perspectives INSIGHTS FROM EURASIA GROUP politics and the · china 65 The government is working for a soft landing by addressing economic anxieties and stock market volatility with

PAKISTAN

NIGERIA

IRAN

VENEZUELA

INDONESIA

UKRAINE

PHILIPPINES

THAILAND

SAUDI ARABIA

INDIA

RUSSIA

COLOMBIA

ALGERIA

EGYPT

ARGENTINA

TURKEY

SOUTH AFRICA

CHINA

MEXICO

BRAZIL

BULGARIA

SOUTH KOREA

HUNGARY

POLAND 77

76

74

72

69

69

65

65

64

63

63

62

62

62

61

60

60

57

57

56

54

52

45

43 Economy

Security

Society

Government

perspectives politics and the markets october 2008

latin america Faces Growing challenges

l atin American countries have experienced remarkable economic prosperity during the past five years, and their governments have been strengthened by skyrocketing

approval ratings. The next 12 months, however, could be more challenging—due in large part to the limits of the so-called “irresponsible left.” (The most identifiable trend in Latin America over the past five to seven years has been a turn toward the left in terms of political and fiscal policies.) As it is, countries throughout the region are already struggling with rising inflation. Though the recent drop in commodity prices may provide some relief on this front, it reflects slowing global growth, which is yet another problem. Policy responses throughout the region will be varied, but countries that have embarked on heterodox economic policies or resource nationalism will probably face greater difficulties than those that have not.

For instance, Argentina and Venezuela are facing much higher inflation, while their fiscal and external positions are vulnerable. High oil and commodity prices have given them some breathing room and could delay the day of reckoning, but it will become more difficult to maintain stability and growth as the costs of populist policies continue to rise. Argentina looks particularly weak: The Cristina Fernández de Kirchner administra-tion faced a significant setback during the country’s farming crisis when it was forced to suspend a tax on agricultural exports, yet the country is increasingly dependent on high commodity prices. Given that Presi-dent Fernández de Kirchner is unlikely to alter current

Global political risk indexThe GPRI, which is produced by Eurasia Group, measures a country’s ability to absorb political shocks. The higher the number, the more stable the country.

Courtesy of Citi Private Bank

INSIGHTS FROM EURASIA GROUP

(continued on inside cover)Government

society

security

economy

By Christopher Garman DireCtor, Latin ameriCa

policies, which place a premium on price controls and manipulation of inflation sta-tistics, the government’s fiscal position may very well deteriorate in 2009 amid grow-ing speculation over whether she will finish out her term.

Meanwhile, if oil prices drop further, Venezuela and Ecuador may suffer, though any repercussions will not be felt before 2009 or 2010. After Venezuela’s upcoming regional elections this November, President Hugo Chavez will be forced to try to rein in inflation, which is running above 30%. However, lower oil prices will make fiscal adjustments difficult. While Chavez has staying power, he could be weakened in 2009. In Ecuador, President Rafael Correa will benefit from the upcoming referen-dum on a new constitution that gives the executive branch more power. Nonethe-less, if oil revenues fall, speculation about a default on the country’s sovereign debt is likely to increase.

Brazil, Colombia, Mexico and Peru, which have pursued prudent, market-friendly macroeconomic policies, will also face challenges, but the costs of adjustment will be relatively small. Each of these gov-ernments will probably show more caution on the fiscal front, and their central banks have more decisively moved to raise rates. Of the four, Mexico is most vulnerable due to its proximity to the US and the govern-ment’s budget dependence on oil revenues. Its biggest risk during the next few years will come from reform paralysis rather than dramatic policy changes. In Brazil, meanwhile, President Luiz Inácio Lula da Silva will probably respond to any external crisis by veering toward economic conser-vatism, though there is not much room for fiscal adjustment.

On Sept. 6, Ali Asif Zardari, cochairman of the Pakistan People’s Party (PPP), was elected as the president of Pakistan. Zardari’s victory means that the PPP—having outmaneuvered the Pakistan Muslim League-Nawaz (PML-N)—now controls both the presidency and the coalition government, and has a fragile majority in the national assembly. Despite this advantage, the government will face major challenges in the coming months that could put its long-term survival at risk.

Politically, the PPP needs to satisfy the junior coalition partners and carefully manage its relationship with the PML-N to prevent destructive competition that could lead to the kind of dysfunctional civilian governance Pakistan experienced in the 1990s. At the same time, the government needs to improve the political, economic and security conditions that are causing public discontent. The key issue is a constitutional

amendment that allows the president to sack an elected government. Although the PPP has pledged to overturn it, Zardari is reluctant to weaken the powers of his own office.

Economically, Pakistan is facing a crisis with the specter of sovereign default haunting the government. In August, its reported foreign exchange reserves fell below $9.4 billion, and the PPP-led government needs to secure significant foreign assistance. While Saudi Arabia is likely to offer a multimillion-dollar oil facility and provide budgetary support, the International Monetary Fund (IMF) has outlined tough political and economic conditions in return for a soft loan. The government is reluctant to accept them because it fears a backlash from the public. Failure to secure an IMF loan, however, would deepen the economic crisis by the end of the year.

stability spotliGht

ForecastratinG

43

2 politics and the markets

(continued from cover) close-up: pakistan NEw PREsIdENT FacEs wIdE-RaNGING challENGEs

By maria Kuusisto, anaLyst, asia

5,000

10,000

15,000

20,000

KSE100

Aug-08

Jul-08

Jun-08

May-08

Apr-08

Mar-08

Feb-08

Jan-08

Dec-07

Nov-07

Oct-07

Sep-07

60

80

100

Sovereign bond

*The KSE 100 Index was started in November 1991 with a base of 1,000 point, and it is recomposed semiannually, and was last recomposed on 28 February 2007 closing statistics.

Source: Bloomberg, accessed on 04 September 2008.

KS

E 1

00

Inde

x*

Sovereign bond price

(in Pakistani rupees)

pakistan bond prices and kse 100

Political turmoil has significantly contributed to declines in Pakistan’s sovereign bond prices and the falling KSE 100, the Karachi Stock Exchange’s main equity index.

Pakistan President Asif Ali Zardari

inside the indexIn the following briefs, Eurasia Group analysts highlight the connections between stability and key political issues in important emerging markets.

constitutional provisions. At the same time, falling oil prices will hurt the country’s 2009 budget.

russia Gpri 62

reactinG to Financial turmoil

Russia’s response to the deepening financial tur-moil in the country has been largely reactive. The state temporarily shuttered the Moscow stock exchanges, lowered reserve requirements and pledged massive liquidity injections, but only to the large state-owned banks. Early market response was positive, but eco-nomic and political risks to the market recovery persist. At this stage, the financial turmoil poses minimal risks to Russia’s political stability, but if the real economy suffers significantly, politics will become more turbulent.

leGend

Government

society

security

economy

Legend: Positive change Negative change No change

politics and the markets 3

chinaGpri 65

moves to promote Growth

As consumer inflation falls, Beijing is trying to stimu-late growth through lending quota relaxations, interest rate cuts and an expansion of targeted fiscal spending. Top Chinese policymakers are concerned about the ramifications of the unrav-eling US financial crisis. However, recent moves to promote growth are not simply a reaction to it; they are in part intended to signal to the domestic public that the government is respond-ing rapidly to prevent further deterioration.

nigeriaGpri 45

potential For succession crisis

As uncertainty rises about President Umaru Yar’Adua’s failing health, and the government takes a more aggressive security stance toward the country’s raging militia insurgency in the Niger Delta, political tension threatens to destabilize the country. A potential succession process may become mired in legal controversy, given seemingly conflicting

ukraineGpri 57

political turmoil continues

Following the government collapse in September, political parties have been struggling to agree on the format of a new coalition. Failure to formulate a new coalition by mid October and a subsequent call for new elections in late 2008 is a strong possibility, and a scenario that would further prolong this period of political uncertainty. Meanwhile, tension with Russia will remain over President Viktor Yushchenko’s NATO membership plans, and the dominant steel sector will continue to suffer the effects of a drop in global demand.

thailandGpri 60

new prime minister may resolve crisis

Political uncertainty will persist through 2008 due to infighting between the country’s elite in Bangkok. However, the selection of former Prime Minister Thaksin Shinawatra’s brother-in-law, Somchai Wongsawat, as the country’s next prime minister slightly increases the probability of reaching a reasonably quick resolution to the immediate crisis, which involves protesters who have seized control of the Government House. Somchai is more moderate and open to compromise than Samak Sundaravej, his predecessor, which could make him more acceptable to the parliamentary opposition. This acceptance could give him the ability to isolate and outmaneuver the demonstrators in the streets, who are making unrealistic demands for political changes.

china

thailand

russia

niGeria

ukraine

Copyright 2008, Citigroup Inc. All rights reserved. (2181)

Citi Private Bank has retained Eurasia Group to offer political analysis and insight. The opinions expressed in this report are solely those of Eurasia Group and do not necessarily reflect the opinions of Citi Private Bank or other business units of Citigroup Inc. Eurasia Group developed the first qualitative comparative political-and-economic-stability index, which Citi Private Bank has licensed, called the Global Political Risk Index, or GPRI. The index is designed to measure a country’s ability to absorb external or internal political shocks. Although the timing of such events cannot be predicted, the GPRI is meant to gauge how well particular nations would be able to withstand them. Countries comprising the GPRI were selected based on having significant tradable sovereign debt and being listed in the JPMorgan Emerging Markets Bond Index Global or other relevant benchmark indexes.

the outlookKey issues and possible outcomes for the coming month

Legend: Positive outlook Negative outlook Neutral outlook *The GPRI, which is produced by Eurasia Group, measures a country’s ability to absorb political shocks. The higher the number, the more stable the country.

country Gpri* outlook what to watch For

algeria 62 All policies—except those related to the energy sector—remain on hold, awaiting the president’s decision to extend his term.

argentina 63 Government will continue to underreport inflation.

brazil 69 Government-backed candidates will do well in local elections; proposals for oil and mining reform may be unveiled.

bulgaria 72 Sanctions on EU funds raise political pressure, but fiscal effect is limited.

china 65 The government is working for a soft landing by addressing economic anxieties and stock market volatility with new pro-growth policies.

colombia 62 Congress will vote on a proposal to allow President Uribe to run again in 2010, creating risk for democratic institutions.

egypt 63 Government’s slow response to a rock slide in Cairo’s slums will worsen public discontent, particularly among the poor.

hungary 76 The minority government will not make progress on budget and tax reform, due to little prospect of compromise with opposition.

india 61 Government will increase subsidies and handouts ahead of national elections, leading to further fiscal deterioration.

indonesia 56 Decline in oil prices will help improve President Yudhoyono’s reelection chances.

iran 52 President Ahmadinejad’s position improves with a perceived endorsement from the supreme leader.

mexico 69 As the election cycle formally begins this month, the 2009 tax law will be approved without significant changes from the 2008 version.

nigeria 45 As President Yar’Adua’s health deteriorates, elite blocs within ruling party begin intense competition to influence his succession.

pakistan 43 Popular tension heightens as the government wavers on pro-democracy issues that could maintain power in the presidency.

philippines 57 Focus stays on early maneuvering for 2010 elections, but constitutional change could become an issue.

poland 77 Facing the threat of presidential veto, Civic Platform will be forced to compromise on its legislative reform agenda.

russia 62 Georgia-related tensions with the West, global finance worries and political risk continue to temper investor views of Russia.

saudi arabia 60 Partial opening of stock market bodes well for liberalization, but conservatives may resist some economic reforms.

south africa 65 The finance minister will stress continuity in medium-term budget statement.

south korea 74 President Lee builds political momentum as legislature begins to pass tax, privatization and deregulatory reforms.

thailand 60 Government standoff with protesters is likely to continue, but new prime minister slightly improves chance of compromise.

turkey 64 Growing corruption allegations tarnish the Justice and Development Party’s image and support.

ukraine 57 Following the ruling coalition’s September collapse, politicians will be more focused on short-term politics than long-term policy.

venezuela 54 Inflation will remain high as the government increases spending in the run-up to November’s local and regional elections.

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