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Watch List Findings: May 27, 2017

|May 26, 2017

What follows are the preliminary findings for issues identified in the daily Watch Lists this week. We are only sending findings that we regard as significant or potentially significant to keep this list manageable. We have findings for all the Watch List items. Should you be interested in findings not listed here, please contact us and we will email them to you.

To emphasize, you can contact us if there is an item not included here for which you’d like to see the findings.

Our goal, as always, is to focus on what matters and not on things that don’t.

Items from May 25

Brazil: President Michel Temer briefly invoked a decree calling for the military to restore order in Brasilia after protesters demanding the president’s resignation vandalized government buildings and property. Since assuming office, Temer has regularly confronted opposition to his spending reforms. After he was implicated in a corruption scandal, some of his opponents called for his impeachment. We will be following the court’s handling of the corruption allegations against Temer and will be looking for signs that the political instability could lead to substantial changes in Brazil.

  • Finding: Life in Brazil has continued without much disruption. Financial markets did not plummet, the Congress continued holding sessions and major protests did not break out in other areas. It looks like the court proceedings regarding Temer’s investigation will move slowly. The Supreme Court has suspended the case until after the tape that purportedly captured Temer discussing bribes can be further examined, a process that will take about 30 days. In addition, Temer’s lawyers have asked for clarification on several related juridical matters, and getting these answers will also take time.

United States-China: The U.S. has conducted a freedom of navigation operation in the South China Sea for the first time since Donald Trump took office. Considering the rising tensions on the Korean Peninsula and in U.S.-China relations, it will be important to watch for China’s reaction and to determine how this relates to the economic and security issues in the region. Also, China’s Ministry of Commerce has published a report on the U.S.-China trade relationship that predicts Chinese imports of U.S. goods will increase to $8 trillion in the next five years. This report should be scrutinized.

  • Finding: A Chinese Foreign Ministry spokesman accused the United States of trespassing in sovereign Chinese territory and urged the U.S. to “correct its mistakes.” China’s reaction thus far has been limited to issuing statements. There is no indication that this freedom of navigation operation has affected the U.S.-Chinese economic relationship or the situation on the Korean Peninsula, where China has been unable or unwilling to get Kim Jong Un to back down. The Ministry of Commerce report requires further research.

NATO: Prior to their meeting on May 25, NATO leaders announced that they will be forming a plan to increase NATO contributions to fighting terrorism, mentioning the Islamic State specifically. This may be just a token diplomatic statement to appease the U.S., or NATO may actually be considering committing forces to fight IS. We will be watching to see if there is a unified sense in NATO of what this action plan represents.

  • Finding: There has been considerable clamor about NATO formally joining the global coalition against IS. Countries such as the U.K., France and Belgium that have experienced attacks on their soil have a deep interest in seeing the Western military alliance take on a larger role in the efforts to degrade and eventually destroy IS. A large deployment of ground forces in Syria or Iraq is unlikely, however. Many NATO member states, especially the U.K. and Canada, are already involved in the air campaign and are supporting local anti-Islamic State forces on the ground. NATO’s formal entry into the fight will probably entail more air and intelligence operations, as well as special operations, not a large-scale offensive.

Items from May 24

China: The yield curve for Chinese government bonds has partially inverted, meaning shorter-term bonds now offer higher interest rates than longer-term bonds. Five-year and seven-year bonds now have higher rates than 10-year bonds, and three-year bonds have a higher rate than five-year bonds (but not seven-year bonds). Yield curve inversions are potential indicators of a coming recession. But different factors, including market forces and monetary policy, can impact the shape of the curve. We need to understand what factors are driving this partial inversion to determine its likely implications.

  • Finding: Chinese regulators recently implemented measures that restrict the flows of certain types of funds from banks to bank subsidiaries that invest in wealth management products and other off-balance-sheet securities often managed by bank subsidiaries. This decreased the demand for bonds of all maturities. But the 7-year bond trades in much lower volumes than the 10-year bond, so the decline in demand for the 7-year had a greater effect on its yield than it did on the 10-year, leading to a greater increase in the 7-year rate. There are insurance markets for 5-year and 10-year bonds but not 7-year bonds, which could in part account for the smaller volume.

Azerbaijan: We have previously written about Azerbaijan’s growing challenges with the state-owned International Bank of Azerbaijan after it failed to make a $100 million debt payment. On May 24, the bank announced its restructuring plan, which will give creditors three options: accept a 20 percent reduction in the value of their debt investment in exchange for a higher interest rate; exchange their current IBA bonds for newly issued ones; or exchange current IBA bonds for Azerbaijani sovereign debt. The Azerbaijani government also announced that it will be selling its majority stake in the bank after the debt restructuring is completed later this year.

  • Finding: The restructuring vote will require approval by two-thirds of the bank’s creditors, although the state oil fund, which is certain to approve, makes up about a third of the votes. IBA has warned creditors that it will shut down if a deal on restructuring is not reached, risking a much greater loss for the creditors in the bankruptcy process.

Philippines-United States: A transcript produced by the Philippine Department of Foreign Affairs of an April 29 phone conversation between U.S. President Donald Trump and Philippine President Rodrigo Duterte has been leaked. Besides demonstrating that leaks don’t occur only in the U.S. these days, the important issue to understand is the intent behind the release of this transcript.

Philippines: A group reportedly linked to the Islamic State, called the Maute, has attacked the city hall and a church in the city of Marawi on the Philippine island of Mindanao. President Rodrigo Duterte has declared martial law on the island and cut short a visit to Russia. Although the fighting has died down, the group has not been neutralized. There are also conflicting claims about whether Maute is actually affiliated with the Islamic State. Domestic unrest of this sort is not uncommon in the Philippines, but considering the country’s strategic importance in our model, we need a better sense of whether this unrest will have significant implications. Maute’s links to IS are also important to assess.

  • Finding: Casualties in the city have been low, but the Maute fighters still have not been dislodged from the buildings they captured, and snipers are targeting Philippine forces and civilians. Maute raised an Islamic State flag over one of the buildings it took over, but Philippine government officials insist there is no IS in the country. At least for now, IS has not said that it considers Maute to be an affiliated group or a part of its system of caliphate provinces outside Syria and Iraq. This is a domestic crisis for Duterte, but it does not appear that it has had any effect on the balance of power in the region. China and the U.S. have both pledged support for the Philippines, but neither has intervened. As long as that is the case, and as long as the fighting is contained, this is of limited importance.

Bahrain: Five people have been killed and 286 arrested since police raided a prominent Shiite cleric’s home in Bahrain on May 23. Saudi Arabia has declared its support for Bahrain’s moves to contain the unrest, while the U.S. has expressed concern. The raid comes after two recent extremist attacks in Saudi Arabia’s eastern Qatif region. This could be an isolated incident or an indication of Shiite unrest brewing in the Persian Gulf.

  • Finding: There have not been any other incidences of Shiite unrest in either Bahrain or Saudi Arabia. It is too early, however, to conclude that the attacks against security forces in the Saudi kingdom’s Shiite areas in the east and the crackdown on the Shiite majority in Bahrain are isolated incidents. With the start of the holy month of Ramadan on May 27, we could see even more violence. The Islamic State has an interest in attacking Shiites in these two countries to create more problems for their governments.

Items from May 23

Germany: In an interview with Der Spiegel, German Economy Minister Brigitte Zypries indicated that she supports moves to stimulate the German economy. She said that she sees room for higher wages, including a higher minimum wage, and that public investment in infrastructure and education also need to develop. She cited the finance minister as an obstacle to these measures. We need to understand why Zypries is advocating a stimulus, and we need to study the relationship between Germany’s finance and economy ministries.

  • Finding: This is simply part of ongoing electoral campaigning. Germany is currently governed by a grand coalition comprising the Christian Democratic Union, Christian Social Union in Bavaria and the Social Democratic Party. The economy minister, Zypries, is a member of the Social Democrats, the country’s major left-wing party, while Finance Minister Wolfgang Schaeuble is part of the major right-wing party, the CDU. Though they are part of the same coalition now, both parties hope to win enough votes in federal elections in September to be able to govern alone. In the coming months, we will see more disagreement on economic policies coming from members of the government.

Items from May 22

North Korea: The USS Ronald Reagan and its carrier group left their forward-deployed homeport in Yokosuka, Japan, for patrols in the Western Pacific and are expected to enter the Sea of Japan by the end of the month. This marks the second U.S. aircraft carrier battle group operating near the Korean Peninsula. A third is in San Diego preparing for deployment. We need to start tracking military movements in Guam as well as fighter planes stationed in South Korea and Japan to get a read on any U.S. preparations for a strike on North Korea.

  • Finding: Five U.S. Global Hawk drones and 12 F-16s fighter aircraft have been transferred from the U.S. mainland to Kadena Air Base in Okinawa, where they will conduct drills. The drones will then be deployed at Yokota Air Base. Japan is also considering joint naval drills in the Western Pacific with the U.S., U.K. and France. In addition, see the Reality Check published May 23.

Russia: Signs of distress are mounting in Russia’s defense industry and military acquisitions. The State Armaments Program is undergoing budget cuts, and the Military Industrial Commission decided to stop full-scale production on its most expensive projects, especially ships and aircraft. There are also many production delays and renewed emphasis on modernization over acquisition. We need to assess the state of Russia’s defense industry and determine what type of impact any issues will have on the military and economy.

  • Finding: The Military Industrial Commission will review the new State Armaments Program in July, and it is expected to be approved by President Vladimir Putin in September. The program would be in effect from 2018 to 2025 and has a draft budget of approximately 17 trillion rubles ($300 billion). That is 3 trillion rubles more than planned. Approximately 25 percent of the budget is expected to fund land and airborne forces, which would include purchasing air defense systems (particularly for Arctic territory), T-90 and T-14 tanks, armored vehicles for infantry, and armored personnel carriers. Putin said that by the end of 2017, the share of modern weapons in the ground forces should be 42 percent and in the airborne forces 58 percent. Funds will also be allocated toward developing smart weapons and automated communications and reconnaissance systems. The plan calls for abandoning the development of several weapons programs, including a new aircraft carrier, a new nuclear-powered destroyer, a strategic bomber and a fighter interceptor.



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