12 August, 2011

Salaam Mumbai

Uday India, 20 August 2011

"I am delighted to welcome Her Excellency Hina Rabbani Khar and members of her delegation, to India”, were the words of India’s External Affairs Minister on July 27, 2011. The venue was New Delhi, the city with Mughal vestiges and the date was exactly two weeks after July 13: the fateful day which signified a possible resurgence of cross-border encouraged terrorism in India. Two weeks had gone past and harried Indian security agencies failed to nab any human element behind the blasts, even after tracing innumerable phone calls.
                One thing was however noteworthy. Before the talks went ahead with the expected pleasantries and before Mr Krishna sounded the hyperbole of “a resurgent South Asia, proudly marching forth on a path of development, in a terror free and harmonious atmosphere” and in that venture, he sought the co-operation of India’s conjoined twin; Ms Khar met the Kashmiri separatists led by Syed Ali Shah Geelani and the Mirwaiz faction at the Pakistan High Commission.

The Three Stories 

Amit paced up with the preparations. Lest he missed out any object of importance, howsoever trivial it was, he kept on checking his baggage fastidiously. After all, it was for the first time, he was crossing Indian territory. The passport - the vital of them all and the dollars - the most crucial were all being thoroughly checked. The jumbo poster reflecting his four year old research; which he had critically built up using power-point, a somewhat boring job to him, was beside his baggage; nicely rolled into a cylindrical holder.
                His flight was next day, in the evening. In hindsight, it appears that Amit was both fortunate as well as unfortunate at the same time. His date of journey was July 12, 2006. He was going to board a Singapore Airlines flight to Seoul. His misfortunes were at least two-fold, if not manifold. One, he was boarding the flight from Mumbai. Secondly, the date of journey was a day after July 11, 2006. Well, on the other hand, he was fortunate enough not to board the flight on July 11!
                It was close to 7 pm in Mumbai on July 11, 2006, when Amit came to know from Ujjwal that Pratap had gone to Churchgate and not yet returned. His cell phone was not responding. Repeated calls made to him from different phones turned out to be futile. Amit and Ujjwal had more than sufficient reasons to send shivers down their spines.
                “I guess the police have jammed the network,” quipped Ujjwal. But Amit was skeptical. He kept on trying: his efforts missing the target in consonance with the inability of the Mumbai police to apprehend the serial blasts which unnerved the citizenry, bamboozling them to the horrifying extreme. Mumbaikars were rudely shaken up from their vada-pao siesta, in fact, after a long time almost forgotten since 1992-93, which had brought to limelight, the D-Company and its chief mentor Dawood Ibrahim Kaskar.
                “Dawood is supposed to be in Karachi”, fumbled Joseph, Ujjwal’s neighbour in the hostel. “Could he have done this?”, was Joseph’s bland query, as puerile as his ability to solve intricate problems in calculus.

                Ujjwal firmly retorted: “Please try to understand that Dawood works through networks.”

                “Yes, fine, I know that”, Joseph retaliated in a manner as if he was a defence expert, “but why will he do it this time around?” Joseph’s counter-argument was nonetheless interesting: “In 1993, they cited reasons of Muslims being slaughtered in Mumbai, their properties being vandalized. What will they substantiate now?”

                To cut the novel short, the triumvirate of Amit, Ujjwal and Joseph were successful in spotting the co-ordinates of Pratap, who in turn was superbly fortunate to miss the splinters from the bombs planted in pressure-cookers kept in the first class bogeys of the sub-urban trains. Amit could board his flight in the evening next day, taxied out of the deadly, ghostly city of Mumbai.

                Almost unscathed, life went on in the city. No major protests paralysed it in retaliation to the inefficiency of the police force. Bollywood kept on bombarding the outside world with its show-business. Amit, Joseph, Ujjwal and of course, Pratap completed their doctoral studies to move out of India’s financial capital in different directions. And the city waited not long though for another adventure.

                Two years are what most institutes and universities in India and abroad provide for a post-doctoral scholarship to ‘beggarly’ Indian PhDs. But Joseph was lucky enough to bag an extension to another term. And this was his enjoyment time he and his comrades of the old Mumbai-days were busy reminiscing at their preferred location the Leopold Café at Colaba, South Mumbai. Amit was struggling to be as ecstatic as Joseph, basically smiling under peer coercion. The poor lad was exasperated with tackling his phoren boss.

                Nonetheless, the four musketeers were enjoying their drink at Leopold, and at times glancing toward the busy road, in some unknown apprehension; as if. It was well past 7 pm and Ujjwal urged the others to leave as they had to meet Prof. Diwakar one hour later. As Pratap turned his back toward the main road to settle the dues, he heard shells being fired; sounds which were unfamiliar to not only the four old friends but by reasonable estimates were seemingly horrendous to other visitors in the café as well.

                Within moments, some of the customers fell. Before anyone could comprehend the reality, pools of blood splatlered the greasy floor of Leopold Café. Amit’s, Joseph’s, Pratap’s and Ujjwal’s evening, their homecoming to India, were severely jolted by the terror mechanism which had embedded itself in Mumbai since 1993. Was it the D-company this time? Was it the Students Islamic Movement of India (SIMI) or the Lashkar-e-Taiba (LeT)? Was the Inter-Services-Intelligence (ISI) the mastermind behind the attacks? Such questions kept on hitting their minds incessantly like projectiles; seeking answers to those were simply useless at that juncture however.

                Bullets were not only pumped into Leopold Café, basically targeting foreigners; miscreants also sneaked into the neighbouring Nariman House and held on for a couple of days till the equanimity of the commandos of the elite National Security Guards (NSG) turned the tables. It was November 26, 2008. News of casualties started pouring in from Chhatrapati Shivaji Railway Terminus and Oberoi Trident Hotel, another hub of foreign nationals.

Mumbai had been taken hostage.

                July 13, 2011 was slightly different. The four musketeers were no longer in Mumbai. Joseph was searching for his next scholarship and Pratap had settled in the Land of Washington; maybe for good, and maybe due to the fear of being bombed in Mumbai. It had been hard to contact Ujjwal whereas Amit had cocooned himself in the safest city of India; Kolkata: the city of dilapidated palaces.

Talkative Neighbours

Three sessions of talks were held between the foreign secretaries of India and Pakistan on June 23-24, 2011; and exactly three major explosions rocked Mumbai, barely three weeks later, on July 13.

                Under the resumed dialogue process, the Foreign Secretaries Salman Bashir of Pakistan and Nirupama Rao of India met in Islamabad for bilateral talks on ‘peace’ and ‘security’, encompassing the cliché Confidence Building Measures (CBMs) and the contentious issue of Jammu and Kashmir.

                And it was Dadar, Opera House and Zaveri Bazaar, all crowded areas, where Improvised Explosive Devices (IEDs) splintered to take into their obnoxious fold; according to conservative official reports (till 23:00 hrs on July 13), 13 dead and around 80 injured.

                Non-official media reports retorted with higher numbers of 20-21 dead and over hundred forced to lie in hospitals and nursing homes. This incident mirrored, to a lesser extent, the fifth anniversary of the horrific July serial train blasts in the city.

                Three general questions loom large at this critical juncture. One, do these blasts indicate the resurgence of non-state actor-led cross-border terrorism in India? Two, to what extent have the Indian security apparatus failed (or succeeded) in combating urban-centric terrorism? And third, would this act of terror impede the verbal transactions which have been initiated at the diplomatic levels between India and Pakistan?

                As Nirupama Rao boldly asserted in Karan Thapar’s TV show Devil’s Advocate that “nothing is set in stone”; at least as far as India-Pakistan rapprochement is concerned, the bilateral atmosphere seems to be devoid of adventurous ‘atmospherics’, at least in the foreseeable future. On the one hand, Ms Rao confirms that “there has been a very glacial pace to the whole process as far as the 26/11 trials are concerned.”

                On the other hand, she informed the Indian media and public at large of a couple of positive bytes about the Pakistani government. She said: “But let me tell you what kind of feedback we got from the Pakistanis at this round. And they spoke of the need to discuss all the serious and substantive issues between the two countries and that terrorism was at the forefront of this.”

                Rao confessed to Thapar that there was hardly any visible progress in Pakistan regarding the 26/11 trials. But, the lack of progress, according to Rao, should not mean that dialogue was not an option with Pakistan. Hence, one thing was not uncertain at all; that is, the resumption of the India-Pakistan dialogue process shall not be stalled. The expected meeting between the respective foreign ministers in New Delhi at the end of July happened as scheduled.

                In this regard, it is noteworthy to quote Ms Rao again: “I think the decision to reengage with Pakistan and to talk about the issues that divide us, that Ministers said, I think is a very realistic approach to dealing with problems with Pakistan.” So, the fact of the matter is resuming dialogue with Pakistan is the official line taken by South Block till the civilian government in Islamabad vouch in being not involved with any ‘non-state’ actor-led terrorism in Indian cities.

                In fact, Mr Zardari had come to reprimand the blasts in Mumbai; which will ease matters between the two nations. After all, Islamabad itself is wary of terror and hence a bilateral joint framework to tackle the scourge is the sanest approach to bring peace in South Asia. Furthermore, the Indian ministry of Home Affairs is yet to establish any linkage between the blast and terror groups based across the Indus and hence is unable to indict the Pakistani state apparatus directly.

                With the third question resolved, the answers to the first two are relatively straightforward. First, the July 13 Mumbai blasts are more of a desperate attempt on the part of the ultras to reassert their ‘lost’ grip over the terror network in India. After 26/11, India has witnessed about 31 months of peace, to be precise. A brief interregnum was a solo piece of violence at Pune in February, last year. Thus it will be far-fetched to assume that the July 13 incident implies a re-invigorated terror regime in India.

                And such a hypothesis was echoed by India’s urbane Home Minister, Mr Chidambaram, when after the blasts, he stressed the ‘efficiency’ of his police force as reflected in their capability of keeping India sufficiently terror free for a considerable amount of time.

                With the Maoist insurgency spreading its tentacles deep in the countryside and with stones being pelted in Kashmir at the security machinery, it seems that the Indian security forces have done reasonably well to contain cross-border bred terror. Well, it could be the case that involvement of global jihadi networks in Afghanistan and Iraq may have depleted their intensity levels in India and that has incidentally raised the success levels of Indian forces.

                Nevertheless, it would not be preposterous—in times to come—to assume further terror attacks in India, mainly in its major cities. It will be a gargantuan job for the security apparatus to make India absolutely terror-free. And for natural reasons, people’s anger at the government’s [in]action will continue.

                Here, it won’t be less than worthwhile to compare the joint statements of the meetings of foreign secretaries of the two neighbours spread over years.

                For instance, in 2011 it reads: “Under the resumed dialogue process, the Foreign Secretaries of Pakistan and India met in Islamabad, on June 23-24, 2011 for bilateral talks on Peace and Security including CBMs, Jammu and Kashmir and promotion of friendly exchanges. Three sessions of talks were held.”

                In 2006 it went like this: “The Foreign Secretaries of India and Pakistan met in New Delhi on January 17-18, 2006 to commence the third round of talks under the India-Pakistan Composite Dialogue framework. Foreign Secretary of India Shri Shyam Saran led the Indian delegation while the Pakistan delegation was led by Foreign Secretary Mr Riaz Mohammad Khan. They discussed issues related to ‘Peace and Security including CBMs’ and ‘Jammu and Kashmir’. The talks were held in a cordial atmosphere and were constructive too.”

                Do we observe any major discernible change in a span of 5 years? Despite the gruesome tale of 26/11, and the Sharm-el-Sheikh diplomatic fizzle, India and Pakistan are ‘talking’ with each other. There is one change however. Talks now, are mere parleys; and not within the ambit of the so-called Composite Dialogue: a mere change in nomenclature? Meanwhile, India had kept a sustained pressure on the civilian authority in Pakistan through its bulky ‘dossier diplomacy’; which nevertheless has not produced any tangible results for India.

As the experts say

On July 24, 2011, in the state-sponsored Indian Television channel DD News, intense discussions were going on amongst strategists and ex-armymen regarding the ‘fate’ of internal security in India. The anchor cited the comparison with our northern neighbour, China. The Chinese had pumped in to the tune of $105 bn, as per Beijing’s nomenclature, for Domestic Security; which incidentally, is $10 bn-$15 bn more than the budget on external security.

                The Director of New Delhi based Institute for Conflict Management, Ajay Sahni, however argued that he found no reason to lament on the budget or the lack of it as he saw the existing budget not properly utilised. The elite NSG, still flexing its muscles because of its coronation through Operation Black Tornado during that ill-fated 26/11, does not have enough bullet-proof jackets for its personnel. Whereas, at the other end, armoured vehicles are being bought to combat urban-centric terror; a definite signature of ridiculous decision-making: that is, arming without thinking.

                It remains a fact that Force One, the special weapons and tactics emergency response force set up after 26/11, is still short of bulletproof jackets, night-vision equipment, secure communications kits and blast-proof eyewear, writes Praveen Swami in The Hindu. It even lacks a training base and is short of officers.

                The panelists stressed human intelligence as the key to successfully tackling terror; which in fact is no stupendous thinking in the backdrop of its effective implementation against Osama bin Laden. Another panelist, E N Rammohan, former Director General (DG) of India’s Border Security Force (BSF) advised on empowering the state police forces in the cutting edge technology to handle terror. Listening to Rammohan, this author was reminded of a bolder proposal from Maj Gen. Dhruv Katoch, Additional Director of Centre for Land Warfare Studies (CLAWS), New Delhi. Maj Gen Katoch believes that India needs to do away with the elite Indian Police Service (IPS) and rather build up its state police services as a bottom-up approach.

                Strategist Praveen Swami, on the other hand, is quite critical of the Indian authorities. In his Op-Ed in The Hindu, he writes: “India’s post-26/11 police reforms painted stripes on a donkey and passed it off as a tiger.” The Associate Editor of The Hindu further informs us regarding the infirmity of our security apparatus. Maharashtra’s Anti-Terrorism Squad, according to Swami, “still has less than half the required number of personnel; its special weapons and tactics unit is undertrained and under-resourced; its coastal security programme has run aground.”

                Though Swami contemplates the setting up of a NATGRID, even if mired with procrastination by cabinet decisions, Ajay Sahni comments that such institutional frameworks will be epitomes of “garbage in and garbage out” unless backed by solid ground network (read, human intelligence).

Salaam Mumbai

In his regular column for Uday India on May 21, 2011, Prakash Nanda wrote: “We have seen how openly the LeT staged an impressive rally in Lahore in memory of Laden.” Furthermore, he asserted: “And most important, we have the Pakistani establishment which will always keep Ladenism live and kicking for its sheer survival.”

                With a one-and-a-half times increase in population over 20 years (after the liberalisation in 1991) being compensated with 4 times increase in Gross Domestic Product; with a dip in official poverty rate from 45 to 32 per cent of the total population, with number of billionaires in Forbes’ rich list going up from 1 to 49; and with a rising urban population; India will remain a lucrative target for terrorists, whether abetted by state actors or not. Actually, India will remain a soft target because of the vacillation exhibited by the policy-makers residing in New Delhi.

                And as the July 21st issue of The Economist recommends another ‘bang’ in the Indian economy like that happened 20 years back, it is mostly assumed to realistic proportions that explosive ‘bangs’ decimating lives would continue to accompany India’s growth as it had had since 1993. Pessimistic futuristic predictions could be averted though. An Indian government imposing itself in world fora with the tag of a Realist is not simply hypothetical, but a preferred option. Indian democracy must exert itself.

                Till then, Mumbai will continue to endure blasts; may be ‘a-periodically’ but as a matter of routine. The Mumbaikaars will tolerate them without a din. And at every casualty, we will say: “Salaam Mumbai.”

09 August, 2011

The Financial Crisis in Europe

Leaders from the 15 eurozone countries along with British Prime Minister Gordon Brown met Oct. 12 to try to solve the worldwide liquidity crisis. In a show of unity, the leaders agreed on measures such as guaranteeing interbank loans for up to five years and buying stakes in banks. But this show of unity was missing a Europe-wide solution. Proposed measures were simply guidelines for member states to follow in the development and implementation of their own independent solutions.

Main European economies quickly started putting the agreed-upon measures into action Oct. 13 by offering concrete proposals for infusing liquidity directly into banks. This would be done either by injecting capital straight into the banks (as the United Kingdom did with eight banks on Oct. 8) or by setting up interbank loan guarantees. Together, Germany, France and the United Kingdom announced more than 163 billion euros ($222 billion) of new bank liquidity and 700 billion euros (nearly $1 trillion) in interbank loan guarantees.

The U.S. subprime mortgage mess impacted Europe almost immediately after it erupted in August 2007, causing write-downs and credit losses among some of the largest European banks. The Europe-wide cost of the subprime to date has been $323.3 billion in asset write-downs. Most analysts — though not STRATFOR —mistook Europe’s initial resilience in the face of the U.S. subprime crisis for an overall economic robustness that would stave off a wider economic crisis.

Europe can only wish the U.S. subprime crisis were the extent of its problems, however.

The Importance of Banking to the European Economy

The underlying reason for Europe’s vulnerability is rooted not in the U.S. subprime — that is only the proximate trigger — but instead in the importance of banks to the entire European economy. In the United States, the crisis might be contained within the financial and housing sectors alone, but in Europe, the close connections between banks and industry almost assure a broad and deep spread of the contagion. Unlike the United States, where the government has spent more than a century battling to break the links among government, industry and banks, this battle is only rarely joined in Europe. If anything, such links — one could even say collusion — between banks and businesses were encouraged from the very beginning of modern European capitalism.

Since the 19th century, European financing and investing has been coordinated between banks and industry, and encouraged by the government, because industrialization was a modernizing project led by the state that did not spring up spontaneously as it did in the United States. Bank executives often sat on the boards of the most important industries, and industrial executives also sat on the boards of the most important banks, making sure that capital was readily available for steady growth. This allowed long-term investment into capital-intense industries (such as automobiles and industrial machinery) without the fear of quick investor flight should a single quarterly report come back negative.

The most famous example of this type of cozy link are the ties between Siemens AG and Deutsche Bank, a relationship which has existed for more than 100 years. An overlapping and intermingling of interests results from this type of arrangement, insulating the system from many minor shocks like strikes or changes in government, but making the system less flexible in the face of major shocks like serious recessions or credit crises. Therefore, in times of a global shortage of capital, European corporations are left with few financing alternatives they are comfortable with. (In contrast, while banks are an important source of financing in the United States, corporations there depend much more on the stock market for investment. This forces American firms to compete ruthlessly for capital and constantly seek greater and greater efficiencies.)

The Next Wave of Problems

Wholly unrelated to exposure to American subprime, Europe’s banking vulnerabilities can be broken down into three categories: the broad credit crunch, European subprime and the Balkan/Baltic overexposure.
The first issue, the global credit crunch, exacerbates all inefficiencies and underlying economic deficiencies that in capital-rich situations would either be smoothed over or brought to a much softer landing. Think of submerged rocks; many are far enough below the surface that vessels can simply sail over them. But when the tide drops, the rocks can become deadly obstacles.

Various European countries had such inefficiencies long before the U.S. subprime problem initiated the global credit crunch. Many of these were caused by the post-9/11 global credit expansion in combination with the adoption of the euro. After the Sept. 11 attacks, many feared the end was nigh. To tackle these sentiments, all monetary authorities — the European Central Bank (ECB) included — flooded money into the system. The U.S. Federal Reserve System dropped interest rates to 1 percent, and the ECB dropped them to 2 percent.
The euro’s adoption granted this low interest rate environment, which normally only a state of Germany’s strength and heft could sustain, to all of the eurozone. This easy credit environment echoed by affiliation to most of the smaller and poorer (and newer) EU members as well. Cheap credit led to a consumer spending boom — which was stronger in the traditionally credit-poor smaller, poorer, newer economies — leading not only to a real estate expansion, but also to an overall economic boom that, even without the subprime issue and the global credit crunch, was going to burst.

Underneath the global credit crunch looms the second problem: the European subprime crisis. This issue is particularly acute in places like Spain and Ireland that have recently experienced a lending boom propped up by euro’s low interest rates. The adoption of the euro in Spain, Portugal, Italy and Ireland spread low interest rates normally reserved for the highly developed, low-inflation economy of Germany to typically credit-starved countries like Spain and Ireland, granting consumers there cheap credit for the first time. The subsequent real estate boom — Spain built more homes in 2006 than Germany, France and the United Kingdom combined — led to the growth of the banking and construction industry. Banks pushed for more lending by giving out liberal mortgage terms — in Ireland the no-down-payment 110 percent mortgage was a popular product, and in Spain credit checks were often waived — creating a pool of mortgages that might soon become as unstable as the U.S. subprime pool.

The poorer, smaller and newer European countries gorged the most on this new credit, and none gorged more deeply than the Baltic and Balkan countries, leading to the third problem: Baltic and Balkan overexposure. Growth rates approached 15 percent in the Baltics, surpassing even East Asian possibilities — but all on the back of borrowed money. This scorching growth caused double-digit inflation, which will now make it more difficult for the Baltic states to take out loans to service their enormous trade imbalances. The only reason that growth rates were less impressive (or frightening) in the Balkans is because these countries either came later to EU membership, as with Bulgaria and Romania, or have not yet joined at all, in the case of Croatia and Serbia, so they did not experience the full credit-expanding effect of being associated with the European Union.

The Financial Crisis in Europe
Fueling the surges were Italian, French, Austrian, Greek and Scandinavian banks. Limited as they were by their local domestic markets, they pushed aggressively into their Eastern neighbors. The Scandinavian banks rushed into the Baltic countries and the Greek and Austrian banks focused on the Balkans, while the Italian and French also went to Russia. UniCredit, the Italian behemoth with vast operations across Eastern Europe, announced Oct. 6 that it was facing a credit crisis, and it is hardly alone.

The “new” European states have witnessed the greatest expansion in terms of credit, by any measure, of any countries in the world in the past five years (with the possible exceptions of oil-booming Qatar and United Arab Emirates). But because that credit is almost entirely sourced from abroad, the easy credit environment has now collapsed, and heavy foreign ownership of even the domestic banks means that those who have the money have their core interests elsewhere. This swathe of states is now mired in almost Soviet-era credit starvation, while the banks that once led the charge are having difficulty even maintaining credit lines in their home markets.

The Challenge of Coordinating a Response

Europe’s inability to adequately address the challenge goes well beyond the issue that different portions of Europe face very different banking problems.
The capacity of European capitals to deal with the crisis varies greatly, but the core concern lies in the fact that it is the capitals, not Brussels, that must do the dealing. When the Maastricht Treaty was signed in 1992, EU member states agreed to form a common currency, but they refused to surrender control over their individual financial and banking sectors. European banks therefore are not regulated at the Continental level, hugely limiting the possibilities of any sort of coordinated action like the U.S. $700 billion bailout plan.

The Oct. 12-13 announcements are cases in point. While the eurozone members have agreed to follow general guidelines, any assistance packages must be developed, staffed, funded and managed by the national authorities, not Brussels or the ECB. This means that the administrative burden will have to be multiplied 15-fold at least, as every country undertakes and implements its own bailout/liquidity injection package.

As the crisis unfolded, disagreements on the member state level were immediately evident, with France and Italy initially recommending a Europe-wide bailout proposal similar to the American plan. France and Italy, both saddled with large and growing budget deficits and national debts, are the two major states most in need of such a bailout. But Germany and the United Kingdom, the more fiscally healthy states that would have been expected to pay for the bulk of the plan, quickly vetoed the idea.

The Europeans then decided to go with an EU-wide set of measures that would guide the individual member states’ liquidity injection packages. At the EU level, the only actual proposals have been two steps: a broad reduction in interest rates and an increase in the minimum government-guaranteed bank deposit from 20,000 euros ($27,000) to 50,000 euros ($68,300). It is worth noting that many individual European countries are now guaranteeing all personal deposits to shore up depositor confidence.

Even in the case of the interest rate cut, Europe had to dodge EU structures. The ECB’s sole treaty-dictated basis for guiding interest rate policy is inflation; the treaty ceiling is 2 percent. Eurozone inflation is already at 3.6 percent, indicating that rates should not have been reduced. Obviously, circumstances dictated that they needed to be, but like many states’ decisions to increase deposit insurance, this move could only be made by ignoring EU law and convention. And if the ECB can abandon its mandates in times of economic crisis, what stops the member states from doing the same? The next legalism sure to be widely ignored will be the prohibitions on excessive deficit spending, which many would call the fundamental requirement of eurozone membership.

The Individual States’ Responses

EU treaty details aside, the issue now will be the ability of the individual states to act. The stronger a state’s economic fundamentals, the more likely the country in question will be able to raise money to tackle the situation effectively in some way, whether by raising taxes or issuing bonds. (Bonds of economies with good fundamentals in particular are an attractive location for parking one’s money while stock markets and real estate around the world undergo corrections.)

The three leading criteria to consider are the government’s share of the economy, the government budget deficit and the level of national indebtedness. Combining these three variables gives a good snapshot of whether a particular country will be able to raise capital during a credit crunch. Incidentally, European governments consume the highest percentage of their countries’ resources in the world, greatly reducing their ability to surge government spending.

Not surprisingly, the most seriously threatened European states are France, Italy, Greece and Hungary, each of which is running a serious budget deficit while also being burdened by high government debt. Three of these four (France, Italy and Greece) also have very active banks in emerging markets of the Balkans and Central Europe, home to the European states that are likely to suffer the most from the credit crisis. These four countries are closely followed by Romania, Poland, Slovakia, Bosnia, the Netherlands, Portugal and Lithuania.
The Financial Crisis in Europe

Further bloating the deficits of many European countries will be the many bailouts and reserve funds being planned to deal with the liquidity crisis on an individual country basis. On Oct. 13, Germany announced a 70 billion euro ($95 billion) bank capitalization plan and up to 400 billion euros ($543 billion) for interbank loan guarantees. On the same day, France announced slightly smaller figures — a 40 billion euro ($54.3 billion) injection plan for banks and up to 300 billion euros ($407.25 billion) for interbank loan guarantees. The United Kingdom infused further liquidity into its banks by propping up Royal Bank of Scotland with 20 billion pounds ($34 billion) and Lloyds and HBOS, which are merging, with 17 billion pounds ($29.2 billion).

This followed an Oct. 5 announcement by the German government of a (second) bailout proposal for real estate giant Hypo to the tune of 50 billion euros ($67.9 billion). The Netherlands and France bailed out Fortis with 17 billion euros ($23.3 billion) and 14.5 billion euros ($19.8 billion) respectively. Struggling Iceland — where the country, not just the banking sector, is now technically insolvent — nationalized its entire banking sector. Nationalization is even sweeping the usually laissez-faire United Kingdom, which announced that it was seizing control of mortgage lender Bradford & Bingley on Sept. 29, followed by an even more dramatic move in which the government announced it would spend 50 billion pounds ($87.8 billion) on rescuing (and thus partially nationalizing) Abbey, Barclays, HBOS, HSBC, Lloyds TSB, Nationwide Building Society, Royal Bank of Scotland and Standard Chartered.
Unlike the British and German bank-specific bailouts, Spain set up a 30 billion euro (about $41 billion) aid package to buy good assets from banks to inject liquidity into the entire system. The Spanish approach seems to suggest that unlike in the United Kingdom and Germany, where only a few bad apples needed to be nationalized, the entire Spanish system might be threatened. 

This is certainly a possibility in a country where 70 percent of all bank savings portfolios are in real estate, and where real estate is dangerously overheated.
Also relevant to determining the exposure of a particular European state is its dependence on foreign exports, both in terms of goods and services. By this measure, Germany, the Czech Republic and Sweden will suffer as their industrial exports slacken due to a decline in worldwide demand. Extremely high trade imbalances will also become more difficult to sustain as credit to purchase European exports becomes more difficult for buyers to procure. Again, particularly at risk are countries in Central Europe with extremely high current account deficits (in terms of percentage of GDP). This will be especially true if demand in western EU countries dulls for Central European exports, further bloating the Central European countries’ current account deficits — which of course are no longer easy to finance.

The Financial Crisis in Europe
Even assuming that each bailout plan functions perfectly, and that the U.S. economy pulls through relatively quickly, Europe is settling in for a protracted banking crisis. Ultimately, the American problem is limited to the United States’ financial and housing sectors. Should the United States’ problems spread to other sectors, the crisis at its core will still remain a credit crunch. In Europe, various regionalized and interconnected weaknesses are much broader and deeper, pointing to systemic problems in the banking sector itself. For the United States, developments the week of Oct. 5 might signal the beginning of the end of the crisis. But for Europe, this is merely the end of the beginning.

Republished with permission from STRATFOR

Global Economic Downturn: A Crisis of Political Economy

By George Friedman

Classical political economists like Adam Smith or David Ricardo never used the term “economy” by itself. They always used the term “political economy.” For classical economists, it was impossible to understand politics without economics or economics without politics. The two fields are certainly different but they are also intimately linked. The use of the term “economy” by itself did not begin until the late 19th century. Smith understood that while an efficient market would emerge from individual choices, those choices were framed by the political system in which they were made, just as the political system was shaped by economic realities. For classical economists, the political and economic systems were intertwined, each dependent on the other for its existence.

The current economic crisis is best understood as a crisis of political economy. Moreover, it has to be understood as a global crisis enveloping the United States, Europe and China that has different details but one overriding theme: the relationship between the political order and economic life. On a global scale, or at least for most of the world’s major economies, there is a crisis of political economy. Let’s consider how it evolved.

Origin of the Crisis

As we all know, the origin of the current financial crisis was the subprime mortgage meltdown in the United States. To be more precise, it originated in a financial system generating paper assets whose value depended on the price of housing. It assumed that the price of homes would always rise and, at the very least, if the price fluctuated the value of the paper could still be determined. Neither proved to be true. The price of housing declined and, worse, the value of the paper assets became indeterminate. This placed the entire American financial system in a state of gridlock and the crisis spilled over into Europe, where many financial institutions had purchased the paper as well.

From the standpoint of economics, this was essentially a financial crisis: who made or lost money and how much. From the standpoint of political economy it raised a different question: the legitimacy of the financial elite. Think of a national system as a series of subsystems — political, economic, military and so on. Then think of the economic system as being divisible into subsystems — various corporate verticals with their own elites, with one of the verticals being the financial system. Obviously, this oversimplifies the situation, but I’m doing that to make a point. One of the systems, the financial system, failed, and this failure was due to decisions made by the financial elite. This created a massive political problem centered not so much on confidence in any particular financial instrument but on the competence and honesty of the financial elite itself. A sense emerged that the financial elite was either stupid or dishonest or both. The idea was that the financial elite had violated all principles of fiduciary, social and moral responsibility in seeking its own personal gain at the expense of society as a whole.

Fair or not, this perception created a massive political crisis. This was the true systemic crisis, compared to which the crisis of the financial institutions was trivial. The question was whether the political system was capable not merely of fixing the crisis but also of holding the perpetrators responsible. Alternatively, if the financial crisis did not involve criminality, how could the political system not have created laws to render such actions criminal? Was the political elite in collusion with the financial elite?

There was a crisis of confidence in the financial system and a crisis of confidence in the political system. The U.S. government’s actions in September 2008 were designed first to deal with the failures of the financial system. Many expected this would be followed by dealing with the failures of the financial elite, but this is perceived not to have happened. Indeed, the perception is that having spent large sums of money to stabilize the financial system, the political elite allowed the financial elite to manage the system to its benefit.

This generated the second crisis — the crisis of the political elite. The Tea Party movement emerged in part as critics of the political elite, focusing on the measures taken to stabilize the system and arguing that it had created a new financial crisis, this time in excessive sovereign debt. The Tea Party’s perception was extreme, but the idea was that the political elite had solved the financial problem both by generating massive debt and by accumulating excessive state power. Its argument was that the political elite used the financial crisis to dramatically increase the power of the state (health care reform was the poster child for this) while mismanaging the financial system through excessive sovereign debt.

The Crisis in Europe

The sovereign debt question also created both a financial crisis and then a political crisis in Europe. While the American financial crisis certainly affected Europe, the European political crisis was deepened by the resulting recession. There had long been a minority in Europe who felt that the European Union had been constructed either to support the financial elite at the expense of the broader population or to strengthen Northern Europe, particularly France and Germany, at the expense of the periphery — or both. What had been a minority view was strengthened by the recession.

The European crisis paralleled the American crisis in that financial institutions were bailed out. But the deeper crisis was that Europe did not act as a single unit to deal with all European banks but instead worked on a national basis, with each nation focused on its own banks and the European Central Bank seeming to favor Northern Europe in general and Germany in particular. This became the theme particularly when the recession generated disproportionate crises in peripheral countries like Greece.

There are two narratives to the story. One is the German version, which has become the common explanation. It holds that Greece wound up in a sovereign debt crisis because of the irresponsibility of the Greek government in maintaining social welfare programs in excess of what it could fund, and now the Greeks were expecting others, particularly the Germans, to bail them out.

The Greek narrative, which is less noted, was that the Germans rigged the European Union in their favor. Germany is the world’s third-largest exporter, after China and the United States (and closing rapidly on the No. 2 spot). By forming a free trade zone, the Germans created captive markets for their goods. During the prosperity of the first 20 years or so, this was hidden beneath general growth. But once a crisis hit, the inability of Greece to devalue its money — which, as the euro, was controlled by the European Central Bank — and the ability of Germany to continue exporting without any ability of Greece to control those exports exacerbated Greece’s recession, leading to a sovereign debt crisis. Moreover, the regulations generated by Brussels so enhanced the German position that Greece was helpless.

Which narrative is true is not the point. The point is that Europe is facing two political crises generated by economics. One crisis is similar to the American one, which is the belief that Europe’s political elite protected the financial elite. The other is a distinctly European one, a regional crisis in which parts of Europe have come to distrust each other rather vocally. This could become an existential crisis for the European Union.

The Crisis in China

The American and European crises struck hard at China, which, as the world’s largest export economy, is a hostage to external demand, particularly from the United States and Europe. When the United States and Europe went into recession, the Chinese government faced an unemployment crisis. If factories closed, workers would be unemployed, and unemployment in China could lead to massive social instability. The Chinese government had two responses. The first was to keep factories going by encouraging price reductions to the point where profit margins on exports evaporated. The second was to provide unprecedented amounts of credit to enterprises facing default on debts in order to keep them in business.

The strategy worked, of course, but only at the cost of substantial inflation. This led to a second crisis, where workers faced the contraction of already small incomes. The response was to increase incomes, which in turn increased the cost of goods exported once again, making China’s wage rates less competitive, for example, than Mexico’s.

China had previously encouraged entrepreneurs. This was easy when Europe and the United States were booming. Now, the rational move by entrepreneurs was to go offshore or lay off workers, or both. The Chinese government couldn’t afford this, so it began to intrude more and more into the economy. The political elite sought to stabilize the situation — and their own positions — by increasing controls on the financial and other corporate elites.

In different ways, that is what happened in all three places — the United States, Europe and China — at least as first steps. In the United States, the first impulse was to regulate the financial sector, stimulate the economy and increase control over sectors of the economy. In Europe, where there were already substantial controls over the economy, the political elite started to parse how those controls would work and who would benefit more. In China, where the political elite always retained implicit power over the economy, that power was increased. In all three cases, the first impulse was to use political controls.

In all three, this generated resistance. In the United States, the Tea Party was simply the most active and effective manifestation of that resistance. It went beyond them. In Europe, the resistance came from anti-Europeanists (and anti-immigration forces that blamed the European Union’s open border policies for uncontrolled immigration). It also came from political elites of countries like Ireland who were confronting the political elites of other countries. In China, the resistance has come from those being hurt by inflation, both consumers and business interests whose exports are less competitive and profitable.

Not every significant economy is caught in this crisis. Russia went through this crisis years ago and had already tilted toward the political elite’s control over the economy. Brazil and India have not experienced the extremes of China, but then they haven’t had the extreme growth rates of China. But when the United States, Europe and China go into a crisis of this sort, it can reasonably be said that the center of gravity of the world’s economy and most of its military power is in crisis. It is not a trivial moment.

Crisis does not mean collapse. The United States has substantial political legitimacy to draw on. Europe has less but its constituent nations are strong. China’s Communist Party is a formidable entity but it is no longer dealing with a financial crisis. It is dealing with a political crisis over the manner in which the political elite has managed the financial crisis. It is this political crisis that is most dangerous, because as the political elite weakens it loses the ability to manage and control other elites.

It is vital to understand that this is not an ideological challenge. Left-wingers opposing globalization and right-wingers opposing immigration are engaged in the same process — challenging the legitimacy of the elites. Nor is it simply a class issue. The challenge emanates from many areas. The challengers are not yet the majority, but they are not so far away from it as to be discounted. The real problem is that, while the challenge to the elites goes on, the profound differences in the challengers make an alternative political elite difficult to imagine.

The Crisis of Legitimacy

This, then, is the third crisis that can emerge: that the elites become delegitimized and all that there is to replace them is a deeply divided and hostile force, united in hostility to the elites but without any coherent ideology of its own. In the United States this would lead to paralysis. In Europe it would lead to a devolution to the nation-state. In China it would lead to regional fragmentation and conflict.

These are all extreme outcomes and there are many arrestors. But we cannot understand what is going on without understanding two things. The first is that the political economic crisis, if not global, is at least widespread, and uprisings elsewhere have their own roots but are linked in some ways to this crisis. The second is that the crisis is an economic problem that has triggered a political problem, which in turn is making the economic problem worse.

The followers of Adam Smith may believe in an autonomous economic sphere disengaged from politics, but Adam Smith was far more subtle. That’s why he called his greatest book the Wealth of Nations. It was about wealth, but it was also about nations. It was a work of political economy that teaches us a great deal about the moment we are in.

Republished with permission from STRATFOR

06 August, 2011

The Great Game in Central Asia

Geopolitics, August 2011, pp 66 - 68, 



Will the SCO expand itself to accommodate the aspirations of a ‘pariah’ Iran? Will India show enough energy to sneak into the organisation which may antagonize USA? The geopolitical calculus seems to be murky.

At the 11th Summit meeting of the Shanghai Co-operation Organisation (SCO) in the second week of June 2011 at Astana, Kazakhstan, Iranian President Mahmoud Ahmadi-Nejad, predictably, roared thus: “Which one of our countries (has played a role) in the black era of slavery, or in the destruction of hundreds of millions of human beings?”

In the same venue, he called for a post-Soviet security alliance against America-backed West. He has made it a habit, in tune with Hugo Chavez and Fidel Castro, to lambast the US (specific leaders in particular) at important platforms. His personal traits notwithstanding, domestic pressures and internal discontent could be assumed to provide the necessary fillip for such explosive demagogy.

In 2009 at Yekaterinberg, Russia, the Iranian President had echoed similar sentiments, with special emphasis on a single currency for intra-SCO trade and an exclusive ‘energy club’. If STRATFOR’s analysis is to be relied upon, “Iran spent the better part of the past decade using its nuclear program (or the threat of one) to try to get a primo spot at the world's geopolitical table.” In case of Iran, STRATFOR further contends:

"Highly publicize your progress on a nuclear program, stir in a reputation for irrational behavior — you've got a brilliant strategy for getting concessions from major powers."

Nevertheless, it is clear that Iran strongly aspires to be SCO’s 7th full member: a desire the cocooned SCO doesn’t really seem to relish. Iran currently holds an observer status in the group and had applied for full membership in a request filed on March 24, 2008. From a geopolitical perspective though, a bonding between Iran and the SCO could only benefit the regional cartel. Iran is world’s 2nd largest natural gas producer and if clubbed with SCO, would enhance the energy capabilities of the group and hence uplift its negotiating powers with the rest of the world.

Moreover, an expansion of SCO is overdue and with Iran expressing an earnest desire, it seems logical that the glue must be searched. More so, since the primary (unstated) objective of SCO was to erect a security alliance vis-à-vis North Atlantic Treaty Organisation (NATO), which was apparently stated through the aim of addressing religious extremism and border security in Central Asia.

In the post-1979 era, after the Khomeini-led Islamic Revolution in Iran, and furthermore with the ascension of Ahmadi-Nejad, it seems somewhat certain that it would be difficult for Iran to forge a ‘workable’ relationship with USA, at least in the foreseeable future. And in the unholy backdrop created by Washington’s maneuvers to the extent of browbeating a defiant Iran, the bilateral equation of the two countries does not appear to be analytically solvable. In such a scenario, Iran as a full member could only provide fillip to SCO since the latter’s primary motive was to construct a multi-polar world, challenging US dominance.

Additionally, since Russia may act as a viable mediator in the 5+1 party talks with Iran with regard to its allegedly ‘clandestine’ nuclear programme, inclusion of Iran in SCO can only provide ‘negotiating leverage’ to Russia and by group extension, to China. Such a measure, due to its natural fallout, would also strengthen the strategic objectives of these two countries in the United Nations Security Council (UNSC).

Hence, it was no wonder that the Deputy Head of Tajikistan's Center for Strategic Research, Seifollah Safarov underlined the positive outcomes of Iran's membership in the SCO. To quote him: "Changing Iran's membership status in the Shanghai Organization will provide further grounds for cooperation among the organization's members in confronting security threats that have targeted the region.”

According to Wan Chengcai, a Chinese expert on Russian foreign policy, SCO is constantly growing in stature which is understood from its appeal to countries like Mongolia, Iran, India, Pakistan and of late, Afghanistan.

Despite the apparently favourable bonding parameters, all is not well between Iran and SCO. Russia and China do not want a rhetorically violent Iran with its ‘pariah’ tag. That is why Russia has ‘urged’ Ahmadi-Nejad to conform to the guidelines of International Atomic Energy Agency (IAEA) and get on with the 5+1 party talks. It is veritably clear that the SCO doesn’t prefer to openly antagonize the US, at least at the present juncture. On the other hand, the elasticity of the SCO is being challenged.

India’s equation with the SCO

While putting into effect Indian foreign policy, there has been an incessant conflict between idealism and realism, with the former winning on the majority of occasions. An obvious criticism has been that India led too much focus on idealism at the cost of national interest. It is also a fact that power projection has never been the adopted methodology for New Delhi.

Sunil Dasgupta and Stephen Cohen in their paper for The Washington Quarterly are correct to assert that ‘strategic restraint’ has been India’s doctrine. They conclude thus: “Linear projections of current trends do not predict India abandoning its strategic restraint; for that, it will require a major and unforeseeable disruption at home or abroad.”

On bilateral terms, India’s relations with Russia have been more than cordial. Even after the fall of communism, and post 9/11 American dominance in the world order, Indo-Russia ties, especially in defence has leapfrogged. With Central Asia, (after 1991) India has remained tentative; mainly because of the ‘territorial disconnect’ due to the presence of Pakistan and also because the former being a land-locked region.

Nevertheless, as and when opportunities existed, like during the Russian invasion of Afghanistan (1979-89) and after 9/11, India has skillfully projected its ‘soft power’ in Afghanistan and tried to use the ‘land of Abdali’ as the launching pad for Central Asia. However, New Delhi has been diffident to even accept the making of an Air Base at Ayni near Dushanbe, Tajikistan.

However, as far as joining SCO is concerned, India never expressed its desire earnestly. Like Iran, India is an SCO-observer, but has never been overly ambitious to claim a permanent membership, unlike Iran. In the Summit-meetings of SCO, India’s Prime Minister had been hardly visible, except in Yekaterinberg, 2009. Finally, after sufficient dilly-dallying, India at last expressed its intent of being a permanent member in 2010.

Will the SCO expand?

In an article in the Central Asia – Caucasus Analyst (August 2009), Richard Weitz posits a viable reason “why the SCO has not designated new members since its founding, or new formal observers since Iran’s accession in 2005, is that, despite numerous attempts, the SCO governments have been unable to define the legal basis for such expansion.”

Moreover, SCO, for obvious reasons is keen to pull in the energy-rich Turkmenistan into its fold, whereas the latter has always exhibited diplomatic coyness. Ashgabat is part of the Central Asian geopolitical framework, both in terms of topography as well as history. So, if the SCO has to expand, its first preference must be Turkmenistan and not Iran. India, on the other hand, might not be a distant proposition, till Russian persuasion exists. But the obvious impediment to include India would come from three quarters.  

First, India itself, as New Delhi’s strategic restraint doctrine would hardly enable it to free the holy gyves of Nehruvian dogma and openly adhere to Realpolitik. Furthermore, it might not be prudent for India to displease the US by joining a security framework which is basically antithetical to US interests.

Second is the China-Pakistan factor. SCO has made it almost clear that if India has to be co-opted, then Pakistan would come as part of the ‘package’. China insists on such a configuration as it would not allow the rising Asian power to challenge its authority in the SCO; in conjunction with Russia. Moscow, on the other hand, would prefer a scenario in which India joins the SCO without Pakistan. But it has to be kept in consideration that any extension of SCO to integrate South Asia, naturally must go through Afghanistan and Pakistan. India may not appreciate such a formation, but it is to a large extent, inevitable.

And third, the SCO members must be wary of the inherent discord between India and Pakistan. Interestingly, at the 11th Summit of SCO, India’s External Affairs Minister had to face verbal bombardments from the Kazakh president regarding the progress in Kashmir dispute. These are ominous signs for India. India had nonetheless fought bilateral issues with its ‘childhood enemy’ Pakistan in multilateral forums; viz. in South Asian Association for Regional Co-operation (SAARC), but that is a platform where India reigns supreme, both politically as well as economically. However, in an ‘expanded’ SCO, India might not get such an advantage and to what extent the present Indian political dispensation is ready to take up challenges of such genre is perhaps not difficult to fathom.

On the other hand, a recent RAND study alleges that Iran continues to provide ‘measured’ support to Taliban insurgents in Afghanistan and also maintains close relations with the same Afghan central government that is battling Taliban forces. The research rules out any abatement in confrontation between Iran and the US. In such an atmosphere, it seems highly unlikely that the US would welcome any moves by the SCO to accommodate Iran.  

Interestingly, Iran and India have shown similar modus operandi in Afghanistan. Both the countries provided support, (military aid by Iran and logistical help by India), to the Tajik-dominated Northern Alliance, as a counterweight to the Taliban. Moreover, both the countries have pumped in major investment projects in infrastructure and education for Kabul. It won’t be preposterous to assume that these two states would harbour roughly similar mode of operation in Central Asia through the SCO. In that sense, SCO provides a decent platform for interaction to both these nations.

However, there are other impediments. Inclusion of Iran, India and Pakistan into SCO can further complicate matters for the regional block. Iran suspects that Pakistan abets the Sunni-insurgent group Jundallah, which wreaks havoc at times within Iran. And the plethora of bilateral matters plaguing India-Pakistan ties may come to the fore in an extended SCO.

Such factors can easily dissuade the region-specific issues of Central Asia and make SCO an unnecessary bickering ground for ‘outsiders’, as far as the original members are concerned. At the same time, however, an enlargement of SCO can broaden its scope and widen its reach in the global geopolitical chessboard; with a resurgent Russia and intimidating China gaining most of the fruits.

What’s in store for the future?
Since independence, India has hardly deviated from its non-committal position in aligning with power blocks. Perhaps that is the perpetual backdrop which adumbrates India’s incumbent Prime Minister Manmohan Singh’s articulation: “India is too large a country to be boxed into any alliance”. Iran, on the other hand, presently is a Mullah-dominated theocracy, the rudders of which are with a vociferous President.

Till Iran is under the umbrella of Shi-ite Mulla-ism and India holds the banner of its age-old foreign policy paradigm, a ‘strategic bonhomie’ between the two nations is an unlikely outcome; prevalent may be in the writings of academicians and in the domain of wishful thinking.

Even if India and Iran share the same dais through the SCO, it is a definite possibility that India would keep a safe distance from Tehran and not antagonize White house to any significant degree. Both nations want to be a part of the SCO for reasons specific to each. But a bilateral strategic partnership is not seen to be evolving out of the SCO.

Before that occurs however, Iran’s asymmetric military doctrine (allegations of aiding Hezbollah and other Shi-ite insurgent groups in Middle East) and India-Pakistan outstanding bilateral problems would continue to ensnare the SCO-veterans to allow a smooth direct entry for these two nations.