10-20 years, there have been several massive blackouts affecting tens of millions of people over large areas, in countries and regions as diverse as north-eastern North America (2003), Italy (2003), Brazil and Paraguay (2009), and most notably large parts of India in July 2012. These serve as test cases for a cyber attack – although arguably the blackout in north-eastern North America is less relevant as a simulation for the present day because people are much more ‘dependent’ on their mobile phones than in 2003.

Natural disasters such as earthquakes and major floods also serve as a test case for a government’s response to a cyber attack, because the presumed consequences of a cyber attack – namely the loss of power and communications – are similar to that of a natural disaster.

Unsurprisingly, countries which are less urbanised and less dependent on modern infrastructure are arguably better placed to cope with cyber attacks, if only because their citizens are more accustomed to life without constant electricity, mobile phones, and complex distribution systems.

One of the themes that BMI is exploring is how more and more household goods and transportation are being increasingly linked to the internet. This being, the case, cyber attacks in the future will be worse than today, as more ‘stuff’ gets linked to computer networks.

Although we see good reason to subscribe to the 2013 ‘good news’ optimism, we add one major caveat: Spain. While US politicians can continue kicking the can down the road, and the Chinese authorities have an unrivalled ability to mobilise resources and squeeze more juice out of their mercantilist investment growth model, Spain cannot be so easily turned around. A gaping hole in the state’s coffers, a deep recession, destructively high and rising unemployment, and an inability to engineer immediate currency devaluation, all give cause for concern.

However, there still seems to be a lot of good faith going around. The market has faith in the European Central Bank (ECB)’s Outright Monetary Transactions (OMTs), the ECB has faith that Spain will enter a structural macroeconomic adjustment programme, and the Spanish government has faith in its ability to avoid an official bailout.

This is dangerous thinking.

As we have argued previously, the collapse in peripheral eurozone sovereign bond yields after the OMT facility was unveiled on September 6, 2012 has provided the Spanish government with a false sense of hope that it can avoid taking the contentious decision of negotiating a bailout. As long as the market pressure is off their shoulders, the Spanish government will continue to drag its feet. However, with the economic data flow poor and potentially deteriorating further this year, positive investor sentiment could dissipate quickly and the market could once again ratchet up the pressure on the government.

As such, we warn that once the current euphoria dies down and investors once again take stock of global risks, Spain will likely be the first target to pop up on the radar. Market turbulence could come back with a vengeance.

Further analysis of Spain’s debt dynamics, fiscal problems, and the eurozone crisis is available to subscribers at Business Monitor Online.

Earlier today, Business Monitor Online published analysis on the unfolding events in Mali. The questions we answered include:

• Who Currently Controls Northern Mali?
• Why Has France Decided To Act Now?
• Will The Airstrikes Be Effective?
• How Have Other International Actors Responded To The French Mission?
• Where Do Things Move From Here?
• What Are The Downside Risks Of An Intervention?

One of the consequences of the fall of former Libyan leader Colonel Qadhafi is that arms and militancy spread south across the Sahara into the land-locked African nation of Mali.

More broadly, there are concerns that Saharan Africa (the Sahel region) is becoming a safe haven and training ground for al-Qaeda or al-Qaeda affiliated groups.

The fighting in Mali has displaced hundreds of thousands of people, some of them into neighbouring Niger, Burkina Faso, and Mauritania.
Hollande’s actions signal willingness by the French government to take a stand against regional Islamist militancy and maintain France’s involvement in its former African colonies.

However, Hollande is also taking a risk in starting a potentially open-ended mission at a time when France is struggling with domestic economic issues.

This Week’s Trivia Question

Last week, the theme was imaginary Japanese companies, and we asked which early 1990s thriller featured a plot by Japanese companies to dominate the US economy? (This book seems ridiculously dated nowadays, of course.) And for a bonus, which early 1960s novel portrayed a California and Western USA controlled by Japan following its victory in World War II?

The answers are Rising Sun by Michael Crichton, and The Man in the High Castle by Philip K. Dick.

This week, the theme is Venezuela’s political transition. Venezuela’s Supreme Court recently cited the case of which former senior US official being sworn into his position in Cuba as a possible precedent for allowing President Hugo Chavez to take the oath of office for his new term from the island state?

The report outlines the main global themes for the year ahead, as well as a detailed explanation of our regional growth forecasts. It also provides a comprehensive outlook for commodity prices and geopolitics. The complete global picture is essential for planning future growth strategies and understanding potential business risks.

Use BMI’s core views on the global outlook for 2013 to support your investment decision-making and risk planning activities. The report answers key questions, such as:

• What are the downside risks troubling Asian economic growth?
• What lies in store for the eurozone in 2013?
• How will China’s continued reduced demand for industrial metals affect Latin America’s macroeconomic outlook in 2013?
• How will the post-Arab Spring uncertainties affect the Middle East and North Africa regions?
• What is the outlook for global commodity prices in 2013, and which are the commodities to watch?
• What geopolitical risks does 2013 pose?

The special report draws on BMI’s 28 years of analytical experience to critically assess the global economic and political outlook for 2013, which in turn will support you in assessing the opportunities and challenges for your business operations over the coming year and beyond.

• We expect mining industry expansion in Latin American countries such as Mexico and Colombia, but we expect to see further problems in Argentina due to business environment concerns.
• We anticipate slower Chinese growth by H2 2013, which will weigh on mining equities. Continuing problems in the eurozone will also push mining shares lower. Companies that are well diversified, such as BHP Billiton, should outperform.
• Capital expenditure will continue to fall, limiting investment in greenfield projects and affecting mining services companies such as Caterpillar, Joy Global, and Atlas Copco.
• Africa will continue attracting Chinese investment. West African countries such as Sierra Leone and Guinea have enormous high-grade iron ore reserves which are still crucial for China’s infrastructure plans.
• The global coal trade will shift, with the US in particular becoming a major net exporter of coal. This will favor firms such as Peabody Energy.
• The mining industry will see further consolidation, which will have the effect of limiting greenfield investment.
• Frontier markets with improving political environments and major mineral reserves will continue attracting investment. We highlight Mongolia, Mozambique, and Sierra Leone.

Our full feature on global mining, as well as our forecasts for a wide range of commodities, is available to subscribers at Business Monitor Online.

Although Venezuela’s political trajectory will remain highly uncertain, we believe that the ruling PSUV party will take steps to extend Chávez’s presidency for as long as possible, in order to maintain political stability and dominance over the country’s institutions. That said, we do not rule out a deeper political crisis, with the potential for military intervention, as political and social tensions are set to heighten in the near term.

Currently, the opposition’s chances of winning a snap presidential election are low, following their waning support after a disappointing performance during the December 16, 2012 regional elections.

The best bet for the PSUV to avoid a major political and social crisis at this point is to unite behind Chávez, which is what we believe will transpire as long as the president is alive, even if he steps down from office. Indeed, the PSUV will seek to maintain the strong popular support Chávez has built throughout his 14 years in power, in order to diminish social tensions.

Also, the PSUV will use Chávez’s legacy to avoid intra-party fragmentation, in order to entirely shut out the opposition in prospective elections in the near future.

Nonetheless, once Chávez dies, political tensions will intensify, and we do not rule out a major political crisis. Although Chávez has named Vice-President Nicolas Maduro as his chosen successor, Maduro could still meet resistance from the PSUV.

Without Chávez’s influence, the political vacuum could lead to a destabilising power struggle within the party, with the potential for intervention by the military faction, headed by Diosdado Cabello (President of the National Assembly).

In addition, the Bolivarian militia, which is estimated to have at least 20,000 members who are ideologically loyal to Chávez’s ‘socialist revolution’, could also step in if it determines that the government is deviating from ‘Chavismo’.

Furthermore, opposition supporters would also play a role through mass mobilisation, implying that civil-military conflict cannot be ruled out.

Although financial market optimism has prevailed, signaling that investors interpret any move towards a Venezuela without President Chávez as a positive event, we believe that a meaningful shift away from the current policy mix would only be brought about after a painful and destabilising process, which we believe could take years to unfold. As such, once investors realise the high levels of political risk, we believe they will reassess their relative optimism.

Developed countries such as Japan and South Korea have maintained relatively high levels of support to farm production for many years. Although both countries have been reducing the support they provide to farmers, it is still twice the average of OECD member countries (i.e. most developed states). Direct subsidies to farmers are rather rare in Japan and South Korea, and government support to production takes the form of market price support and import quotas. The Japanese government allocated JPY2.3trn in 2012 as part as of its farm support programme.

China implemented in 2004 a large government support programme for agriculture in order to promote further production, including input subsidies, procurement prices, direct payments to farmers, and preferential loan rates. The government has been stepping up this support policy since then, with subsidies to farmers soaring by almost 170% between 2007 and 2011 to CNY138.1bn (US$22.1bn), making China the global leader in absolute terms. The sharp increase pushed the share of Chinese farm income from subsidies to 17%, nearing the OECD average of 18%. The number and scope of programmes providing budgetary support to agriculture has been constantly increasing since 2004. To an increasing extent they take the form of direct income support payment, with seed, fertiliser and machinery subsidies. Going forward, we expect China to maintain a generous subsidy policy, as the country is struggling to meet its goal of being 95% self-sufficient in wheat, corn and rice.

India and Indonesia have similar profiles. Both countries increased support to farmers, but growing fiscal deficits, especially in the case of India, are pushing these two nations to phase out part of their subsidies programmes. India spent US$4.43bn on subsidising domestic production and imports of fertilisers in 2011, but it announced in March 2012 that it would cut by a fifth the subsidy it gives to phosphate and potash-based fertilisers in FY2012/13 in an effort to reduce its growing fiscal deficit. However, the government left unchanged the level of subsidies for urea, the crop nutrient used the most and that accounts for the bulk of the government’s spending on fertilisers.

Similarly, Indonesia is struggling to reduce fuel subsidies (the government allocates a hefty 15.8% of its total expenditures to the oil subsidy) and aims to maintain farm subsidies below 2009 levels in order to address its fiscal deficit. Expenditures on fertilisers are targeted at IDR15.3trn in FY2012/13, down 10.0% year-on-year (y-o-y). Despite the recent drop in input subsidies, we believe India and Indonesia will return to more generous policies in the coming years.

Although growth looks set to come in at the weakest level since the 2009 recession in 2012, we continue to anticipate a significant pickup in economic activity in 2013. We forecast real GDP expansion of 3.5%, as we expect a construction backlog to bolster growth, and continued stimulus measures to modestly boost activity in the consumer and manufacturing sectors.

Over the medium term, we believe that slowing private consumption growth and the end of the China-led commodity boom will constrain Brazil’s average real GDP growth to 3.5% between 2012 and 2017. Indeed, we believe that Brazil’s consumer story is in for a period of more moderate growth in the next few years due to reduced consumer purchasing power, on the back of continued currency weakness, and high household indebtedness.

In addition, we foresee a supportive, but bifurcated, investment picture going forward. While a massive growth acceleration programme and significant commodity wealth will continue to support one of the region’s largest infrastructure project pipelines, our view of China’s economy to rebalance has important implications for Brazil. As Chinese investment comes off the boil, we anticipate that the slowdown in economic activity will feed through to lower average prices for base metals and iron ore, squeezing firms’ margins and forcing them to re-evaluate their capital expenditure programmes in major commodity-producing countries. As such, we expect that investment inflows related to the commodity sector are likely to moderate, feeding through to slower economic growth in Brazil overall.

Full analysis of the Brazilian economy is available to subscribers at Business Monitor Online.

Mudavadi’s decision to quit the alliance appears to have been the result of a failure to agree on who the coalition’s presidential candidate will be. This deals a blow to Kenyatta, the Jubilee flagbearer, as it will diminish his share of the vote among the Luhya (Kenya’s second biggest ethnic group after Kenyatta’s Kikuyu group) in western Kenya.

On the one hand, Mudavadi’s withdrawal plays into the hands of the rival Coalition for Reform and Democracy (CORD), which has confirmed that Prime Minister Raila Odinga will be its contender in the presidential race and which also includes current Vice-President Kalonzo Musyoka. Indeed, a Ruto/Mudavadi/Kenyatta ticket would have presented the most formidable challenge to Odinga.

On the other hand, the withdrawal of Mudavadi, who has since entered an alliance with fellow Luhya Justice Minister Eugene Wamalwa, is likely to diminish Odinga’s chances of a first-round victory as it will dilute the support that Odinga would have received by virtue of his representing what would have been the only major non-Kikuyu affiliated alliance. Although the political landscape following coalition announcements in early December suggested to us that the election would be a two-horse race between the Odinga/Musyoka and the Ruto/Mudavadi/Kenyatta alliances, we now believe that Mudavadi’s own coalition brings the number of major contenders to three.

Full coverage of Kenya’s political situation, as well as its economic outlook, is available to subscribers at Business Monitor Online.

This Week’s Trivia Question

In our last weekly trivia question, posted on December 14, the theme was films set at Christmas time. We asked which 1980s action film featured a corporate Christmas party being taken over by terrorists? The hint was that it featured a Japanese company with an office in Los Angeles. The answer is of course Die Hard (1988), and the company was the Nakatomi Corporation. This week, sticking with the theme of imaginary Japanese companies, which early 1990s thriller featured a plot by Japanese companies to dominate the US economy? (This book seems ridiculously dated nowadays, of course.) And for a bonus, which early 1960s novel portrayed a California and Western USA controlled by Japan following its victory in World War II?

• Growth Rates To Converge: Average real GDP growth rate differentials between the economies of the hydrocarbon-rich Gulf on the one hand, and the net oil importers of North Africa on the other, are set to narrow. Base effects are obviously a key aspect of this convergence, with the former group of states beginning to experience a cyclical downturn following two consecutive years of above average economic expansion. That said, and in contrast to previous years, we believe the non-oil sectors across the Gulf Cooperation Council (GCC) will outperform the oil sectors, as hydrocarbon output has in the majority of cases plateaued.
• Policy Risks In Focus: The nature of political risks is set to evolve, with the focus shifting towards increasingly erratic and unpredictable policy decisions, as opposed to large-scale civil unrest. In the Gulf, government policies will focus on efforts to increase participation rates of the national workforce in the private sector, in addition to legislation which aims to help move away from a dependence on hydrocarbons. In North Africa and the Levant, governments could face their biggest tests since early 2011, with highly unpopular economic reforms needing to be implemented, yet widespread public opposition and elevated unemployment raising risks of policy slippage or reversals.
• Little Hope For ‘Crisis States’: We do not expect a resolution to some of the most pertinent crises in MENA at the moment. Although we include Libya and Yemen in this category, the main concerns are Syria and Iran, where growth has slowed sharply following the imposition of international sanctions on each state’s respective oil sector. Presidential elections in June in Iran only further raise the risks of increased social unrest or erratic policy in the Islamic Republic in 2013, not to mention the rising risk of an Israeli air strike, especially if a hardliner wins the presidency.
• Balance Of Payments Strains Will Remain: The temporary impact of higher global commodity prices, lower tourism revenues, weak external demand and a slowdown in foreign investment will prevent a stabilisation in the balance of payments dynamics of net oil importers. Although the pace of foreign currency reserve depletion is likely to slow, many of these states will become increasingly reliant on external financial aid to prevent currency devaluations.
• Equities Over Fixed Income: With sovereign and corporate borrowing costs at multi-year lows, particularly in the Gulf, we believe the rally in regional fixed income markets is set to come to an end in 2013. In contrast, following two consecutive years of broadly sideways trading, equity markets could be set to head higher, particularly if the aforementioned uptick in non-hydrocarbon growth begins to materialise.

Our full MENA outlook is available to subscribers at Business Monitor Online.