June 2012 Political Risk Letter

ANGOLA

Succession Uncertainty a Risk
Legislative elections are scheduled for August 31, but a Supreme Court ruling that annulled the appointment of the head of the election commission creates a possibility of yet another delay. Regardless of when the election is held, the result is all but certain to be a convincing victory for the governing MPLA, which, in accordance with constitutional changes made in 2010, will elect its candidate to the presidency. Although the MPLA has yet to officially designate its presidential candidate, the incumbent, José Eduardo dos Santos, shows no sign of preparing for retirement, and will likely be the party’s standard-bearer.

That said, there is a high probability that dos Santos will step down before the completion of his four-year term. The recent appointment of the head of the state-owned oil company, Manuel Vicente, to the post of minister of state for economic coordination may indicate that he is being groomed as the president’s heir. Vicente does enjoy a good rapport with foreign oil companies, and his inclusion in the president’s inner circle is a positive signal to Angola’s investment partners.
However, his designation as dos Santos’ successor would probably not sit well with the battle-hardened old guard of the MPLA, who do not particularly trust the younger technocrats. Consequently, the race to succeed dos Santos is still open, and jockeying by aspiring contenders may generate worrisome tensions atop the party hierarchy until the matter is settled.

BOLIVIA

Morales Maintains Populist Course
Since winning the presidency, President Evo Morales has made it his custom to time major policy announcements, such as the nationalization of privately held strategic assets, to occur on May 1, the international day of the worker, thereby adding symbolic power to the populist moves. This year, the president took the opportunity to announce the nationalization of Bolivia’s national power grid, through the expropriation of the shares held by the local subsidiary of Spain’s REE, which Morales claimed had not met its investment obligations.
Unfortunately, Morales’ moves against foreign-run firms no longer produce quite the same amount of goodwill among his traditional base as was the case a few years ago. Consequently, it appears that preventing a further erosion of his support will require him to go to the nationalization well more frequently than he used to. A mere five weeks after expropriating REE’s shares in the power grid, the government announced the nationalization of the Colquiri zinc- and tin-mining operation owned by Sinchi Wayra, a subsidiary of Glencore.
The nationalization drive begun in May 2006 coincided with a commodities boom, which has helped to obscure the negative implications of the expansion of state control for Bolivia’s long-term economic health. Even so, the government acknowledges that it cannot adequately exploit Bolivia’s wealth of resources on its own, and is seeking out new foreign investment, albeit on its terms.
Morales’ recent suggestion that he is considering nationalizing all of the country’s natural resources highlights the ongoing high risk of politically motivated moves against foreign interests, which will only increase as the president attempts to repair his crumbling electoral base ahead of the next round of elections.

CZECH REPUBLIC

No Margin for Error
Prime Minister Petr Nečas’ center-right government very nearly collapsed in April 2012, as the withdrawal of the VV, the most junior partner in the three-party coalition, left the two parties that remained—Nečas’ ODS and TOP 09—short of a majority in the Parliament. With the support of the VV faction headed by Deputy Prime Minister Karolina Peake, the government claims a two-seat majority in the 200-member Chamber of Deputies.
Nečas has stated that he will call for an early election if he fails to win approval of austerity measures designed to reduce the fiscal deficit to less than 1% of GDP by 2015, gambling that the near certainty of crushing losses for the governing parties in the event of a snap poll will provide a strong incentive for his partners to press ahead against what promises to be a powerful backlash. However, the narrowness of the coalition’s majority leaves little margin for error, and the possibility that a handful of lawmakers might suffer a failure of nerve that results in the collapse of the government can hardly be ruled out.
Beyond the immediate challenges facing the government, the direct election of the president beginning in 2013 creates the potential for additional risks going forward. The recent poll data suggests that the opposition CSSD has a very good chance of winning the presidency next year. Although the powers of the president are limited, such an outcome would create another threat to the survival of Nečas’ government through the end of the 18-month forecast period.
If the austerity measures and other reforms produce the desired results and the economy is firmly on a path toward sustained moderate growth by the time the next election falls due, the center-right parties will be favored to win. That said, given the divisions within the ODS on the issue of closer European integration and disagreements among the partners on key issues, the probability of a center-right coalition remaining in power for the entire five-year forecast period is only marginally higher than those for the most likely alternatives.
In that regard, the government’s comfortable debt position will work in its favor, and recent market activity suggests that investors have noted the progress made thus far in the areas of fiscal consolidation and structural reforms. Whether that confidence can be sustained will depend to a significant degree on perceptions of the government’s ability to keep its reform program on track.

FRANCE

Policy Reset Brings Uncertainty
François Hollande, the Socialist presidential candidate, emerged the victor in a run-off election held on May 6, taking 51.6% of the vote in a two-way contest against the incumbent, Nicolas Sarkozy. At legislative elections held in June, the PS won 280 seats in the 577-member Parliament, nine short of a majority. However, the backing of three smaller left-leaning blocs provides the PS-led government with a comfortable majority of 331 seats.
The top priority of the new regime will be achieving a lasting resolution of the euro-zone debt crisis, and Hollande’s preferred course contrasts sharply with that of Sarkozy, who in the main supported Germany’s position that painful austerity was the path to solvency for the euro-zone’s debt-crippled members. During the presidential campaign, Hollande pledged to push for renegotiation of a recently concluded EU fiscal pact with the aim of ensuring greater emphasis on pro-growth policies and an expanded role for the ECB in relieving the debt pressure weighing so heavily on the peripheral states.
Hollande’s success at repairing a damaging rift within the PS suggests that he possesses the skills required to bridge the gap between emerging pro-austerity and growth-first factions within the EU. The outcome of a recent EU summit suggests that German Chancellor Angela Merkel is prepared to meet him halfway, but if his proposed course change fails to right the euro zone ship, the result could be a loss of influence for France over the medium term.
The president will face no similar challenge as he goes about implementing his domestic agenda, at least in the early going. A number of measures enacted by presidential decree in the very near term include a temporary freeze on fuel prices, a 30% reduction in presidential and ministerial salaries, and a lowering of the retirement age to 60 years. Those are crowd-pleasing moves, but their positive economic impact is debatable, particularly given the degree to which France’s economic health is linked to the stability of the broader European bloc.

HAITI

No End to Political Dysfunction
Tensions between President Michel Martelly and the opposition majority in the National Assembly, which contributed to a five-month delay in filling the prime minister’s post in 2011, continue to run high, and the risk of political instability was heightened further in late February, when Prime Minister Garry Conille submitted his resignation after just four months in the post. Conille was forced out by the president, with whom he had butted heads over a probe into some $300 million of reconstruction contracts and control over government appointments.
Conille’s designated successor, Foreign Minister Laurent Lamothe, was sworn in as prime minister in May. He has promised to pursue a pro-business policy agenda designed to attract higher levels of foreign investment, which will be essential to reducing widespread poverty and freeing Haiti from dependence on foreign financial assistance. Lamothe is a close ally of the president, but he lacks political experience. That will be a significant handicap, as the prime minister is responsible for securing legislative support for the government’s policies, no easy task in the current political climate.
In terms of Martelly’s relations with the legislature, both the leader of the Senate, Simon Dieuseul Desras, and Levaillant Louis-Jeune, his counterpart in the Chamber of Deputies, are openly hostile to the president. Significantly, Louis-Jeune was elected as coordinator of INITE, the dominant force in the Chamber of Deputies, in early March. He replaced Sen. Joseph Lambert, whose leadership position came under challenge after he sought a rapprochement with President Martelly.
All of which suggests that the spirit of cooperation needed to build sustained momentum behind a combined post-disaster recovery and long-term development effort is likely to be lacking for the foreseeable future. As long as that remains the case, foreign donors will remain reluctant to follow through on pledges of financial support. The government’s resistance to auditing hundreds of millions of dollars worth of state contracts purportedly awarded without competitive bidding—a key point of disagreement between Martelly and Conille—will only reinforce the skepticism of donors.

INDIA

Confidence Ebbing
A combination of political paralysis and policy uncertainty stemming from the inability of Prime Minister Manmohan Singh to secure majority support for crucial reform measures has cast a pall over the business climate in India. Disappointment over the government’s inability to win approval of a high-profile anti-corruption measure and its U-turn on a reform to open the local market to foreign big-box retailers in late 2011 has more recently given way to alarm over tax measures included in the 2012/2013 budget that authorize the government to retroactively impose a capital gains tax on foreign companies participating in previously completed mergers and acquisitions involving locally based firms.
Clear evidence of weakening confidence and growing intolerance of the obstacles posed by a tangled bureaucracy, widespread corruption, and erratic policy making is apparent in the sub-par inflows of FDI since August 2011 and a recent retreat by institutional investors that sent the Bombay Stock Exchange index plummeting by more than 13% between late February and early June 2012.
The unfavorable signals have caught the attention of global credit-rating agencies. In April, Standard & Poor’s revised its credit outlook for India from stable to negative, and Fitch followed suit in June, shortly before Standard & Poor’s issued a warning that India was at risk of becoming the first of the so-called BRICS to lose its investment-grade rating.
The government is hoping that Singh’s assumption of personal responsibility for the Finance portfolio in late June, a move prompted by Pranab Mukherjee’s resignation in advance of a run for the presidency later this year, will help to bolster confidence. The prime minister rose to prominence as the architect of a liberal reform program carried out in the early 1990s, and he has hinted that he will take another stab at securing passage of controversial reforms, including proposals to raise the cap on FDI in the insurance industry from 26% to 49%, and to make the voting rights of foreign investors in private banks commensurate with their shareholdings, that have been stalled by opposition within the governing UPA coalition.
While Singh’s expanded economic policy role might have a temporary positive effect on market sentiment, it is difficult to see how the move might improve the prospects for overcoming the opposition of the TMC, the second largest party in the UPA, which has been the chief barrier to securing parliamentary approval of the reforms. A combination of disappointing real GDP growth and expanding fiscal and current account deficits is contributing to anxiety among investors. A positive near-term shift in sentiment is unlikely in the absence of a significant breakthrough on the reform front, in which case the risk of damaging market volatility will persist.

NORWAY

Bubble Trouble
Battles over policy within Prime Minister Jens Stoltenberg’s Red-Green coalition government have become increasingly frequent in 2012. Even so, the risk of the coalition collapsing before the next general election in September 2013 is low. Opinion polls conducted in early June put support for both the SV and the Sp below the 4% minimum required to secure parliamentary representation. Although the constitution does not allow for snap elections, neither of the parties could expect to benefit electorally by withdrawing from the government.
The DNA has managed to sustain its own popular support around 30%. However, with the main opposition Conservative Party currently polling at 31%, and the further right FrP favored by nearly 20% of voters, the Red-Green coalition’s chances of winning a third consecutive term are growing increasingly dim, particularly given the rather unpromising near-term outlook for the economy.
As Norway is not a member of either the EU or the monetary union, its ability to influence developments on that front is limited. In its favor, however, its status as West Europe’s only major oil producer provides it with a significant cushion against external shocks. For that reason, the attention of officials in Oslo is for the time being more focused on growing evidence that low interest rates are fueling a housing bubble that could have a devastating impact on the economy if it is not brought under control.
Monetary authorities have made clear that their top priority is preventing the further appreciation of the krone, which is undermining the competitiveness of Norway’s non-oil exports. Although a 4% pay hike granted by the government following a general strike by public-sector workers has upside implications for inflation, Norges Bank is unlikely to consider a rate increase until sometime next year. Capital inflows will provide protection against the bursting of the bubble in the near-term, but any developments that negatively affect Norway’s safe-haven status would create a high risk of losses for the banking industry.

OMAN

Risk of Unrest Receding
The anniversary of the unprecedented eruption of political protests for greater democracy and transparency passed peacefully in February, as no major gatherings were held amid a beefed-up police presence in urban areas. A combination of generous government spending, the judicious use of repressive measures against the most outspoken government critics, and minor political concessions involving the limited expansion of elected legislative bodies appears to have successfully dampened anti-government sentiment.
Even if the Omani citizenry is by-and-large satisfied with the modest expansion of public influence granted by Sultan Qaboos, the precedent set by last year’s protests means that the possibility of periodic episodes of public activism has become a fact of life that officials will have to consider moving forward. Consequently, some risk of unrest will persist, although it is highly improbable that protesters might directly challenge the authority of the sultan.
Far more problematic for the government is the new-found appetite for strike activity that has become apparent in the wake of last year’s unrest. Workers in construction, oil, airport services, and other sectors have walked off the job in support of demands for increased pay and benefits. The government has been using state media to urge both public- and private-sector employees to register as candidates for upcoming elections to fill seats in newly created municipal councils, presumably with the expectation that direct involvement in political affairs will tame the militant spirit among the labor force.
For the time being, healthy public spending on jobs and social welfare, facilitated by high oil prices, will probably be a more effective tool for pacifying the work force and containing unrest among unemployed youth.

POLAND

Tusk Prepared to Move Forward

In May 2012, Prime Minister Donald Tusk’s coalition government secured parliamentary approval of reforms to the national pension system that will bolster Poland’s long-term fiscal position and, of greater immediate importance, will help to hold the public-sector debt ratio below the constitutionally mandated maximum of 60% of GDP. The prolonged negotiations between the main governing PO and its coalition partner, the PSL, over the reforms ensured that voters had plenty of time to ponder just how much they dislike the changes, and the popularity of both parties has weakened significantly since last year’s election.
The stress of these developments has widened existing cracks in his party’s unity, which have been exacerbated by the aggressive courtship of potential defectors by the RP, a new center-right party created by Janusz Palikot, himself a former member of the PO. There is little danger that the government might be toppled from power in the near term, but the dissension in the PO ranks is undeniable, and the risk of a damaging erosion of the party’s parliamentary strength that threatens its survival cannot be ruled out.
Having finally decided to tackle long-promised reforms, Tusk appears to be prepared to move forward, with revisions of labor-market rules next on the agenda. PO officials have indicated that they want to run complete their reform program as early in the term as possible, thereby ensuring ample time to repair the damage to the party’s standing among the electorate before elections are required in 2015.

SOUTH KOREA

Peninsular Tensions Loom Large
The incumbent NFP (formerly the Grand National Party) retained a narrow majority at legislative elections held in April, winning 152 of the 300 seats in the National Assembly. The victory creates some momentum for the NFP as it prepares its campaign to retain control of the presidency at an election in December 2012. Park Guen-hye appears to be solidifying her claim to the NFP’s nomination, and polls suggest that she would easily defeat Moon Jae-in, the early front-runner to win the primary to choose the DUP’s candidate. Opinion surveys indicate that Park would face a bigger challenge from Ahn Choel-soo, a successful businessman who could contest the election as an independent, but as the race will be decided on a first-past-the-post basis, Park stands to benefit if she faces two or more challengers.
The threat to national security posed by an ongoing leadership transition in North Korea is unlikely to alter the electoral calculus, but it does have potentially serious negative implications for South Korea’s attractiveness to foreign investors. Kim Jong-un, who succeeded his father as leader of North Korea in late 2011, needs to prove that he possesses the iron fist required to rule the military-dominated authoritarian state, and periodic threatening gestures toward South Korea—such as a ballistic missile launch in mid-April—are likely to figure prominently in that process.
Reports that Kim Jong-un has restarted North Korea’s nuclear weapons program most likely reflect a desire to improve the country’s diplomatic leverage, but, if confirmed, the move will undoubtedly have a chilling effect on investment in South Korea, reinforcing an economic slowdown that is otherwise forecast to hold real GDP growth to no more than 3% in 2012.

VIETNAM

Cautious Reform
The imprisonment of nine executives from Vinashin, the state-owned shipbuilding company, following their conviction on charges of economic mismanagement highlights the commitment of the newly installed CPV leadership to pressing ahead with reform of the grossly inefficient state-run sector of the economy. Vinashin found itself on the brink of bankruptcy after accruing debts totaling $4.4 billion, and its default on payments to international lenders resulted in a downgrading of Vietnam’s credit rating.
In addition to prosecuting (or at least removing) incompetent or reckless executives at other firms, the government has introduced other reforms, including requirements that state enterprises publish reports of audited earnings and divest non-core businesses, and is expected to revive a privatization program that in addition to generating income promises to enhance competition between the state and private sectors.
While these are positive steps in terms of opportunities for foreign investors, the chances of a rapid and fundamental restructuring of state-owned enterprises are very slim. Economic prosperity is essential to public acceptance of the CPV’s political monopoly, and the party leadership will not risk opening the door to the wrenching dislocations that would accompany a sweeping overhaul of the state sector. Tightening measures to rein in inflation will hold real GDP growth below 6% in 2012, a sub-par performance that will reinforce the bias toward a cautious approach to reforms.
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