1417 STRATFOR 2007 Annual Forecast

2007 Annual Forecast:
Time to Look Inward
Ta b l e o f C o n t e n t s
January 2007
2007 Annual Forecast

2 0 0 7 A n n u a l F o r e c a s t : Ti m e t o L o o k I n w a r d . . . . . . . . . . . . . . . . . . . . . . . . 1 Middle East: Pivoting on Developments B e t w e e n Wa s h i n g t o n a n d Te h r a n . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 East Asia: Domestic Politics Come to the Fore...................14 Former Soviet Union: The Kremlin Gathers Strength..........21 Europe: Changing of the Guard.....................................27 South Asia: Pakistani Politics in the Spotlight.................32 L a t i n A m e r i c a : A Ye a r o f I n t r o s p e c t i o n . . . . . . . . . . . . . . . . . . . . . . . . . . . 3 7 Africa: Attracting Outside Interest, But Conflicts Continue...............................................43 Global Economy: A Short U.S. Slowdown, A Prolonged Chinese Problem......................................48
A b o u t S t r at f or . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 5 C o n ta c t S t r at f o r . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5 6
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Strategic Forecasting, Inc. 700 Lavaca Street, Suite 900 Austin, TX 78701 Tel: 1.877.9STRAT4 www.stratfor.com

Time to Look Inward
January 2007 2 0 0 7 A n n u a l F o r e c a s t : Ti m e t o L o o k I n w a r d In 2006, the U.S.-jihadist war appeared to reduce itself to the scope of Iraq and to be transformed into a U.S.-Iranian confrontation. Hopes of a political settlement blew apart in the middle of the year, focusing global attention on the outcome in Iraq. But, contrary to the self-indulgent myth, appearances are not reality. The reality is that Iraq is not synonymous with the war, and the U.S.-jihadist war is not the most important thing going on in the world. In 2006, the Russians began aggressively transforming the face of Eurasia, moving to reclaim the sphere of inuence they lost in the 1990s. And China started to deal with its severe nancial problems chiey, by avoiding the consequences. It let the economy roar ahead, failing to bring it under control and thereby buying time while it increased the power of the Communist Party and the security apparatus, making sure that whatever fallout there is will not endanger the regime. In 2007, Russia and China certainly will rank as least as high in importance as the U.S. conicts in the Muslim world. Indeed, these developments will force the United States to reconsider just how many resources it can afford to devote to the jihadist war when faced with an increasingly dangerous world lled with great powers, if not superpowers. In 2007, Russia and China will rank at least as high in importance as the U.S. conf licts in the Muslim world. The year 2006 ended with U.S. President George W. Bush trying to recoup in Iraq. With the Iranians blocking the emergence of a coalition government in Baghdad, it became clear that the Iranians expected the United States to fail in Iraq. Indeed, following the U.S. elections in November, most reasonable people expected the United States to begin withdrawing forces. If that were the case, the United States would have no ability to inuence events in Iraq. Bush chose to confound expectations by actually increasing the number of troops. The term surge is a misnomer. Still, it was not what was expected, and Bushs hope is that this strategy will cause all parties to the war to reconsider their comfortable assumptions about the United States in Iraq. In 2007, we will see whether the strategy succeeds. The fact is that the United States cannot simply withdraw forces from Iraq, as that would leave Iran the dominant power in the region. That is an unacceptable outcome
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Time to Look Inward
January 2007 for the United States, and for Saudi Arabia and other Persian Gulf states. However, an increase of about 20,000 troops will not provide the resources needed for a military solution. At the same time, the Iranians are risking much too. If they overplay their hand, they know that the United States has both resources and limits. The United States is blocking Iranian ambitions as much as Iran is blocking American ambitions. As 2007 unfolds, this will open new possibilities for political arrangements. We would not be surprised to see some moves, however tentative, toward a political settlement in 2007. This war will not end in victory for anyone. That is the basis of all negotiations. This will raise the broader question of al Qaeda. The situation in Afghanistan has deteriorated dramatically. As we have always argued, the Taliban retreated from the cities, but they never were defeated. Now they are back. The Soviets failed to defeat the Afghans with 300,000 troops and an endless supply of ruthlessness. The United States and its allies will not succeed with a small fraction of that number. The war against jihadists has now spread to Somalia and elsewhere. Iraq is not the whole of the war by any means, and in 2007 we expect to be hearing a great deal more about problems military and otherwise in the rest of the Muslim world, from the Atlantic to the Pacic. In Iraq, the United States is blocking Iranian ambitions as much as Iran is blocking American ambitions. As 2007 unfolds, this will open new possibilities for political arrangements. This war will not end in victory for anyone. That is the basis of all negotiations. Meanwhile, the weakness of the Bush administration clearly is not ending. Bush seems to be acting decisively, until one considers how small his room for maneuver actually is. These things happen periodically in the United States. Presidents Nixon, Johnson, Truman all ended their years in ofce unable to wield power. The United States always recovers from this. Nevertheless, such cycles in the presidency create opportunities for other powers to act. Whenever the worlds leading power moves toward political paralysis, others become much more aggressive. We see this and will continue to see this in places from Venezuela to Asia. But the most important actions will be taken by the great powers, Russia and China.
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Time to Look Inward
January 2007 Russia has clearly reasserted itself. The state is now the center of both Russian society and economy. Russia now clearly intends to return to being the center around which all former Soviet states revolve. Moscow has discovered, not surprisingly, that energy and other natural resources provide it with a tremendous lever in the region. That, plus the ubiquitous Russian intelligence service, allows the Russians to shape the region. At the moment, given U.S. preoccupations, the response of the Americans to the Russian resurgence has not been substantial. The Russians would not be deterred anyway; for them, this is a matter of fundamental national interests. But they also need not be concerned: The United States has neither the appetite nor bandwidth for resistance. We expect the Russians to continue to step up their regional assertiveness through the coming year. We already have seen crises all around the Russian periphery, and we expect to see more. At a certain point, the Russian desire to dominate the former Soviet sphere will clash substantially with U.S. and other interests, including those of the Chinese. The Russians are not foolhardy, but they are feeling their strength. The way business is conducted in Russia has changed dramatically in the last couple of years: Who you do business with and how you do it has changed. Now, those changes will be extended to the region. The Russians do not intend to exclude Western economic interests from their sphere, but they do intend to make certain that those economic interests behave in ways that suit Russian national interest. The Russians will not be solely concerned with what they call their nearabroad. They are masters of leverage, and they know the United States is bogged down in Iraq and the Muslim world. They have made it clear to the Americans that it cannot be assumed that Russia will simply support the U.S. position on international issues. Moscows position on Iran and Syria has been unacceptable to the United States. But then, Washingtons position on Ukraine and Georgia has been unacceptable to the Russians. The Russians will continue to exacerbate problems for the United States in the Muslim world. They want to limit American power, and they will use such means to do so. The Chinese are looking inward primarily. Their problem is internal, with a huge overhanging portfolio of nonperforming and troubled loans. A conservative estimate is that bad loans in China equal about 40 percent of gross domestic product. A more reasonable estimate is about 60 percent. These numbers closely resemble those of Japan in 1990 and tower over those of South Korea or Taiwan in 1996. The Chinese have huge currency
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Time to Look Inward
January 2007 reserves but then so did Japan, South Korea and Taiwan. Those reserves historically have not stabilized Asian banking systems when the consequences of undisciplined lending come home to roost. Chinese enterprises have used exports as did Japan and South Korea and Taiwan to maintain cash ow to pay loans. But surging protless exports merely exacerbates the problem. The Chinese government tried to stop the runaway train in 2006; it failed to do so. Westerners have again confused high growth rates with economic health, as they did with Japan and East Asia. But where rates of return on capital are extremely low or even negative, high growth rates are a symptom of disease. Chinas nancial system already has changed dramatically from the way it was a few years ago. Internal lending and nancing patterns have shifted, and foreign direct investment excluding money being recycled by the Chinese has declined substantially. Many deals that were launched with high expectations ve years ago are facing substantial problems or failure. But the most important changes in China can be seen in its politics. The Communist Party chief in Shanghai and hundreds of his allies have been arrested for corruption. Incidents of resistance to land seizures have increased, bringing with them violence and arrests. The Party has reasserted itself as the master of the state, and the Chinese security services have increased their intrusiveness and vigilance. In China, putting off the reckoning as long as possible and controlling the social and political consequences as efciently as possible are the orders of the day. Beijing is trying to regain control of the economy but it is more likely to do so through political power than through economic processes. Whenever the worlds leading power moves toward political paralysis, others become much more aggressive. We see this and will continue to see this in places from Venezuela to Asia. But the most important actions will be taken by the great powers, Russia and China. For Westerners, the question on China is, when will it crash? For the Chinese, the question is, how do you save the Party apparatus in the face of enormous economic and social stress? It should be recalled that Japan did not just fall apart one day. It experienced an enormous growth surge, followed by a managed decline of growth in which the pain was distributed economically.
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Time to Look Inward
January 2007 For China, the problem is the failure to slow growth. This failure has told the leadership that they need to increase the power of the state, and of the Party over the state. In a hundred ways, that is happening. At the same time, China is becoming more insecure about its geopolitical position. Issues ranging from trade disputes to Taiwan are being exacerbated by the insecurity that clearly is being felt by Beijing. The regime sees the United States as a threat to its security over the long term, and is taking steps to assert itself against the United States. Chinas lasers hit U.S. satellites last year as a demonstration of prowess, and a Chinese submarine penetrated the perimeter of a U.S. carrier battle group. China is not about to undertake military adventures in 2007, but it also is not prepared to be a passive onlooker in the Pacic. There will be more friction. The United States, Russia and China are the active great powers. The Europeans and Japan remain largely passive and reactive. They will not be shaping the global environment in 2007. Latin America will churn and shift, but there is no decisive event coming there. Africa remains what it has been. Thus, 2007 will be a year for great powers and for that matter, for those who would challenge great powers, particularly the United States. Middle East: Pivoting on Developments B e t w e e n W a s h i n g t o n a n d Te h r a n Our 2006 forecast said that the United States would succeed in creating a political solution in Baghdad that would allow for a drawdown in the Sunni insurgency and the implementation of a U.S. exit strategy from Iraq. For much of the year, this forecast held true: In June 2006, Abu Musab al-Zarqawi was killed in an airstrike followed by the complete formation of the Iraqi government and an announcement by the United States that it would reduce its force in Iraq by two brigades. Al-Zarqawis death signaled a commitment from the Sunni bloc to the political process, and it was then up to the Shiite bloc to reciprocate. However, we made a critical error in reading Irans intentions at this point. The Iranians saw an opportunity to use their militant and political assets in Iraq to delay a political resolution through a major escalation in SunniShiite sectarian violence. As a result, the United States was buried deeper
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Time to Look Inward
January 2007 in Iraq, and Iran was able to strengthen its negotiating position substantially. The Iranian strategy involved activating Hezbollah, which manifested in the summer war between Hezbollah and Israel that left Israel politically and militarily paralyzed. Contrary to our prediction that the general trend for the Middle East would be toward political accommodation, the region witnessed a number of are-ups that were largely attributed to the Iranian calculus in consolidating its gains in Iraq. We were correct, however, in forecasting that the Iranian nuclear issue would make its way to the U.N. Security Council, but no substantive punitive measures would be taken against Iran. In the Israeli-Palestinian arena, we correctly forecast that Hamas would emerge as a major player on the Palestinian political scene in the wake of the parliamentary elections in January, and that this would lead to major internal upheaval within the Palestinian territories. However, despite the gains it made in the elections, Hamas was unable to assume control of the security forces as we anticipated. We were right in saying that the Kadima Party in Israel would win the March elections and a center-left coalition would emerge, but would not be able to make signicant headway toward unilateral disengagement from the Palestinian territories. The United States is at a critical juncture: It no longer can afford to dedicate U.S. troops to an unattainablemission of securing the country solely through military force. We also anticipated that Syrian President Bashar al Assad would be able to keep his regime intact despite the blowback incurred from the assassination of former Lebanese Prime Minister Rak al-Hariri, and that edgling militant Islamist movements in Lebanon would make their presence known in the Levant, but would not be able to ignite sustainable insurgencies. Regarding the al Qaeda movement, we accurately said the group would further devolve into local insurgencies, though the group did not end up losing its grip on Iraq as we anticipated. The U.S.-Iranian standoff over the fate of Iraq will have a profound impact on the course of geopolitical events in 2007. After the 2003 U.S. invasion of Iraq, Iran seized the opportunity to assert itself as the regional kingmaker while the United States became increasingly paralyzed in Iraq. The United States now nds itself at a critical juncture: It no longer can afford to stay the
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Time to Look Inward
January 2007 course in Iraq and dedicate U.S. troops to an unattainable mission of securing the country solely through military force. As advocated by the Baker-Hamilton report, the time has come for the United States and Iran to stop giving each other the silent treatment and work toward a comprehensive settlement for Iraq. But the United States is still far from its desired negotiating position, and thus will continue to shy away from the Baker-Hamilton reports recommendations until it can level the playing eld against Iran. Before Washington moves forward on the diplomatic front, it will need to disprove the perception that the United States has been permanently marginalized in Iraq and ultimately will have to withdraw its forces something that would leave Iran to pick up the pieces and project Shiite inuence into the heart of the Arab world. This perception of marginalization is what has driven heightening Sunni concerns that United States no longer will be the security guarantor against an empowered Shiite bloc, led by Iran. To shatter these expectations and demonstrate that the United States is still very much in the game, U.S. President George W. Bush announced Jan. 10 a strategy to surge U.S. troops in Iraq. The increase will total 21,500 troops, with a peak of 17,500 in Baghdad and another 4,000 in Anbar province. Ultimately, this looks unlikely even to bring the total level of U.S. forces to their peak strength of 160,000 the number of troops that were in Iraq in November and December 2005, in the buildup to the general elections Dec. 15. It is likely to be accompanied by a shift in tactics to focus more specically on counterinsurgency operations. Without stability in Baghdad, there can be no Iraqi state. The forces will certainly be useful assisting with security inside Baghdad and leaving units that would otherwise be shifted to the capital available to confront issues in their respective areas of responsibility. However, in and of itself, this new deployment will be insufcient to turn the tide in Iraq. Operation Together Forward the failed attempt after Abu Musab al-Zarqawis death to use a small surge in troop levels in Baghdad to impose security there is a case in point. Together Forward was essentially the U.S. militarys last, best effort to secure Baghdad with the existing force structure. Baghdad remains the key. Without stability there, there can be no Iraqi state. But the proposed surge of 21,500 troops without a new, concerted diplomatic effort is unlikely to succeed in effecting a political resolution in Baghdad. 7

Time to Look Inward
January 2007 However, there is a key psychological element to this strategy. The United States will spend the coming months taking an aggressive stance against Iranian operations in Iraq, including additional raids on Iranian diplomatic ofces and arrests of Iranian ofcials in the country who are suspected of orchestrating attacks against U.S. and Iraqi forces. The U.S. military will be posturing to dispel the Iranian perception that the battleground will remain within Iraqs borders. The United States could also step up covert efforts to ramp up the militant activities of Irans indigenous separatist groups, such as the Ahvazi Arabs in the oil-rich province of Khuzestan in western Iran. Coinciding with U.S. moves, Israel will accelerate its own psychological warfare campaign, using a variety of leaks and denials to heavily publicize Israeli military plans to strike Iranian nuclear sites. By upping the ante against Iran, the United States is placing a critical bet that the Iranians will reconsider their Iraq strategy and come to the negotiating table rather than risk a serious miscalculation. Iran will push its nuclear agenda forward, and the U.N. Security Council will be unable to pressure Tehran into curtailing its nuclear program. To go along with the troop surge, the United States will focus on rearranging the Iraqi Cabinet to try to create a stronger, more functional government in Baghdad. This will involve sidelining allies of Shiite rebel leader Muqtada al-Sadr and bringing in a stronger Sunni presence, which will undoubtedly be a complicated and messy affair. Iraqi Prime Minister Nouri al-Maliki also could resign in as little as four months, triggering a struggle for power and a substantial are-up in intra-Shiite frictions over his replacement. By the years end, Iraqs largest and most inuential Shiite party, the Supreme Council for Islamic Revolution in Iraq, might be better able to solidify its position in the government. Iraq is unlikely to split up into federal zones in the coming year, but neither will it behave as a coherent state entity. Violence will escalate on all sides: Shiite, Sunni, jihadist and even Kurdish, with the Sunni-Kurdish fault line in northern Iraq becoming active toward the end of the year, as the Kirkuk referendum issue approaches. For its part, Iran has been keen to bring the Americans to the negotiating table on its terms. It wields the ability, through militants, to manipulate the security situation in Iraq and thus to keep an effective government from
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Time to Look Inward
January 2007 taking power in Baghdad, but it lacks the means to impose a government of its own creation there. Tehran will focus this year on increasing the political and military costs to the United States of remaining in Iraq by lending more support to militants there, including Shiite gunmen and segments of the Sunni insurgency but ultimately, given the limitations and uncertainties on both sides, it is possible that a political settlement of sorts, however weak and tenuous, will be forged in 2007. Iran will also use this year to push its nuclear agenda forward. The U.N. Security Council will be unable to pressure Tehran into curtailing its nuclear program. Iran will use the U.S. distraction in Iraq to move closer to its objective of becoming a full-edged nuclear power, which will in turn strengthen Tehrans bargaining position on Iraq and expand its inuence in the region. The United States and Israel are militarily occupied by Iraq and Hezbollah, respectively. The logic behind Irans strategy is to use this window of opportunity to advance its nuclear program to the point where a nuclear Iran will have to be accepted as part of any deal the United States wants on Iraq. A major shake-up in the Iranian regime is likely, and it could upset Irans calculus in dealing with the United States on Iraq. All the pieces might appear to be falling into place for Iran, but a major shake-up in the Iranian regime is likely to happen this year, and it could upset Irans calculus in dealing with the United States on Iraq. Iranian Supreme Leader Ayatollah Ali Khamenei is terminally ill with cancer and could die this year. His death will send a shockwave through the Iranian public, which will come to doubt the Iranian governments ability to navigate the country through this critical period. There will not, however, be a complete breakdown of the Iranian political system. There are mechanisms in place to ensure the leadership transition goes relatively smoothly. While his health further deteriorates, Khamenei will likely position former Iranian President Ali Akbar Hashemi Rafsanjani to lead the country. Rafsanjani is believed to be committed to Khameneis vision for Iraq and the ascendance of a nuclear-powered Iran, but he also is known for his pragmatic leanings and ability to negotiate more easily with the United States. Rumors are also circulating that Iranian President Mahmoud Ahmadinejads days could also be numbered, and that Khamenei will make the arrangements this year
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January 2007 to remove the rebrand president from his post. Khameneis health will likely dictate whether Rafsanjani receives the position as supreme leader or president before the end of the year. The United States will keep a close eye on any potential shake-ups in Tehran to decide how to proceed in devising a diplomatic strategy. The questions surrounding the Iranian leadership will ensure that 2007 will largely be a waiting game over the fate of Iraq. Israel will make a big show of the perception that its patience is rapidly wearing thin as Irans nuclear ambitions develop into reality. Israels focus for this year will be on pulling itself back together militarily and politically following its defeat in the 2006 summer war against Hezbollah. Israel is still unlikely to follow through with threats to launch pre-emptive strikes against Iranian nuclear facilities this year. Doing so unilaterally would only further compromise the U.S. position in Iraq once Iran unleashes its militant proxies in the region. Instead, Israels focus will turn toward Hezbollah. Iran made it clear during the summer war that it will use Hezbollah as a lever in negotiations over Iraq. Israel badly wishes to eliminate this lever, particularly since Israel has a pressing need to create conditions under which it could launch a pre-emptive strike against Iranian nuclear sites. Israels strategy to contain Irans nuclear ambitions begins with the crippling of Hezbollahs militant arm. This rationale likely factored into Israels decision to go forth with a full-scale incursion into Lebanon this past summer, though the results surely deed Israels expectations. Israel is likely to revisit its objective of crushing Hezbollah in the summer of 2007, and has already begun to justify a coming military escalation in Lebanon through public declarations that Hezbollah and/or Syria will be the one to instigate the conict. Who ends up igniting the war is unimportant. The big question for this year will be whether Israel can develop the capability to root out Hezbollah forces in their strongholds in the Bekaa Valley. A good deal of restructuring will have to take place rst, beginning with former Israeli Prime Minister Ehud Baraks return to the political scene. Israel could move indirectly to destabilize Hezbollah in Lebanon ahead of a military confrontation. Hezbollah is currently brimming with condence, but it also must be careful to preserve its legitimacy. By provoking sectarian violence in Lebanon, Israel could pit Hezbollah ghters against fellow Lebanese, which would wear down Hezbollahs military forces and tarnish its reputation
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Time to Look Inward
January 2007 as a nationalist movement, making the organization more vulnerable to an Israeli onslaught. The Israeli Mossad could also be engaged in attempts this year to eliminate elements of Hezbollahs core leadership to further destabilize the party. Though Syria will be busy building up weapons acquisitions from its defense partners in Moscow, the Syrian regime will be careful to avoid provoking a major military conict with Israel. In elections slated for March, Syrian President Bashar al Assad will be re-elected by a wide margin, and no opposition forces will be strong enough to challenge the al Assad regime this year. Though Syria will keep the window open for talks with the United States, it will continue with its agenda to re-consolidate inuence in Lebanon, which involves political intimidation frequently in the form of assassinations. The Bush administration is unlikely to make any major overtures to Syria this coming year, knowing that Damascus falls well below Tehran in its ability to wield any real inuence in Iraq. Syria will be emboldened through its alliance with Iran and could instigate a low-level insurgency in the Golan Heights through a shadowy group of militant actors on the regimes payroll, but will play its cards carefully for fear of inviting Israeli airstrikes on its own soil. While consolidating its power, Hezbollah will focus intently on preparing for a military confrontation with Israel. Lebanon will become an intense battleeld for Sunni-Shiite inuence, mainly played out between the Saudis on one side and the Syrians and Iranians on the other. The expiration of Lebanons lame-duck President Emile Lahouds term in ofce will come in September and will be preceded by intense political jockeying between Lebanons rival factions over his replacement. In the end, the next president will likely be a friend to the Syrians. Hezbollah will be able to expand its inuence in the government by forcibly increasing the number of seats that it and its allies hold in the Lebanese Cabinet. With veto power, Hezbollah will be able to block any major legislation that harms Syrian, Iranian or Hezbollah interests, including disarmament of Hezbollahs militant arm or any punitive measures against the Syrian regime for the February 2005 assassination of former Lebanese Prime Minister Rak al-Hariri. While consolidating its political power, Hezbollah will intently focus on preparing for a military confrontation with Israel.
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Time to Look Inward
January 2007 The Sunni Arab reaction to a rising Iran will intensify in the coming year. Though the Sunni Arab states are highly dependent on the United States to ensure their national security, they will make it clear that they are not going to sit idle while the United States fumbles around in Iraq. The Arab states, particularly Saudi Arabia and Egypt, will increase pressure on the Americans to act by strengthening the Sunni insurgency in Iraq and by showcasing plans to develop civilian nuclear programs to counter Iran. The sudden departure of Saudi Ambassador to the United States Prince Turki al-Faisal brought to light rifts within the Saudi regime over how to deal with Irans expansion at the expense of the U.S. military position in the region. Even though the kingdom has recently enacted a succession law to oversee the transfer of power, tensions over the Iraq situation could exacerbate matters. Moreover, Saudi King Abdullah has sought to bring in people from outside the royal family to ll key positions within the foreign policy establishment, which will further complicate these tensions. Initially, King Abdullah chose advisers and strategists such as Adel al-Jubeir and Nawaf Obaid a new crop of young, educated Saudis selected for their expertise rather than members of the royal family. Although technocrats long ago replaced royal gures in the kingdoms oil and economic sector, it seems the current king plans to gradually replace royals with technocrats in the foreign policy arena. An example of this was the appointment of al-Jubeir as Riyadhs ambassador to Washington after Prince Turki abruptly resigned. Egypts political system is in a period of uncertainty, since it is dependent on the fate of aging President Hosni Mubarak. A Cabinet reshufe could result in new oil and foreign ministers. While the Oil Ministry will continue to be managed by a technocrat, the Foreign Ministry portfolio would likely remain in the hands of the royal family. Despite disagreements within the top ruling circles on how to deal with an assertive Iran and the rise of the Shia in the region, it is unlikely that the key players within the House of Saud will allow these disagreements to lead to instability within the system at least not while the sons of Abdul Aziz, the founder of modern Saudi Arabia, remain rmly in control of the reins of power.
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Time to Look Inward
January 2007 Egypts political system has also entered a period of uncertainty, as President Hosni Mubarak given his advanced age and hence deteriorating health could either die or become incapacitated during the course of the next year. Mubaraks absence would have a destabilizing effect on the countrys political system, as questions would arise over his potential successors ability to govern as effectively. Mubaraks probable replacement will be Omar Suleiman, the countrys intelligence chief. The stage will likely be set for Suleiman this year when Mubarak nominates him as vice president. The uncertainty surrounding Mubaraks fate has developed into a key issue as Cairo is under domestic and, to a lesser extent, international pressure to effect political reforms. The government could conduct a referendum on the constitution and replace the emergency laws that have been in force since 1981 as a means to sustain its hold on power and counter the rise of the Muslim Brotherhood, which is the largest opposition group in the country. The devolution of al Qaeda will continue, as the movement struggles to carry out a major attack outside its main theaters of operation in Iraq, Afghanistan and Pakistan. On the Israeli-Palestinian front, Hamas and Fatah will continue to struggle over how to create a power-sharing agreement in the government. As long as Hamas can continue to be bankrolled by the Iranians and the Gulf Arab states, the party can avoid making any serious concessions to Fatah in reshufing the Cabinet. Palestinian National Authority (PNA) President Mahmoud Abbas will not resort to calling for early elections unless he can be assured that Hamas would be marginalized in the polls an unlikely prospect for the near future. The stalemate in the Palestinian territories will lead Hamas leadership to make gestures with heavy caveats toward recognizing Israel, though Israel will not take the bait. The Israeli government will work to ensure that Hamas and Fatah are prevented from coming together in an agreement; while Israel is sorting out its own issues at home, it will much prefer to have the Palestinians ghting each other than focusing their attention on attacking Israel. The impasse in the territories will prevent the Israelis and the Palestinians from engaging in any serious nal-status negotiations this year. Turkey will have presidential elections in May and parliamentary elections in November. Barring a major domestic crisis, the military is unlikely to force early parliamentary elections to prevent the ruling Islamist-grounded Justice and Development Party (AKP) from gaining the presidency, though the AKP
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Time to Look Inward
January 2007 could see its parliamentary majority weaken. Turkeys continued resistance to the European Unions demands on Cyprus will ensure that EU accession talks will remain stalled this year. Turkeys withering EU aspirations will lead the country to turn its attention more toward its Arab backyard, where Iraqs worsening situation becomes a direct concern for Ankara. Turkey will do its best to prevent U.S. forces from redeploying to northern Iraq. For Turkey, a built-up U.S. military presence in northern Iraq would be an obstacle to Turkish interests in containing Iraqs Kurdish faction. As the United States makes shifts to its Iraq strategy throughout the year, Turkey will warn Iraqs Kurdish faction not to make any bold moves to consolidate its autonomy and lay claim to the oil-rich city of Kirkuk. The devolution of al Qaeda will continue in 2007, as the movement struggles to carry out a major, successful attack outside its main theaters of operation in Iraq, Afghanistan and Pakistan. Though the jihadist forces in Iraq were largely eclipsed by Sunni-Shiite sectarian ghting in Iraq in the latter half of 2006, they are likely to receive a boost this year as the need for a robust Sunni insurgency grows among the Sunni Arab states. Iran, at the same time, has an interest in maintaining the Sunni jihadist component of the insurgency to target U.S. forces. The Egyptian node of al Qaeda will likely pull off its annual attack in the Sinai Peninsula, giving the Mubarak government another excuse to crack down on the countrys Islamist opposition. Al Qaeda will try to spread into the Maghreb, the Levant and deeper into the Persian Gulf this year, though any attempted attacks are likely to fail. East Asia: Domestic Politics Come to the Fore This will be a political year in East Asia. Japans new leadership is focused on constitutional change and a test for the Liberal Democratic Party (LDP) leadership in the House of Councillors elections early in the third quarter. Chinas Communist Party Congress in the fourth quarter will identify the next generation of leaders, who will formally take over in 2012. South Korean presidential elections in December could see the return of the more conservative Grand National Party (GNP). Taiwan will hold legislative elections in December (ahead of a presidential election in early 2008), which will see a strong showing by the Kuomintang and the People First Party, but could stir a nal burst of pro-independence activity. Even North Korea might see some political readjustments as leader Kim Jong Il considers younger cadres to replace the aging (and dying) current ofcials.
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January 2007 In Southeast Asia, Vietnam will adjust its party and government leadership in order to align with the economic changes accompanying its World Trade Organization (WTO) membership. Vietnamese parliamentary elections are slated for May, and a presidential election is scheduled for September. Thailand will be focused on the continued political and social distress from the September 2006 coup. The Philippines will readdress defense relations with the United States around the time of the legislative elections in the second quarter. Even Australia will hold parliamentary elections in the fourth quarter. In all, with the United States still heavily focused on Iraq and Iran, and with the U.S. presidential race already in full swing, Asia will grow more introverted in 2007, as the key countries deal with domestic politics. This is a year of preparation and transition. China Our annual forecast for East Asia once again revolves around China. We have been pessimistic about the country for a decade, predicting nancial troubles leading to social and political destabilization. We are consistently asked when this economic crisis will strike China. But that is the wrong question. It is not a matter of when nancial troubles will strike; they already have. It is a matter of how they manifest, how the Chinese deal with them and whether the Chinese are capable of controlling the situation. If China already is in the grips of an economic crisis, why is no one noticing? In part, it is because the problems are manifesting primarily in social and political reactions, not in raw economic numbers. In part, it is because Chinas sheer size makes it difcult to fathom economic collapse. And in part, it is because investors and observers have consistently been behind the curve on noticing negative trends in Asian economies. Look at Japan. The Japanese economic malaise struck in the late 1980s with little fanfare, and most investors and observers did not even notice there was a problem until several years later. Early indicators, including the massive rush of Japanese capital abroad, were ignored or seen as signs of strength. But Japan went from being the next rival to the United States to being the moribund economic sluggard of East Asia. China can only hope to have such a controlled slowdown.
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Time to Look Inward
January 2007 In our annual forecast for 2006, we said that signs of instability in the Chinese economy would manifest themselves and they did. International ratings agencies issued reports citing massive inefciencies and bad debts in the banking system. Foreign direct investment (FDI) into China stagnated for the third year in a row in 2006. A closer look at the FDI numbers, however, reveals that while the total dollar amount has remained relatively steady since 2004, the percent of FDI coming from Hong Kong and the free ports, such as the Virgin Islands, has increased. That means FDI from the United States and Asia is dropping. Though it is not making headlines, an unseen hand is at work. The shine is rubbing off China, and money is slowing down. The slowdown in new funds is affecting Beijings ability to move money around within the country. Chinas economic growth has been anything but even, and the regional wealth gaps, as well as the urban-rural split, are rising signicantly. These are now the focus of government ofcials on all levels and a frequent topic of discussion in the Chinese state media. An abundance of individuals, state think tanks, research institutes and government surveys are highlighting the problems, but there is a dearth of concrete solutions. Chinese President Hu Jintao is planning major changes in the economy that likely will not be seen until after the 2008 Olympics. The Chinese government has been nothing if not masterful in delaying and diffusing the impact of its economic troubles. It has used tactics ranging from a massive shell game with bad debt in the banking system (passing off the problems to the asset management companies and inviting foreign banks to buy stakes in order to esh out the equity-to-debt ratio in the major banks) to misdirection of public attention (to Chinas space program, the Olympic preparations and disagreements with Japan over interpretations of history). As Beijing selectively treats the symptoms of years of inefcient Asian-style economic planning, it is hoping to postpone the pain indenitely. Beijing wants neither the Japanese-style economic malaise nor the sudden crash seen in East Asia in 1997. The central government has thus far been unable to coerce or entice local and provincial leaders to accept the economic reforms, so Beijing is turning to a tried-and-true method: sacking ofcials. The September 2006 move against the leadership in Shanghai was just a warning shot. Chinese President Hu Jintao is reshufing the deck at the local and provincial levels ahead of an overhaul of the top leadership at the Party Congress later in the year. 16

Time to Look Inward
January 2007 This year likely will bring a new vice president, along with several replacements on the Central Committee and Politburo. Though age will be the given reason for the replacements, the underlying issue is the centrality of not only the Party, but also Hus leadership. He is cleaning house, removing the remnants of the Jiang Zemin regime and any opposition to his new left movement. Hu plans major changes in the economy, not the least of which is recentralization. These changes will not come all at once, and will be unlikely until after the 2008 Olympics. But the groundwork is being laid now. Autocratic control from the center over the location and target of investment and economic expansion will not be easy or painless, but Hu is tightening the core of the Party and its various security organs in order to deal with it. Beijing is looking to the example of South Korea in the 1970s (under the autocratic Park Chung Hee) or Singapore in shaping its future economic policies tight control from the center but relative freedom on the edges, so long as it coincides with government-set priorities. Social and political opposition will be repressed in the name of stability and strength. But this will really come in late 2008 or early 2009. Beijing will have to deal with trade frictions with the new U.S. Congress as well as rising talk of Taiwanese independence. For now, Hu simply needs to lock in his control and ensure that the leadership from the top down owes its loyalty to him and not to foreign business interests. He is doing this through purges, new guidelines for choosing local and provincial leaders and scheduled changes in the top echelons. China faces two potential domestic security challenges in 2007: the 10th anniversary of Hong Kongs reversion to Chinese rule on July 1, and the 80th anniversary of the Peoples Liberation Army on Aug. 1. Both provide highprole opportunities for domestic (and foreign-backed) opposition to stir trouble. Beijing will be watching closely to prevent or dissuade acts by pro-democracy and human rights activists, including those linked to the Falun Gong. There also are rumblings that Uighur separatists might be regrouping after a decade of near silence, with the assistance and instigation of Islamist militants in Afghanistan and Central Asia.
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Time to Look Inward
January 2007 On the international front, Beijing will have two major issues to deal with in 2007: trade frictions with the new Democratic Congress in the United States, and rising talk of Taiwanese independence. As Taiwan nears parliamentary elections ahead of its 2008 presidential election, outgoing President Chen Shui-bian is set to increase his push for independence. Even if it is ultimately just rhetoric, Beijing cannot tolerate such actions and already is warning of tensions. Chen sees this year as a perfect opportunity to throw a monkey wrench into Chinese politics. Beijing is desperate to keep China stable and attractive ahead of the 2008 Olympics, and Chen hopes China will be forced to exercise restraint in dealing with his political posturing. But Chen also sees his actions as a way to complicate the leadership changes in China. Hus supporters might be left in their future economic plans, but they also are less interested in waving Chinas military might around (at least until they have the domestic situation under control). The Jiang faction Hu is ousting, however, is much more hawkish, and debate over what to do about Taiwanese moves toward independence will add a layer of turmoil to the upcoming Communist Party Congress. Japan and the Koreas Elsewhere in Northeast Asia, Japans new prime minister, Shinzo Abe, will push ahead with plans to change the constitution before the year is out. Former Prime Minister Junichiro Koizumi laid the framework; it is up to Abe to build the new Japan one that is structured like a normal country, with a military unrestricted by a defeatist constitution. Japan is looking to take a place in the world that bets its status as the second-largest economy; to do so, it must alter its constitution and restructure its Self-Defense Forces into a true military. Tokyo will be much more active internationally, but the big battle is at home, where the ruling LDP will have to prove itself to domestic constituents in the House of Councillors elections in July. Ultimately, the LDP will win, but at home Abe and the LDP must show that the hints of economic recovery are sustainable. Neighboring South Korea is dealing with its own political issues. The general elections in December will bring in a new president, as the current rules only allow a single term. President Roh Moo Hyuns Uri Party is fracturing and will collapse in short order, to rebuild itself under a new name and new leadership. The renamed party will seek to distance itself from Roh long before December,
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Time to Look Inward
January 2007 and with his party leaving, Roh will focus his attention on a nal push for his own national initiatives namely, closer ties with North Korea and a restructured military that ultimately allows South Korea to reduce its dependence on the United States. The conservative GNP appears set to win the December elections, and that will bring a shift in U.S. relations. Unlike Roh, the GNP supports a stronger line against North Korea and closer military integration with the United States. This will leave Roh scrambling in his nal months to lock in defense programs more in step with his view of the future. Roh also will make a major push for a second inter-Korean summit before his term is up. An inter-Korean summit might intrigue North Korea as well. Pyongyang already has been vocal in its attempts to impact the South Korean elections, and timing a summit for sometime in the late summer could weaken some of the support for the GNP. With North Koreas 2006 nuclear tests bringing few repercussions, relations with China growing stronger and the United States still focused on Iraq, Kim feels more secure and could push forward with a few new economic experiments. South Koreas December elections will bring in a new president; the conservative GNP appears set to win, and that would bring a shift in U.S. relations. To facilitate this, a few younger cadres could rise in the North Korean ranks, on the heels of the death of Foreign Minister Paek Nam Sun. For the past decade, Kim has relied on the support of his fathers associates to maintain continuity and stability, slowly moving individuals of his own generation into power. But there is a new generation of younger elite awaiting their opportunity, and Kim can extend his reign and install potentially expendable ofcials to lead economic and even political experiments aimed at strengthening the nation for the future. But before Pyongyang embarks on another round of dtente with South Korea and pursues modest economic reforms, Kim might make one more statement of strength and carry out another nuclear test. This will depend on whether North Korea can convince the United States to lift economic sanctions, particularly the restrictions on North Koreas overseas banking (through which the countrys elite funnel their money). If negotiations fail to bring about a shift in U.S. actions, a second test is more likely.
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Time to Look Inward
January 2007 Southeast Asia In Southeast Asia, Thailand takes center stage. This former bastion of economic stability (at least since recovering from the 1997 economic crisis, which was precipitated by the collapse of the baht) is going through one of its periodic upheavals. The coup leaders have not been able to quickly and aggressively gain control, and the ousted government and its allies remain strong and emboldened. Though there was a public groundswell to oust former Prime Minister Thaksin Shinawatra, this has not translated into solid support for the military-backed interim regime. The battle lines being drawn between the Thaksin supporters and the current regime run not only through businesses and civil society, but also through the military and police forces. The rst spate of violence broke out in Bangkok with the New Years bombings. Both sides are building toward a confrontation, and though it might remain conned to the courtrooms and newspapers, the impact on Thailands economy is already starting to show. Investor condence in Thailand is slipping and will continue to fall until a more permanent solution can be arranged. Unless the military and the interim regime crack down swiftly on the growing opposition, stability and order might not even begin to emerge until the end of 2007. Lack of economic growth in the Philippines will taint the parliamentary elections, weakening support for President Gloria Macapagal Arroyo. In the Philippines, defense relations with the United States will again come to the forefront, and the lack of economic growth will taint the parliamentary elections, weakening support for President Gloria Macapagal Arroyo. Though Manila believes it has nally killed the remaining founder of Abu Sayyaf, its talks with the Moro Islamic Liberation Front appear to have fallen apart, and the ghting in southern Philippines could are up again in 2007. The problems elsewhere in Southeast Asia will only add to the allure of Vietnam, the regions newest WTO member. Hanoi has addressed many of the problems that undermined its earlier attempts at opening economically and attracting foreign investments. With FDI stagnating in China, and places such as Thailand and the Philippines facing domestic political and social troubles, Vietnam becomes the regions darling. This will play into Vietnams parliamentary and presidential elections, which will not be too contentious but instead will reect the continued focus on anti-corruption and economic modernization. 20

Time to Look Inward
January 2007 Indonesia might also begin to see a return of foreign economic interest. President Susilo Bambang Yudhoyono remains popular, does not face re-election until 2009 and is bringing a sense of stability to a country that has been politically and socially troubled since the fall of former President Suharto in the wake of the 1997 Asian economic crisis. The insurgency in Aceh has been quelled, East Timor relations are relatively calm and the separatism in West Papua has not gained traction. Meanwhile, Indonesia avoided a major militant attack in 2006, and security forces killed one of the top Islamist militants threatening the country. In 2007, Yudhoyono will focus on strengthening social cohesion, revitalizing Indonesias energy sector and rebuilding Jakartas regional relations. Japan and China could enter into some competition over economic and political relations with Indonesia in the coming year as each eyes the nations strategic location. In Australia, Prime Minister John Howard will head for another election victory, though his partys lead might be slipping to the opposition. But the Labor Party, under new leadership, has not managed to build a credible threat to Howards rule. Unemployment and interest rates will be a challenge for Howard, but not enough yet to give the Labor Party an edge. On the international front, Canberra will continue expanding its role in Asia, dealing with security issues in the Pacic islands nations, strengthening defense relations with Indonesia and expanding economic and energy ties with China. In all, East Asia in 2007 is a region focused rst and foremost on domestic political issues and secondarily on regional issues. The regions economies will slow in 2007, further complicating the political bickering. This is a year for transition, retrenchment and preparation, as the regions leaders anticipate a major shift in U.S. attitudes and actions by the end of 2008, after the U.S. presidential election. Until then, Asia will look to itself, and the growing rivalry for regional dominance between China and Japan will become more dened closer to the end of the year. Former Soviet Union: The Kremlin Gathers Strength The trend for 2007 in the Former Soviet Union will be Russias consolidation of control over its internal affairs. As the parliamentary and presidential elections approach, Russian President Vladimir Putin will centralize control over the country and its periphery, set himself up for a post-presidential career and install a successor who will perpetuate his policies. A signicant
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Time to Look Inward
January 2007 increase in military spending, coupled with a foreign policy aimed at ensuring Russias domination of its near-abroad and control over strategic sectors of its economy, will further strengthen the Kremlins hold on power. Russia in 2006 followed a policy of consolidating power within its borders and in its near-abroad, as we predicted in our 2006 annual forecast. Since the inux of Western inuence via color revolutions over the past several years, Moscow has sought to reverse such advances and has managed to reassert its inuence in some but not all of the most essential regions along its borders. While relations have improved between Russia and the key peripheral state of Ukraine since the installation of pro-Russian Ukrainian Prime Minister Viktor Yanukovich, Russia and Georgia are on increasingly worsening terms. Russia will continue to field new weapons systems, and will continue to make strategic aviation and deployable airborne regiments a priority. As we pointed out in 2006, Russia slowly began to eld new weapons systems this year, prompted by strong energy revenues although not nearly as many types or numbers as Russian generals claim. Nevertheless, the deliberate, persistent nature of this elding will continue in 2007. The elding of the new Topol-M mobile land-based intercontinental ballistic missile is, at this point, simply a matter of cranking them out of the factory. The naval Bulava and its parent missile submarine, the Borei, will likely continue to encounter major setbacks, despite priority funding. Strategic aviation will continue to be another priority, as will deployable airborne regiments. Russia has, as we predicted, continued to cooperate with Central Asian regimes on pursuing military cooperation under the auspices of regional organizations. However, contrary to our previous annual forecast, Russia has not been able to entirely evict Western military from its periphery the U.S. airbase at Manas, Kyrgyzstan, remains a thorn in the Russian side. Russias relationship with the West, particularly the United States, in 2006 was punctuated by confrontational moves. Although toward the end of the year Moscow and Washington brokered several friendly deals, the two Cold War adversaries remain at odds. We accurately forecast Moscows strategy of perpetuating conict far from its borders in order to distract Washington
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Time to Look Inward
January 2007 from meddling in its domain. This strategy has led to expanded Russian relations with Iran, Syria and, to a certain extent, North Korea. Likewise, our prediction that Russia would substantially increase energy prices for Western Europe panned out in 2006. Internally, Moscow met our expectations and ramped up itscentralization of control over the economic sectors it considers strategic energy, precious minerals and metals. The Kremlin deems it essential to run the industries that bring it the most income, even though that control sometimes dees common economic sense and even though state-controlled companies are not always procient at exploiting assets. The money already made from these sectors allows Russia not to worry too much about the recent decline in oil prices. With its stabilization fund of windfall oil revenue and the gold and currency reserves totaling almost $400 billion, Moscow can handle a substantial drop in prices without missing a beat. Moscow will continue to expand state control over the oil, natural gas, gold, diamond and metals industries. The consolidation trend will continue and increase in 2007, as Russia prepares for the Dec. 2 parliamentary elections and the presidential election March 2, 2008. Expansion of state control over the oil, natural gas, gold, diamond and metals industries will be coupled with the consolidation of political forces and a crackdown on dissent. The deaths of former Russian Federal Security Service agent Alexander Litvinenko and journalist Anna Politkovskaya have been attributed to their outspoken opposition to the Kremlin, and others could vanish from the political scene one way or another as elections draw near. Because Russias electoral laws have been changed to favor larger and more established parties, many smaller groups will seek to coalesce into larger entities. The pro-Kremlin United Russia party is expected to take most of the seats in the parliament, thereby gaining the ability to alter the constitution, and the opposition forces remain weak and unable to unite into a viable force. The new parliament, much like the current one, will exist solely to implement the presidents will. Putin will select a successor, and the two front-runners for that position First Deputy Prime Minister Dmitry Medvedev and Defense Minister and Deputy Prime Minister Sergei Ivanov will expand their public roles in 2007. The two men have been exhibiting pragmatic foreign policy outlooks, as we
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Time to Look Inward
January 2007 indicated in our previous annual forecast. Putin will not make his choice until the last possible moment, and though he could choose another candidate, Medvedev and Ivanov are the current favorites. Putin will remain in a position of power, either by retaining the presidency with the help of the newly elected parliament or by assuming control over a strategic industry such as natural gas. Internal consolidation will remain closely tied to Russias expanding control over its periphery. Moscow has had considerable success reasserting its inuence in Ukraine following the March parliamentary elections and the installation of Viktor Yanukovich as prime minister. We indicated in our previous annual forecast that Russia was likely to act to install a friendly regime using the election as a key event, though we did not predict that Ukraine would return to the Russian fold to the degree it did in 2006. Following the Orange Revolution of 2004, pro-Western forces gained control under President Viktor Yushchenko, though they have not been altogether successful at actually governing Ukraine. Russias public support of Yanukovich as a presidential candidate in 2004 was unsuccessful, but with Moscows behind-the-scenes support, Yanukovichs Party of Regions won a plurality in 2006 and, after months of wrangling, managed to form a majority coalition in the parliament. Belarus will have to look Westward for investment and support, and attempt to gain some leeway against Russia. Since then, Ukraine has remained in deadlock, with the executive and legislative branches continuously working to undermine each other and doing little actual policymaking. Yanukovich has been more successful in this row and has undercut much of Yushchenkos authority. Yushchenko has but one chance to regain control, and it is not a good option to dismiss the parliament and call early elections. In order for Yushchenko to retain a vestige of power, he will need to rekindle the Orange Coalition with ambitious former ally Yulia Timoshenko, but that would mean Yushchenko would have to share the spotlight with her. Ukraines neighbor Belarus has experienced a signicant deterioration of relations with Russia over the past year. A last-minute deal for supplies of Russian natural gas signaled an end to Russias subsidization of President Aleksandr Lukashenkos regime.
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Time to Look Inward
January 2007 In order to avoid becoming a complete peon of the Kremlin, Lukashenko will have to look Westward for investment and support, and this option gives him at least some leeway against Moscow. Belarus has been beholden to Russia for Lukashenkos entire 13-year presidency. The country is now at least somewhat in play, but Russia still has the tools to counter Belarus Western ambitions. The oil cut-off on Jan. 8 signaled Russias willingness to inict damage to its own economy in order to bring the wayward republic under control. Tensions are set to escalate in the Caucasus, as relations between Georgia and Russia show no signs of improving, and as Armenia and Azerbaijan inch toward an escalation of the Nagorno-Karabakh conict. As Tbilisi further extricates itself from economic ties to Moscow, the conict over Georgias two secessionist regions, South Ossetia and Abkhazia, will intensify. The United Nations is almost certain to grant independence to the Serbian province of Kosovo; this will prompt Russia to call for the same status for secessionist entities outside its own borders. Russia is likely to seek to increase its presence in Abkhazia and South Ossetia under the guise of peacekeeping efforts, and Georgia will respond in kind. Given the poor state of relations between Moscow and Tbilisi, the conict is likely to escalate to something just short of outright war, perpetuating the scenario laid out in our 2006 annual forecast. Azerbaijan has signicantly increased its income from energy projects and has pledged to spend approximately $1 billion on defense in 2007, up from $700 million in 2006. Although Azerbaijans military has been inferior to Armenias, the spending hike could bring increased confrontation between the two over the Armenian-controlled Nagorno-Karabakh region in Azerbaijan. As with Georgias secessionist regions, the determination of Kosovos status will prompt an escalation in the Nagorno-Karabakh conict. A diplomatic solution is not likely in the near future. Russia historically has dominated Central Asia, with most of the countries especially regional leaders Kazakhstan and Uzbekistan ruled by Sovietera cadres with allegiance to Moscow, and the others deferring to their giant neighbor anyway. At the end of 2006, Russia gained an opportunity to expand its inuence further. The Dec. 21 death of Turkmenistans presidentfor-life, Saparmurat Niyazov, another Soviet-era leader, has prompted Russia, China and other regional players to attempt to project greater inuence in the energy-rich state. Acting Turkmen President Gurbanguly
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Time to Look Inward
January 2007 Berdimukhammedov is the certain winner of the Feb. 11 poll, but the shape of his agenda remains unclear, since not much is known about the man. While neighboring Kazakhstan and Uzbekistan will want to assure that Turkmenistan is friendly, or at least innocuous, Russia has a keen interest in maintaining control over Turkmenistans natural gas deposits the fth-largest in the world. If the new president is unwilling to cooperate with Moscow, the Kremlin will use its available tools ranging from political pressure to assassination to ensure that he will not hold ofce for long. Russias neighboring states, especially Kazakhstan and Uzbekistan, will become increasingly concerned for their own sovereignty. As Russia moves to solidify its presence in Central Asia via Turkmenistan, neighboring states, especially Kazakhstan and Uzbekistan, will become increasingly concerned for their own sovereignty. While Kazakhstan remains politically loyal to Moscow, it has economic partnerships particularly in the lucrative energy sector with companies from many other countries, including India, South Korea, China and the West. Should Astana grow disconcerted by Moscows encroaching presence, the Kazakh government could seek to counterbalance Moscow and expand its relationship with Beijing via Kazakhstans new Chinese-educated Prime Minister Karim Masimov and China is certainly looking to increase its inuence in Central Asia. Uzbek President Islam Karimov is also likely to be concerned for his regime as Russian inuence expands. Karimov might continue giving Russia control of energy assets in order to preserve his own rule, while keeping open the option to turn to China. However, as long as the Russians do not employ heavy-handed tactics in Turkmenistan, Uzbekistan and Kazakhstan both will seek to perpetuate their existing relationships with Moscow. Russia also has been looking to expand its inuence in Africa. Closer relations are likely in 2007, as Moscow forgives African countries Soviet-era debt and looks to increase cooperation in the mining sector. As Russia consolidates control over its own industries, expanding into Africa and other regions could be the next step toward increasing control over the worlds deposits of highvalue commodities. But for this to work, Moscow has to do something in Africa that it has been loathe to do at home: invest its own money. Should Russia do that, Moscow could gain a lot of assets and inuence very quickly.
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Time to Look Inward
January 2007 Russia will attempt to maintain the status quo in its relations with the United States and Europe in order to focus on domestic issues. However, Moscow will continue to cooperate with Iran, Syria, the Hamas-led Palestinian government and other regimes considered unfriendly to the United States. In these relationships, Russia prots from arms and equipment sales and derails U.S. goals in the Middle East while dividing Washingtons attention. Relations with European leaders are not likely to see improvement; German Chancellor Angela Merkel will make European energy security a priority of Germanys EU presidency, and whoever is elected the next French leader will not view Russia in the same favorable light as President Jacques Chirac has. Europe: Changing of the Guard The most signicant development in Europe in the year 2006, as we expected in our last annual forecast, was Germanys re-emergence as a major global power. Under Chancellor Angela Merkel, Berlin seized the mantle of European leadership from Paris and has been the mover and shaker of European politics. On some of the details in our previous annual forecast, we did stumble. For example, we expected British Prime Minister Tony Blair to step down in 2006 and whatever Italian government formed after Italys general elections to fall; neither event happened. But both of these aberrations only reinforced Germanys centrality. In staying on, Blair has destroyed his ability to transfer power to someone (Chancellor of the Exchequer Gordon Brown) who might regenerate the Labor Partys political fortunes. Italys Romano Prodi now leads a nine-party coalition that makes the preceding, haphazard government look rock-solid. Add in a France that is also in the midst of an internal leadership feud with elections scheduled for April and May 2007 and the stage was cleared for Merkel to lead Europe in spirit in 2006. Even events beyond Europe primarily the repeated energy crises involving Russia only weakened the European Unions ability to act and strengthened Berlins. Germany will attempt to capitalize on this in 2007. Merkel, now with a year of experience under her belt, faces a rare opportunity. Germany is one of only a handful of countries that will not be mired in internal politics in 2007. Russia, the United States, South Korea and China
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Time to Look Inward
January 2007 are all gearing up for elections; and France, the United Kingdom and Egypt are managing leadership transitions. This makes Germany the country with the greatest opportunity to impact European and global developments. Merkels only challenge is not biting off more than she can chew. However, this does not necessarily mean Berlin will be successful. Germany has the greatest opportunity to impact European and global developments. The EU presidency is a funny thing, rotating as it does in six-month stints among the member states and thus giving Malta and Luxembourg as much time to shape the EU agenda as the unions powerhouses receive. Normally, only the largest EU states have the power and authority to meaningfully affect union-wide policies. Since one of those states holds the presidency for the rst half of 2007 and since that state is Germany this will be the European Unions best chance to x its various institutional problems. Successful EU presidencies are marked by the choice of one or two specic, manageable, achievable programs that no major EU state opposes. For example, the most successful EU presidencies in the past several years have been Finland (1999), Sweden (2001) and Spain (2002), which dealt with Kosovo, demographics and terrorism, respectively. During all three presidencies, the leaders of those states selected topics over which there was little disagreement and, in some cases, an agreed-upon urgency. In contrast, the most spectacular failed presidencies were Belgium (2001) and the United Kingdom (2004). In both cases, the states leaders took on controversial topics that faced deep opposition: establishing an EU-wide tax and reforming the Common Agricultural Policy, respectively. Germany seems ready to try to rectify Europes institutional problems. Currently, the European Union uses the same decision-making structure that existed when the unions predecessor, the European Economic Community, was founded in 1958 with only six members. After Bulgaria and Romanias Jan. 1 accessions, the European Union now has 27 members. States have the right to veto any policy with which they disagree, ranging from foreign and military policies to cheese and legal issues. As such, the union is largely ungovernable and is in dire need of reform. Merkel wants to use her turn in the big chair to dust off the European constitution and establish a roadmap for its ratication.
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January 2007 In this she will fail. The constitution, while far from perfect, would somewhat streamline the European Unions decision-making process and lessen the use of national vetoes. Merkel wants to see the constitution adopted in full, in its current form. However, two of the unions most pro-integration states France (under Gaullist President Jacques Chirac, no less) and the Netherlands have already voted down the constitution in national referendums. All EU members must approve the constitution for it to take effect. Put another way, it is an already failed document with no future. If anything, should Merkel succeed in restarting the ratication process, it could well prove to be the worst of all worlds. Two Europhilic states have already voted it down (and are likely to do so again), not to mention that it never even went before the Euroskeptic electorates of Poland and the United Kingdom the rst time around. Though such a document is essential if Europe is to federalize, unfortunately for Europeanists, it is not an approvable document. The EU constitution is an already failed document with no future. Letting it die its ignoble death in France and the Netherlands would have been the smartest action. Letting it die now would be the second-best choice. But burning resources in order to go through the motions of submitting it to another preordained death is simply a waste of one of Europes last chances to reform in the near future (aside from the upcoming 2008 presidency of France, another major EU power. Italy, hardly the harbinger of logical organization does not take the reins until 2014). It is time for Europe to cut its losses and work with what it has. The decision to do just that will ultimately be made just not in 2007. The doomed constitution is not the only project Merkel aims to tackle. By luck of the draw, Merkel will be in the big chair when potential crises in Bosnia, Kosovo and Serbia come to a head; she will bear the responsibility of relaunching partnership talks with the Russians; and she wants to initiate free trade talks with the United States. Any one of these issues would make for a busy presidency, and Merkels ambition risks causing her to fail at all of them although we have to give her kudos for trying. Still, even if Germany fails to implement its agenda, it is the only major power that has the freedom to set one. And there may yet be time for Merkel to shift gears. If she can select an issue that the entire European Union
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January 2007 can agree on and a policy that everyone can get behind such as a common European reaction to the Russian-Belarusian energy crisis that is brewing she could become Europes strongest post-World War II leader. The opportunity is hers to lose, and the lengthy agenda she has cooked up as of the years beginning is perhaps the most efcient way to do that. The expansion of the European Union has reduced the possibility of a European superpower to a mere idea. While Germany settles into its leadership role, France will see the end of its Gaullist era. Former French President Charles de Gaulle believed France was not simply a middle-sized continental power, but a global power. Thus, he felt it was Frances duty and right to punch well above its weight on the world stage a mindset that often put Paris at odds with Washingtons policies. A united Europe was de Gaulles brainchild in many ways, as it was a means of suppressing German nationalism and diverting German energy into actualizing de Gaulles view of the world. Ultimately, de Gaulles goal was to use Europe as a platform from which France could act as a credible global power. Chirac is the most recent torchbearer of de Gaulles legacy and has been at or near the top of the French political system for 33 years. Though Chirac and his Gaullist predecessors successes in uniting Europe should never be ignored, the expansion of the European Union has reduced the possibility of a European superpower to merely an idea. The United Kingdom would never allow itself to be subservient to Paris, Europes neutrals want no part in a common military policy and the states of Central Europe feel more kinship with the United States than they ever have with France. But most of all, it is Germanys reawakening that has killed de Gaulles vision. Germany is once again making policies more sophisticated than apologizing for World War II, and is now developing interests independent of Paris. With Germany back in the game, France simply lacks the economic, political and demographic heft to lead Europe. It might remain a powerful state with an undeniable stake in the Continents future, but it will never be the pre-eminent leader of a superpower.
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January 2007 We will not attempt to call the outcome of Frances April-May 2007 presidential election. For now, socialist Sgolne Royal and conservative Nicolas Sarkozy appear evenly matched. They disagree on a number of issues, from crime to immigration to globalization to labor reform. But on one thing they agree: de Gaulles legacy has failed, and it is time to try something else. Germany is making policies more sophisticated than apologizing for World War II, and is now developing interests independent of Paris. France will still be a powerful and vibrant state, but it will be a France with a more realistic view of its place in the world. This could bring it more power as it focuses on internal reform or on revitalizing relations with powers such as London, Warsaw and even Washington at which de Gaulle would have chafed. But what is sure is that France will no longer seek to lead Europe on its own, and this, if nothing else, will punctuate European attempts to form a superpower. The implications of such abandonment are deep and many. They include, but are not limited to: Any serious talk of a special partnership with Russia will end, laying the groundwork for more businesslike and colder relations. Most common European positions, such as they are, on foreign policy issues will collapse, leading to a large-scale removal of a European approach to global issues in which the European Union does not have a direct economic interest. Outside powers will have the opportunity to play individual European powers against each other something of critical importance when one considers that each of the unions 27 members retains veto power over many EU policy realms.
France is on the cusp of change. In May, it will have a new president; in June, it will have a new Parliament. And the country and the Continent will never be the same.
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January 2007 South Asia: Pakistani Politics in the Spotlight As we expected, India and Pakistan made little progress in normalizing relations in 2006. Though the Kashmiri militant group Lashkar-e-Taiba carried out a deadly railway attack in Mumbai in July, relations between the rival countries remained in the usual state of distrust, preventing any major breakthroughs. We noted that Pakistani President Gen. Pervez Musharraf would face a galvanized opposition and would be forced to decide whether to stay on as the countrys military chief. Musharraf successfully staved off opposition attempts to unseat him, allowing him to keep his dual portfolio as president and head of the military. In line with our 2006 forecast, the Baloch nationalist insurgency added to Musharrafs list of worries. He dealt with the insurgents through a combination of military and negotiation tactics. Pakistan will be the main focus in South Asia as it gears up for its general elections in January 2008. Our forecast that Indias leftist parties would develop a stronger presence in the government and further hamper Indian Prime Minister Manmohan Singhs privatization efforts was correct. India also worked to expand its global inuence by signing a landmark civilian nuclear deal with the United States. The insurgencies in Nepal and Sri Lanka remained signicant in 2006, though we failed to predict in the annual forecast that the Maoist rebels and the political alliance in Kathmandu would be able to forge a power-sharing agreement and strip Nepals King Gyanendra of his powers. In 2007, the main focus in South Asia will be on the Pakistani political scene, as the country gears up for general elections slated for Jan. 15, 2008. Musharraf battled a heavy wave of domestic criticism this past year, exacerbated by continued U.S. pressure on Pakistan to cooperate on the counterterrorism front and by U.S. airstrikes against Taliban and al Qaeda targets on Pakistani soil that resulted in a high number of civilian casualties. Accusations have been ying that Musharraf has spent too much time hobnobbing with U.S. ofcials in Washington rather than defending Pakistans territorial integrity; but the general has developed a solid strategy to secure his re-election and outmaneuver the main opposition forces in the country namely the Pakistan Peoples Party (PPP), led by exiled former Pakistani Prime Minister Benazir Bhutto, the Pakistan Muslim League-Nawaz (PML-N), led by ousted Pakistani Prime Minister Nawaz Sharif and the Mutahiddah Majlis-i-Amal (MMA) coalition of Islamist parties.
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January 2007 Musharraf has a comfortable majority in the sitting parliament to help him win a re-election bid, but his standing cannot be assured after the general elections are held and a new parliament comes to power. To consolidate his hold over the government, Musharraf will bend the rules and schedule a legislative vote ahead of the general election to get re-elected to another ve-year term. Musharraf could even attempt to bypass this step by calling snap elections in the spring of 2007 if he feels condent enough in his ability to win. Snap elections or no, the legislative election results will be rigged as needed to allow Musharrafs parliamentary allies to hold onto their seats. The opposition forces will then use the allegations of a rigged election to hold street demonstrations, but are unlikely to muster enough support to change the election results signicantly. Musharraf will continue with a careful strategy to prevent the PPP, the PML-N and the MMA from uniting in a potent opposition force, fueling distrust among the already severely divided parties by hinting at making deals with the various opposition leaders. Musharraf will also be able to hold onto his position as military chief this year. Pakistani President Gen. Pervez Musharraf will distance himself from Washington to enhance his domestic image before elections, becoming even more restrained in U.S. counterterrorism cooperation. The biggest threat to Musharrafs election plan is the potential for largescale U.S. military activity on Pakistani soil that would undermine the militarys condence in the general and turn public support against him. To enhance his domestic image, Musharraf will distance himself from Washington in the coming year and become even more restrained in cooperating with U.S. forces on the counterterrorism front. Pakistans relations with Afghan President Hamid Karzais government will further deteriorate this year as the Taliban insurgency strengthens. The Taliban will continue opposing NATO forces in Afghanistan and launch a spring offensive. NATO is not likely to have the capacity to surge troop levels and redouble reconstruction efforts. Nevertheless, Afghanistan will remain at least for this year a priority for the alliance. Because the Taliban lacks the strength to take the country from NATO forces and NATO forces are not willing to let things slip that far 2007 in Afghanistan will look much like 2006. Security operations will continue, and Taliban forces will improve their tactics and build on operational successes.
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January 2007 India will keep a close watch on political developments in Pakistan, privately preferring the continuation of Musharrafs relatively stable regime. India and Pakistan will go through the motions of continuing peace talks, but those talks will only be for show. Primarily to boost his credibility at home, Musharraf will try to push India into resolving the long-standing Kashmir dispute, and New Delhi will politely rebuff Musharrafs proposals. For India, Pakistans continued support for Kashmiri militant groups remains the block to any meaningful progress in the Kashmir negotiations. Kashmiri militant groups operating in India are stepping up their efforts to stage attacks designed to incite communal tensions between Hindus and Muslims and revitalize the Kashmir cause among Indian Muslims. However, such attacks have become routinized enough in India that incidents like the July 2006 Mumbai railway bombings prompt no notable shift in Indian society and policy. Kashmiri militant groups could attempt to vary their target set from the usual crowded market and transportation sites in major cities to the countrys much-valued information technology (IT) sector. Such an attack would force an Indian response and threaten the countrys ability to sustain a healthy inow of foreign investment. But the Pakistani government and intelligence service have largely maintained their hold over these militant groups to prevent them from altering their tactics in India. Particularly while in the heat of the election season, the Pakistani regime will be uninterested in provoking a major conict with India. That said, Kashmiri militant groups will likely succeed in carrying out another large attack in a major Indian city this year that would fall in line with their usual target selection of markets, transportation hubs and religious and tourist sites. Such an attack will increase tensions on both sides of the border and lead India to implicate the Pakistani regime, but the Indian government led by Prime Minister Manmohan Singh is unlikely to respond with a major military confrontation against Pakistan. Indias attention will primarily be absorbed by domestic political and social issues. No major shift in the Indian political landscape is expected in the coming year; the main opposition Bharatiya Janata Party is suffering from internal divisions and is unable to threaten seriously the ruling Congress partys hold on power. The Congress partys main headache will come from its allies in the Left Front, who will continue to link up with powerful trade unions to resist Singhs privatization efforts and labor policies. As a result, Singhs government will need to turn more toward populist politics in an attempt to quell domestic unrest.
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January 2007 Barring a signicant attack by Kashmiri militants on Indias IT sector in 2007, the country should experience sustained economic growth in the range of 8 percent, similar to the past year. Indias economic focus will be on expanding its automotive, steel, aviation and IT sectors, though substantial growth will be hampered by political considerations and slow infrastructural growth. The Left Front will also make noise over the Singh governments growing alliance with Washington. India and the United States will cement their landmark civilian nuclear deal this year through a bilateral treaty; however, Singh will maintain a multilateral foreign policy agenda to tame the opposition and avoid getting caught in any binding agreements with the United States that would require it to place a moratorium on nuclear testing or impose punitive measures against Iran. Domestic political and social issues will absorb India, which will turn toward populist politics to try quelling domestic unrest. India will also keep a watchful eye on its porous northeastern border, where a political crisis in Bangladesh spells a likely increase in militant trafc into India. General elections in Bangladesh were scheduled for Jan. 22, but have been delayed following the resignation of the caretaker government. The main opposition, led by Sheikh Hasina of the Awami League, likely has the numbers to win a majority against the ruling Bangladesh National Party (BNP), led by Hasinas bitter rival, Khaleda Zia; however, the Awami League has damaged its secular credentials by allying with one of Bangladeshs most notable radical Islamist parties a politically opportunistic move that has dismayed a large number of voters. The Awami League has announced a boycott of the polls until changes are made to the pro-BNP caretaker government in charge of conducting the elections, and until the BNP makes assurances that the elections will be free and fair. The polls are guaranteed to be rigged under the caretaker government, but the Awami League is trying to level the playing eld before it takes part. After a series of negotiations and violent demonstrations, the BNP will likely give in to some of the Awami Leagues demands in order to allow the elections to take place. Nonetheless, the results are bound to be disputed, and Bangladesh will continue to be wracked by political violence for much of the year. Whether the Awami League or BNP emerges victorious means little in the larger strategic view of Bangladesh; the instability caused by the warring parties is unlikely to wane regardless of which party is in charge. But the political developments in Bangladesh will be a cause for concern for India, 35

Time to Look Inward
January 2007 as the rival political factions turn increasingly toward radical Islamist parties for coalition support. The growing Islamist inuence in Bangladesh will give rise to radical groups that will play host to jihadist and Kashmiri militant operatives with an interest in launching attacks in India. The Indian government will attempt to secure its northeastern border, but is unlikely to intervene directly in Bangladesh. The undeclared civil war in Sri Lanka between Liberation Tigers of Tamil Eelam rebels and Sri Lankan armed forces will escalate. To Indias south, the undeclared civil war in Sri Lanka between Liberation Tigers of Tamil Eelam rebels and Sri Lankan armed forces will escalate this year in heavy tit-for-tat ghting as the Sri Lankan army attempts to divide the northern and eastern Tamil strongholds in the country. Neither the Tamil Tigers nor the Sri Lankan army has a clear enough advantage to launch a sustained offensive that would result in a decisive victory. India will be concerned with the Tamil refugees owing into the southern Indian state of Tamil Nadu, but cannot afford to throw its support fully behind the Sri Lankan government for fear of alienating Indias sizable Tamil population. The ongoing instability in Sri Lanka will give Indias regional adversaries namely Pakistan, and to a lesser extent China the opportunity to meddle in Indias backyard and escalate the conict by providing arms and support for the Sri Lankan government. These parties are not as interested in helping the Sri Lankan army wipe out the Tamil Tiger rebels as they are in prolonging Sri Lankas crisis to keep India preoccupied. External involvement, however, could lead the Tigers to target foreign diplomatic personnel in Sri Lanka. India will at least have one border that it can worry less about this year. Political developments in Nepal in 2006 reached a point where the Maoist rebels now have a solid opportunity to integrate themselves in the countrys political and military apparatuses. Parliamentary elections will be held in April 2007, giving the Maoists a chance to enter the government formally. Though this should be a relatively stable year for Nepal, bursts of instability can be expected as dissident Maoist factions resist the integration effort. A return to a militant insurgency is unlikely, but extortion, kidnappings and economic blockades remain usable options for the Maoists.
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January 2007 L a t i n A m e r i c a : A Ye a r o f I n t r o s p e c t i o n The 2006 annual forecast correctly noted the regional leftist swing in Latin America that impacted the 18-month election cycle, which ended with leftist Venezuelan President Hugo Chavezs successful re-election bid. This regional movement was successful in some countries, with leftist candidates winning in Ecuador, Nicaragua and, of course, Venezuela. But the movement failed elsewhere, as conservatives won in Peru, Mexico and Colombia. As the forecast noted, the left has divided into two factions: the Lula moderates (named after Brazilian President Luiz Inacio Lula da Silvas centrist spin on the left) and the Chavista radicals (named after self-appointed regional leftist leader Chavez). This divide is growing and has become more apparent as the moderates have inched ever closer to the center and Chavez and his allies move even further into left eld. As the dust from Latin Americas marathon run of elections settles, the newly elected leaders will turn their sights to myriad domestic challenges. The year will be characterized by internal policies that will only peripherally affect regional and global relations. Argentina will have the one prominent presidential election of 2007, but this will enhance the countrys self-reective nature as it engages in internal debate about its economic and social future. Major offensives against out-of-control organized crime will be prominent policy features in many countries, including Brazil, Venezuela and Mexico. The war between drug cartels and the Mexican government likely will remain at an impasse. With the lefts loss of presidential elections in Peru and Mexico, Chavezs attempt to unify the region under a leftist banner has largely failed. The onus for regional integration is back on the Southern Cone which Brazil and Argentina will lead as a trade bloc, rather than an ideological bloc. Overall, however, we expect that regional relations will continue to be fragmented as usual, and the goal of regional integration will remain elusive. Regional politics will remain centered on the common goals of most Latin American countries: economic growth, maintaining legitimacy through social programs and at least the appearance of combating corruption, enhancing energy infrastructure and maintaining domestic order. As long as Latin America remains embroiled in domestic affairs, the United States is unlikely to pay it signicant attention in 2007.
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January 2007 Mexico Mexicos new President Felipe Calderon is focusing aggressively on serious domestic issues: drugs and drug-related violence, immigration, social unrest and the need for reforms in labor, education, nance and energy. Former President Vicente Fox did little to try to stop the drug cartels from doing business; Calderon has the heavy task of assuming control over this largely lawless situation. In one of his rst moves as president, Calderon deployed federal security forces to his home state of Michoacan to battle drug cartels and their hired guns. The Michoacan operation has seen some success, and the government plans to send federal security forces to several other troubled states, but the cartels are not likely to sustain any signicant damage. The war between drug cartels and the Mexican government is likely to remain at an impasse; Calderon will keep the troops rolling in, and the cartels though affected will regroup and recover. Tensions between the government and drug cartels will increase since Calderons plan will root out corrupt security forces and government ofcials who have facilitated the drug trade. Losing the protection corrupt ofcials granted them could be a heavier blow to the cartels than any military or police operation. Calderon is expected to continue this push; he entered the presidency with a weak authority, publicly challenged by his defeated opponent Andres Manuel Lopez Obrador. Calderons very public battle against crime and drug trafcking will lend him more credibility both domestically and with the United States as he attempts to push more difcult labor and energy reforms through the legislature. Calderons experience as a politician, his National Action Partys newly won legislative seats and a potential alliance with the Institutional Revolutionary Party all suggest that he will have an easier time passing reforms than his predecessor did. Assuming he successfully consolidates power, Calderon will also slowly lay the groundwork to address the development of Mexicos offshore oil deposits. Cuba and Nicaragua Some countries that rose to the forefront of political discussion in 2006 are unlikely to actually be signicant drivers in 2007 namely Nicaragua. Nicaraguan President Daniel Ortega will receive signicant aid from Venezuela, but that aid will be directed entirely at providing basic necessities such as oil and electricity. The transition of power from Fidel Castro to Raul Castro has already taken place in Cuba. The island will now go through the long, slow process of pulling itself out of economic ruin. Fidel Castros eventual death will not
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January 2007 greatly affect Cuba, as Raul Castro will deal rmly with any civil unrest. Any potential changes in U.S. policy toward Cuba will depend on a consensus within the Cuban-American community, which has long stood in favor of economically isolating the Cuban regime. However, current divisions in the Cuban-American populations opinion, combined with the new Democratic majority in the U.S. Congress, could open the way to decreasing trade and travel restrictions. Ecuador, Venezuela and Colombia The geopolitical impact that Ecuadors newly inaugurated President Rafael Correa will have remains somewhat ambiguous. At this point, Correa seems poised to initiate many political battles. He could seek some debt restructuring and will try to use his overwhelming popularity to push for a constitutional rewrite, but these actions will face opposition in the legislature, could cause domestic unrest and will further alienate international business interests. Correa will clash with Colombia over his refusal to ght the Revolutionary Armed Forces of Colombia (FARC) and his objections to Colombias decision to spray herbicides on coca plantations along the border. Correa walked a ne line in his campaign rhetoric between asserting his independence and calling Chavez a close personal friend and ally; he will continue trying to nd a comfortable balance in 2007, much as Bolivian President Evo Morales did in 2006. We expect tensions to rise between Colombia and both its old rival, Venezuela, and its newly unhelpful neighbor, Ecuador. In particular, Colombia will grapple with Ecuador and Venezuela in pursuing the elimination of paramilitary and guerrilla groups operating within the country and routinely crossing borders. Tensions between Colombia and both Venezuela and Ecuador likely will rise. Peace talks with FARC have largely stalled under Colombian President Alvaro Uribe Velezs administration, and ghting FARC is especially difcult because neighboring states have offered the group de facto asylum. Ecuador might or might not directly aid FARC, but Venezuela has done so overtly and will likely continue to do so. FARC sees Chavez as an ally and has gone so far as to issue an open letter to the Venezuelan leader saying that FARC needs to preserve an alliance with Chavez in the face
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January 2007 of the common enemy of imperialism. Venezuelas motivations in promoting a good relationship with FARC are twofold. First, an angry FARC on its borders signicantly threatens Venezuelas security, and a policy of covert mutual back-scratching is a cheap solution. Second, Venezuela is politically opposed to the United States and the largely U.S.-funded war against drugs that Colombia is carrying out. Sandwiched between FARC-friendly Chavez and his Ecuadorian ally Correa, Colombia is set to face diplomatic challenges while ghting the ongoing war with guerrilla groups this year. Venezuela began 2007 with several Cabinet changes that indicate a trajectory shift for Chavezs government. His goals this year will focus on combating the severe crime wave that is devastating Venezuela and on consolidating leftist parties in the country into a single political group. In his attempts to install himself as the chief leftist in Latin America, Chavez has largely and publicly failed. After a year of contentious elections in the region, Chavez is left with noncontiguous allies in the nonpowerhouse states of Ecuador, Cuba, Nicaragua and Bolivia and even these have distanced themselves from him. His world tour to secure a spot on the U.N. Security Council yielded a brief foray into the international spotlight but no high seat. In 2007, Chavez will continue to cultivate relationships with Iran, Syria and other regimes at odds with the United States, but these budding relations will form little more than a symbolic cadre of anti-U.S. nations. Chavez will continue to pose little real threat to the United States, partly because Venezuela is thoroughly invested in the U.S. oil market and partly because it simply lacks the capacity to affect U.S. interests. Venezuela will continue to have ckle diplomatic relations, but any extreme escalations of tension are unlikely. This is not to say that Venezuela has not pursued a noticeable enhancement of its military capabilities. Although deals to buy military transport planes from Spain have fallen through, Russia is set to continue delivery of various military planes and equipment including the expected construction of a Kalashnikov factory in Venezuela that will be able to manufacture hundreds of thousands of light arms per year. Though these actions signal an interest in beeng up Venezuelas image in the region, they also are intended to strengthen Chavezs position domestically. He maintains a rm grip on the military and has managed to maintain signicant support among the populace, despite a fervent opposition movement. Chavezs military buildup is likely intended to maintain a show of force domestically, not to launch aggressive acts across Venezuelas borders.
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January 2007 Chavez recently announced plans to nationalize the energy and utility sectors, take political control of the Central Bank and assume control of operations in the oil-rich Orinoco Basin. Though Chavez will continue to advance his agenda, he still needs foreign investment primarily in the oil sector. Though Chavez has said there will be no negotiations, he has said he will compensate the affected industries from Venezuelas reserves. By avoiding expropriation, Venezuela appears poised to orchestrate a smoother transition to nationalization. However, if pushed, Chavez will adopt a harder line. He wants control and will do what he must to obtain it. Bolivia and the Southern Cone In 2007, Bolivia will continue to reform its economy and work on creating a new constitution. In attempting to rewrite the constitution, President Morales must balance the needs of the poor indigenous Bolivians and the wealthier Bolivians who live in the cities of the lowlands. The wealthy want representation in the government and greater autonomy, while the poor want increased coca production and land redistribution. In 2007, the constitutional negotiations will continue, with compromises made on both sides. If Morales is pushed to make even more concessions to coca growers, he will run the risk of prompting the U.S. to further reduce aid. Bolivia will continue to reform its economy and work on creating a new constitution. Though Brazil, Argentina and Chile irted with the idea of abandoning Bolivia after its natural gas nationalization in 2006, the three countries likely will continue to engage the country. All three depend on Bolivian natural gas, and dreams of independence from the countrys turbulent politics remain too costly to be implemented. Ongoing negotiations between Bolivia and Brazilian oil company Petroleo Brasileiro (Petrobras) have held center stage in this process, as Petrobras has vast interest in and, through heavy investment, much control over Bolivian oil and natural gas. Though Argentina has negotiated a deal with Bolivia to increase natural gas imports, it is likely to increase domestic gas speculation, as the prospects for a pipeline that can handle the necessary ow from Bolivia remain uncertain. After its 2002 crash, Argentinas economy began recovering, with surprisingly high levels of exports and strict regulation of ination that continually threatens to get out of control. Argentina will be an important economic
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January 2007 leader in South America especially in the Southern Cone as it continues to recover in 2007. Because Argentina is one of Latin Americas largest economies, the countrys October elections could set the pace for the region in 2007 and signal a strong move toward the center and away from Chavezs radical left. The elections will prompt dialogue on the future of Argentinas economic policies, including ination control, energy development and the direction of Mercosur. Under President Nestor Kirchner, Argentina has cultivated leftist economic policies that have bolstered the countrys economy without falling into the anti-U.S. rhetoric of the Chavista left. Overall, the current Kirchner administration has emerged as relatively conservative, a balance of sorts to Chavezs radical anti-U.S. agenda. In the event that Kirchner does not seek re-election, his wife, Cristina Fernandez de Kirchner, is an extremely popular politician who would be likely to win the 2007 presidential election. With either Kirchner at the helm, Argentina will stay in the center left, thus effectively ending the leftist movement in Latin America and maintaining the Argentine balance between more conservative politics and more leftist economics. Chile will maintain a developed infrastructure, a healthy business climate and relatively low levels of corruption. Chile spent much of 2006 actively seeking out economic ties to the rest of the world particularly Asia and it will persevere in 2007. Argentina will maintain the balance between more conservative politics and more leftist economics. Brazil will continue on roughly the same path in 2007 as in 2006, despite increased crackdowns on organized crime in Rio de Janeiro and Sao Paulo. Da Silva is ghting an uphill battle to increase economic growth to at least match the regions average at about 4 percent. Meanwhile, ongoing infrastructure improvements in the countrys interior particularly the construction of railroads to move soy and iron are laying the groundwork to transform Brazil from a coastal power to a continental-sized power with more balanced demographics. In sum, 2007 will be a decidedly introspective year for Latin America. Broader intraregional relations will, in many cases, take a backseat to domestic issues as newly elected and re-elected leaders settle into their
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January 2007 posts and turn their focus toward their constituents. Domestic problems of rampant crime and corruption will continue to be a policy focus, as will economic policies that promote reform and enhance stability. Africa: Attracting Outside Interest, But Conflicts Continue The 2006 annual forecast for Africa accurately said that the major powers involved in African political affairs would diverge. We forecast that world economic players, led by China, would signicantly expand their ties to a number of commodity-rich sub-Saharan African countries in order to secure access to the continents natural resources. We also were correct in saying the United States and Europe would be less active in sub-Saharan Africa in 2006 but would maintain their political relationships there and remain engaged with several African countries on security matters. Though we made the call that the United States would work with countries in the Horn of Africa particularly Ethiopia, Djibouti and Kenya to contain the spread of militant Islamism, we did not anticipate that what had been disparate Islamic courts would go on to become a force that, by the second half of the year, controlled not only the Somalian capital of Mogadishu but also large swathes of southern and central Somalia. Conf lict in Sudans Darfur and southern regions will continue, where insurgent groups remain intent on gaining greater autonomy or independence. Africas major powers, South Africa and Nigeria, were preoccupied with political crises in 2006 another forecast we made that kept them from successfully mediating Africas conicts. South Africa remained embroiled with a since-dismissed rape and corruption case against former Deputy President Jacob Zuma. Along with signicant political problems associated with President Olusegun Obasanjos attempt to amend the countrys constitution to permit him a presidential third term, Nigeria faced a signicant increase in the number of militant attacks against the countrys oil infrastructure and personnel, which caused a reduction in oil output.
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January 2007 In 2007, outside powers including the United States, Russia, China and India will continue jockeying for control over Africas resources and engaging in bidding wars over oil and gas and minerals concessions. Terrorism concerns will drive greater foreign particularly U.S. involvement in the Horn of Africa. Conict will continue in Sudans Darfur and southern regions, where insurgent groups remain intent on gaining greater autonomy or outright independence. The Darfur conict has spilled into Chad and the Central African Republic two countries that, along with Sudan, have armed and used militias against each other. Those militias have in turn fomented insurgencies against their own governments. Because Khartoum feels it necessary to defeat the National Redemption Front which is intent on acquiring greater autonomy for Darfur no U.N. peacekeeping force will touch the ground in Darfur in spite of widespread international pressure on Sudan to accept such a force. Khartoum will continue opposing the idea of a U.N. peacekeeping force, based on fears that such a force would invade to occupy the country and bring criminal charges against the ruling regime for instigating genocide in Darfur. As a result of this impasse between Khartoum and the Western governments and nongovernmental organizations that want the Darfur conict to end, Sudanese President Omar al Bashir will accept a token reinforcement of the existing African Union (AU) mission in Darfur. The beefed-up AU force will likely prove no more successful at containing the humanitarian crisis in Darfur in 2007 than the existing force of 7,000 was in 2006. Ethiopia both supporting and supported by the United States will maintain its intervention in Somalia in order to prevent the resurgence of that countrys Supreme Islamic Courts Council (SICC) and the al Qaeda suspects it harbors. Though Ethiopia is cooperating with U.S. forces to keep Somalia from becoming a training ground for transnational jihadists intent on launching attacks in the Horn of Africa and beyond, it is also acting out of concern that the SICC objective to create a Greater Somalia will destabilize ethnic Somali lands in Ethiopia (not to mention ethnic Somali areas in Kenya and Djibouti). While its forces are preoccupied with Somalia, Addis Ababa will face increasing threats from neighboring Eritrea and from domestic insurgent
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January 2007 groups demanding more freedom for Ethiopias Oromo and Ogaden regions. Facing these threats along with the ongoing hostilities in Somalia that will only deepen while Ethiopian troops are there Addis Ababa will call for peacekeepers from African countries not bordering Somalia to pacify the Islamists and reinforce Somalias otherwise powerless Transitional Federal Government (TFG). Ethiopia will face increasing threats from Eritrea and from domestic insurgent groups demanding more freedom for the Oromo and Ogaden regions. Despite losing Mogadishu and their control over southern and central Somalia, the Islamists and their militia whose approximately 3,000 members buried their weapons and uniforms and blended in with the population to avoid facing Ethiopias superior forces can still regroup and wage a guerrilla campaign against Ethiopian troops and the shaky TFG now centered in Mogadishu. Somalian President Abdullahi Yusuf is a newcomer to Mogadishu, having entered the city Jan. 8 for the rst time since becoming president in 2004. Because he hails from the Darood clan in the northern autonomous Puntland region, Yusufs presidency is distrusted in a country deeply divided by antagonistic and historic clan rivalries. Furthermore, many Somalians consider the TFG a construct imposed by foreign interlopers. Thus, Yusuf and the TFG face formidable challenges as they try to provide law and order in Somalia. Uncertainty over the deployment of international peacekeepers, Somalis lack of condence in the TFG to provide law and order and the continued presence of a dispersed but not defeated SICC all translate into continuing conict in Somalia. The country will see a return to what most Somalis know best clan-based warfare as Yusuf attempts to exert his newfound power from Mogadishu. More ominous, though, is the likelihood of guerrilla and jihadist warfare within and launched from Somalia. Africas leading oil producer, Nigeria, will see an increase in nationwide political violence and attacks in the Niger Delta in the run-up to the countrys presidential election in April. Umaru Musa Yaradua, governor of northern Nigerias Katsina state and the ruling Peoples Democratic Party (PDP) presidential candidate, will likely win the April election. Opposition parties will strive to band together in an attempt to unseat the PDP, but personality
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January 2007 clashes will keep the opposition from uniting. Presidential aspirants including Atiku Abubakar of the Action Congress Party and former military ruler Gen. Muhammadu Buhari, the All Nigeria Peoples Party candidate, will not be willing to yield to other candidates, so the opposition vote will be divided. Violence will intensify in the Niger Delta region. Militant groups will continue attacking the regions oil infrastructure in order to bring attention to their socioeconomic grievances, and those same militants will serve as pawns for politicians striving to ll their campaign coffers and oppose the effective extension of Obasanjos rule through his chosen successor, Yaradua. Angola will emerge as the regions wildcard, thanks to an increasingly stable political environment. The government struck a peace deal with the secessionists in the oil-rich Cabinda province in 2006 and is now free to drive increasingly hard bargains for Angolas oil and mineral concessions. To do this, Luanda will become more aggressive internationally by joining the Organization of the Petroleum Exporting Countries and strengthening partnerships with Russia and China. This increasing assertiveness will draw the attention of South Africa, which could view Angolas moves as threats to its hegemony in southern Africa. Angola will work toward holding elections for the rst time since 1992 and will conduct voter registrations in 2007 in anticipation of presidential elections to be held in 2008. Angolan President Jose Eduardo Dos Santos will use 2007 to identify and promote his chosen successor. The increasingly stable political system in the Democratic Republic of the Congo will help it generate greater foreign investment. South Africa will continue to be paralyzed by inghting in the ruling ANC party, which will hold its leadership Congress in late 2007. The government will continue maligning Zuma to prevent him from contesting the party and state presidencies. South Africa begins 2007 with a two-year rotating seat on the U.N. Security Council, and though it will strive to strengthen its role as a mediator of conicts in Africa and elsewhere, its internal divisions will prevent it from realizing that goal. Increased Russian and Chinese activity in Africa will cause alarm in Pretoria which, while welcoming the investment and cooperation these countries will offer, will increasingly resent the narrow terms and conditions that will accompany their involvement. As a result, South Africa will position itself as Africas champion to resist what will be perceived to be renewed colonial imposition.
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January 2007 The Democratic Republic of the Congos recent presidential election allowed sitting President Joseph Kabila to retain his ofce. The countrys increasingly stable political system will help it generate greater foreign investment. Kabila will present himself as a democratic leader who is also able to mediate regional conicts, but he will spend most of his time consolidating his control at home and selling mineral concessions. Kabila will devote scant attention to the simmering Tutsi-led rebellion in the countrys largely ungoverned eastern provinces because the insurgency will not threaten his hold on power. Jean-Pierre Bemba, who lost the November 2006 presidential election to Kabila, will serve as an opposition political leader in the countrys Senate and will contest Kabilas power from that position. Zimbabwean President Robert Mugabe will come under increasing pressure from the countrys citizens to resolve Zimbabwes worsening economic problems. Spiraling ination and the populations inability to feed itself will prompt increasing civic opposition to Mugabes rule, and Mugabe will rely more on the countrys security forces to contain that opposition. Mugabes recent moves to extend his presidential term by two years to 2010 is aimed at preventing anyone from his close circle in the ruling Zimbabwe African National Union-Patriotic Front (ZANU-PF) party apparatus from challenging him. However, if Mugabe begins showing signs that his age is catching up to him (he turns 83 this year), he will nd members of the ZANU-PF ruling elite forcefully challenging his grip on power. Cote dIvoire has been divided since 2002, when a failed coup attempt led to a civil war. That will not change, as President Laurent Gbagbo maintains control in the southern half of the country. Gbagbo will continue using revenue generated from cocoa and coffee sales to enforce his rule and arm the countrys military and his private militias. The big question will be whether the U.N. and French peacekeeping forces will stay and keep maintaining the Zone of Condence between Cote dIvoires halves. Should the U.N. and French troops leave, nothing would prevent fresh ghting. The United Nations and France want to avoid renewed conict in the country, yet maintaining the status quo comes at a cost: Gbagbo is effectively protected from any threat to his power. This situation gives him no incentive to strike any sort of peace deal with the 3.5 million northern Ivorians, who oppose Gbagbos rule because of their exclusion from Ivorian citizenship and full social, economic and political participation.
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Time to Look Inward
January 2007 Global Economy: A Short U.S. Slowdown, A Prolonged Chinese Problem In our 2006 annual forecast, we predicted that the year would consist of rapid growth for all of the worlds major economies despite strong commodities prices. In particular, we expected that the United States, China and even Japan would enjoy a near-unprecedented level of growth and that the United States would only begin to dip as the end of the year approached. We are pleased to report that global growth on the back of strong performance in all regions indeed pushed the limits of what the global economy is capable of. We also predicted that commodity prices would fall back from their dizzying highs. That they did, if only in ts and starts, and not en masse until actually after the New Year. The U.S. economic slowdown will likely be mild and brief. The U.S. economy at the beginning of 2007 is enmeshed in a slowdown. The expansion that took place over the past four years which averaged an impressive 3.4 percent per quarter is over, and the system needs to take a bit of a breather. Data supporting this stance include a weak housing market, stubbornly high ination, robust energy prices, agging worker productivity and an inverted yield curve all classic indicators of economic malaise. This is where the U.S. economy begins the year. But slowdown does not equal recession, and both for structural and tactical reasons we expect the slowdown to be mild and brief. Structurally, the foundations of the U.S. economy emphasis on technology, a well-developed infrastructure, a culture of entrepreneurship that rewards risk-taking, an educated workforce, etc. remain in place. This slowdown is simply a cyclical downturn, not a symptom of a broader structural deciency. Furthermore, as the U.S. baby boomers mature, their retirement savings are making the world awash with capital. This is keeping interest rates far lower than they would normally be, and should contribute to that often-sought-after soft landing for the American economy. Tactically, in the past month commodities prices whether corn, oil or copper have plummeted from their historical and near-historical highs. When these products prices fall, economic activity of all stripes tends to get a new lease on life. So just as the American economy is taking a breather, the
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Time to Look Inward
January 2007 building blocks of a strong recovery are falling into place. Add in that the U.S. stock markets have not experienced a serious sell-off and it seems that investor sentiment has never really soured. All this indicates a mild correction not a recession. Barring a severe shock to the international system, the slowdown likely will evaporate sometime around the beginning of the third quarter, although if past proves prologue the media will recognize that the U.S. slowdown is real by about the time it has ended. With the question of how bad it will be answered, there is only one left: How far will it spread? By the end of the year, Japan will risk slipping back into the economic catalepsy that it experienced from 1990 to 2004. Japan likely will get the worst of it. Japans economic problems are nothing new, but they were held in abeyance in 2006 by strong consumer spending. That spending ultimately depends on consumer condence, and in 2006 Japan had the benet of an experienced charismatic leader: Junichiro Koizumi. His successor, Prime Minister Shinzo Abe, lacks the gravitas and track record of the spectacularly coiffed Koizumi. That plus long-overdue efforts to get serious about axing extra spending will combine with decreasing U.S. demand to engineer a slowdown in the Land of the Rising Sun. By the latter part of 2007, Japan will even risk slipping back into the economic catalepsy that ruled it from 1990 to 2004. This is the year when Abe will be tested to see if he can at least keep Japan on economic life support. Contrary to the expectations laid out in our previous annual forecast and a raft of data released early in the year 2006 turned out to be a banner year for the Europeans. Though some of the shine came off this growth late in the year, it certainly remains impressive by European standards. Growth is strongest in Germany, but it is hardly paltry in the other major economies. And for the 12 countries that recently joined the union, the mix of an expanded market and EU support payments made 2006 an excellent year.
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Time to Look Inward
January 2007 It would doubly surprise us, however, if the European Unions economic growth sustains itself this year. The euro is close to historical highs; the last time this happened, the slowdown in European exports alone nearly caused a recession. Furthermore, Italy and Germany which make up about half of the eurozone implemented sharp tax increases Jan. 1 as part of their budget-balancing efforts. These increases will undoubtedly cool down growth. Add in a rising housing bubble in several European economies that makes the U.S. housing surge of the past few years look downright miniscule, and it is extremely unlikely that Europe will be able to come anywhere close to replicating its 2006 feat. The likely exceptions will be the 12 Central European and Mediterranean states that have joined the EU since 2004. However, since their economies account for only about 5 percent of the European Unions total gross domestic product, their strength will have little impact on the combined European bottom line. And before waxing philosophic about shining Europe, bear in mind that in the EU banner year of 2006, growth in the eurozone was an estimated 2.1 percent. That is impressive growth for Europe, but rather sedate from Asian or American points of view. U.S. President George W. Bush and the Republicans must concede some worker protection guarantees to Democrats in order to move any potential trade agreements forward. As long as the global economic slowdown is not severe, pocketbook issues will not signicantly change the current momentum of ongoing trade negotiations. The Doha round of global trade talks will continue to ounder, as political changes in France will not reduce French opposition to opening up Europes Common Agricultural Policy enough to bring about a Doha breakthrough. Meanwhile, the leadership change in the U.S. Congress from one that was cautiously supportive of free trade to one that is ambivalent (at best) undercuts any gains that will come with a change in French leadership. In short, Doha is dead, and it will remain dead through 2007. The trade game, therefore, will move to the small groups, particularly in Asia, and to the countless bilateral trade negotiations around the world that have become the main venue for trade talks in the past two years. By the end of 2007, the highlight of the year could be the beginning of serious discussions of a Transatlantic Free Trade Agreement (TAFTA).
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Time to Look Inward
January 2007 In the United States, President George W. Bush will retain some form of fast-track authority, but it will not be the same blank-check authority U.S. presidents enjoyed for all but eight of the past 30 years. Democrats will try to walk a ne line between trying to appease labor and environmental groups on trade issues and reassuring businesses that the party is not anti-trade. Incoming Democratic committee chairmen with sway over trade issues have expressed a willingness to renew the presidents authority for fast-track trade negotiations on the condition that heightened foreign and domestic labor and environmental safeguards accompany such trade deals. Such workforce and environmental safeguards abroad will have to be minimal and symbolic if the U.S. trade representative is to be effective, but symbolic statements might be sufcient for congressional Democrats. The president and Republicans will be forced to concede some worker protection guarantees to Democrats in order to move any potential trade agreements forward this year. Such concessions will be crucial if any progress is to be made in renewing and developing new agreements in Latin American countries in particular, Panama, Peru and Colombia and with South Korea and Malaysia. The East Asia Forum will provide the most signicant trade agreements in 2007, as the major economies of East Asia begin a series of talks aimed at building on the successful Association of Southeast Asian Nations (ASEAN) Free Trade Agreement, which is harmonizing tariffs and reducing nontariff barriers to trade throughout the region. The ASEAN Free Trade Agreement, for its part, will begin to shift in 2007 from an informal treaty organization to one with specic rules for members. ASEAN boosters see this as a move toward complete EU-style integration by 2015. The East Asia Forum will provide the most significant trade agreements in 2007. German Chancellor Angela Merkels strengthening position in the European Union could prove an effective platform for her to achieve her long-standing goal of reigniting TAFTA negotiations. The barriers to a successful agreement are high, but both sides probably will be attracted by the prospect of an agreement that would make a full-on NAFTA-vs.-EU trade war unlikely. Progress toward talks will be slow, and little other than a commitment to enter into talks is likely in 2007, but it could nonetheless prove a turning point in global trade relations.
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Time to Look Inward
January 2007 China We have been pessimistic about the Chinese economic systems long-term stability for some time now. The core problem is that in Asia, capital is treated as a political good to be distributed on the basis of achieving social goals. In contrast, the West broadly uses capital as an end in and of itself. Put another way, Asia splashes its money around to ensure high employment and cares little for its rates of return, while the West prefers a thrifty approach that seeks to maximize efciency. This makes the Western economies far more adaptable and sustainable, while the Asian economies grow more quickly but also suffer from cataclysmic crashes when their inefciencies overwhelm them. In the past decade, those inefciencies have sparked two very different days of reckoning. In Japan, social cohesion was sufcient enough that Tokyo was able to force excruciatingly slow and piecemeal changes to the system. Japan has nally emerged from (parts of) its dysfunction, but only after 15 years of near-zero growth. In contrast, during the 1997 crash Indonesia fell apart nearly overnight because its political and economic systems were not as unied as Japans, and Jakarta lacked Tokyos credibility with its populace. Though the Chinese system is socially unstable and economically irrational, the Chinese are succeeding in using threats, lies, nationalism and force to keep it from melting down. China is a different place. Its political authorities credibility, like its level of economic development, is somewhere between that of Japan and Indonesia. It cannot afford a Japanese-style malaise, but at the same time it does not live in fear of an Indonesian-style collapse. But perhaps Beijings greatest advantage is awareness. Not only have the Chinese witnessed the Japanese and Indonesian trials and tribulations, they also have studied the Soviet collapse. This is not a country hurtling headlong into oblivion, ideologically blind to its faults. The Chinese know the bad loan problem is at the heart of their nancial weakness and unlike the Soviets, Japanese or Indonesians before them are taking steps to address it. At the core of Chinese strategy are efforts to slow the countrys breakneck economic growth by forcing the rational, Western-style use of capital and introducing the market discipline that is common in the West. In this they have
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Time to Look Inward
January 2007 largely failed, as those beneting from the old system have the power to ignore central government dictates. Since the central government began taking rm steps to limit growth, it has only accelerated. This leaves Beijing to manage the problem it cannot solve. The Chinese have done this in two ways. First, they have relocated the bulk of the bad loans to asset management companies, allowing them to declare, with some credibility, that the state banks are clean. Such banks can then approach international entities whether institutional or equity for investment and managerial assistance in changing the way the banks do business. The bad loans are still there they have just been shifted into another arm of the government. The second technique is more basic: lie. According to the ofcial government position, no Chinese state bank has made a single bad loan since 2001. Put techniques one and two together and you have on paper a nancial system in remarkably healthy shape. This is but one of myriad creative ways in which the Chinese are managing their problems, but all of these successful techniques have one characteristic in common: they are political and security-related in nature, not economic or nancial. The state is managing the transition by adjusting Chinese expectations and making fundamental changes in behavior. The Chinese economic system has escaped the central governments grasp, and the government now is using noneconomic tools in its attempts to reassert control. For 2007, this means that while the underlying core of the Chinese system is as socially unstable and economically irrational as ever, the Chinese are succeeding in using threats, lies, nationalism and force to keep it from melting down. A sort of political reckoning that started when Chinese President Hu Jintao took command began to gather traction in 2006, and could well prove painful in 2007. Subconsciously, foreigners have noticed the difference in timbre in China. Foreign direct investment, while still large, is no longer growing, and many foreign rms are either looking for ways to hedge themselves against government dictates or examining alternate investment locations such as South Korea, Vietnam or the Philippines.
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Time to Look Inward
January 2007 Chinas leaders are both aware and creative, and the Chinese economys fall will not happen this year (nor is it likely in 2008, as the patriotic burst from the Olympics will help Beijing hold the center), but do not confuse growth with strength, or market share with prot. Chinas problems are mounting, not getting solved.
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A b o u t S t r at f or
January 2007 Founded in 1996, Strategic Forecasting Inc. (Stratfor) is the worlds leading private intelligence rm. Well beyond recording facts and communicating news, Stratfor gathers timely intelligence, applies expert analysis and translates it into actionable information that helps clients make competent and protable strategic decisions.
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C on ta c t S t r at f or
January 2007
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