Q3 2014-2015: International Crises Mask Broad Domestic Stability

BMI View: International crises in Ukraine, Syria and Iraq, and the South China Sea mask the fact that domestic political risks will remain contained in most major economies.

As we enter the second half of 2014, the world is seeing a notable increase in international political risk in several quarters. The rapid military gains by the Syria- and Iraq-based Islamic State in Iraq and al-Sham (ISIS) in northern Iraq has brought the country to the brink of civil war. Meanwhile, Ukraine continues to experience a Russian-backed insurgency in the east of the country, despite efforts by the major powers and the new Ukrainian government to end the fighting. Elsewhere, tensions remain high between China and Vietnam in the South China Sea. None of the underlying grievances in these crises will disappear anytime soon. As such, all three regions will merit attention for the foreseeable future.

On a more positive note, domestic political risks in most of the world's major economies appear to be well contained. For example, Brazil, Egypt and Turkey all saw mass protests in 2013, but have returned to calm. In addition, the world's election calendar will be less busy in the second half of 2014, with only Indonesia, Turkey, Brazil, and the United States among G-20 economies holding presidential or legislative (or both) elections. In each of these cases, we do not envisage significant changes to the status quo. Arguably the most unusual political events in H2 2014 will be independence referendums in Scotland and Catalonia (the latter non-binding). We expect Scotland to vote against separation from the UK, but Catalonia may well favour secession, thereby raising the risk of a political crisis in Spain.

Q3 2014-2015: International Crises Mask Broad Domestic Stability

BMI View: International crises in Ukraine, Syria and Iraq, and the South China Sea mask the fact that domestic political risks will remain contained in most major economies.

As we enter the second half of 2014, the world is seeing a notable increase in international political risk in several quarters. The rapid military gains by the Syria- and Iraq-based Islamic State in Iraq and al-Sham (ISIS) in northern Iraq has brought the country to the brink of civil war. Meanwhile, Ukraine continues to experience a Russian-backed insurgency in the east of the country, despite efforts by the major powers and the new Ukrainian government to end the fighting. Elsewhere, tensions remain high between China and Vietnam in the South China Sea. None of the underlying grievances in these crises will disappear anytime soon. As such, all three regions will merit attention for the foreseeable future.

On a more positive note, domestic political risks in most of the world's major economies appear to be well contained. For example, Brazil, Egypt and Turkey all saw mass protests in 2013, but have returned to calm. In addition, the world's election calendar will be less busy in the second half of 2014, with only Indonesia, Turkey, Brazil, and the United States among G-20 economies holding presidential or legislative (or both) elections. In each of these cases, we do not envisage significant changes to the status quo. Arguably the most unusual political events in H2 2014 will be independence referendums in Scotland and Catalonia (the latter non-binding). We expect Scotland to vote against separation from the UK, but Catalonia may well favour secession, thereby raising the risk of a political crisis in Spain.

On a global basis, we highlight three key themes below:

Theme 1: From 'Global' Discontent To Idiosyncratic Factors

The key theme we raised in our mid-2013 Global Political Outlook, published on June 28 last year, was policy missteps in emerging markets - a topic which we said would remain in play for the foreseeable future. At the time, we argued that the best years for Emerging Markets (EMs), in terms of rapid economic growth and the pace of improvements in living standards, are over, and that governments will face greater challenges in managing the expectations of voters, who have become accustomed to the economic rewards of the 2000s. At the same time, many voters have been chafing at the relative absence of benefits for themselves during the boom years. We still believe that the above is true. However, we also see political risks emerging from more country-specific factors. For example, in Ukraine, mass demonstrations in late 2013-early 2014 were prompted by divisions over whether the country ought to align with the EU or Russia. In Thailand, the protests that prompted a military coup on May 22, 2014 opposed the Shinawatra family's continued grip on politics. In Taiwan, tens of thousands of people protested in April against closer economic ties with China. Overall, we reiterate that major protests can emerge with lightning speed, thanks to the use of social media.

Theme 2: The United States' Diminished Ability To Shape The World

The second important theme is the United States' diminished ability to shape global events, especially by means of military action. This is evident from Washington's cautious approach to the conflicts in Syria and Ukraine, and the stand-off between China and Vietnam in the South China Sea. The US political establishment and American voters are notably war-weary after more than a decade of fighting in Afghanistan and Iraq, which has claimed more than 6,000 American troop lives, and tens of thousands more injured. Opinion polls show that the percentage of Americans favouring a more active role abroad is at its lowest in many years. We still believe that the US has the wherewithal to intervene militarily in extreme scenarios, such as a major North Korean attack on the South, but for the most part, Washington will avoid foreign military entanglements, other than through the use of drone strikes or selected airstrikes. The main drawback of all this is that anti-American states such as North Korea and Iran, as well as competitor great powers Russia and China, and even US allies, currently perceive America as weak. Arguably, this perception has already emboldened China in its maritime disputes with its neighbours, and Russia in its actions towards Ukraine. That said, we do not expect this American war-weariness to last indefinitely. It is quite possible that the next US president will seek to reassert America's global leadership, and that by that time, American society will be recovering from the impact of the Afghan and Iraq wars.

Theme 3: Possible Return Of Food Price Inflation

We continue to expect Chicago Board of Trade (CBOT) grain prices to generally average lower in 2014 than 2013 as supply improves and demand growth remains relatively subdued. However, we highlight some key flashpoints that could drive food prices higher in the coming months (see March 17, 2014, 'Food Price Inflation: Where Are The Risks?'). In particular, we see upside risks to prices from the prospects of stronger ethanol production in the US, the increasing probability of the return of El Niño, improved livestock production (which raises demand for feed), and trade disruptions. Given the high weighting of food prices in consumer price inflation baskets in emerging markets, any significant increase in the cost of food could raise political temperatures.

Global 'Hotspots': Ukraine, Iran, Syria-Iraq, Koreas, Asia Maritime Disputes, Afghanistan

Ukraine - East to remain unstable: Although the Ukrainian crisis has faded from the headlines, the conflict is far from over. We believe that Russia will refrain from invading eastern Ukraine, for fear of getting bogged down in a costly military occupation and triggering more punitive sanctions from the West. Even so, Russia will continue supporting separatists in eastern Ukraine, until Kiev agrees to a new constitution that would empower the eastern regions. Greater autonomy there would allow Moscow to exert considerable influence on the Ukrainian state for the foreseeable future. Meanwhile, as we have emphasised previously, the crisis in Ukraine has global ramifications ( see March 17, 2014, 'Russia-Ukraine Crisis: Nine Geopolitical Consequences'.).

1: The crisis in Ukraine underscores the very real dangers associated with ongoing (but usually low-key) geopolitical competition between Russia and the West in Eurasia.

2: Russia has strengthened its position in Western Eurasia, but has harmed its economy and its international image (at least in the eyes of Western policymakers and investors).

3: The US-led West may be perceived as weak, owing to the constraints it faces. However, in the short term, the NATO alliance may regain a greater sense of purpose.

4: US efforts to enlist Russia in other foreign policy challenges (e.g. the Iran nuclear dispute and wars in Syria and Afghanistan) may now suffer.

5: The Ukraine crisis could further dissuade North Korea and Iran from abandoning their nuclear weapons programmes.

6: China appears to have adopted a tougher foreign policy stance following Russia's actions in Ukraine, especially in its territorial disputes with Vietnam and the Philippines, and potentially with Japan too.

7: Turkey will be uncomfortable with Russia's increased strength in the Greater Black Sea Region, where it also seeks to exert influence.

8: Secessionist movements elsewhere could receive a psychological boost from Crimea's separation from Ukraine.

9: The Russia-Ukraine crisis will test the effectiveness of economic linkages (and nuclear weapons) in preventing 'Great Power' conflict.

Overall, the Crimean crisis will lead to a distinctly cooler period in relations between Russia and the West (see May 2, 2014, 'Russia And The West: Multi-Year Cool Period Ahead). Thus far, the sanctions imposed by the West on Russia have been relatively mild, but could yet be toughened. The main trigger for a further escalation of the crisis would be a Russian military advance into eastern or southern Ukraine. This would be viewed as blatant aggression, requiring a firmer (though still non-military) response from the West. The West would also blame Russia for a major increase in rebel activity, thus exacerbating the crisis.

Iran-US rapprochement - Now or never: We reaffirm our core view that the interim agreement between Iran and the so-called P5+1 powers (the US, Russia, China, UK, France and Germany) countries on the former's nuclear programme, which was signed in November 2013, will be extended for another six months following its expiry on July 20. The next few months will be critical in determining whether the tentative rapprochement between Iran and the US will succeed, or prove ephemeral. The prospects of a genuine breakthrough are arguably the best they have been since the late 1990s, with Presidents Hassan Rouhani and Barack Obama both keen to reduce tensions.

Nonetheless, there are obstacles on both sides, as well as sceptical third parties. Presidents Rouhani and Obama face opposition from hardliners in their own countries, due to the legacy of mistrust that has prevailed since the Iranian Revolution of 1979 (anti-Americanism was one of the cornerstones of the revolution). In addition, several Middle Eastern states close to the US, especially Israel and Saudi Arabia, do not trust Iran's leadership and fear that Obama, in his keenness to see a rapprochement, could sacrifice their security concerns about Iran's nuclear programme. Meanwhile, the deterioration in Russia-West relations could relieve some of the international pressure on Iran, if Moscow decides to unilaterally improve its relations with Tehran as a means of retaliating against Washington and Brussels. Furthermore, even if Iran and the US reach a quasi-permanent deal to end the more controversial aspects of Tehran's nuclear programme, disagreements could still emerge at a later date over fine technical details and implementation. Israel is well aware that even though the US and North Korea signed a deal in 1994 to freeze the latter's nuclear programme, Pyongyang went on to develop an atomic arsenal over the subsequent decade.

So long as the Iran-US rapprochement appears to remain on track, Washington will refrain from military action, and Israel will feel tremendous pressure to hold off on air strikes (see November 28, 2013, 'Iran Deal Causes Discomfort, But Military Action Unlikely'). However, there is still a risk that if Israel deems the US to have neglected its security concerns, it could decide to act unilaterally. Meanwhile, if the rapprochement visibly falls apart, hardliners in the US could pressure Obama to act militarily, on the basis that all diplomatic efforts to prevent a nuclear Iran have been exhausted.

Iraq and Syria - Increasingly interlinked conflict: The fate of Iraq and Syria is becoming increasingly intertwined, as spill-over effects from the Syrian civil war have contributed to increasing sectarian tensions in Iraq. This resulted in the takeover by radical Jihadist group Islamic State in Iraq and al-Sham (ISIS, also rendered Islamic State in Iraq and the Levant-ISIL) of northern Iraq in June 2014. Iraq and Syria have now become twin battlegrounds for a sectarian conflict between Shi'a and Sunni Muslims, and a proxy conflict between the major regional actors (principally Shi'a Iran and Sunni Saudi Arabia). The fighting in Syria and Iraq will remain the major risk to systemic stability in the Levant and the wider Middle East over the coming years. We anticipate that the US will launch airstrikes against ISIS in Iraq - and possibly Syria - to halt the group's advance.

The civil war in Syria will continue over the next five to ten years. President Bashar al-Assad's regime appears to be carving out a belt of territory stretching from the port cities of Tartous and Latakia in north-western Syria to Damascus in the south. However, it appears to lack the resources and the manpower to regain full control of the country. At the same time, infighting among rebel groups continues, and lawlessness prevails in rebel-held territories. Neither government forces nor rebel groups have been capable of delivering a 'knock-out' blow against each other. President Assad's regime has unity, and considerable domestic and international backing (from Iran and Russia), whereas the rebels have suffered from fragmentation, divisions between its external backers (Saudi Arabia, Turkey, and Qatar), and only lukewarm support from the West.

Risks that Iraq will return to full-blown sectarian civil war are also high. While ISIS and its allies are highly unlikely to take over the heavily protected south - where virtually all the country's oil is currently produced - the central government in Baghdad is unlikely to retake the north anytime soon. Iraq will maintain formal unity within a more fragile federalised state over the coming years in our view, although risks of the disintegration of the country are significant. In late June 2014, Turkey's ruling AKP party stated that it is willing to accept a Kurdish state in northern Iraq, marking a significant shift in policy. At the same time, Israel backed the formation of a Kurdish state. We believe that the issue of Kurdish independence could gain new momentum as a result of the present Iraq crisis.

Korean Peninsula - Greater uncertainty ahead: North Korea will remain unpredictable, as its leader Kim Jong Un moves to consolidate his power. The annual session of parliament on April 9, 2014, did not result in a major purge of government officials, but we believe that a power struggle is underway between senior figures around Kim (see May 30, 'Internal Rivalry To Destabilise Regime'). This would explain the demotion of Choe Ryong Hae, a senior politico-military official and de facto number two man, in late April, and the appointment of a new defence minister - the fourth in two-and-a-half years - in June. The turnover of the military's senior-most positions has been extraordinarily high under Kim Jong Un, suggesting personnel disagreements at the top. Against this backdrop, we will remain vigilant towards signs of internal dissent, or even a localised uprising. Due to the opacity of North Korea, we caution that major political change could come with surprising speed.

As ever, it is quite possible that North Korea will seek to test the South, the US, and Japan in some way. The most likely course of action would be a military engagement with the South in the disputed West Sea area, and we caution that there is a risk of a limited battle at sea or on land, if Seoul retaliates against Pyongyang's provocations. Alternatively, the North could carry out further missile or nuclear tests, if it deems them politically expedient. The anniversaries of the founding of the state (September 9) and ruling party (October 10) usually offer opportunities for military grandstanding.

Asia's maritime disputes - China's assertiveness rising: We expect relations between China and its neighbours to remain strained as a result of Beijing's increasing assertiveness in regional maritime disputes. In the spring of 2014, the emphasis shifted from the East China Sea (where China claims the Japanese-administered Senkaku Islands (known as Diaoyu in Chinese)) to the South China Sea, where China established an oil rig in waters claimed by Vietnam. This assertiveness will encourage Asian states such as Vietnam and the Philippines to strengthen their ties with the US as a counterweight to China. Overall, we cannot preclude skirmishes at sea between rival naval vessels.

Sino-Japanese relations will remain tense, especially in the East China Sea, as has been the case throughout 2013. With China and Japan increasing their aerial and naval activities in the area of the disputed islands, the risks are rising of a collision or skirmish between aircraft or ships that leads to fatalities, which in turn would raise tensions further (see November 15, 2013, 'Sino-Japanese Conflict Scenarios: Geopolitical And Economic Implications'). There are two 'worst-case' scenarios we can envisage. Firstly, a civilian airliner could be mistaken for a military aircraft and attacked, in a similar manner to the destruction of a South Korean airliner for violating Soviet airspace in 1983. Secondly, China may decide to seize the Senkaku/Diaoyu Islands by force, calculating that a short, sharp operation (potentially similar in scope to Russia's takeover of Crimea in March 2014) would work to its advantage, and that neither Japan nor the US would risk war with China over such tiny and uninhabited islands. However, we believe that in the event of a Chinese seizure of the islands, Japan would respond militarily, as Prime Minister Shinzo Abe has stated. Despite the negativity surrounding Sino-Japanese relations, we still believe that neither China nor Japan wants conflict. Even so, the Senkaku/Diaoyu dispute will linger for the foreseeable future.

Afghanistan - Moving to a new era: Two events in 2014 will define Afghanistan's future for many years to come. Firstly, the country will inaugurate a new president in the summer of 2014 to succeed Hamid Karzai, who has been in office since 2002. As of late June, Ashraf Ghani, a former World Bank official and finance minister, was claiming victory, but his rival Abdullah Abdullah, a former foreign minister, was disputing this. The stand-off could rob the next president of legitimacy. Even with a credible mandate, the next president would face colossal governance and security challenges, and will also have the disadvantage of a lack of experience.

Secondly, by the end of 2014, the US and its NATO allies will have withdrawn the vast majority of their military forces from Afghanistan. Although the US will initially maintain 9,800 troops in Afghanistan beyond 2014 for training and counter-terrorism purposes, the Western exit will leave a security vacuum, given that the Afghan security forces are considered insufficiently robust. This could be exploited by the Taliban insurgents in many parts of the country.

Countries adjacent to or near Afghanistan, such as Pakistan, India, the Central Asian republics, and Russia will be especially concerned that the security vacuum could allow Islamist militants to deepen their presence in the region and carry out new attacks.

ELECTION TIMETABLE, Q2 2014-2015
Country Election Type Date Dominant Party/Nominated Candidate Opposition Party/Candidate(s) Expected Outcome STPR*
JULY
Indonesia Presidential 9 July N/A Joko Widodo (Indonesian Democratic Party-Struggle (PDI-P)), Prabowo Subianto (GERINDRA), various others Widodo win 68.8
Slovenia Legislative 13 July Positive Slovenia Party Slovenian Democratic Party, Miro Cerar's Party, others Too uncertain 64.2
AUGUST
Turkey Presidential 10 August Recep Tayyip Erdogan (AKP) (TBA) Ekmeleddin ?hsano?lu (Joint opposition) Erdogan win 52.1
SEPTEMBER
Russia Regional 14 September United Russia Various United Russia win 70.2
Sweden Legislative 14 September Moderate Party-led coalition Social Democrats, Green, Liberal, others Opposition win 89.0
Fiji Legislative 17 September Frank Bainimarama (Independent) N/A N/A 51.5
United Kingdom (Scotland) Referendum 18 September Pro-Independence Pro-Status quo Status quo win 82.5
New Zealand Legislative 20 September National Party, backed by ACT, United Future, Maori Party Labour Party, Greens National Party win 84.0
France Legislative (Senate) 21/28 September Socialist Party Union for a Popular Movement (UMP), others N/A 81.7
Canada (New Brunswick) Provincial 22 September Progressive Conservative Liberal Party, New Democrat (NDP) N/A N/A
OCTOBER
Bolivia Presidential 5 October Evo Morales (Movimiento al Socialismo (MAS)) Samuel Doria Medina (Frente de Unidad Nacional) Morales win 50.6
Legislative Movimiento al Socialismo (MAS) Various MAS win
Brazil Presidential 5 October Dilma Rousseff (PT) Aecio Neves (PSDB), Eduardo Campos, others Rousseff win 69.6
Legislative Partido dos Trabalhadores (PT), Partido do Movimento Democrático Brasileiro (PMDB) Partido da Social Democracia Brasileira (PSDB), Partido Socialista Brasileiro (PSB) Too uncertain
Bosnia-Herzegovina Presidential 12 October Rotating Presidency N/A N/A 36.2
Legislative Various Various N/A
Botswana Presidential October Ian Khama (Botswana Democratic Party) Duma Boko (Umbrella for Democratic Change) Khama win 72.9
Legislative Botswana Democratic Party Botswana Congress Party, Umbrella for Democratic Change (UDC) BDP win
Mozambique Presidential 15 October Felipe Nyussi (Frelimo) Afonso Dhlakama (TBC) (Renamo), Daviz Simango (TBC) (MDM) Nyussi win 56.2
Legislative Frelimo (Frente de Libertação de Moçambique) Renamo (Resistência Nacional Moçambicana), Mozambique Democratic Movement (MDM) Frelimo win
Tunisia Legislative 26 October Ennahda Niida Tounes Too uncertain 51.5
Uruguay Presidential 26 October Tabare Vazquez (Frente Amplio) Pedro Bordaberry (Partido Colorado), Luis Alberto Lacalle Pou (Partido Nacional) N/A 74.8
Legislative Frente Amplio Partido Colorado, Partido Nacional N/A
NOVEMBER
Romania Presidential 2 November TBA (Social Liberal Union (USL)) TBA (NLP) USL win 63.5
United States Legislative 4 November Republicans (House); Democrats (Senate) N/A Republic win (House); Republican win (Senate) 84.6
Gubernatorial (36 out of 50 states) N/A N/A N/A
Spain (Catalonia) Referendum 9 November Pro-Independence Anti-Independence Pro-Independence win N/A
Tunisia Presidential 23 November TBA TBA Too uncertain 51.5
Australia (Victoria) Legislative 29 November Liberal-National coalition Australian Labor Party N/A N/A
Taiwan Municipal 29 November Kuomintang (KMT) Democratic Progressive Party (DPP) N/A 81.7
Moldova Legislative 30 November Liberal Democratic Party-Democratic Party-Liberal Reformists Pro-European Coalition Party of Communists Too uncertain 44.4
Lebanon Legislative November Interim Government March 8, March 14 (competing separately) Too uncertain 45.2
Namibia Presidential November Hage Geingob (SWAPO) Various Geingob win 70.8
Legislative SWAPO Rally for Democracy and Progress, others SWAPO win
DECEMBER
Uzbekistan Legislative 21 December Uzbekistan Liberal Democratic Party N/A ULDP win 61.7
Croatia Presidential December Ivo Josipovic (Social Democrats) Kolinda Grabar Kitarovic (Croatian Democratic Union) Josipovic win 64.6
2015
JANUARY
FEBRUARY
Nigeria Presidential 14 February Goodluck Jonathan (TBC) (People's Democratic Party) TBA (All Progressives Congress) Jonathan win 41.7
Legislative PDP APC PDP win
Gubernatorial 28 February N/A N/A N/A
Yemen Presidential by February Abdrabbu Mansur Hadi (General People's Congress) TBA Hadi win 44.6
Legislative General People's Congress (GPC) TBA GPC win
MARCH
Estonia Legislative March Reform Party-Social Democrats coalition Centre Party, IRL Too uncertain 80.4
APRIL
Finland Legislative by 19 April National Coalition Party (NCP)-led five-party coalition Centre Party, True Finns, Left Alliance N/A 87.5
MAY
United Kingdom Legislative 7 May Conservative-Liberal Democrat coalition Labour Party, UK Independence Party, others Conservative win 82.5
Somalia (Somaliland only) Presidential May Ahmed Mohamed Mohamud Silanyo TBA Too uncertain N/A
Legislative Peace, Unity, And Development (Kulmiye) United People's Democratic Party Too uncertain
JUNE
Turkey Legislative 13 June AKP Party People's Republican Party (CHP), Nationalist Action Party (MHP) AKP win 52.1
JULY
Mexico Legislative July (may move to June) Institutional Revolutionary Party (PRI) National Action Party (PAN), Party of the Democratic Revolution (PRD) Too uncertain 63.5
South Sudan Presidential by 9 July Salva Kiir (SPLM) TBA Kiir win 33.1
Legislative Sudan People's Liberation Movement (SPLM) TBA SPLM win
AUGUST
SEPTEMBER
Guatemala Presidential 13 September TBA (Patriotic Party) TBA 47.5
Legislative Patriotic Party Renewed Democratic Liberty, National Unity of Hope, Nationalist Change Union, others Too uncertain
Denmark Legislative by 14 September Social Democrats-Social Liberal Party coalition Venstre (Right), Danish People's Party, Socialist People's Party, Red-Green Alliance Too uncertain 94.4
Venezuela Legislative by September Socialist Party of Venezuela (PSUV) Mesa de la Unidad Democratica (MUD) PSUV win 44.2
OCTOBER
Canada Legislative 9 October Conservative Party New Democratic Party, Liberals Too uncertain 94.0
Portugal Legislative by 11 October Social Democratic Party-Popular Party coalition Socialist Party Too uncertain 70.2
Tanzania Presidential 25 October TBA (Chama Cha Mapinduzi party) Chadema (Party for Democracy and Progerss) CCM win 62.3
Argentina Presidential October TBA TBA Too uncertain 51.5
Legislative Front for Victory (FPV) Republican Proposal (PRO), others Too uncertain
Cote d'Ivoire Presidential October Alassane Ouattara TBA Too uncertain 56.5
Legislative Rassemblement des Républicains (RDR)
Poland Legislative October Civic Platform-Polish People's Party coalition Law and Justice Party, Your Movement Too uncertain 76.5
Thailand Legislative October N/A Puea Thai Party, Democrat Party, others Too uncertain 62.3
NOVEMBER
Myanmar Presidential by 7 November Thein Sein (TBC) TBA Too uncertain 56.9
Legislative Union Solidarity and Development Party (USDP) National League for Democracy (NLD) USDP win
Belarus Presidential 20 November Alexander Lukashenko TBA Lukashenko win 59.6
DECEMBER
Spain Legislative by 20 December People's Party Socialists, United Left Too uncertain 66.2
Sources: BMI, world media. N/A = not applicable, no clear party, or no house view. TBA/TBC = to be announced/confirmed. Note: Election dates are subject to change at short notice.

United States Of America

We maintain our view that the Republicans are likely to retain control of the House of Representatives after the mid-term election in November, and we believe they are also slightly favoured to win control of the Senate. Such an outcome would give the Republican Party control of both chambers of the legislature for the final two years of President Barack Obama's term in office, which runs until January 2017. Consequently, we believe that there is a relatively low chance of progress on the president's major legislative initiatives, such as immigration reform. We also envisage a strong likelihood of a return to the high-stakes, partisan brinksmanship that has prompted major crises over raising the federal debt ceiling in recent years and led to a government shutdown in October 2013.

The Obama administration, facing blocks in the legislature, will increasingly pursue its policy goals via executive orders and other administrative powers. One recent example of this approach was a set of new policies regulating carbon emissions issued by the Environmental Protection Agency, although the scope for imposing policy initiatives via executive action is relatively limited compared with enacting new laws. As the White House's ability to move the political agenda becomes curtailed, we believe the focus will turn in the coming quarters towards the 2016 presidential election. Although this is quite a long way off, the contest is likely to affect policy positions taken by the president and by Republicans in Congress, as both sides try to position their respective candidates favourably.

Latin America

Brazil: We retain our view that President Dilma Rousseff will win a second term in Brazil's October presidential election, but the election will go to a second round, as no candidate is likely to garner a majority. The next few months will be crucial to Rousseff's re-election bid, as economic growth is slowing, inflation remains high, and protests are likely to persist during the World Cup. Recent data from pollster Datafolha showed that in a race between President Rousseff of the Partido dos Trabalhadores (PT), Aécio Neves of the Partido da Social Democracia Brasileira (PSDB), and Eduardo Campos of the Partido Socialista Brasileiro (PSB), Rousseff would garner 41.0% of the vote. This puts her well ahead of Neves (22.0%) and Campos (14.0%).

In contrast to Rousseff, we would expect Aécio Neves of the PSDB to take a much more investor-friendly approach towards economic policy, if he is elected president. Neves has advocated more concrete measures to improve the profitability of state-owned oil company Petrobras, including a more aggressive push to close the gap between domestic and international oil prices. In addition, the PSDB candidate has spoken out in favour of greater central bank independence in order to combat persistent inflationary pressures. As such, we believe that a Neves victory in October, while not our core view, would lead to a significant shift in economic policy in the coming years.

Assuming that Rousseff wins a second term, we would expect to see piecemeal attempts to reduce the high cost of doing business in the country and improve the climate for foreign investment. Her administration has increasingly acknowledged these challenges in recent months.

Venezuela: Although the number and scale of anti-government protests have declined since February, we believe that President Nicolas Maduro's hardline stance against its opponents will inflame tensions and keep political risk elevated. This dynamic will be exacerbated by continued economic malaise and a rising sense of disillusionment with Maduro.

In particular, we expect that the upcoming trial of opposition leader Leopoldo López in August will likely provide another source of tension, given his importance to the demonstrations and the circumstances surrounding his case. López is a leading advocate of radical government reform, including Maduro's resignation. Prosecutors laying out the government's position explicitly state that López's culpability incorporates not only his own actions, but the actions of those 'inspired' by him. Such a broad interpretation of justice, if accepted in the courtroom, could ultimately lead to a prison sentence of 10 years for what will be seen by the opposition as merely the crime of speaking out against the government. We expect further demonstrations will attempt to pressure the government to back down, and ultimately release López and others considered by protestors to be political prisoners.

Mexico: Mexico will hold mid-term congressional elections in June or July 2015. Nine state governorships, 661 seats in state legislatures, as well the entire lower house of the federal legislature will be contested. It is far too early to call the result. The ruling Partido Revolucionario Institucional (PRI) will look to reinforce its position as the dominant political force across the country under President Enrique Peña Nieto's reformist slogan. The main challenger to the PRI will be the largest centre-right opposition party, the Partido Acción Nacional (PAN). The PAN will need a strong result in the mid-term elections to improve its chances of returning to the presidency in the next general election in 2018. However, the PAN, which was an ally of the PRI throughout the approval of recent reforms, will have to distance itself from the PRI to regain the popular support it has lost in recent years. The largest centre-left party, the Partido Democrático Revolucionario (PRD), will attempt to regain momentum through its opposition to energy sector liberalisation, a reform which remains largely unpopular among a significant part of the population. However, the PRD is unlikely to gain enough seats and governorships to derail the government's centre-right political rhetoric.

Europe

Eurozone: As has been the case throughout the sovereign debt crisis, the most important policy decisions will come from the European Central Bank (ECB) rather than the EU itself or national governments. The lack of cohesion between member states, a breakdown of the previously tight Franco-German alliance, and the absence of palatable and easy-to-implement solutions to the crisis, continue to limit policymaking to piecemeal 'second-best' solutions. As such, the ECB will continue to play a major role in supporting banking and sovereign debt funding markets to provide policymakers with enough breathing space to pursue structural reforms.

Marking a further step in this direction, the ECB on June 5 introduced an array of measures to ease monetary policy (see June 6, 'Assessing The Aftermath Of ECB Policy Action). These included a 10bps cut to the refinancing rate (to 0.15%) and the deposit rate (to -0.10%), a 35bps cut to the marginal lending rate (to 0.40%), targeted long-term refinancing operations (TLTRO, of EUR400bn), a suspension of SMP (securities market programme) sterilisation, and an extension of short-term fixed-rate full-allotment lending. While we believe that these are positive steps, it remains to be seen whether the ECB's actions will be sufficient to credibly reduce the threat of deflation. We err on the side of caution and continue to expect additional policy easing going forward.

Italy: Matteo Renzi, the new prime minister, has pledged to overhaul Italy's political system and macroeconomic landscape through structural reform. While Renzi's urgent reform agenda and tentative public support are, in theory, exactly what Italy needs to boost its long-term growth potential, we stress that there are several key impediments to his success.

Renzi has inherited the same left-right coalition of his predecessor, Enrico Letta, which failed to produce any concrete results due to political infighting. Given the significant chance of infighting eventually destabilising the coalition, the successful passage of electoral and Senate reform (the first item on the new government's agenda) is, in our view, a pre-condition for the long-term political stability necessary to implement structural reform. Italy's unusual bi-cameral legislature (where the upper house has equal power to the lower house) is largely to blame for a series of ineffective and fractious coalition governments. The proposed amendments seek to eliminate the Senate as a lawmaking body, while ensuring that any future election will guarantee the winner a governable majority. However, while electoral reform could pass both houses of parliament fairly quickly, Senate reform would require a constitutional amendment. This would be a lengthy process that would probably take more than a year to accomplish.

Renzi has repeatedly stated that he wants to strengthen his mandate for reform through a popular vote, and he accomplished this by scoring a historic victory for his centre-left Democratic Party (PD) in European Parliamentary elections in May. However, the waning popularity of opposition parties could decrease their willingness to cooperate with Renzi. Assuming the passage of electoral and Senate reform in the next twelve months, we would anticipate fresh elections to be held soon after, as the PD would expect to attain a governable majority under the new system.

United Kingdom: The Scottish independence referendum due to be held on September 18, 2014 will mark one of the biggest tests for the United Kingdom since its effective formation in 1707, but we forecast that Scottish voters will opt for continued union with England, Wales, and Northern Ireland (see June 24, 'Scottish Referendum Primer'). The vote has significant political and economic implications for all parts of the UK, but it will also be closely watched in Brussels as secessionist movements across Europe have found a new lease of life during the economic crisis. For that reason, even in the unlikely event that Scotland votes for independence, the European Union would resist admitting the new sovereign state into the single market, given the precedent that this would set for other regions pushing for independence (such as Catalonia in Spain).

Ultimately, we do not expect Scottish independence to succeed. The Scottish National Party (SNP), which is leading the campaign, has failed to provide credible answers to the most important political and economic questions such as membership to the EU, or what currency would be used in the new Scotland. Even so, around a third of Scottish voters still support independence. These are most likely conviction voters that are wedded to cultural arguments or independence ideology. The 'no' campaign has a consistent lead, and we expect undecided voters to disproportionately side with the 'no' camp, as the certainty of staying in the United Kingdom will trump the political and economic uncertainty of leaving it. Even if independence is rejected, as we expect, the vote will nonetheless have significant political implications for the UK over the long term. Chief among these will be further devolution of powers to Holyrood to address voter concerns that parties with limited support in Scotland can still govern the country from Westminster.

Spain: Catalonia plans to hold a non-binding referendum on independence on November 9, 2014, and a 'yes' vote is looking increasingly likely, according to opinion polls. This would plunge Spain into political crisis, because the vote would be invalidated by the central government. However, Catalan politicians would use a 'yes' outcome as ammunition for calling for an official referendum and repatriating more powers from the government.

If the Spanish government manages block the vote from taking place, we expect Catalan President Artus Mas to dissolve the Catalan Assembly and hold regional elections as a de facto referendum. Although we believe full independence will not be achieved anytime soon, growing concerns over the implications of Catalonia's secession will weigh on investor perceptions of Spain's sovereign credit risk profile.

Romania: The ruling Social-Liberal Union (USL)'s strong performance in the May 2014 EU parliamentary elections suggests that their as yet unannounced candidate is the most likely winner of the presidential election in November. Former Senate President Crin Antonescu had looked like the clear frontrunner as the sole USL candidate, but he withdrew from the race at the end of May, having pulled his National Liberal Party (PNL, the junior member of the USL bloc) out of the coalition earlier this year. The establishment of a new opposition coalition comprising the PNL and Democratic Liberal Party (PDL) in May has resulted in an alliance better positioned to tackle Prime Minister Victor Ponta's USL in the presidential election, but is unlikely to win. Overall, the likelihood of a USL president should increase policy certainty in Romania, ending years of instability caused by Ponta's fractious relationship with outgoing President Traian Basescu, who is an independent.

Turkey: Prime Minister Recep Tayyip Erdogan and the ruling Justice and Development Party (AKP) have survived a turbulent period with their popular support intact, reinforcing our view that the party faces no real threat to its continued hold on power. Given that Erdogan's three-term limit as AKP leader expires in 2015, our core view is that he will seek and win the presidency in upcoming elections in August 2014. At present, the Turkish presidency is a largely ceremonial role, but if he were to win, Erdogan's personal authority would allow him to remain the undisputed leader of the Islamist-leaning AKP and the driving force of its policy agenda.

This would occur either through legislation aimed at creating an executive presidency, or simply through the support of the AKP party. While Erdogan's continuation in power would imply a high degree of political stability, we would expect his polarising and more authoritarian ruling style to exacerbate social tensions in the coming years. Furthermore, we caution that signs of an increasingly populist policy agenda could discourage foreign investment by damaging Turkey's reputation for prudent fiscal and economic management.

Russia And Eurasia

Russia will hold gubernatorial and regional legislative elections in more than 30 regions on September 14, 2014. Direct elections of governors were suspended following a series of terrorist attacks in 2004, but were reintroduced in 2012 following mass protests in the wake of the allegedly rigged State Duma elections in December 2011. We do not expect to see any challenges to the ruling United Russia party's grip on power in the regions and republics. Support for the United Russia party is reflected in the high approval rating of President Vladimir Putin, which stood at a six-year high of 86% in June, as measured by the Moscow-based Levada public polling centre.

Further reinforcing our view is the fact that five out of the seven North Caucasian republics have rescinded their right to vote directly for local presidents. Dagestan, Ingushetia, North Ossetia, Karachay-Cherkessia, and most recently Kabardino-Balkaria have opted for leadership appointments directly from Moscow. The newly-added Crimean republic is also likely to follow suit. While these republics have opted 'voluntarily' for this arrangement, it is likely that they have done so under the Kremlin's dictation, as direct voting could elect presidents that are disloyal to the centre, and/or be hamstrung by militant factions that would further destabilise these regions.

The most closely watched election will probably that of the governor of St Petersburg. The incumbent Georgy Poltavchenko 'resigned' on June 4, mainly so that he can stand for early re-election on September 14. Several other governors have 'resigned' to stand for early re-election, apparently because they believe that their popularity will decline by the time their originally scheduled elections come due, as Russia's economy slows down. Early re-elections also give the governors' opponents less time to organise against them.

Middle East And North Africa

Egypt: Political risks in Egypt will moderate further over the coming quarters following the election of Abdel Fattah al-Sisi as president in May 2014. The improving political climate will bolster the economic outlook, particularly for investment. That said, political risks will not vanish. Since the overthrow of President Mohammed Morsi in July 2013, Egypt's interim government, with the help of the judiciary, has orchestrated a major crackdown on the Muslim Brotherhood, leading to the arrests of many of its leaders. Protests by Muslim Brotherhood supporters, as well as secular groups calling for an improvement in transparency and human rights, will continue.

We expect parliamentary elections to be held in Q3 2014, which will be met by substantial protests. A fragmented parliament will be elected, with the Islamist Al Nour party receiving the largest number of seats, although still far short of a majority. Overall, it is looking increasingly likely that a majority of seats will be reserved for independents - thus reducing the legislature's ability to effectively challenge the President.

Yemen: Yemen's security situation has deteriorated significantly since January, when the National Reconciliation Conference officially ended with the decision that Yemen will become a federalised country. The Conference should lead to a constitution-making process followed by presidential and parliamentary elections, possibly in early 2015. In the meantime, separatist movements in the north and the south of the country and continued activity by Al Qaeda in the Arabian Peninsula (AQAP) will hinder the government's efforts at state-building over the coming quarters. The executive is also unlikely to be able to improve the dire economic situation, which will in turn increase popular support for separatist and insurgent groups.

We believe that Yemen's constitution-making process will proceed slowly and efforts to build federalism will remain piecemeal, with security risks remaining elevated in H2 2014 and in 2015. The country will remain unstable for several years to come, and although it is not our core view, we cannot preclude that Yemen will experience full-blown civil war over the next five years.

Sub-Saharan Africa

Nigeria: The increasingly high profile of radical Islamist group Boko Haram has raised the 'usual' political risks associated with general elections, which are due in February 2015. At the heart of Nigeria's political woes is an ongoing battle for power among the country's various ethnic, religious and geographic groupings, with the rivalry between northerners and southerners being the clearest broad division.

Some Nigerians believe that the Boko Haram threat is being caused, or at least exploited, by northern politicians who are concerned about the prospect of another term for President Goodluck Jonathan, a southerner. These politicians are supposedly looking to make the country ungovernable in a bid to prevent Jonathan from securing a second term. Security risks will therefore remain pertinent until the election at least.

Even then, we do not believe that existing grievances will necessarily dissipate. A victory for Jonathan - or any other southerner - would see northern frustrations continue. Yet, if a northerner wins the presidency, militancy in the southern oil-producing region, which has subsided during Jonathan's presidency owing to his being from the region, could re-emerge. Ultimately, we believe that competition for power between different groups will remain a threat to stability until there is devolution of power away from Abuja.

As regards the 2015 election, neither the ruling People's Democratic Party (PDP) nor the opposition All Progressives Congress have announced their candidates. There were 'Jonathan 2015' campaign posters in the streets in Abuja when BMI visited in June. However, given that no formal announcement has yet been made, these will have almost certainly been posted by the president's supporters (with or without his knowledge) rather than by his team. The outcome of the election is equally uncertain. For the first time in the party's history, victory for the PDP is not guaranteed owing to internal wrangling, dissatisfaction with the government's response to security threats, and the recent unification of the opposition. A great deal will depend on final candidate selection.

Mozambique: The ruling Frente de Libertação de Moçambique (Frelimo) party in March 2014 selected Felipe Nyussi to be its candidate in presidential elections in October. Nyussi was one of a group of three 'pre-candidates', who are all seen as loyal to outgoing President Armando Guebuza. Nyussi will represent continuity within the party and for the country should he win the election.

In some respects, this may be detrimental to Frelimo's prospects in the election. There is growing dissatisfaction among ordinary Mozambicans, owing to the belief that the fruits of strong economic growth have not been widely shared during Guebuza's two-term tenure (2005-2015), and to the perception that those loyal to him have benefited disproportionately. Luisa Diogo, a former prime minister who was beaten in the primaries by Nyussi and who is viewed as being part of the anti-Guebuza faction within Frelimo, would have represented a change that many Mozambicans feel is necessary.

Even so, Nyussi and Frelimo are almost certain to win at the polls in October, given the advantages of incumbency and the extent of Frelimo's dominance. Furthermore, although there is internal competition for power within Frelimo, the party manages to present a united front when it comes to national elections.

Frelimo's biggest challenge will come from the Movimento Democrático de Moçambique (MDM), which, despite only winning three out of a possible 53 mayoral seats, made a strong showing in local elections in November 2013. The party managed to secure 365 (30%) of 1,216 municipal assembly seats while MDM mayoral candidates took more than 40% of the vote in the 10 most populous municipalities, indicating that the party is winning popular support.

Kenya: Somalia-based al-Shabaab will continue its terrorist campaign across Kenya. We anticipate that bombings and relatively small-scale attacks will hit Nairobi, Mombasa, and other cities over the coming months. Most victims are likely to be local civilians, with few attacks targeting military or security installations. Kenya's security forces have proven unable to respond to the deteriorating situation. The military and police are underfunded and poorly coordinated. President Uhuru Kenyatta's claim that the June 15 Mpeketoni attack was the work of local political groups rather than a terrorist operation was a failed attempt to divert attention from his government's poor security record. Popular anger - especially towards Interior Minister Joseph Ole Lenku - is likely to build.

Tourist arrivals are already falling, and a poor performance in the vital tourism sector contributed to our recent decision to downgrade our 2014 real GDP forecast from 5.7% to 5.5%. Headline growth would suffer further if attacks begin to explicitly target foreigners in the country. For example, a large-scale attack on a major Nairobi hotel or a game park - which are popular with Europeans - would deal a devastating blow to the industry.

Asia-Pacific

China: China's anti-corruption drive will continue over the coming months, although its pace appears to have slowed this year from the relative fever pitch seen earlier in President Xi Jinping's administration (he became Communist Party leader in November 2012). Most recently, the government charged Liu Tienan, formerly the deputy chief of the National Development and Reform Commission (China's top economic planning body), with accepting bribes. While Liu's expulsion from the Communist Party in 2013 suggested that his fate was already sealed, his indictment provides yet another example of the downfall of a high-ranking official with ties to the energy industry (Liu was also the head of the National Energy Administration). In 2013, the government removed the former chairman of China National Petroleum Corporation (CNPC) Jiang Jiemin from his post as the director of the State-owned Assets Supervision and Administration Commission (Sasac).

Jiang was known to be a key ally of Zhou Yongkang, another former CNPC chairman who most notably served as Minister of Public Security in the 2000s. Zhou has also been the target of high-level corruption charges from the government. The above developments suggest that President Xi is targeting officials with substantial networks of influence within China's State-Owned Enterprises (SOE) in an effort to undermine vested interests which may oppose his aggressive economic reform agenda.

However, it is questionable whether Xi will be able to maintain the pace of his anti-corruption agenda. Reports have surfaced recently that former presidents Hu Jintao and Jiang Zemin have warned Xi against taking his anti-corruption drive too far, perhaps suggesting that the scale of the corruption problem could undermine support for the Communist Party. For this reason, while political purges tied to anti-corruption drives are a common feature of leadership transitions in China, it is likely that rapid pace of Xi's anti-corruption efforts will be gradually toned down over the coming quarters.

Japan: Prime Minister Shinzo Abe's ambitious economic reform programme (known as 'Abenomics') will face delays to implementation, due to opposition from within the ruling Liberal Democratic Party (LDP) and its coalition partner, New Komeito. As of late June 2014, there has been little measureable progress, with several bills, including Abe's bid to legalise casinos, delayed beyond the summer Diet session. Abe has maintained his upbeat reformist rhetoric since he raised the idea of the 'three arrows' of 'Abenomics' in early 2013. The first two arrows were ultra-loose monetary policy and fiscal stimulus, but the third - and most ambitious - arrow of structural reform is proving the most difficult to implement.

Abe's reform plans cover a wide variety of issues including increasing child-care facilities (to enhance female participation in the workforce), liberalising the agricultural sector, cutting corporate tax rates, and even relaxing labour laws in special economic zones. While Abe's reform plans would be positive for the economy in the long term, the divergence in priorities held by urban and rural electorates will likely prevent the LDP from quickly passing any major reforms. Moreover, New Komeito will be less supportive of substantial cuts to subsidies and pensions, having previously opposed such policies back in the 2000s.

Meanwhile, there is a risk that Abe's focus on reinterpreting Japan's constitution to enhance the operational remit of its military to participate in collective security (i.e. assisting Japan's allies) will divert political capital away from the economic reform agenda. Opinion polls show that Japanese are largely opposed (by around 55%) to exercising collective self-defence. Therefore, if Abe spends too much energy focusing on military issues at the expense of the economy, his popularity could decline further. Abe's approval rating fell to 43% in June from 49% in May, according to an Asahi newspaper poll, possibly because of his defence proposals. However, this is still high by the standards of recent Japanese prime ministers.

India: We expect the diverging priorities of the federal and state governments to complicate the efforts of India's new prime minister, Narendra Modi, to achieve his twin goals of economic growth and fiscal consolidation. Following its landslide electoral victory in May, Modi's Bharatiya Janata Party (BJP) has taken steps to expedite infrastructure projects, improve coordination between various ministries, and increase the supply of rice available for sale to dampen rising inflationary pressures. At the same time, the government announced a steep price increase for rail transport (for both passengers and freight) and was rumoured to be considering raising the price of liquefied petroleum gas (widely used for cooking) to rein the fiscal deficit in the FY2014/15 budget.

However, the BJP will find it difficult to implement the subsidy cuts it has vowed to pass, as the party still requires state authorities to impose these changes at the local level. The reforms also require the support of the Upper House (Rajya Sabha). Reflecting these political realities, the government on June 25 partly rolled back some of the rail fare increases announced a week earlier, amid pressure from coalition and minority parties, which wanted to avoid raising the ire of voters in Mumbai, which has an extensive rail network. With both state governments and minority parties keen to avoid pushing up the cost of living for their electorates, we believe that fiscal slippage and some level of dilution of reforms will be inevitable, thereby reducing the ability of the BJP to pursue its goal of fiscal consolidation.

Indonesia: Presidential elections will be held on July 9, and the race between frontrunner and Jakarta governor Joko Widodo (known as 'Jokowi') and former general Prabowo Subianto has tightened considerably. Recent polls reveal that Jokowi's 20-plus percentage point lead from earlier this year has all but evaporated, with some surveys pointing to a statistical dead heat. While we believe that Jokowi will prevail, there is nevertheless a growing risk that Prabowo will surprise everyone and win the election.

Given that financial markets have generally welcomed Jokowi's candidacy, a Prabowo victory could spur a sell-off in Indonesian assets. Jokowi is seen as an economic reformer, while Prabowo has stated that, if elected, he would look to double Indonesia's debt-to-GDP ratio in an effort to ramp up investment spending. We view this as a substantial risk to the sovereign's investment-grade status. Prabowo has also espoused a more economic-nationalist agenda and indicated an intention to return to the principles of Indonesia's 1945 constitution, which enshrines a substantial amount of power in the executive. Should Prabowo be elected and follow through on his intentions, he could undo democratic reforms to the constitution enacted in 1999-2002 after the fall of long-time strongman Suharto (who is Prabowo's former father-in-law), potentially making Indonesia's political system more authoritarian.

New Zealand: We expect the National Party, the dominant party in the ruling coalition, to once again win the largest proportion of the votes in parliamentary elections due on 20 September. The latest opinion poll held in mid-June suggests that support for the National Party has continued to rise, even indicating that the party could win a clear majority without its current coalition partners. Support for the major opposition Labour and Green parties has waned, and the National Party's strong track record of economic management over the last eight years will remain a key advantage, as the electorate's top concern remains the health of the economy.

Thailand: Short-term political stability has been restored since the Thai military seized power in a coup on May 22. The banning of protests and the implementation of curfews have caused violent clashes between the Red Shirts (those that support the ousted prime minister Yingluck Shinawatra and her exiled brother and former premier Thaksin) and Yellow Shirts (opponents of the Shinawatras) die down greatly. The hope is that with violence having been subdued, opposing forces can work together on a solution to the recurring crisis. However, little progress has been made, and while the military has continued to claim that democratic reforms are needed before the country can return to civilian rule (elections are scheduled for October 2015), the lack of clarity is fanning concerns that the military will remain in power for an extended period. This would raise risks of a Red Shirt backlash.

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