PRL Volume XXXIII, Number 6 June 2011
Pressure for Populist Policies
President Evo Morales has suffered a series of political setbacks in recent months, the most notable being his U-turn on planned fuel-price hikes in the face of widespread protests at the end of 2010, and, in April 2011, an acrimonious and sometimes violent 11-day strike over wages by the country’s main labor organization. The walkout was ended with minor concessions from the government, but produced lingering resentment among the unions.
The confrontations are evidence of Morales’ loss of credibility among the organizations that have provided the bedrock of his support throughout his tumultuous presidency, a development that is corroborated by his plummeting approval rating, which according to one recent poll has fallen to near 30%. All of which poses a dilemma for the president, as his willingness to acquiesce in the face of strong public pressure will likely encourage other aggrieved groups to aggressively press their demands, and his declining popularity will make it that much more difficult for him to resist such pressure.
The government’s position is not immediately threatened, as MAS still controls a two-thirds legislative majority. However, both the president and his party have taken a major hit to their popularity, and the possibility of destabilizing tensions within the governing party cannot be ruled out.
In a bid to repair ties with his base, Morales has declared his intention to dismantle the market-based regulatory framework established by decree amid an economic crisis in 1985. The planned changes will require the overhaul of rules for investment and trade, as well as revisions to the regulations affecting key industries, including hydrocarbons, mining, power generation, banking, and telecommunications.
A massive new gas find holds the potential to attract sizeable new investment from those foreign companies that have remained aloof since Morales declared state ownership of the country’s hydrocarbons deposits in 2006, but the uncertainty created by the proposed remaking of the regulatory framework may dampen interest in the near term. Likewise, suggestions that the government is prepared to renationalize mining operations that were privatized in the 1990s could deter investment in that sector, with negative implications for the government’s plans to exploit its substantial lithium reserves.
Reforms Move Forward, Slowly
A PCC congress held in April 2011, the first in 14 years, confirmed the governing party’s commitment to moving ahead with a program of economic liberalization aimed at realizing President Raúl Castro’s stated goal of “perfecting socialism” by transitioning from an economic model based on centralized state control to a mixed economy with a significant private sector that operates according to market principles. Participants approved more than 300 changes to existing economic guidelines that, if fully implemented, will ultimately reduce the state’s role in non-strategic sectors to that of regulator. At the same time, while the plan envisions the maintenance of a substantial social safety net, the government will no longer guarantee lifetime employment, housing, and access to basic goods and services at heavily subsidized prices.
However, the government is moving forward with a great deal of caution. Tellingly, a plan to lay off some 500,000 state workers by the end of March 2011, first announced in September 2010, has been put on hold, as policy-makers instead focus on establishing the legal foundation for a rapid expansion of the private sector, which will be crucial to absorbing the large pool of unemployed Cubans created by what amounts to a 20% reduction of the public-sector work force.
Although more than 220,000 new private business licenses have been issued since the rules for obtaining the permits were relaxed last fall, the government remains firmly in control of the manufacturing sector, and the tiny scale of many of the new businesses, which are concentrated in the dining, retail, and personal services industries, limits their potential to generate a large number of jobs. No doubt with such limitations in mind, the government has also discussed the possibility of transferring responsibility for the delivery of some state services to the private sector.
Officials have also stepped up efforts to attract foreign investment in key economic sectors, especially in tourism, where a significant rise in investment would generate rapid growth of construction jobs in the near term, while also creating the potential for a large number of permanent jobs in a variety of enterprises catering to foreign travelers.
The government will have little choice but to court foreign partners for nickel mining and oil exploration, both of which will require outside expertise, capital, and technology if they are to be developed successfully. However, in areas where foreign involvement is not deemed essential, the government will continue to play a dominant role.
Bailout Issue Will Test Coalition Unity
The center-right KOK won a narrow victory at the April 17 general election, securing 20.4% of the vote, compared to a 19.1% share obtained by both the center-left SDP and the nationalist PS, which took advantage of strong anti-incumbent sentiment and a collapse in support for KESK, the lead party in the previous government, to position itself as a legitimate contender for political power. KOK leader Jyrki Kateinen’s task of forging a majority coalition was greatly complicated by the refusal of the PS to abandon its adamant opposition to any consideration of further bailouts for debt-burdened euro-zone countries and the clear vote of no-confidence in KESK, which effectively made the inclusion of either party a less-than-ideal prospect.
After prolonged and intense negotiations, Katainen managed to pull together a six-party coalition that includes the left-leaning SDP and VAS, the VIHR and the SFP (both of which participated in the previous KESK-led government, and the conservative KD. The unwieldy and ideologically diverse coalition, which took office in late June, has committed to implementing an economic program that includes a mix of tax hikes and spending cuts aimed at restoring fiscal discipline, along with tax cuts designed to spur job growth and stimulate economic activity.
Responsibility for implementing the government’s fiscal consolidation program falls to SDP leader Jutta Urpilainen, who was appointed minister of finance, the post held by Katainen in the previous government. Beyond catching the inevitable flak produced by the tax increases and spending cuts, she will also have to face down the unions over wage restraint, which will be essential to boosting the country’s competitiveness.
But Urpilainen will face a more immediate—and potentially more significant—test of her political leadership over the issue of extending a second financial lifeline to Greece. During the campaign, the SDP pledged that Finland’s support for future bailouts would be conditioned on ensuring that private creditors shared at least some of the cost (and the risks) of propping up the debt-burdened peripheral euro-zone states. Given the enormous risks associated with a strategic default, the SDP will likely face pressure to retreat from that position, and it is far from clear that Urpilainen possesses the leadership skills required to ensure that her party acts accordingly.
The strong showing of the UPA bloc of parties at the 2009 general election freed Prime Minister Manmohan Singh’s government from its dependence on the Communist-dominated Left Front, boosting expectations that the regime’s reform efforts would gain momentum during its second term. However, those hopes faded amid rising tensions between the dominant INC and its smaller coalition partners, and the results of a recent round of state elections appear to have all but eliminated any chance of progress on reform measures that are seen as crucial to India’s economic development.
Although the INC’s generally disappointing performance in the state contests does not necessarily portend the party’s defeat at the general election that falls due in 2014, the results in West Bengal, where the Trinamool Congress crushed the incumbent Communist government, and in Tamil Nadu, where the DMK was trounced by its main rival, suggest that Prime Minister Singh can expect difficulties with two of the more important junior partners in the federal coalition over the coming months.
The Trinamool Congress has not been an especially cooperative partner—it has consistently opposed efforts to loosen restrictions on state land acquisition for economic development—and there is little reason to expect that the party will become more of a team player after having been so generously rewarded by voters for its independent stance. For its part, the DMK’s post-defeat soul-searching will no doubt include serious consideration of whether the party has anything to gain from continuing its partnership with the INC.
Even if the collapse of Singh’s government were to trigger an early election, there is little evidence to suggest that the main opposition BJP is prepared to take advantage of the INC’s troubles, and the poor showing of the Communists at the recent state elections indicates that the chances of a Left Front victory are slim to none.
The diminished appeal of both the INC and the BJP points to the potential for greater fragmentation of political power following the next general election, with smaller regional parties gaining at the expense of the two dominant rivals. Such a scenario implies not only greater political instability, as achieving a parliamentary majority will require the formation of ever more unwieldy coalitions, but also the risk that federal elections could be decided on the basis of local issues, a development that would make it increasingly difficult to achieve consensus on a national agenda.
Yudhoyono Losing His Mojo
Public dissatisfaction over high unemployment, rising commodity prices, and a lack of progress in efforts to battle government corruption have contributed to a slide in popular support for President Susilo Bambang Yudhoyono, whose approval rating has fallen below 50% for the first time in his presidency. Yudhoyono has repeatedly back-pedaled on reforms in the face of threats to the unity of his six-party coalition, with the result that only 17 of 70 targeted bills were passed in Parliament last year.
All six parties signed on to a new coalition agreement in late May that is designed to promote cohesion and enforce discipline, but a provision requiring the unanimous consent of the coalition partners to any Cabinet reshuffle suggests that the pact will do little to improve the government’s productivity.
At the same time, there is a growing risk of at least a partial reversal of the domestic security gains made under Yudhoyono. The government has succeeded in weakening the JI terrorist network, but smaller extremist groups operating independently of JI are growing in number, and appear to be foregoing high-profile attacks on foreign targets in favor of more limited operations designed to exacerbate sectarian tensions. To the extent that the change in tactics poses a threat to broader internal stability and social harmony, the development has negative implications for the risk to foreign businesses, especially if the president’s loss of popular support discourages an aggressive response to the threat.
What the president might do to improve public perceptions of his government’s handling of the economy is unclear, as the fundamentals are actually quite strong and the economy is performing at a high level. Solid growth of private consumption, fixed investment, and exports contributed to real GDP growth of 6.5% (year-on-year) in the first quarter of 2011, only slightly off the 6.9% pace of expansion in the final quarter of 2010. The disruption of trade with Japan will dampen growth in the second and third quarters, but the economy is nevertheless forecast to expand by close to 6% this year.
No Mandate for Radicalism
On June 5, Peru held a presidential run-off election that pitted Ollanta Humala, the candidate of the left-wing Peru Wins alliance, against Keiko Fujimori, the leader of the right-leaning Force 2011. In a contest that for many Peruvians was an exercise in determining the lesser of two evils, Humala prevailed, winning 51.5% of the vote.
Having lost the 2006 presidential election after being linked in the minds of moderate voters to Venezuela’s controversial leftist president, Hugo Chávez, Humala this time made a point of toning down his leftist rhetoric. During the run-off campaign, he pivoted away from the more radical elements of his campaign platform, such as nationalization of strategic industries, focusing instead on more broadly appealing promises of social inclusion and improved public services.
Although the strategy worked, the international business community (along with many Peruvians) is waiting to see which Humala will take office in late July. Will it be the radical nationalist whose party platform initially included a pledge to nationalize key industries, or the more moderate Humala, who promised during the run-off campaign to achieve socialist ends by implementing market-based economic policies?
The legislative arithmetic suggests that it will be the latter. The Peru Wins alliance, headed by Humala’s PNP, won just 47 seats in the 130-member Congress. The new government can only achieve a majority with the support of centrist and center-right parties, none of which will endorse a radical departure from the liberal policy course established over the past decade. Moreover, Humala lacks anything approaching a popular mandate for radical reform. The fact that the two most extreme candidates advanced to the run-off election was wholly attributable to the division of the centrist vote among three candidates, who won a combined 45% of the first-round vote.
In short, most of the signs point to Humala steering a relatively steady policy course. His government may be more accommodating of pressure from labor unions and his sensitivity to the grievances of the indigenous population could have negative implications for investors in the extractive sectors. However, in general, Humala’s government is not expected to deliberately provoke or alienate international mining firms, whose production will continue to be the lifeblood of the economy.
Tusk Risks Being Too Cautious
Prime Minister Donald Tusk has made it clear that action on promised administrative and labor-market reforms will not be a high priority ahead of parliamentary elections scheduled for October 2011, and doubts are growing as to Tusk’s willingness to meet the challenge head-on, even in the likely event that the main governing PO secures another term. Tusk has adopted a similarly relaxed approach to laying a foundation for long-term fiscal stability, as the government will rely on solid growth and proceeds from privatization to narrow the budget shortfall in the near term. There is already widespread skepticism that the government will meet its obligation to reduce the deficit to less than 3% of GDP by the end of next year. The EU has criticized the government’s reliance on one-off revenue measures, and is pressing for spending cuts, so far to no avail.
The prime minister is taking a rather big risk. Failure to quickly rein in the budget deficit, which expanded to 7.9% of GDP in 2010, would increase the potential for a slide in the value of the zloty against the euro, a development that would not only hurt indebted households carrying euro-denominated mortgages, but would all but certainly push the total public debt burden above the 55% of GDP threshold at which the constitution requires the implementation of painful austerity measures. Indeed, the debt level is already dangerously close to the threshold, and could surpass it by the end of 2011 even if the zloty holds firm.
Longer-term fiscal stability will require aggressive steps to contain the growth of non-discretionary spending, which accounts for more than two-thirds of all state expenditures. The present stable economic conditions have inclined investors to give Tusk the benefit of the doubt, but it is widely understood that far-reaching reform of the pension and health systems is essential, and there is a risk that confidence will weaken if Tusk downplays the need for structural reforms during the upcoming campaign.
Minority Status Limits Scope for Reform
The handicap created by the minority status of the center-right Alliance for Sweden government headed by Prime Minister Fredrik Reinfeldt has been compounded by a decline in the coalition’s popularity and a revival of support for the center-left Red-Green bloc of opposition parties. In mid-March, the opposition dealt the Alliance its first legislative defeat since the September 2010 election by securing parliamentary approval of legislation blocking the sale of government stakes in mortgage lender SBAB, utility Vattenfall, the post office, and telecom operator TeliaSonera.
The setback points to difficulties implementing other key items on the government’s agenda, including tax cuts and labor-market reforms. A major test will come in September, when the government submits its 2012 budget for parliamentary approval. If the budget becomes hung up in the Parliament, Reinfeldt will come under pressure to call an early election.
Poll data showing increased support for the Sweden Democrats is a potential silver lining for the Alliance, as the center-left parties will be wary of provoking an early election that might result in further gains for the far-right party. However, the probability is growing that Reinfeldt might seek to bolster his government’s position by reaching an agreement under which the Sweden Democrats would support the Alliance on confidence issues in return for the government’s endorsement of legislation tightening immigration restrictions, similar to the arrangement that has kept a minority center-right government in power in Denmark since 2001.
A combination of weaker external demand, inventory drawdown, and monetary and fiscal tightening will slow the pace of real GDP growth to 3% this year. The Riksbank has hiked interest rates five times since July 2010, and monetary authorities have signaled that the pace of tightening will increase over the coming months. In addition to slowing the torrid pace of investment and inventory accumulation, higher interest rates will reinforce upward pressure on the krona, with negative implications for export competitiveness.
UNITED ARAB EMIRATES
So Far, So Good
Domestic conditions in the UAE have remained remarkably stable in 2011, in contrast to the ongoing upheaval elsewhere in the region. In a gesture aimed at pre-empting calls for sweeping political reform, federal officials have agreed to expand the franchise for elections to the Federal National Council (FNC) later this year, but any expansion of voting rights will be too limited to have a significant effect on the composition of the FNC, which in any case is only an advisory body.
President Khalifa Bin Zayed Al Nahyan, who is also the emir of Abu Dhabi, can count on the unwavering support of the other emirs in the Supreme Council of Rulers, and there is little evidence to suggest that anti-government sentiment is so widespread as to create a real danger of mass protests on a scale that might produce serious political instability.
Notwithstanding Dubai’s highly publicized debt troubles, the federal government has enormous financial resources at its disposal, and will respond at the first hint of trouble with an increase in already generous state spending, an approach that should be sufficient to keep a lid on unrest. That said, the UAE has cracked down on those expressing even mild dissent and has lent military assistance to the besieged regime in Bahrain under the auspices of the GCC, a clear indication that the royal leaders in the UAE are taking nothing for granted.
Dubai has made progress toward addressing the debt troubles of state-owned conglomerates, most notably in the form of a deal to restructure nearly $25 billion of debts owed by Dubai World. Even so, some $18 billion of debt is due to mature in 2011, and especially troubled firms will face financing obstacles. A prime candidate for difficulties is Dubai Holding, a financial services unit of state-owned Dubai Group, which was forced to restructure a $550 million loan in December 2010, after missing a payment the previous month.
The federal government has pledged to implement the reforms required to obtain an emerging-market designation from MSCI, which is crucial to salvaging the country’s hopes of becoming a regional hub for equity investors. However, officials have conditioned moves to ease restrictions on foreign ownership in some sectors on the agreement of participants in the Doha Development Agenda, a free-trade initiative sponsored by the WTO, to reduce tariffs on the federation’s key exports, including petrochemicals and aluminum. Whether the necessary progress might be made before the MSCI next takes up the UAE’s case for a status upgrade is debatable.Back to Insights