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Sunday, November 6, 2011

Europe at Crossroads: Part I

King Abdullah bin Abdul-Aziz Al Saud first gets tautological and then philosophical about women's right to drive (Oct 2005).

Barbara Walters: "Would you support allowing women to drive?"

His Excellency King Abdullah: "I believe strongly in the rights of women.  My mother is a woman.  My sister is a woman.  My daughter is a woman.  My wife is a woman.  I believe the day will come when women will drive.  In fact if you look at the areas of Saudi Arabia, the desert, and in the rural areas, you will find that women do drive.  The issue will require patience.  In time I believe that it will be possible.  I believe that patience is a virtue."

Yours, thinking about the European experiment analyst,


Fig. 1: Night Map of the European Peninsula

The last time when Europe was at crossroads it was the late 19th century.  At that time Europe was grappling with unstable power balances in South-Central Europe and the Balkan Peninsula brought about by the simultaneous decline of the Sick Man of Europe and the overflow of creative energies, ethno-linguistic political aspirations and military capabilities of the German speaking peoples under the leadership of Prussia.  It took Europe three wars (the Balkan War and the two world wars) before it could finally decide which turn it must take.

In my view Europe is at crossroads again.  Much has changed since the 19th century.  However just as it was back then, Germany continues to remain too small to allow for the complete expression of capital and creative surpluses of the German speaking peoples.  The European debt crisis is right in the fore.  But lurking behind the façade of a debt crisis are the same 150 year old risks to the natural and complete expression of the surpluses of the German speaking peoples – potential loss of cost effective and free access to raw materials, and to markets in Europe.  I will skirt the Q of war as a means of dispute resolution mechanism and instead focus on financial and geoeconomic solutions to the debt crisis.  The good thing about the crisis is that it is solvable.  By solvable I mean it is within Europe's ability to solve the problem on its own.  There are five principal, non-mutually exclusive solutions to the problem, some European, some that rely on external help:

1. ECB Bond Purchase: ECB significantly expands the purchase of bonds of troubled sovereigns and systematically important European FIs.
2. Austerity and Deflation in the Periphery: In the short-run, strong austerity measures, public sector pay cut and sharp reduction in capital spending in the short run.  In the medium-run, facilitating ECB oversight of the budgetary process, denationalization or Europeanization of national assets, significant improvement in tax collections and linking of public sector wage hikes and credit availability to productivity gain as determined by some central institution.
3. The Indian Way: Since 1947 India worked towards achieving a political union.  The goal was achieved at a significant economic cost.  The center instituted mechanisms for perpetual transfer of wealth from productive regions and productive peoples to those that were perennially inefficient.  Europe over a similar period instead walked the road of economic integration while leaving significant political differenced unresolved.  The Indian way is European core permanently subsidizing the periphery.
4. An IMF-led bailout
5. A China-led bailout

In this five-part note we look at each of these options, understand their implications, and examine the difficulties in their being exercised.  Here is the first part.  In Part II we look at austerity and deflation in the periphery.

Option 1: ECB Bond Purchase (aka, ECB provides liquidity)

a. Who does it cheer in the short run?  The equity markets, CDS purchasers, private bond holders, Belgium, Portugal, Italy, Greece, Spain, France, the UK and the US
b. Who does it offend?  Ireland, the Nordic countries and Germany

c. Who are neutral?  China, Russia, India

d. Likelihood of exercise in a meaningful quantum: nearly 0.

e. Why is the exercise of ‘Option 1’ unlikely? – Because Germany wouldn't have it that way.  The reason for that lies in why Germany started the EU project in the first place.  Germany brought the EU project to the forefront, again, after the Berlin Wall was brought down [1].  To the Germans, this made perfect sense.  If Germany were to succeed (i) trade barriers would fall allowing her cost efficient and secure access to raw materials [2]; (ii) barrier-free access to a large market would make Germany’s continual investment in high technology affordable, allowing her to continue to maintain its high-tech edge; (iii) Germany would deploy its surplus capital in productive endeavors in nation states in the geographic and cultural vicinity as opposed to, say, in China, India or South America; (iv) nationalism in Europe  would wane with the rise of the notion of a common economic destiny (in the late 19th and early 20th centuries raucous expressions of the idea of nationalism caused internecine wars that culminated into the demise of European colonialism); (v) with the wane of nationalism, Germany could take a serious stab at reconstructing the European states from their current religio-linguistic basis into a law-based society – a change as transformational as the metamorphosis of a caterpillar into a butterfly.

f. What happens if ECB significantly expands its bond purchase program?
Ø  inflation in the EMU

Ø  moral hazard – the ones with  irresponsible credit behavior are left off hook and those that behaved responsibly are left to pick the tab 

Ø  Having barrier-free access to a large market benefits Germany only if such a market becomes self-sustaining.  No one wants to have access to a large market which one must also fund in perpetuity.

Ø  German nationalism is stoked. 

Ø  The fire of German nationalism will reduce the goal of German elites’ to transform Europe into a law-based society to cinders.

Ø  It will beget nationalistic feelings elsewhere in Europe, leading to resurrection of unions inspired by nationalism causing a reversal of intra-European free trade.

[1] The European dream is the manifestation of release of latent energies of the Germanic peoples following the collapse of the Holy Roman Empire in the early 19th century.
[2] secure from the vagaries of nationalistic jostling of the various European national states

Sunday, October 9, 2011

The Regional Geopolitics of Creation of Pakistan

This post is about Pakistan, not of its present state but of its birth itself.

Yours, thinking about Pakistan's strategic importance to China, UK and US analyst,

Protagonists: Britain, the Indian National Congress, Japan, the Indian Right and Russia

Frederick C. King, “India in the War and After”, An Irish Quarterly Review, vol. 31, no. 122, Jun 1942, pp. 185-192.

Disclaimer: This post is NOT a review or critique of the aforementioned paper.  Nor does all what I type below follows from what is contained in the paper.  My referencing the paper is merely for the purpose of acknowledging its role in enriching my own information set about the topic I address in this post.

Time to Say Goodbye
As early as 1941 (if not before) the British were already planning to leave the Indian subcontinent.  They had reached the consensus that it was better to continue to exert control of the subcontinental dynamics through the levers of the educational system and trade dependency system they had built in India, the regional foreign relations dynamics and military exigencies vis-à-vis key external powers [1] they had set into momentum and the economic and social policy blueprint that leaders of the Indian National Congress had acquired while at the London School of Economics.

The Japanese Shadow & British Concerns
British prime concern was that if they were to leave, the Indian subcontinent would fall to the march of Japanese materialism [2].

British Comfortable with Indian Military Capabilities
The British felt confident about India’s ability to pay the cost of her own defense against Japan.  In their view, India had (i) a large pool of ‘martial races[3] from which fighting men could be drawn, (ii) Indian farmer and coolies [4] were fatalistic, sturdy and had little requirements; their physical capabilities and simple-mindedness [5] could be commandeered to bolster professional forces and erect a second line of defense, (iii) India’s indigenous production of steel, leather and rubber was adequate to meet the needs of the army, (iv) Indians had improvised their little technological resources to produce arms and ammunitions of adequate quality [6], in sufficient quantity and, (v) India’s eastern topography would act as a force multiplier against the vastly technologically superior Japanese (superior to the Indians, not the British themselves!) – for about 5 months a year, rains and marshes would render mechanized formations useless.

But Feared the Fifth Column
The British were however concerned that the Japanese may instead of marching to the beats of their martial self-image, adopt a different strategy in India – work on her internal differences and wait and watch while the British administration implodes under the weight of fight in Europe and an India rendered ungovernable by exposed fault lines.

In the context of the impending Japanese invasion, no other fault line worried the British than the Hindu- Mohammedan rift.  It would have worked as follows:

A small though ideologically committed number of Indian leaders [7] reasoned that India’s best interests rested in subservience to Japan, a Buddhist nation, than to Mohammedans or to the British [8].  The British feared that inspired by continued Japanese military successes in the Pacific Theatre, the fringe could rapidly grow in size.  If this were to happen, the Indian masses would break away from the Congress, a party that the British had long cultivated and whose leaders were more or less tuned to British line of thinking in their external outlook.  Beyond that, the Indian leaders that preferred Japan also belonged to the same social group which, unlike the Congress, was willing to use direct action in response to calls to revert India or a part of her to a political framework that harked back to Mughal era .  In the fringe were to take the centerstage, widespread rioting would be inevitable.  That would cripple the British administrative machinery in India and cause a rebellion in the ranks of her Mohammedan soldiers fighting for the British on the European soil.  Consequently, the British Empire in the Indian subcontinent would likely implode and the Japanese would move in and gain control of a literally interminable supply of men for war against the USA.

Pakistan – a Solution (to British Problems)
As I mentioned right in the beginning, the British trusted the institutional levers they had built in India to allow them to retain control of the subcontinental dynamics even after their departure.  These levers could however be exercised only if India did not fall to Japan following the British departure and if power was transferred to the Congress as opposed to those Hindus that preferred a Japan-led Asia.  The British had one other major geopolitical concern – how to ensure that their successor(s) in the Indian subcontinent would continue to uphold their long-followed policy of denying Russia access to warm water ports of the Indian Ocean?

On the matter of securing their institutional levers in India, Britain considered it of utmost importance that India be granted independence sooner rather than later.  However with Jinnah having threatened violence if his demand for creation of a Mughal-inspired political set-up was not met, the power transfer process ran a high risk of miscarriage with the consequent implosion of British administration in India and the rise of Japan in the subcontinent.  Getting M.K. Gandhi to concede to Jinnah’s demands became a necessity for this reason alone.  M.K. Gandhi however would have none of this.  He did not threaten to jump right in and join Jinnah in the game of chicken [9].   He instead back-pedalled on the independence movement itself.  The politician wrote as a sage in the Harijan weekly ( April 1942).

“The attainment of independence is an impossibility until we have solved the communal tangle.  We may not blind ourselves to a naked fact.  How to tackle the problem is another question; we will never tackle it so long as either or both parties think independence will or can come without any solution of the tangle.  There are two ways of solving what has almost become insoluble.  One is the royal way of non-violence; the other of violence.  

All interested in freedom have to make the choice.  I suppose the choice has already been made by the chief actors.  But the rank and file do not know their own minds.  It is necessary for them, if they can, to think independently and take non-violent action in terms of unity. It consists in Hindus and Muslims on the wayside fraternizing with one another if they believe joint life is a perfect possibility, nay a necessity.”

This line was echoed by the Congress party.  While they were not excited about the prospects of the Japanese replacing the British, they were nevertheless confident that Britain, in defense of her own self-interest, would not abandon her responsibilities in the subcontinent.  Thus, the Congress decided to put its own independence movement in the cold storage. 

As I have just argued however, the British were eager to grant independence to India.  While the Congress was high on ideals, it did not have the moral courage to pursue what was required to deal with the vexed “communal tangle”.  Or perhaps, I am wrong and that it was not an issue about the Congress’ moral courage or lack thereof but about India herself lacking in adequate capability.  In that case Indians should be grateful to people such as M.K. Gandhi for recognizing India’s weakness, and thereby, not putting the nation on the path of achieving what was at the time, impossible.  This weakness, irrespective of whether it was in Congress’ moral fibre or India herself, played straight into the British hands.  Knowing that the Congress leaders themselves did not have a solution to the “communal tangle” but to kick it down the road, the British set their minds on whetting M.A. Jinnah’s dreams  a part of his dreams became their action point.  This act, as history bears testimony, eventually broke Congress' resolve and they reluctantly conceded to India’s partition.

The emergence of Pakistan would cut off India from Central Asia, bottle the Indian energies in the subcontinent, block prospects of overland pipelines and thereby make her dependent on the British for her energy security.  More importantly though from the British perspective, it united the Hindus behind the Congress, thus pre-empting Japan from waging a 'fifth column' war and, pulled a dark curtain on Russia’s dreams for access to the Indian Ocean.

Pakistan’s birth and the timing of India’s independence were both preordained by the geopolitical imperatives of an exhausted empire.

Fig. 1: Map of British India and Dependencies (1945)

[1] mainly Russia and China, to a far lesser extent, Persia and the Ottoman empire
[2] The Japanese began imbibing the idea of materialism as a way of life in 1853 through contacts with the Americans and Europeans which were not borne out of choice but humiliation forced upon them.
[3] The concept of ‘martial race’ is not a British creation but perhaps no one in the past 300 years have succeeded better at creating new superficial yet distinct identities and utilizing those to maintain a steady supply of natives in support of the master’s wars.
[4] Farmers and coolies constituted over 70% of the Indian population.
[5] Over 84% of the Indians were illiterate (1931 census).
[6] The British encouraged the home-made arms enterprise in the land where today the “Good Taliban” meets the “Bad Taliban”.  Darra Adam Khel was quite possibly a British creation.
[7] The most well-known amongst such leaders was Subhash Chandra Bose.
[8] Even just five years before independence, hardly any Indian leader had concrete ideas on how India would maintain her independence once she emerges from the British yoke.  This includes M.K. Gandhi and J. Nehru who towered over on the Indian political landscape after the departure of Lokmanya Tilak.  M.A. Jinnah had a very different idea of an independent India – an India where power is transferred to claimants of the Mughal heritage.  With imagination and capabilities falling short of what was needed to maintain independence, the political differences mainly centred over the question of whether to continue with the current master, the British, revert to the old master, the Mohammedans, or welcome the new master, the Japanese.
[9] game of chicken – Get into a truck.  Orient towards the opponent.  Press the gas pedal.

Wednesday, March 16, 2011

Libya, No-fly Zone & the Next 10 Days

[added March 20, 2011, 1015 GMT] Pop quiz: how many wars is the US currently engaged in?  You might think 3: Afghanistan (2001-), Iraq (2003-) and now, Libya.  Did you miss out Pakistan (2004-)?  It is a UAV-show all the way.  Pakistan’s toll is 2000+, and counting.

Yours, thinking about MENA Analyst,


I predicted three weeks ago (cliquez ici) that rebels in Libya are unlikely to succeed in deposing  Gaddafi. I stick to this prediction and make further predictions.  I would not classify this post as 'analysis'.  If you are interested in knowing the basis of what I state here then feel free to write back.

Gaddafi’s forces have reached Ajdabiya (labeled A on the map of north eastern Libya).  I do not expect them to march into Benghazi just yet which is 100 miles north of Ajdabiya.  Instead they will likely gain further mass around Ajdabiya over the next few days and another contingent would head east 250 miles to Torbuk (labeled B on the map).  Once Torbuk is taken they will take Benghazi in a pincer movement [1]. Panic has already begun to set amongst rebels in Benghazi.  They have started sending their family members towards the Egyptian border (the solid north-south line on the east-end of the map).    The misty-eyed idealists that joined the protests will desert in large numbers.  The ground leaders will likely stay on as for them it is a fight to finish.  The mercenaries fighting alongside the rebels will do the same or flee back home (the Mediterranean looks more likely though as getting home means traversing southern Libya, which firmly remains within Gaddafi's control) .  The key behind-the-stage actors and Gaddafi-appointed diplomats that sided with the rebels will likely take asylum in the European capitals.

Map 1: Map of East Libya.  Places of interest on the map - the towns of Ajdabiya, Torbuk and Benghazi, the Mediterranean Sea to the north and Egyptian border to the east.

I fear widespread massacre of those left behind in coastal towns in the region above the purple line (see the map).  This should be “over” [2] in about 10 days.

China will be able to hold back the growing international calls for a UN-mandated no-fly zone (NFZ) for at least a week [3].  Its job is not too hard as: 
  • US has no interest in unilateral action.  
  • When push-comes-to-shove Germany will say a firm no to a EU-organized NFZ.
  • France has no interest in taking the lead on the NFZ.  Its loud noises on this count are a reflection of power games with Germany on matters concerning the future of the Eurozone and not North Africa.
  • Britain has the capacity but not the political will to play a leading role in enforcing the NFZ.
  • The Egyptian military does not have an interest in enforcing the NFZ.  And without Egyptian participation, Arabs (read, GCC Arabs) have no ability to project power beyond the Arabian Peninsula or the Persian Gulf.  Besides, as much as the GCC leaders despise Gaddafi, they would (privately) heave a sigh of relief if Gaddafi manages to arrest the domino.
  • Russia does not favor the NFZ.

My main concern in not whether an NFZ can be established but what (if anything at all) can be done to broker peace.  NFZ will not save lives; a brokered truce will.

There is of course the possibility of assassination and that would send the events along an entirely different path.  For me such an event would be a random draw - I profess complete cluelessness about its potential occurrence.  That aside, I think it is astounding to see how much structure there is underlying the seemingly chaotic games played by those who run the world.

[1] There is no point chasing up north when those that are being chased can escape to the East and regroup.  Besides, Gaddafi can achieve victory at a lower cost by breaking the will of his antagonists.  That is much easier done when the antagonists are cornered and forced to fight or set sail across the Mediterranean than when they have an opportunity to draw out Gaddafi’s forces into a desert safari.

[2] The phenomenon we are observing in Libya and the broader Arab world is an organic phenomenon and not an incident.  So, nothing will really be over in the true sense of the word over. Therefore the quotes.

[3] Contrary to widespread media reports Gaddafi has hitherto used his air force for mainly:

· organizing troops movements
· destroying ammunition depots that are controlled by rebels
· destroying food depots and water catchments in rebel areas

He has had enough time to organize his artillery logistics.  Even if an NFZ were imposed now I do not think it would make much difference.

Tuesday, March 15, 2011

A Short Note on the German-French Proposals for Strengthening the EMU

I visited Sendai in 2004.  It is sad to see the destruction inflicted on the city by the 2011 earthquake/tsunami.  I salute the spirit of the Japanese people and their sense of civic responsibility in such extraordinary times.

Yours, thinking about the European-experiment Analyst,


This post is with reference to a recent news item in Reuters.

Essentially what the article states is that France and Germany, the EMU-G2, are pushing for a fiscal union, tax union and a benefits union [1]

Where there are proposals there is opposition.  A sampling is here:

* Southern Europe is opposed to the idea of the abolition of inflation-indexed wages.  Inflation in Eastern European nations has structural causes though their muted response on this matter is keeping in line with their political weight in the EMU.   

* Cross-border tax arbitrage vis-à-vis continental Europe has been critical to the success of Ireland's corporate sector and thus it is opposed to floors on corporate tax rates.

* Countries with a strong center-left political constituency are opposed to raising the retirement age (for most people above 62 an increase in retirement age would mean no work or significant underemployment and yet, a delayed onset of benefits).

* The proposal by the EMU-G2 that EMU sovereigns adopt laws that place a cap on their sovereign debt is rather amusing - it has never worked in the past as a sustained institutional practice in any part of the world except in cases where the control of debt accumulation process was handed over to another sovereign.

However the proposals are sound - no monetary union can survive crises without fiscal coordination and a common defense policy.  The latter has become and continues to remain a non-issue as a result of the fall of the Berlin Wall and the subsequent re-orientation of Russia's approach towards outward projection of power.  Thus the EMU-G2 must sow the seeds of a fiscal union in order to perpetuate the EMU.  The only problem is that the ability to set tax rates, the ability to control transfer payments and the ability to respond to political crises with fiscal measures are essential ingredients of sovereignty.  A complete fulfilment of the EMU-G2 proposals will therefore not just make EMU's financial system robust but also put an end to the sovereignty of the EMU member states.  Which is fine except that I do not know of any time in history when a larger state emerged from individual components solely on the basis of a shared notion of common economic destiny and financial stability.  Banks do not make sovereign states.  Economics does not make a sovereign state.  Period [2]

[1] A welfare state is a post-WWII construct and thus the emergence of importance of alignment in benefits policies is a historical oddity.

[2] I am not suggesting that Germany is attempting to create a state in this manner.  At an appropriate time (if it comes at all), Germany will lay the foundations of such a state in the shared cultural values.  A discourse on this matter is way out of scope of this short note.  

Tuesday, March 1, 2011

On Bank of Thailand's Policy Stance in the Context of Local and Global Forces

First a brief on approaches to risk management at financial institutions and in foreign relations.

Contingent credit lines (CCLs), colloquially known as overdraft facilities are used by firms to ensure operational liquidity.  A CCL is essentially an up-and-out American barrier call option sold by an FI.  Here, the strike is the market credit spread of the client, i.e., the credit spread that the client would be charged if it were to avail a similar facility directly from the market.  And, if the client's FI-estimated default spread were to rise to hit the barrier at any time during the term of the facility then the CCL facility would be automatically cancelled [1].

FIs manage the default risk on CCLs on the basis of diversification.  Hedging is an alternative approach to managing default risk.  However that does not work for a portfolio comprising CCLs issued to SME firms in emerging markets (EMs) such as Thailand because (i) barrier options cannot be hedged when the market credit spread of the client is close to the barrier, (ii) the hedge instruments would be a portfolio of forward default swaps and there is no liquid market for forward default swap contracts written on SME firms.  So, diversification is the only practical way.

Similar approaches hold for mitigating foreign relations risk.  One of the long-term consequences of the recent events in the Middle East and North Africa (MENA) region will be a structural break in political games - they will change from (if I may exaggerate a little) one-party games to multiple-party games.  In a one-party game hedging can be practical.  Unlike in matters related to risk management at FIs, hedging turns increasingly ineffective as a tool to manage risks in foreign relations in a multi-party game, just as diversification becomes increasingly more suitable.  China’s foreign policy approach in the MENA region is predicated on the assumption that hedging would work.  This has indeed worked for China in the past.  But it will work less in the future as MENA dynamics shift to multi-party games.  China however does not appear particularly skilled at using the diversification approach to managing foreign relations risk.  Therefore the events in the MENA region do not look good when viewed from China’s perspective.

Yours, thinking about the MENA region, Analyst,


Disclaimer: The figures below are approximate.  While the general argument stands, I do not recommend using these figures for your professional work.

The US government conducted its first round of quantitative easing (QE1) in 2008 to prevent a credit crisis-induced deflation spiral in non-consumable real assets.  Despite QE1 deflation in non-consumables has continued to remain a primary concern in the US policy circles.  Consequently the US government initiated a second round of quantitative easing in 4Q2010.  The first round of quantitative easing transferred a fair bit of toxic assets to the government.  With the US government’s credit rating intact, this raised the capitalization of the US financial system from its dangerously level.  Lending to the private sector however continued to decline.  Where there was surplus capital it was recycled back into US government securities or kept aside for acquiring failing financial institutions (FIs) of which there were plenty.  The important point here is that money from QE1 did not leave the US shores.

Investment opportunities in the US have remained few.  However the risk of failure of large US-based FIs has fallen considerably since 2008.  Thus unlike during the period of QE1, reserve excess on account of QE2 flowed out of the US shores.  The EMU is expected to barely register any growth; Japan is much too dependent on international demand for growth; what China needs is not more financial capital but a rebalancing of its growth model.  The US-based FIs therefore channelized the excess due to QE2 into commodity markets [2] and countries such as Thailand [3] which have a liberal capital control framework, a robust domestic demand and, low public debt/GDP and interest payment/tax receipt ratios.

The surge in capital inflows has also found its way into the property sector which in Thailand had already started witnessing a strong upward price trend since 1H2010 due to the return of consumer confidence, economic buoyancy and the near-absence in exposure of Thai banks to toxic mortgage-backed securities or reliance on wholesale markets for funding.

Wage price inflation in Thailand is however a home-grown phenomenon - its cause is mainly structural - the chronic failure of technical education to keep pace with other factors that have made Thailand an attractive manufacturing destination.  Though in recent years attempts by political leaders to find broader acceptability has also contributed to wage inflation, particularly in low paying jobs.

While credit mispricing in the property sector and in the corporate sector is a growing concern, inflation has been the primary target of BoT’s monetary policy calibration in recent periods.  After 13 consecutive months of keeping the benchmark rate at 1.25%, BoT decoupled its interest rate policy from the West - it carried out 25 bps increases in the benchmark rate in the months of July, August and December last year and then again in Jan-2011, bringing the benchmark rate to 2.25%.

Even before Thailand began raising its benchmark rates, its currency had been appreciating.  To relieve some of the appreciation pressure in 2009 BoT began allowing Thai firms to invest directly in foreign securities.  The move however had little impact then and THB/USD strengthened 2% y/y in 2009 and 12% y/y in 2010.  Given this background the rise in Thai benchmark rates has encouraged volatile capital flows [4] which in turn have tended to boost further currency appreciation.  This could hurt non-agricultural exports in 2011 as this year the Thai economy cannot draw power from base effects and given that global recovery turned out to be much weaker in 2010 than consensus view, the expectations on recovery in 2H2011/1H2012 are more conservative. 

Liberalizing capital outflows is another tool that the Thai authorities have exercised so far.  In 2H2010 the limit on outward FDI, including on those in overseas affiliates of Thai firms, was scrapped and the limit on loans to overseas firms and on investment in offshore property were raised.

To curb THB appreciation the BoT also added calibrated capital control to their repertoire of tools.  For example, in Oct-2010, the 15% tax exemption on foreigners’ earnings from investment in Thai bonds was removed and the sale of bill of exchange [5] certificates to non-residents was banned.

Despite these measures however, short-term capital flows continued on the upward trend and with that, the THB has been appreciating against most major currencies [6].

The Thai authorities are likely to continue encouraging outward FDI and dampen foreign demand for short-term bonds and other financial assets.  Interest rates are likely to be increased further albeit at a slower rate than in 2H2010.  Major hikes are unlikely though even if they occur they are likely to occur only after the general elections that are likely to be held in 3Q2011.  Until then the government will likely continue to rely on subsidies to curb food, transportation and energy price inflation.  Hiking bank reserve ratio is unlikely to help in the case of Thailand though could be used as a signalling mechanism.  In the face of continuing uncertainty in global recovery and the looming political risk in Thailand [7], BoT is unlikely to repeat the harsh capital controls imposed during 2006-08 which triggered what turned out to be the worst peak-to-trough fall in Thailand’s stock market’s history [8].

·      Potential policy missteps with regards to capital control measures
·      Heightened awareness of political risk in the context of the on-going political instabilities in the MENA region à sharp reversal of capital flows into Thailand à a sharp fall in THB/USD à soaring inflation [9] 

[1] E. Loukoianova, S.N. Neftci, and S. Sharma, Pricing and hedging of contingent credit lines, IMF WP/06/13.
[2] Commodities serve as an inflation hedge and their prices are supported by robust consumer demand in several EM economies
[3] in SE Asia, Malaysia, Thailand and Vietnam, and to a lesser extent, Indonesia
[4] Foreigners hold 7% of Thailand’s government bonds and 37% of stock exchange assets (Dec-2010 est.).
[5] A bill of exchange offers higher interest rate than comparable deposit instrument since the former does not carry deposit insurance.
[6] except since events in the MENA region forced international investors to turn greater attention to political risk
[7] Over the past two years aversion to countries that have a debt servicing problem has been a principal factor determining global capital flows.  With the profound changes that are taking place in the MENA region, political uncertainty has come to fore in the minds of international investors.  While Thailand scores well on measures of debt serviceability, it does not on the latter.
[8] The harsh capital control measures triggered the fall but the Global Financial Crisis of 2008-09 was in large part responsible for the magnitude by which Thai stock market receded.
[9] Baring wage price inflation, other causes of inflation in Thailand will not be mitigated by capital flight.

Sunday, February 20, 2011

Dominoes: Tunisia --> Egypt --> Libya (?)

Yours, with thoughts in North Africa, Analyst,


Libya lies to the south of the Mediterranean and in sandwiched between Algeria in the West and Tunisia in the North West and, and Egypt in the East.  Muammar al-Gaddafi has ruled the country since 1969.  Hosni Mubarak ruled Egypt and Zine El Abidine Ben Ali ruled Tunisia in presidential capacity since Oct 1981 and Nov 1987 respectively.  They have now departed.  Will  Muammar al-Gaddafi be next?  Let us begin with a very brief background:

Protests in Libya began on Feb 15.  Human Rights Watch has reported over a 100 deaths.  What started in Benghazi has spread to Albayda and Derna.  The rage continues (which makes twitter a more appropriate medium than a blog).

So then, is it spring or is it a false spring for democracy in Libya?

The situation in Libya is developing at the time of this writing.  What I engage in below is predictive analysis.  Back to the Q, I place my bets on the latter.  We will find out in a few weeks whether I am right.  Time tips it all!  Before we discuss further I must mention one critical assumption I make - foreign powers will not act decisively enough to tip the balance in Libya.

1. Harbingers Gaddafi has had the advantage of Tunisia and Egypt serving as harbingers of a surge in youth power.  This has given him adequate time to (re)identify those he can rely on, the sops he can throw at those with genuine grievances but without a thirst for political power, prep up counter-protesters and, find lines that he can hold should the situation escalate (which has already happened).

2. Internet Penetration Social networking sites were critical to sustaining the momentum in the recent protests.  The internet penetration in Egypt is 16%.  In Libya, it is a meagre 5% [1].  The unrest in Libya has thus far remained concentrated in regions that are geographically distant from the seat of 'real' power (see more on this below).  The dependence of momentum on internet communication is far greater in Libya than in Egypt where protests began in Cairo itself.

3. Power Structure in Libya

3A. The Current Structure There are two power centers - the Revolutionary Leadership, led by Gaddafi, and the People's Congresses.  However, the Revolutionary Leadership can neither be voted out nor dismissed.  The executives of the People's Congresses are elected every four years.  The candidate list that the electorates choose from is approved by the Revolutionary Leadership which also enjoys veto power over any decision made by the Congresses.  The armed forces in Libya, unlike those of Egypt, neither have their own independent power structure nor do they derive their strength from foreign links.  It is true though that the lower rungs have dissatisfied elements.  Indeed, they appear to be involved in the protests.  However, as mentioned before, they do not have surprise on their side.  In all  past uprisings around the globe that I know of where lower-ranked officers have succeeded, the surprise factor has been essential.

3B. Comparisons with Pre-revolutionary Iran Hydrocarbon-related industries accounted for about 50% of the GDP and oil income accounted for about 80% of government revenues in pre-revolutionary Iran.  In Libya hydrocarbon and mineral extraction related industries account for even higher - at a staggering 95% of the GDP.  As a result, the state's tax extraction capability is weak and therefore and therefore information channels are not organized to identify productive sectors or regions of the economy.  Therefore economic dynamism in  Libya  relies critically on patronage structures.

Pre-revolutionary Iran had an urbanization rate of over 50%.  Libya is even more urbanized - nearly 90% of its population lives in urban areas.  The urban unemployment rate in Libya is much higher.  Youth frustration would therefore appear worse in Libya.  However, unlike pre-revolutionary Iran, Libya lacks autonomous Persian bazaars [2].  Also, unlike pre-revolutionary Iran, it lacks religious authorities who could provide a rallying point for moral authority.  Thus while urban frustration may indeed be higher in Libya 2011 than it was in Iran 1979 (it appears so, but I really do not know), it is without avenues for organized expression. [added Feb 25, 2011, 2355 Hrs GMT: After the Soviets were sent packing from Afghanistan in early 1989, the battle-hardened surplus fanned out across the globe; some of them ended up in new foreign lands (e.g., in Jammu & Kashmir, India) and some returned back to their home countries to replicate their Afghan triumph.  LIFG was formed by an assortment of such  returnees who mainly hailed from the same eastern towns where Libya-2011 protests took seed.  Between the mid to late 1990s LIFG carried out assassination attempts on Gaddafi and his regime members.  In the late 1990s however Gaddafi succeeded in fisting this group into submission.  At least that is what appears if you consider ground-action by LIFG as a measure of its existence.  Could this measure however be incorrect?  If yes then, that would falsify my conclusion that "urban frustration ... in Libya 2001 ... is without avenues for organized expression".  I am humbled by the fact that the Shah of Iran having crushed opposition from the religious authorities in the 1960s and early 70s continually scoffed at the idea that they are anything but a spent force.  History however took a different trajectory - the Islamists attracted both the religiously motivated and the secular modernists.  By the time the Shah smelt his coffee it was too late.]

4. Geographic Location of the Protests The protests started in Benghazi which is the industrial and commercial center of Libya.  Then they spread eastwards to the towns of Alquba, Albayda and Derna (see the map) and have thus far remained centered in the eastern part of the country.  Tripoli, the seat of power of Gadaffi, however lies in the far western end of Libya [3]

Map 1: Geography of Libyan protests: Protests in the East (B, C, D).  Political power in the West (A).

It appears that the protesters have chosen to gain strength in parts of Libya where oil wealth is not the only source of economic activity.  That this region is geographically far from Tripoli affords them protection from immediate reprisal and insulates their movement from confusion  or dilution that strong counter-protests can induce.  It also suggests, contrary to reports in the international media, that the unrest is directed at the local government and not at Gaddafi himself [4].

Now, even if the protesters manage to hold on to their gains in the East (I doubt it as they are without an effective leadership or an ideological anchor), how would they carry their movement into Tripoli where counter-protesters and a ruler who has had the time to prepare in advance awaits with forces, who on several occasions in the past have demonstrated staunch loyalty to Muammar al-Gaddafi?      
[1] 2008 est. source: World Bank, self-estimates
[2] The Persian bazaars acted as a magnet for those disaffected with the Shah's system.  It is where such people found camaraderie, employment and developed social networks.  Even though the bazaars enjoyed substantial autonomy from the Shah's governance apparatus, oil wealth would flow there in the form of contracts for pieces of work outsourced to SMEs by those belonging to the thin layer of the Shah's patronage structure. 
[3] By road, Tripoli is over 1000 km from Benghazi and over 1300 from Derna.
[4] Gadaffi proclaimed a few days back that he would join the people in their protests against the government!