OxfAn: 2010' Q2 Prospects

OxfAn: Excerpts:

Key issues in Turkey will be government-military relations, foreign policy and economic recovery, while Tehran will brace itself for international sanctions. The aftermath of elections will dominate the next quarter in Iraq. Cairo will be concerned about inflation, political opposition and the Middle East peace process.

Strategic summary

• A direct clash between the Turkish government and military will probably be avoided, but polarisation will increase, increasing the risk of instability.
• Tehran will prepare for international sanctions, and leaders of the opposition may move towards a compromise with conservatives.
• Slow government formation in Iraq will ensure that few political decisions will be made in the second quarter, and state oil deals will slow and perhaps stall.
• In Egypt, Mohamed El Baradei's campaign will increase local and international scrutiny of elections, and continued work on the Rafah wall may provoke border clashes with Hamas.

ANALYSIS: Turkey faces a number of key challenges in the second quarter:

1. Civil-military relations. The first quarter saw intensified political controversy leading to a confrontation between government supporters and the military:

• Prime Minister Recep Tayyip Erdogan's relationship with Chief of the General Staff General Ilker Basbug was undermined by a series of judicial interrogations of army officers.
• The detention of senior commanders in connection with plots discussed and abandoned seven years ago will spur on the nationalist opposition, and another attempt may be made to ban the Islamist-rooted ruling Justice and Development Party (AKP).
• The government would probably respond by dissolving parliament and seeking a fresh mandate....... the general elections expected in spring 2011, will intensify in the second quarter.

2. Key policies. Erdogan was unable in the first quarter to make progress in his Kurdish and Armenian initiatives, and on EU accession. Little progress can be expected in coming months on the Kurdish issue. The Turkish-Armenian protocol providing for the opening of the frontier and the establishment of full diplomatic relations will remain a dead letter.

On March 4, Turkey recalled its ambassador to the United States in protest against a congressional committee's resolution declaring as genocide the killings of Armenians from Turkish Anatolia during the First World War. The Armenian lobby attempts each year to secure such a move from the full Congress, and if it succeeds, US-Turkish relations would come under further strain. There is a small chance of approval by the House of Representatives, but the resolution will almost certainly be rejected in the Senate. A signal of such a rejection will be necessary to prevent a more serious diplomatic fallout.

Presidential elections in the Turkish Republic of Northern Cyprus (recognised by Turkey alone) take place on April 18:

• Nationalist contender Dervis Eroglu looks set to defeat left-wing incumbent Mehmet Ali Talat, who is seeking to re-unify the island.
• Faced with the prospect of failure of inter-communal talks, the parties (including Turkey, as a guarantor power) are manoeuvring to gain the moral high ground.
• The second quarter is thus unlikely to witness any progress towards re-unification.

In the absence of progress on this issue, and in view of the likely inability of the AKP government to amend the Turkish constitution in line with EU standards, accession talks will mark time.

3. Economic recovery. The coming months will indicate more clearly the strength of the recovery that began in late 2009. GDP looks set to grow no more than 3-4% in 2010 after a 5-6% contraction in 2009. Risks to growth include weak export demand from Europe, the lingering impact of last year's job and income losses, and quickening consumer price inflation. The Consumer Price Index reached 8.2% in January, with food and commodity prices leading the way, and it may temporarily surpass 10.0%. Interest rates cannot fall any further, and the Central Bank overnight borrowing rate may remain at 6.5% for several more months. Fixed investment will pick up only slowly.

4. IMF accord. The government has promised to introduce a fiscal rule by May 15, and its medium-term programme and fiscal plan are due to be updated in May and June respectively. If it can agree with the IMF on the details of these and other policy issues (eg taxation, labour market reforms and a privatisation schedule), a standby accord is likely to be signed:

• IMF lending would alleviate the burden of government debt on the domestic financial sector and expand private sector credit opportunities, improving economic activity. However, the government may be cautious about accepting IMF-style stringency ahead of the 2011 election. In January, it increased indirect taxes, contributing to the surge in inflation, but it also announced a one-off increase in pensions.
• A deal would dispel doubts about the sustainability of the current account deficit, expected to widen from just over 2% of GDP in 2009 to 3-4% in 2010. In addition to IMF credit, an accord would encourage foreign investment and lending at a time of low global capital flows, and the lira could strengthen noticeably. It slipped to a rate of 1.55 to the dollar in late February and another bout of weakness is likely in the absence of an IMF accord.

Iran. Tehran will be preoccupied with control at home and defiance abroad:

1. Tightening grip. While the 2009 protests against the contested presidential elections failed to topple President Mahmoud Ahmadi-Nejad, a new balance of power has emerged in Iran. Power lies with Supreme Leader Ali Khamenei, Ahmadi-Nejad, the Islamic Revolutionary Guards Corps (IRGC) and their clerical and security allies -- while the elected institutions have been marginalised and Khamenei's legitimacy questioned. The momentum of popular protests had faltered by the February 11 Revolution Day rallies. While protests will continue, the reformist leadership of the opposition Green Movement may seek some form of compromise and reconciliation with the conservative establishment later this year.

2. IRGC and the rentier state. Iran's political economy reinforces the power of the IRGC, as the population relies more than ever on public sector employment and payment from the bloated and inefficient welfare state, financed by oil exports. In the second quarter, the government will move forward in its efforts to cut fuel subsidies, in the face of possible US petrol sanctions, which will hurt ordinary Iranians already suffering from high inflation and unemployment. This will make the population even more fearful of instability that might disrupt their dwindling income, and thus more dependent on the state.

The power of the IRGC will continue to grow as it expands its commercial interests. It is unlikely that the opposition movement will be able to mobilise Iranians to take national action to destabilise the state sector, such as a national strike. Nor is it likely that the IRGC will break with the leadership in the face of public protests, given its economic stake in the status quo.

3. Nuclear programme. With its legitimacy under question at home, Tehran will seek to exploit the nuclear issue for prestige purposes, to demonstrate Iran's strength as an international actor and Ahmad-Nejad's confidence and nationalism in defending Iran's 'inalienable' right to develop the full nuclear fuel cycle. There is no consensus in Tehran for a plausible nuclear fuel deal with the UN Security Council (UNSC) permanent members and Germany (P5+1). The second quarter will see intensified US efforts to achieve UNSC consensus on sanctions, although an agreement may not emerge until the third quarter. Iran is bracing itself for further UNSC, US and EU sanctions:

• Due to Chinese reservations, new UNSC sanctions are unlikely to go much further than those already imposed during the past four years. However, they will provide some legitimacy for unilateral US and EU moves.
• Washington is likely to impose sanctions on exports of refined fuel to Iran while the US Treasury will blacklist more Iranian banks, including Iran's Central Bank, and companies associated with the IRGC, such as the Khatam al-Anbiya engineering and construction firm.
• The EU will probably take parallel measures against the same entities and will also make it harder for European firms to do business with Iran by further limiting commercial credits for such trade.

These sanctions will hurt Iranian consumers by raising fuel prices. However, as long as Iran is able to continue with its oil and gas exports, the economy will remain largely unscathed. Thus, sanctions will antagonise the Iranian regime, without inducing any significant concessions from them on the nuclear programme.

Iraq. March 7 elections will set the landscape for politics and the oil sector in the second quarter:

1. Government formation. Despite tensions, the elections are likely to be relatively peaceful, and to take place on time, with the results accepted by most groups. At least three major coalitions will be needed to form a majority voting bloc in parliament. The Kurds' ability to deliver 50 or more seats and to marshal their legislators mean that they are likely to be among those forces forming the government. This does not imply an imminent breakthrough in the federal-Kurdish dispute, but it makes a major breakdown in relations in 2010 unlikely -- a strained alliance will ensue.

Formation of the new government will be slow, though perhaps not as slow as in 2005. Election results will probably be certified by the end of March, with very small numbers of appeals still outstanding. Parliament is likely to continue struggling to achieve quorum, particularly during summer and early autumn, during parliament's recess and Ramadan.

Executive branch formation will probably take around three months:

• A package deal will eventually be agreed by four or five major factions, allowing the ratification of a prime minister, president and council of ministers.
• The branch will only begin to operate in mid-summer and will take some time to develop effective capacity.
• Many experienced individuals will be edged out of their positions as new ministers take over their portfolios, resulting in a period of administrative churn.
• For foreign companies aiming to position themselves with new ministers, the first opportunities for engagement will probably come in late summer or early autumn.

2. Investment, oil and gas. With the federal government paralysed for much of the year, few new deals will be negotiated and many current prospective investment deals will become mired and may stall:

• Some oil and gas deals will not survive 2010, particularly the direct negotiation deals for oilfields such as Nassiriya, Nahr bin Umar and Tuba. The federal government has little ability to push forward such deals this year due to the large number of oil deals signed in the licensing rounds. As Iraq's recovering Oil Ministry has insufficient capacity to service even the licence round deals, new direct negotiation deals are unlikely to materialise this year.
• Moreover, a new government may seek to boost its nationalist credentials by being tough with foreign oil companies. It could require them to commit to terms that are commercially untenable, and that mirror those that Iraq secured for the more mature fields in earlier rounds.

As 2010 will mostly be a 'waiting year' for the deals involving the federal government, a more profitable environment for investment may be found among the increasingly well-funded provincial councils, who have ambitious local plans and will continue functioning until elections in 2013.

Egypt. Cairo has a full agenda in the second quarter and beyond:

1. Domestic politics. The Muslim Brotherhood elected a new leader in January following the election of a new Guidance Council, and has taken a sharp conservative turn. The new leader, Mohammed Badie, has not yet signalled major policy changes, but the removal of several key reformist leaders and controversy over internal elections reflect rifts within the group. However, with several senior members arrested in January and February and the Muslim Brotherhood under severe security pressure ahead of May and October elections, the need for unity may trump internal differences.

Former IAEA chief Mohamed El Baradei's frank criticism of the Mubarak regime represents the regime's most serious challenge to date:

• El Baradei wants to change the constitution -- which restricts political activity and eligibility for the presidency -- and has created a National Front for Change to carry out this campaign.
• Although such change is unlikely, El Baradei is popular and his activism has introduced a wildcard into Egyptian politics.

Key questions are whether the movement behind El Baradei -- for now largely online -- will move to the streets, and whether his credentials will allow him to attract other prominent figures to his cause and repair divisions within Egypt's opposition. The campaign to change the constitution depends largely on his ability to gather mass support and build a grassroots organisation.

Elections will be held for the upper parliamentary house, the Shura Council, in early May, with little competition. Continuing arrests of Muslim Brothers suggest the regime is ensuring it faces no serious challenge. However, in light of El Baradei's call for free and fair elections, this poll will be under greater domestic and international scrutiny. It will also be an opportunity to examine how a new electoral commission, created by constitutional amendment in 2007 to replace judicial supervision of elections, will work.

2. Foreign policy. The situation in Gaza and the Middle East peace process will remain Egypt's foreign policy priorities. Facing mounting domestic opposition to its Gaza policy -- notably its efforts to curb smuggling at the border -- and a deadlock in Palestinian reconciliation and Israeli-Palestinian talks, Egypt will need some sign of progress to deflect criticism. Its relationship with Hamas has rapidly deteriorated in recent months and the construction of a tunnel-blocking wall at the Rafah border could be a flashpoint between Hamas and Egyptian border guards.

3. Economy. The government recently announced initiatives to increase exports and create public-private partnerships for investment in public infrastructure. A law governing such partnerships is expected by June, creating new financial vehicles for investment in infrastructure.

Controlling inflation remains the main objective; expectations that it will fall to single digits after 18 months of double-digit inflation have yet to materialise. Instead, it moved from 13.2% to 13.6% during the first two months of the year.

The Ministry of Finance postponed to 2015 its 2012 target for reducing the fiscal deficit to 3% GDP. The main medium-term challenge is controlling spending while stimulating economic activity, particularly as efforts to implement a new real estate tax and expand sales taxes to increase government revenue are meeting strong opposition and currently are being delayed.

CONCLUSION: In the second quarter, Turkey will face a slow economic recovery, amid continued tensions between government and military. EU accession will make no progress. The Iranian regime will consolidate power at home, while finding itself increasingly isolated abroad. Iraq faces a hiatus in government as post-election wrangling takes place; state oil deals will make less progress than those with provincial councils. Egyptian Shura Council elections will face greater scrutiny than previously, while the Rafah crossing into Gaza may be the scene of violent clashes. Stimulating economic activity will remain a key challenge.