PRL Volume XXXIII, Number 7 July 2011
BDP’s Dominance Challenged
President Ian Khama won praise from the international financial community for his steadfast defense of austerity in the face of a prolonged strike by public-sector workers for higher pay, but he might pay a political price for his stance. Although the outcome of the strike—an agreement in principle to a 3% increase—revealed the limits of the unions’ bargaining power, BOFEPUSU proved its ability to mobilize its members, and sent a clear signal that the government can expect a fight if it moves forward with plans to eliminate public-sector jobs.
The government’s refusal to budge was seen by many of those involved as confirmation of Khama’s frequently noted intolerance of any challenge to his authority, a trait that his critics contend is indicative of autocratic tendencies. Whether that perception will encourage BOFEPUSU, the labor federation that organized the strike, to throw its institutional weight behind an electoral effort to unseat Khama and the long-governing BDP remains to be seen. However, in light of the evidence of cooperation between the unions and opposition parties during the strike, the possibility points to the potential for a significant alteration of the political landscape in Botswana.
Defections from the governing party that led to the formation of the BMD, and the creation of an electoral alliance that includes the BMD, the BNF, and the BCP underscores the emerging threat to the BDP’s monopoly on power. However, previous attempts to forge a united opposition front have been thwarted by the competing ambitions of party leaders, and there is ample reason to doubt that the latest effort can be sustained until elections fall due in 2014. On that basis, it is likely that the BDP will remain the dominant political force in Botswana throughout the five-year forecast period.
The government’s apparent preparedness to get serious about reducing expenditures is a welcome change, but any chance of hitting the 6.8% annual growth target set under the plan will require aggressive moves to create a more hospitable climate for private-sector activity, in particular, the elimination of bureaucratic impediments and a more restrained wages policy.
The government has pledged to redouble its diversification efforts, particularly through the promotion of small and medium-sized businesses. However, activity in the diamond-mining sector will continue to provide the main fuel for growth for the foreseeable future. Increased fiscal pressures and the mixed success of diversification efforts will pose an obstacle to achieving the rapid growth required to achieve the Vision 2016 targets, and real GDP growth is forecast to average 5% per year through 2016.
Stable Political Conditions
Now in the second year of his seven-year term, President Denis Sassou-Nguesso remains comfortably at the government’s helm, owing to an effective divide-and-rule strategy that has neutralized most of his opponents. Sassou-Nguesso’s oil-funded patronage networks will be used to pre-empt the emergence of political players who might seriously threaten the predominance of the ruling PCT at the legislative elections slated for 2012.
The PCT is due to hold a congress at the end of July, but little in the way of changes in the direction of policy or the composition of the government is expected to emerge from the event. At any rate, the wider base of the PCT has little real influence over policy, and its role has gradually diminished over the past 15 years, as the president has invited smaller parties to join the governing coalition.
The retention of all of the key members of the president’s inner circle in influential posts following a post-election government reshuffle in September 2009 suggests that the current stable political conditions will be maintained over the medium term. That said, the trend toward greater centralization of executive power—exemplified by the elimination of the prime minister’s post—has added to the uncertainty surrounding the issue of Sassou-Nguesso’s successor. As such, any deterioration in the president’s health would create a significant threat to stability.
The expected downward trend in oil production has added to the urgency of calls to diversify the economy, through such means as developing the country’s potential to be a regional transportation hub and boosting agricultural production. With the overall fiscal balance expected to show a significant surplus in 2011, financing a diversification program will not be a problem. Unfortunately, inadequate administrative and technical capacity will create a serious impediment to successfully designing and implementing investment programs across various sectors of the economy, and doubts regarding the effective monitoring of spending pose an additional obstacle.
Correa on the Defensive
Facing a loss of popular support and a weakened position in the legislature, President Rafael Correa has stepped up his effort to concentrate political power in the executive branch. In May, voters approved reforms that significantly increase presidential influence over judicial appointments and create a basis for controlling media content. Significantly, only one of the 10 items presented to voters at the referendum was supported by a sizeable majority of all voters. Most of the others were only approved as a result of changes to the voting rules that discounted blank or spoiled ballots.
Ominously for Correa, the “no” camp made a notably strong showing in provinces where the president has previously enjoyed solid support. The proposals were rejected by a majority of voters in all 11 provinces where the indigenous community makes up a majority of the population. The influential CONAIE, which broke with Correa over his hostile response to indigenous protests against oil and mining projects, played a prominent role in the “no” campaign, and the group’s success highlights the potential for the loss of CONAIE’s support to cost Correa politically.
The referendum results point to a clear opportunity for the opposition to make significant legislative gains (and possibly even win the presidency) at elections scheduled for April 2013. However, unless the rival parties can put aside their differences and unite in pursuit of the shared goal of toppling Correa—and there is little evidence thus far that they are moving in that direction—Correa is likely to win another term in 2013.
In the meantime, the president will likely confront a more combative legislative opposition. The AP controls just 53 seats in the 124-member National Assembly. He has managed to enlist the support of smaller parties to build a working majority, but opposition to his reform proposals prompted a handful of defections even before the May vote was held, and with the referendum results indicating that he may be vulnerable in 2013, some of his remaining allies may be less inclined to cooperate with the president.
Bilateral loans secured from China have reduced the near-term risk of a forced exit from the use of the US dollar as the national currency, but the erosion of the central bank’s independence will make it more difficult to sustain the confidence that is crucial to the stability of the dollarized economy.
The dim prospects for an FTA with the US, which currently purchases about 40% of Ecuador’s non-oil exports and accounts for the lion’s share of foreign investment in the country, point to medium-term economic difficulties. In any case, lagging investment in the extractive sectors will hold real GDP growth to an average of 4.1% per year through 2016, well below potential and far short of the level required to produce a measurable improvement in living standards.
No End in Sight
Prime Minister George Papandreou’s embattled center-left government managed to gain approval of additional austerity measures in June, satisfying a key condition for a second package of bailout loans from the EU and the IMF. Another $160 billion in lending was approved in late July, under a deal that includes the restructuring of privately held debt. Although the default will be limited and the damage to Greece’s credit rating temporary, the precedent has undermined confidence in the bonds of other debt-burdened euro-zone countries, heightening the risk of a contagion that could overwhelm the ability of the EU and the IMF to maintain the financial lifeline.
In any case, Greece will continue to labor under the yoke of fiscal austerity indefinitely in the absence of a robust economic rebound that loosens the fiscal strait-jacket. The EU has pledged investment funds for infrastructure projects aimed at reviving the construction industry, but a tangled bureaucracy and the extended timetable for completion of the projects will limit the near-term benefits.
Austerity measures have been met by strong popular opposition, resulting in sometimes violent clashes involving labor unions, student groups, and leftist organizations. Another round of tax hikes and spending cuts has contributed to renewed tensions, and with no end in sight to the country’s debt trap, despite a humiliating default, the incumbent Pasok government’s days are clearly numbered.
At present, the only viable alternative to Pasok is the center-right ND. However, given the ND’s central role in creating the current crisis, many voters will be wary of returning the party to power. In any case, the replacement of Pasok by the ND is unlikely to have a positive effect on market confidence, and so will do little to improve Greece’s prospects for clawing its way out of the deep hole it is in.
Reluctant Embrace of Orthodoxy
Support for Prime Minister Viktor Orban’s Fidesz-MPS has slumped significantly compared to 2010, when it scored a landslide victory at a general election held in April and crushed the main opposition MSZP at local polls held in October. However, while the governing party’s approval rating has fallen below 50%, Fidesz-MPS remains twice as popular as its nearest rival.
More important, the party controls a two-thirds majority in the Parliament and all but one of the country’s municipal governments. Consequently, Orban’s government will have little trouble either approving or implementing any policies it pursues, and does not have to worry about facing the electorate again for nearly three years.
That said, the government will not enjoy complete freedom in choosing its policies. The markets did not respond favorably to Orban’s initial rejection of fiscal orthodoxy, and a resulting slide in the value of the forint added to the financial burden of the large number of Hungarian homeowners who had sought to obtain lower-cost home loans by securing mortgages from Swiss banks. In a bid to restore confidence, Minister Gyorgy Matolcsy has presented a medium-term plan aimed at holding the fiscal deficit to no more than 3% of GDP in 2012 and to less than 2% of GDP by 2014.
However, strikes have already been organized to protest plans to eliminate early retirement options, and teachers and medical personnel will very likely stage demonstrations against proposed education cuts and health-care reforms. There are good reasons to doubt the Orban government’s resolve to push forward with the reforms in the face of opposition from public-sector unions.
A combination of high interest rates (the base rate was held steady at 6% in June), fiscal tightening, elevated unemployment, and the heavy debt burden of households will continue to weigh on domestic consumption and investment in 2011, holding real GDP growth to just 2.5% this year.
The forecast of weaker-than-budgeted real GDP growth does not bode well for the achievement of this year’s revenue target. The deficit came in above-target in 2010, and the government will face heavy pressure to come up with additional savings if it misses the target this year. Unless accompanied by monetary loosening, further belt-tightening will likely hold growth below target again next year, when failure to keep the shortfall to less than 3% of GDP would trigger EU penalties.
The disinflationary effect of tepid domestic demand will be offset by the combination of currency volatility and high prices for food and fuel imports. Anxiety created by the uncertainty surrounding Greece’s debt troubles has contributed to a renewed slide of the forint in recent weeks. Although a deal for a second bailout for Greece may have a calming effect, it is likely to be temporary. On balance, inflation is forecast to average 4.3% in 2011.
Rightward Policy Shift
As the country gears up for general elections on November 26, the latest opinion polls indicate that the Prime Minister John Key’s National Party is poised to win in a landslide. Poll results published in late July put support for National at 56%, compared to just 29% for the main opposition Labour Party. If those numbers were to hold steady through the November vote, Key would win a second term with his party controlling an outright majority of 71 seats in the 123-member Parliament.
In terms of policy direction, National’s ability to govern without outside support can be expected to result in a shift to the right, with deeper cuts to government services and social benefits, and a more aggressive push to privatize state assets. On the latter, Key is expressly seeking a mandate for the partial sale of the government’s share of several firms, including three power companies, the state mining company, Solid Energy, and Air New Zealand, with the aim of closing a budget gap projected to reach $14 billion this year.
The economy has proved much more resilient than initially expected following the February earthquake, the worst natural disaster in 80 years. However, with inflation running well above the upper target of 3%, a better than expected economic performance in the January–March period has increased that likelihood that the central bank will reverse an interest-rate cut announced in the aftermath of the February earthquake as early as September.
That prospect has negative implications for export activity, which has been slowed by the steep appreciation of the local dollar. Although the deepening of the debt crisis in the euro zone would be expected to ease upward pressure on the currency, the accompanying softening of European demand would limit the benefits for New Zealand exporters.
Power Struggles to Continue
A general election was held in early July, and, as in the first election held following the restoration of democratic rule in 2007, political allies of Thaksin Shinawatra, the exiled former prime minister, emerged victorious. The pro-Thaksin PTP won 265 seats in the 500-member Parliament, compared to just 159 for the incumbent Democrat Party.
The Democrats formed a government in late 2008, following the legal dissolution of the People Power Party, the predecessor to the PTP and the winner of the 2007 election, which was found guilty of violating electoral rules. Thaksin and his allies contend that the court acted under the direction of the military and the royal establishment, which are also accused of applying pressure on other parties to join the Democrat-led government.
In any case, the victory of the PTP under the leadership of Thaksin’s youngest sister, Yingluck Shinawatra, is a defeat for the military and the monarchy, as well as the urban elites who are the political bedrock of the existing order and whose own privileged position is threatened by Thaksin’s brand of populism.
Although the PTP holds enough seats to govern on its own, Yingluck has bolstered her position by forming a coalition with a handful of smaller parties, increasing the government’s parliamentary majority to 300 seats. The markets have responded favorably to the election result; the benchmark SET Index rose by 9.5% in July, while the baht made its biggest monthly gain in three years on expectations of improved political stability.
However, the optimism of investors is likely misplaced. The PTP’s undeniable mandate will buy Yingluck some breathing space, and military leaders have taken pains to dispel fears of a coup. Even so, the pre-election appointment of Air Chief Marshal Chalit Pukbhasuk, a leader of the 2006 coup, to the king’s Privy Council is hardly reassuring in that regard. In any case, it is probably only a matter of time before Thaksin’s red-shirted opponents are once again protesting in the streets, providing the generals and the members of the king’s inner circle with opportunities to weaken the foundation of the PTP’s rule.
The new government will revive the growth model dubbed “Thaksinomics,” relying on heavy government spending—on wages, public services, and investment in transportation infrastructure and agricultural modernization—to boost household incomes and fuel consumption-driven growth. To offset the increase in wage costs, Yingluck has proposed reducing the 30% corporate tax rate by one-third over the next two years. Fiscal loosening will increase the risk of inflation and accelerate the accumulation of debt, prospects that will reinforce the tightening bias of the central bank. Higher interest rates will generate upward pressure on the baht, with negative implications for the export sector.
UPDATES TO RECENT REPORTS:
Risk of Unrest Will Persist
Prompt action by President Abdelaziz Bouteflika to address the most immediate grievances of the Algerian population has so far prevented the sort of destabilizing unrest that has toppled or threatened several regimes elsewhere in the region. Nevertheless, the risk will persist in the absence of government action to aggressively promote job-creating industries and steps to create a basis for broader political inclusiveness and enhanced government accountability.
Bouteflika’s regime is moving in the right direction, but it remains to be seen whether the political establishment has the will to follow through. Barring a rather abrupt reversal of the recent policy trend, private, non-energy investment is unlikely to increase to any significant degree in the near term. Consequently, there is every reason to assume that unemployment will continue to run high, contributing to simmering discontent that could boil over if the political temperature were to rise.
Escalating tensions with Libya—where rebel forces have accused Bouteflika’s government of lending covert assistance to Col. Muammar al-Qaddafi’s wobbling regime—are a possibility in that regard, as is renewed restiveness in the Berber-dominated Kabylie region. But as has been made evident by the regional developments over the past six months, even relatively minor incidents, such as a recent protest by conscripted veterans of the civil war demanding compensation for their service, could be the possible catalyst for more generalized unrest.
In the near term, the dinar will appreciate slightly against the US currency, as increased income from oil and gas exports leads to healthy inflows of dollars. The more pronounced strengthening of the dinar against the euro will undermine the competitiveness of Algeria’s non-energy exports to the euro zone, but the central bank will be hesitant to adjust the value of the dinar downward as long as inflation remains a threat to political stability.
Stronger Political Headwinds Coming
The fates have been smiling on Prime Minister Enda Kenny since his party crushed the incumbent Fianna Fail at an early election held in February, clearing the way for Fine Gael to form a majority government in partnership with the Labour Party. The government has won praise for its achievement of the fiscal targets established under a bailout agreement concluded with the EU and the IMF in late 2010, and Kenny has managed to fulfill his pledge to secure a lower interest rate on the emergency loans. At the same time, the EU has retreated somewhat on its insistence that Ireland hike its 12.5% corporate tax rate to make it comparable to the bloc average.
All of which has made the prime minister enormously popular, a fact that in combination with the absence of any overt displays of public opposition to austerity measures has had a positive effect on market sentiment. As a result, the yield on Irish bonds had been falling in recent weeks, even as those on the debt of Spain and Italy moved higher, and private investors came forward with a much-needed capital injection for the very troubled Bank of Ireland in late July, sparing the bank from nationalization.
However, Kenny and the coalition parties will face greater challenges going forward. The government is due to present its first budget in September, and the prime minister has pledged that there will be no tax hikes or cuts to spending on social programs. It is difficult to see how he can honor that promise and still deliver a budget that is acceptable to the IMF. Moreover, a recent agreement between Greece and the EU for a second bailout package requires Greece to restructure some of its privately held debt, and Ireland’s debt rating has been downgraded on the assumption that it too will be forced into selective default in the very likely event that it needs additional bailout loans.
The size and nature of budget cuts, the focus of tax increases on consumption and personal income, and high unemployment all but rule out any significant contribution from household spending as long as the austerity program remains in place, and the government’s financial straits leave no room for the use of fiscal tools to spur demand. Consequently, hopes for a return to positive growth rest on a robust recovery in the export sector. Unfortunately, waning confidence in the ability (or willingness) of the euro zone countries to contain the debt contagion is likely to weigh on growth (and demand) throughout the bloc, limiting the strength of a rebound for Ireland’s exports.
Chronic infighting among the members of Prime Minister Iveta Radičová’s four-party coalition government shows no sign of abating, and the survival of the center-right alliance, which controls a two-seat majority in the 150-member Parliament, remains a matter of significant doubt.
Internal disagreement over Slovakia’s participation in a permanent bailout scheme for the euro zone has been a particular source of tension. The EU’s embrace of a bailout model that includes the financial participation of private creditors may resolve the dispute within Radičová’s government, but relations with the EU are likely to remain prickly.
The likelihood that the coalition parties would sustain losses in the event of an early election will create a deterrent to actions that threaten the survival of the government. Even so, SaS leader Richard Sulík’s rather extreme position on Slovakia’s membership in the euro zone all but ensures that a retreat on its demands would badly damage the party’s credibility. Under the circumstances, Sulík might decide the SaS would be better off taking its chances on an early election.
Real GDP growth held steady at 3.5% in the first quarter of 2011, and recent monthly increases in lending to businesses and households, together with a rise in the index of economic sentiment, create some cause for optimism going forward. Nevertheless, the tightening of fiscal policy throughout Europe will weigh on export performance in 2011, and the government’s austerity measures will limit the potential for a compensatory boost in domestic consumption. On balance, real GDP growth is forecast to slow to 3.6% this year, from 4% in 2010.
Election May Not Come Soon Enough
Hopes that the agreement of the EU and the IMF to deliver a second package of bailout loans to Greece might ease market pressure on Spanish debt have already faded, as the yield on Spanish bonds surged in late July, and an announcement by Moody’s that the country’s rating could be cut weakened confidence in the EU’s measures to stem the spread of a euro-zone debt contagion. Confronting the need for even harsher austerity measures to reassure the markets, Prime Minister José Luis Rodríguez Zapatero has announced that an election will be held on November 20, four months ahead of schedule.
All signs point to a victory for the opposition PP, a factor that should encourage the party to cooperate with the minority PSOE government in implementing another round of austerity measures. The 2011 revenue targets are based on projected real GDP growth of 1.3%, but actual growth is on track to come in well below that level. Zapatero faces the daunting task of making the case for additional spending cuts as the cure for austerity-induced revenue shortfall.
PP leader Mariano Rajoy has pledged that he will do whatever is necessary to restore confidence in Spain’s solvency. However, recent poll numbers indicate that the PP will fall short of winning an outright majority of seats, and will need to secure the support of smaller regional parties to govern. The PP’s allies can be expected to use their leverage to fend off attempts by the central government to force austerity upon the autonomous regional governments, with the result that the administration in Madrid will bear most of the burden for ensuring that fiscal targets are hit.
That prospect does not bode well for Spain or the euro zone more generally. One of the factors fueling the market skepticism regarding Spain’s debt sustainability is the concern that the EU and the IMF do not have—or are not willing to commit—sufficient resources to prevent a crisis in the Spanish banking system and, by extension, to prevent sovereign default. The recent yield trend indicates that the markets have not been reassured by the EU’s handling of the debt crisis in Greece. As some market observers have noted, fears that Spain might be “too big to rescue” could give rise to self-fulfilling pessimism that pushes the country into a crisis.
The ruling AKP won an unprecedented third consecutive term in power at parliamentary elections held on June 12, but fell four seats short of a three-fifths majority. As a result, Prime Minister Recep Tayyip Erdogan will need at least some opposition support to proceed with his plan to overhaul the country’s constitution.
That constraint on the AKP’s exercise of power, minor though it is, has been welcomed by government critics who fear that Erdogan might use the constitutional reform process to pursue authoritarian ends and/or establish an Islamist state. However, the strengthened position of the opposition will not necessarily bring greater political stability. A legislative boycott by members of the Kurdish nationalist BDP at the start of the new parliamentary term was accompanied by an escalation of violence in the mainly Kurdish southeast, and the mass resignation of the top military brass in late July points to a worrisome weakening of an important check on Erdogan’s ambitions.
The combination of rapid real GDP growth (8.9%), rising inflation (8.6%), and a record current account deficit (equivalent to 6.6% of GDP) in 2010 has stirred fears that the economy is in danger of overheating. Although the policy continuity implied by the AKP’s re–election to a third term will provide some protection against a collapse of confidence in the near term, Erdogan faces the simultaneous challenges of building consensus behind changes to the constitution and convincing the Turkish people that slower economic growth is both necessary and beneficial.
In terms of economic reforms, measures to increase direct tax collection, reform the commercial courts (a new code is slated to come into force by July 2012), and streamline a still inelastic labor market are all on the agenda, and will pose daunting challenges even for a gifted political leader like Erdogan.Back to Insights