The (Ex) Washington Realist

Ian Bremmer, contributing editor for TNI and president of the Eurasia Group, offers some predictions for 2007. [This link will take you back to his 2006 predictions.]

1) Iran -- without any doubt, the prospect of intensified international conflict with Iran is the most significant global political risk for 2007, reflecting both the combination of near-certain escalation on the nuclear issue and--at least as importantly for global markets--Iran’s growing influence in Iraq and the broader Middle East.

Despite the Bush administration’s relative weakness (and its decisive setback in the 2006 mid-term elections), the White House will remain steadfast in its refusal to allow Iran to develop a nuclear weapons program. The president still intends to "punish" Tehran if it continues to enrich uranium. Officials at the highest levels of the US government believe that military action against Iran should be avoided if possible but will continue to urge tougher measures against its government in the face of continued intransigence.

The United States will spend most of 2007 attempting to step up pressure on Iran on three distinct fronts. First, it will work through the Security Council on a multilateral Chapter 7 sanctions process. Second, the US will attempt to create some form of coalition of the willing, attempting to persuade G7 partners, EU members, Gulf allies, and other multilateral groups to cut off all financial transactions with Iran, to stop investing in its energy sector, and to work with the US Treasury Department and CIA to find and freeze key Iranian assets. Third, the United States will work on its own to pressure other states to isolate Iran economically, and, more dramatically, will build a strong military, especially naval, presence in the region over the course of the year. The Security Council process is nearing the end of its track (helped in part by US Ambassador to the UN John Bolton becoming a casualty of US domestic politics; not to mention the Russian government publicly opposing coercive diplomacy on the issue). But as the UN process grinds to a halt, the Bush administration will press ahead on the second and third fronts mentioned above. Though highly unlikely to dissuade Tehran from pursuing its nuclear program, US-led efforts will begin to squeeze the Iranian economy (and, more importantly, Iran’s leaders), and draw a sharp Iranian reaction. The importance for markets of Iran’s oil card will grow over the course of 2007.

As alternatives to direct confrontation prove unsuccessful, prospects of US military action will increase. Some form of military strike is certainly possible in 2007. But given that Iran is unlikely to have the capacity to produce a nuclear weapon until 2009--and that the Bush administration harbors serious reservations about another military commitment in the Middle East--Israeli (not American) strategic concerns are likely to drive pressure for action. For this reason, military action against Iran is more likely to wait until 2008. By the end of 2007, the risk of conflict will again add upward pressure on oil prices.

Within Iran, local demonstrations against President Mahmoud Ahmadinejad and significant losses by hardliners in recent municipal elections and balloting for posts in Iran’s assembly of experts remind us that the Iranian public will not blindly follow the president. The setbacks for conservatives will have no near-term impact on policy--neither municipal councils nor the assembly of experts have real influence on foreign policy or the nuclear issue. But with elections for the Majlis, Iran’s parliament, scheduled for February 2008 (possibly before Iran masters nuclear technology) the conservatives must be concerned. Is there anything promising for markets in this? Possibly, but the main winners in the municipal elections still support an aggressive nuclear policy.

Finally (and, for 2007, most critically), a geopolitically resurgent Iran is driving the growing conflict between Shia and Sunnis in neighboring countries. That has the potential to further destabilize the region--and in the worst case scenario could provoke full-blown proxy wars. Early indicators of this risk are most obvious in Iraq (more on that below). But they are also visible in Iran’s support for Hizbullah in Lebanon and for Hamas in the Palestinian territories, as well as in tensions between Bahrain’s majority Shia and its ruling Sunni minority. As a result, Iran and opposition to its government (particularly from Washington and from Arab states) has become a key driver of the risk of broader conflict in the Middle East. Regional stability will deteriorate over the course of the year. Largely (though not only) as a consequence of the Iran issue, I expect that 2007 will be the most politically unstable year in the Middle East in the past two decades.

2) Nigeria -- President Olusegun Obasanjo, his rivals, and would-be successors appear likely to dig in their heels in the conflicts that have already generated considerable uncertainty and violence in the run-up to April’s national elections. There’s a significant risk that elections will be postponed. Even if they aren’t, the open political warfare they have provoked will continue to generate violence, particularly in the Niger delta, with increased amounts of oil shut in.

The conflict in Nigeria steadily intensified over 2006. First, we saw a spike in kidnappings and the expanded bunkering of oil. Then came the destruction of energy infrastructure. Just two weeks ago, we witnessed the first direct attacks on the government. All of this is likely to escalate as April’s elections near, shaking up the ways in which local elites control energy revenues--and the way in which Nigeria is governed. Given the weakness of the country’s party structure and the unwillingness of the major players to back down, a constitutional crisis appears in the offing. And, ominously, there’s a good chance the military will get involved.

It’s still quite unlikely that Nigeria’s various internal conflicts will produce a coup similar to the one in neighboring Cote d’Ivoire. But the ability of western-based multinationals to conduct business operations in this environment will be significantly affected, at least for the final months leading up to the elections. If there were a coup, the trouble might last longer.

This, along with Iraq (risk #3), constitutes the second major geopolitical risk for energy prices in 2007, which is shaping up to be as tough a year for oil supply risk as 2006. Nigeria’s internal troubles also pose problems for regional stability. Nigeria has acted as peacekeeper, model of moderation, and economic stabilizer for a number of its West African neighbors.

3) Iraq -- there’s a growing risk that the central government will collapse and that Iraq will descend into all-out civil war. The security situation inside the country is indeed "grave and deteriorating," as the final report from the bipartisan Iraq Study Group noted. But the Bush administration is extremely unlikely to withdraw significant numbers of troops from Iraq (or otherwise turn security over to the Iraqi government and/or Iraq’s neighbors) until it has made another attempt to stabilize the country. De facto partition is likely the ultimate outcome in Iraq, though we’re unlikely to reach that point in 2007, because the White House and nearly all the Arab states will take the needed steps to delay that result.

All of this bodes quite badly for the Bush administration, which suffered a decisive defeat in the mid-term elections largely because the effort to stabilize the country has gone so badly. The president’s ability to sell the American public new ideas on Iraq (such as a “troop surge” of 20,000 reservists--the policy the president continues to prefer and which most White House advisors presently expect he will implement) will be sharply limited by a series of congressional investigations into administration policies related to the war effort.

The president will probably approve a military move against Shiite cleric Moqtada al Sadr and the Mahdi Army militia group over which he exercises limited control. The offensive may be dominated by US forces or, less effectively, with support from Iraqi troops. Sadr’s militia is no match for US troops, but a stalemate is the likeliest result of any collision of forces. The Iraqi government is crippled by infighting, the United States cannot maintain a presence in the country indefinitely, and the perceived inability of foreign troops to establish security bolsters Sadr’s popularity.

Still, 2007 should see a significant increase in international investment in northern Iraq (as a mini-boom develops in the Kurdish cities of Irbil and Suleymaniye). while there will be significant uncertainty in the broader investment climate and doubts over increases in oil production even if an effective hydrocarbons law is passed in early 2007 (which looks unlikely), substantial foreign aid and troop presence should ensure that Iraq consistently produces more than 2 million barrels of oil per day.

The main risk to Iraqi oil production would come from a Bush administration decision to target the Mahdi army. Support for Moqtada al Sadr is centered in the Shiite neighborhoods of Baghdad. Attacks on this militia group are likely to spread sympathy for him and the Mahdi army among the Shia of Iraq’s south. An escalation of violence there could impact oil operations by making working conditions unsafe. Attacks against pipelines or oil personnel would constitute a more direct threat. At the same time, any US escalation against Baathist or al Qaeda-affiliated Sunni insurgent groups could further strain US-Saudi relations, given the closeness of the House of Saud to certain Sunni tribes in Iraq. While the overall US-Saudi relationship remains strong, the Saudis have already signaled deep discomfort with any political or military solution in Iraq that puts the Sunni minority at excessive risk.

The more indirect impacts of the war are, of course, broader-ranging--as in the second-order effects on politics in the United States and Britain as 2008 US elections approach and the British choose a successor to Tony Blair.

4) Turkey -- there are significant risks in Turkey for the coming year, probably the highest in the broader emerging market class. They will come from domestic politics, particularly Turkey’s presidential (April/May) and parliamentary elections (November). These will pose a serious test for the political and social stability Turkey has enjoyed since 2002. The risks will be magnified by Turkey’s high current account deficit and external financing requirements; the lira will remain particularly vulnerable to changes in global sentiment. (I don’t believe the recent inflows into Turkey of Gulf Arab funds offset these risks. The volumes are more limited than media attention suggests.)

Presidential elections will increase tensions between Turkey’s most determined secularists and Prime Minister Erdogan’s ruling Justice and Development Party (AKP). The former will intensify demands for early parliamentary elections--hoping to enable a new parliament to choose the new president. Failing to achieve this, the secularists, supported by the military, will likely push the AKP to elect a compromise candidate. The significance of the presidential elections is therefore linked to whether Erdogan runs for the office. He is highly unlikely to announce until mid-April, stoking increased market volatility in the first quarter.

Turkey’s parliamentary elections will also be acrimonious--and are almost certain to be tighter than in 2002. A return to coalition government will likely undermine fiscal discipline, slow progress on reform, and generate political instability. The near complete lack of planning for coalition governance--none of the current opposition parties seem to have a clear idea of how an alliance with the AKP might work--is likely to exacerbate the problem. In the most problematic scenario, smaller parties gaining parliamentary representation could come under intense pressure from the secularist establishment not to sign a coalition agreement with Erdogan and the AKP. This would lead to formation of a government comprised of three or more small parties whose primary aim was to keep the AKP out of power--a serious negative for the Turkish economy.

It should be increasingly obvious to all observers that Turkey isn’t going to join the European Union. But there’s little market risk around EU accession in 2007. The AKP’s likeliest strategy will be to pursue a low-gear engagement with the bloc in 2007. While the EU’s recent decision to suspend a few chapters of Turkey’s accession talks underlines Cyprus’ veto power, the issue’s primary importance is that it reveals that most European governments will do whatever is necessary to postpone tough decisions on Turkey’s accession bid. That won’t continue indefinitely, but it will for 2007.

5) Russia -- 2007 will see America’s (and, to a lesser extent, Europe’s) relations with Russia deteriorate faster than those with any other major state. President Putin presides over a government--and a public--which feel humiliated by a decade and a half of perceived western-imposed economic and political injuries. Economically, the cash-starved Yeltsin government cut sweetheart deals with multinational energy firms like BP, Shell, and ExxonMobil to exploit Russian resources. Politically, US and European-led NATO advances encroached on former Soviet territory-- over furious Russian objections. The creation of the Baku-Ceyhan pipeline, which conspicuously bypasses Russian territory, and a series of revolutions and near-revolutions along Russia’s soft underbelly have upped the ante. With American power stretched thin by the war in Iraq and the proliferation conflicts with Iran and North Korea, and Russian power heightened by both Putin’s consolidation of domestic political power within the Kremlin and high commodities prices, the Russian government has never felt stronger. The Kremlin is in strong position to press its advantage--and knows it.

All this means that 2007 will generate increasing risks as the Russian government asserts ever tighter economic control over strategic sectors (squeezing out foreign companies when desired) and political control of the “near abroad” (especially in Ukraine, Belarus, the Caucasus, and others areas the Russian government considers within the country’s traditional sphere of influence). Also, Russia will aggressively approach energy sales to Europe and elsewhere, demanding acquisition of refining and distribution assets abroad and provoking resistance and recrimination from some countries. Finally, the presidential succession (elections in March 2008) will lead to some market instability this year. Russian oligarchs--both in government and the private sector--will seek to consolidate control of assets before the political landscape changes. Their actions could affect foreign firms.

Keeping Russia from a higher spot on the risk list (say, above Turkey), a growing Russian middle class will create still stronger consumer markets for high-end services, white goods, and a construction boom, making Russia one of the world’s most appealing retail markets (with the important caveat of entrenched corruption). And no internal threats to Putin’s political control mean the run-up to elections should not spark capital flight, irrespective of oligarch consolidation. Fixed income markets should remain strong. But for multinational companies investing in strategic sectors, 2007 will be even less pleasant than last year.

6) China -- 2007 should prove a strong year for China, which will benefit from a favorable international climate and better relations with both Japan and the United States. (China’s problems with these two countries are serious, but are more likely to produce real stresses in 2008.) Still, the enormity of China’s impact on global markets makes any potential downside a serious one. There are two particular concerns worth noting.
The most pressing comes from foreign companies in a variety of sectors (from manufacturing to white goods to finance), which will find policy restrictions to market access are creating a considerably more challenging business environment for foreign direct investment. Again, that’s not likely to lead to significant protectionist impulses until 2008, but it will raise the heat on the US-China strategic economic dialogue (which will likely become a matter of serious congressional contention by the end of the year), and also poses real worries for foreign companies overexposed to China for supply chain and manufacture.

There is also a smaller, but significant, domestic risk related to elite consolidation around the five-yearly Communist Party congress in October. The risk of leadership discord and policy stalemate is likely to rise as the Hu administration attempts to bring about the most far-reaching changes in government policy priorities (and top officials) in over a decade.

Hu wants to make a decisive break from Jiang Zemin and his Shanghai clique, officials who have promoted policies intended to spur growth at all (social and economic) costs. Hu hopes to harmonize policies meant to generate economic growth with development that is more sustainable, reduce income inequalities across regions and classes, promote energy conservation and efficiency, and to lessen the burden of China’s growth on its environment. To accomplish all this, Hu needs a big sweep of top officials--a very difficult undertaking given China’s winner-take-all political system. Hu has moved extremely cautiously to date; the changes he will propose could easily elicit a political backlash.

But the good news for international political stability is that Beijing will pursue a more status-quo policy internationally. It will continue to do everything possible to lock up longer-term access to commodities and develop tighter relations with the governments of many underdeveloped countries (which the United States and Japan in particular will see as a growing threat). But China will also cooperate more with the United States and others on big strategic issues like Iran, North Korea, Sudan, and even Israel’s conflicts with Palestinians and its neighbors, distancing itself politically from Russia and keeping the strategic economic dialogue with Washington open for as long as domestic US political pressures will allow. So while risks to China’s emergence (both domestic and international) are worth watching in 2007, the greatest risks for China’s growth and stability are more likely to come to fruition in 2008.

7) Pakistan/Afghanistan - worries over Pakistan are nothing new. For the past several years, the question "what happens if Musharraf is killed?" has dominated debate over Pakistan’s future. It’s not an academic question--there have been a number of near-miss assassination attempts, at least one of which was clearly an inside job. But the growing stability in the Indian/Pakistani relationship has taken some of the urgency from the debate, and pushed Pakistan off the front page.

A new question is now raising the country’s risk profile--"what happens if Musharraf stays?" His ability to maintain the peace and to balance political forces inside and outside of his country is diminishing. He has increasingly been forced to cede local authority in the provinces along the Afghan border to fundamentalist militants. In part that’s because his government was caught flatfooted last year by a catastrophic earthquake in Kashmir (where local fundamentalists were quick to offer effective aid, just as Hizbullah provided badly needed relief services in Lebanon following the Israeli bombing last summer). But Musharraf’s inability to cripple militancy along the border also poses a growing problem for President Hamid Karzai’s government in Afghanistan. A lack of foreign troops and capital has kept the new Afghan government from asserting its power beyond the confines of Kabul (where violence has grown steadily), and the Taliban have taken back strongholds in some parts of the country.

As the security situation in Afghanistan deteriorates, and as the West no longer sees benefit in old information on nuclear proliferation from the AQ Kahn network, Musharraf’s utility to the international community will begin to erode--and Pakistan’s partnership with the United States will face growing pressure. It’s unlikely Pakistan’s leader will be in a position to respond, especially with respect to the Taliban, which means more scrutiny on security practices, less foreign aid, and a tougher fight for the international community over Afghanistan. 2007 is accordingly likely to bring greater dangers from the region, and a resurgent second pole (after Iraq) for international terrorism.