Archive for the ‘Europe’ Category

Russia: Fitch Ratings Pessimistic on Sovereign, Banks

August 18, 2009

Fitch Ratings, one of the three global rating agencies, published reports this week on the state of play in Russia.  The government of Russia’s BBB rating was affirmed, but the Outlook for the rating (i.e., where the rating is likely to go in the next two years) remains negative.  Russia has been more negatively affected by the global downturn than other Emerging Markets (with GDP down over 10% annualized in the first half of this year).  Fitch quotes these reasons why:

“First, it [Russia] was highly exposed to the shocks to global commodity prices and cross-border capital flows, which were of the order of 25% of GDP. Second, monetary policy was overly loose, external borrowing and domestic credit growth was excessive, and the economy was overheating prior to the crisis. Third, vulnerabilities were exacerbated by structural weaknesses including an undiversified economy, a weak banking sector, high inflation, FX mismatches on private sector balance sheets, weak institutions and a difficult business climate – which the authorities failed to address sufficiently during the boom years.”

In addition, Fitch banking analysts expect non-performing loans at Russia’s banks to top off at 25% of total loans, up from 14% in June.  Under its “pessimistic” scenario, Russia’s NPLs rise to 40% and losses amount to 24% of total loans.  Press releases on the Sovereign and the banks are below.

” Fitch Affirms Russia at ‘BBB’; Outlook Negative   04 Aug 2009 7:12 AM (EDT)

Fitch Ratings-London-04 August 2009: Fitch Ratings has today affirmed the Russian Federation’s Long-term foreign and local currency Issuer Default ratings (IDR) at ‘BBB’ with Negative Outlooks. At the same time, the agency has affirmed the Short-term foreign currency IDR at ‘F3’ and the Country Ceiling at ‘BBB+’.

“The Russian economy and sovereign balance sheet have been severely affected by the global financial crisis and, despite signs of economic and financial stabilisation since March, risks to creditworthiness remain on the downside,” says Edward Parker, Head of Emerging Europe in Fitch’s Sovereigns team.

Russian GDP contracted 10.1% y-o-y in H109, a far worse performance than in other larger emerging markets, and foreign exchange reserves (FXR) have fallen by around USD200bn over the past 12 months. The severe impact of the global crisis on Russia reflects three sets of factors. First, it was highly exposed to the shocks to global commodity prices and cross-border capital flows, which were of the order of 25% of GDP. Second, monetary policy was overly loose, external borrowing and domestic credit growth was excessive, and the economy was overheating prior to the crisis. Third, vulnerabilities were exacerbated by structural weaknesses including an undiversified economy, a weak banking sector, high inflation, FX mismatches on private sector balance sheets, weak institutions and a difficult business climate – which the authorities failed to address sufficiently during the boom years.

Fitch forecasts Russia’s real GDP to decline 7% in 2009, before increasing 3.5% in 2010, helped by the inventory cycle, base effects, higher oil prices and a large fiscal stimulus. However, the length and depth of the recession is a downside risk and will have implications for bank asset quality, public finances and, potentially, political pressures on the Russian authorities. Fitch views the banking sector as a key credit weakness. In its base case, the agency projects impaired loans to increase to 25% of total loans by end-2009, requiring recapitalisation of at least USD22bn in addition to the USD24bn injected since Q308. The central bank faces a challenge in providing sufficient liquidity to the banking sector, while reducing inflation to single-digits and avoiding excessive rouble volatility.

The Russian private sector faces maturing external debt payments of USD137bn this year, which may be difficult to refinance in current market conditions. Fitch estimates the roll-over rate was 64% in Q109. Capital outflows and the dollarisation of household bank deposits have eased since the completion of the rouble devaluation process in February, but could re-emerge in the event of renewed financial stress. Nevertheless, overall the country has a strong external liquidity position, with FXR of over USD400bn, and it is a net external creditor to the tune of 17% of GDP at end-2008, compared with a net debtor position for the ‘BBB’ range ten-year median of 13%.

Public finances are a key sovereign rating strength. General government debt was only 8% of GDP at end-2008, well below the ‘BBB’ range 10-year median of 35%. Moreover, Russia has an aggregate USD184bn in its Reserve Fund (RF) and National Wealth Fund (at end-June, equivalent to around 15% of projected 2009 GDP) providing a strong liquidity position to finance budget deficits and to run counter-cyclical fiscal policy. However, Fitch forecasts the recession, fall in oil prices and anti-crisis measures to cause the federal budget to swing from a surplus of 4.1% of GDP in 2008 to a deficit of 8.5% in 2009 and 6% in 2010. Even with a return to the eurobond market next year, this will cause the RF to be depleted in 2010 and require significant fiscal consolidation over the medium-term.

A renewed deterioration in global economic prospects, oil prices and risk appetite leading to a material weakening in the sovereign balance sheet or macroeconomic instability could result in another downgrade (Fitch downgraded Russia’s ratings by one notch on 4 February 2009). Negative shocks from the banking sector or elevated financial pressures from low roll-over rates on external debt or large-scale capital flight would also be negative for the ratings. Furthermore, a failure to narrow the budget deficit, and a consequent rapid increase in government debt and depletion of the sovereign wealth funds could lead to downward pressure on the ratings in the medium-term. In contrast, a material easing of a combination of these risks could see the Outlooks revised to Stable.

Contacts: Edward Parker, London, Tel: +44 (0)20 7417 6340; David Heslam, +44 (0)20 7417 4384.

Media Relations: Peter Fitzpatrick, London, Tel: + 44 (0)20 7417 4364, Email:”

“Fitch Ranks 57 Russian Banks by Loss Absorption Capacity  
14 Aug 2009 5:07 AM (EDT)

Fitch Ratings-London/Moscow-14 August 2009: Fitch Ratings released a report today ranking 57 rated Russian banks based on their loan loss absorption capacity. Fitch considers this capacity to be currently weak at 10 of the banks reviewed, although most of the 10 could likely rely on capital support from shareholders, and moderate at a further 14.

The extent of Russian banks’ asset quality deterioration, their loss absorption capacity and contingency recapitalisation plans are likely to be the main drivers of rating actions over the next 12 to 18 months. Fitch-rated banks reported an average 14% impaired loans (5% non-performing and 9% restructured) at 1 June 2009, up from 10% (3% and 7%) at 1 March.

“However, management figures prepared at a still relatively early stage of the credit downturn are unlikely to fully capture the eventual full extent of asset quality problems,” says Alexander Danilov, Senior Director, Fitch’s Financial Institutions group in Moscow. “The gradual deterioration of banks’ asset quality metrics is likely to continue during the second half of 2009 and into 2010.”

Fitch had previously stated that it expects impaired loans at Russian banks to reach 25% in a base case scenario, resulting in ultimate loan losses of 12.5%. Under a more pessimistic scenario, impaired loans could reach 40% resulting in loan losses of 24%.

Fitch ranked the loan loss absorption capacity of the 57 rated Russian banks to demonstrate their relative vulnerability to loan losses. The agency assessed the banks’ loss absorption based on the maximum reserves to loans ratio they could have sustained at 1 June 2009 without breaching minimum regulatory capital requirements. However, Fitch notes that a lower or higher loss absorption capacity, as defined by this measure, does not automatically mean that a bank is more or less vulnerable to potential loan impairment, as credit losses at individual banks may significantly diverge from Fitch’s average sector assumptions.

For 10 of the 57 banks – VTB24, Rossiya, Bank of Moscow, Swedbank (Russia), VTB, Moscow Bank for Reconstruction and Development, AK Bars, Rosbank, Orgresbank and Unicredit (Russia) – the maximum reserves/loans ratio is below 10%, and Fitch thus regards these banks’ loss absorption capacity as currently weak. However, Fitch notes that the capacity of two of these banks – Bank of Moscow and VTB – should strengthen significantly as a result of upcoming equity injections, and that most of the other eight banks also have relatively strong shareholders, which the agency would expect to contribute new capital in case of need. Fourteen of the banks reviewed had moderate loan loss absorption capacity (a maximum reserves/loans ratio of 10%-15%), while capacity was significant at 14 banks (15%-20%), solid at 11 (20%-32%) and strong at eight (more than 32%).

Banks’ loss absorption capacity has increased significantly in recent quarters as they have received new capital, albeit mainly in the form of subordinated debt, and cut back on loan growth. However, this capacity still remains moderate on a sector basis relative to potential credit losses.

“The recently approved government programme to support banks’ tier 1 capital, if successfully implemented, could help to make recapitalisation a manageable process,” says James Watson, Managing Director, Fitch’s Financial Institutions group, “Defaults would still be possible, in particular at banks with major asset quality or corporate governance failures, although recent government actions suggest a determination to avoid destabilising, unmanaged failures at larger institutions.”

The report, entitled ‘Russian Banks: Measuring Their Loss Absorption Capacity’, focuses mainly on asset quality deterioration trends and banks’ loss absorption capacity. It follows and expands on the July 2009 presentation, entitled ‘Asset Quality Problems Weigh on Russian Bank Ratings’, which provided a summary of Fitch’s sector wide credit loss expectations and recapitalisation requirements. The report and presentation are available at

Contacts: Alexander Danilov, James Watson, Moscow, Tel: +7 495 956 9901.

Media Relations: Marina Moshkina, Moscow, Tel: +7 495 956 9901, Email:; Hannah Warrington, London, Tel: +44 (0) 207 417 6298, Email:”

Russia-Turkey deal: the Czars would be jealous

August 7, 2009
Peter the Great sought a warm-water port on the Black Sea.  Source:
Peter the Great sought a warm-water port on the Black Sea. Source:

The NYTimes published an article today detailing a set of energy deals concluded between Russia and Turkey in Ankara, with Prime Ministers Putin and Erdogan present.  The deal was with Russian energy giant Gazprom, allowing state-owned Gazprom access to Turkish territorial waters, a benefit Russian czars and party chairmen since Peter the Great (pictured above — who ruled Russia from 1682-1725) have sought by force (or threat of force).  Now, in true “Western” fashion, Russia, Inc. is signing a business contract that provides benefits to Turkey as well.  Turkey desires to become an energy hub and has obtained a Russian commitment to build a pipeline across its territory.

The Times article explains how Western interests have competed with Russia for energy agreements with Turkey in order to avoid Russian dominance of the Eurasian energy pipeline system, and the consequent vulnerability of energy-hungry Western Europe.  Russia has used pipeline cutoffs before for political purposes, e.g. with the Ukraine.

Turkey for its part, with a less pro-Western government than heretofore, headed by the moderate Islamist AKP party, probably does not mind playing what the Brits over a century ago called, “the Great Game,” or the Great Power competition in the East.  Has Vlad the Great bested Peter??

Barack Obama: Naif or Visionary?

July 7, 2009

President Obama in Prague earlier this year calling for nuclear disarmament.  Source:

Slip back for a moment to the early 1980s.  The Reagan administration was talking about a winnable nuclear war.  Reagan himself called the MX missile the “Peacekeeper Missile,” a powerful multiple warhead nuclear weapon some interpreted as an effort to obtain a “first-strike capability.”  Orson Welles, that powerful cinematic presence, ambled up to the podium, with the assistance of a cane, on a sunny day in Central Park in June 1982, to address thousands in the Nuclear Freeze movement.  Activists opposing Reagan’s foreign policy, including this blogger, marched from the Lincoln Memorial to the Pentagon in 1981, chanting “No draft, no war, U.S. out of El Salvador!!”  When mounted police trotted alongside the marchers, some began chanting, “Free the horses!”  It was the 1980s, but we wished it was the sixties.

Obama has said he came of age during the Reagan presidency.  So did I.  For many years, I wore a T-shirt I purchased at the Nuclear Freeze rally that had a picture of our blue planet on it, with words above, “Don’t Blow It!”

Barack Obama, spending his last two college years at Columbia University, wrote an article in 1983 profiling two anti-war groups on campus, which is attached and currently making its way around the web.  In addition, he wrote a paper for a poli sci class, for which he received an ‘A’, on how he would negotiate nuclear weapons reduction with the Russians.   This week he will have a chance to implement that paper.  Dreams come true for some of us.

A NYTimes article today explains how Obama’s thinking on nuclear weapons has evolved over the years since that article and poli sci paper.  It suggests that at core he, like Reagan ironically, wants to eliminate nuclear weapons from the planet.  (Read his Prague speech on the matter.)  Yet today, he’ll settle for negotiations with the Russians for nuclear weapons reductions and for efforts at non-proliferation. 

He is a remarkable fellow, our president, with so much confidence and affability that he convinces people to do things.  This is a presidential quality.  A quality W woefully lacked.  I am impressed by the fact that the Russians, in advance of Obama’s trip, have agreed to allow U.S. military overflights to resupply NATO in Afghanistan.  Gobama!!

I just hope that over the years since the early eighties, Obama has come to grasp the complexities and ironies of interstate relations and the way nuclear weapons factor in to whether states make war or peace.  A study of these issues can be emotionally-unsatisfying, especially to a utopian wishing to put an end to the “twisted logic” of national security, bemoaning the “academic discussion of first versus second strike capabalities,” and attempting to confront “the relentless, often silent spread of militarism in this country.”  It’s okay, Mr. President, we all wrote like that in college.  

For the record, militarism is what happened in pre-World War I Germany, as the German General Staff, backed by the Kaiser, virtually hijacked that country; it is not at all what has taken place in America since George Washington turned down the opportunity to become a military dictator. 

The question is, now that Barack Obama is the leader of what he called in 1983 the “military-industrial interests, as they add to their billion dollar erector sets,” can he make the best decisions on weapons systems and force posture that will make the world safer?   

Although nuclear weapons are a horrible reality, they have arguably reduced great power conflict since the end of World War II.  While we hate having this threat hanging over us, it is one of the ironies of being human that it is exactly this threat of mutual destruction that has deterred nuclear-armed states from going to war.   So, President Obama’s goals of reducing nuclear weapons and staunching proliferation make sense, but we must be very careful when talking about nuclear disarmament.  The reality is that if all the peace-loving major powers disarmed, the technology remains out there, the genie is out of the bottle.  Some nasty power some time in the future (need I name names?) could and would build such weapons.  Would we have a deterrent to their use or threatened use of such weapons at that time? Could we develop one quickly? We must tread carefully in this area.  The disarmament and arms control efforts of the liberal democracies in the thirties occurred against the backdrop of Germany’s secret arms buildup, leaving them unable to confront Hitler in 1939.

Furthermore, those of us who opposed the Reagan arms buildup must admit that what Reagan (and George Kennan and Paul Nitze) had hoped would happen happened!  We bankrupted the Soviet Union through an arms race, and that nasty dictatorship withered away.  Was it worth the risk?  Maybe not.  The risk of nuclear war probably increased during the eighties because of the subtle shift in the balance of first strike/second strike capabilities, what Student Obama scorned in 1983.  If rasher men had been running the Soviet Union at the time, they could have interpreted Reagan’s commitment to the MX missile and other weapons systems, in conjunction with statements by such luminaries as Cap Weinberger, as an effort to obtain a first strike advantage, an ability to wipe out your adversary in a first strike so as to sustain only a modest second strike against yourself.

Back to today, the disagreement that Obama has had with his Secretary of Defense, Bob Gates, over whether to modernize our nuclear arsenal, warrants careful consideration.  As the guy calling for nuclear arms reduction and wishing to build alliances through the power of America’s example, Obama does not want to build new “erector sets,” especially when he’s announcing expensive domestic spending initiatives.  Yet it is important for the U.S. to stay at the technological edge in military preparedness, especially as regards weapons that improve defense and deterrence.  I’m not saying that Gates’s initiative is the right one, only that policy makers must choose which technologies will be critical to America’s security and a safer world.  Yet Obama’s priority seems to be, simply, to not build any more nukes.  

The NYTimes article speaks about a class on presidential decision-making at Columbia that was formative for Student Obama, in which he wrote a paper on how to conduct nuclear arms negotiations with the Russians.  I took a course around the same time at Tufts University that was formative for me, called War and War Prevention, taught by Stephen W. Van Evera, now a professor at MIT and author of an important book, Causes of War:  Power and the Roots of Conflict, that I hope Obama and his national security team have studied.  The book’s conclusion: policies that strengthen a nation’s capacity to defend itself, rather than conquer other nations, make the world safer by convincing leaders the world over that conquest is difficult.  So, disarmament doesn’t usher in a safer world, arming with the right armaments, defensive armaments, does.  The book also suggests that misperceptions about this “offense-defense” balance have been a leading cause of wars throughout history, notably the catastrophic World War I.  Therefore, transparency, policy clarity and the disinterested analysis of national security by people outside government would reduce the risks of misperception. 

Ironically, nuclear weapons have bolstered the defense, by discouraging would-be attackers.  It is a depressing thought that the most horrible weapon in history has had a silver-lining, just as the most hopeful prospect – disarmament – has helped cause war.   For a greater understanding of why human affairs involve so much contradiction, we must, alas, turn to Mr. Freud, who last century theorized that two instincts drive human beings – the love and death instincts.  The love instinct (libido) drives us to build and the death instinct to destroy.  President Obama is definitely a builder.  He should just relegate his utopian visions to their proper place on the back burner, so that he can take a hard look at defense policy, formulating one that will promote American security and peace in the world.  The Van Evera book is a starter…

Are Status-quo Powers’ AAA ratings vulnerable?

June 11, 2009

Standard & Poor's Logo    Source: Bloomberg

S&P thinks so.  Moody’s and Fitch do not.

Actually, it is more nuanced than that.  A number of what we might call Status-quo or even declining, though still formidable, great powers — including the U.S., U.K., Germany and France – have sustained dramatic negative consequences from the global recession, including rapidly rising government debt levels.  It is a time of testing our assumptions about what makes a great power, what makes a strong economy, and what makes a wealthy society.  And, however painful, we must revise our assessments of relative power and sovereign creditworthiness as needed.   

No doubt such rising powers as China, India and Brazil are poorer – especially in terms of per capita income, but among advanced countries, the economic growth outlook over the medium term looks dismal, as government seeps into more corners of the economy, controlling banking systems and industrial companies, which if not reversed, could eventually stifle private initiative.  In addition, if gaping government deficits are reversed over the medium term via higher taxes, rather than through spending cuts, the government’s stranglehold on the economy will persist.  No matter what, things should get a lot worse before they get better.  Whether or not they get better is in the hands of policy makers.

The U.S. and its allies in Europe are undergoing exactly what Paul Kennedy warned against over twenty years ago in his book, The Rise and Fall of the Great Powers.  Sovereign financial solvency is the foundation on which military and political power can be projected, and this foundation crumbles when governments ignore deteriorating finances.  Governments today must act quickly to cut deficits, once signs of a durable recovery are clear.

The rating agencies remain relatively sanguine.  With the exception of S&P, they don’t expect the major countries to lose their coveted AAA status, as Japan did over a decade ago.  Moody’s even points out that if all AAA’s deteriorate together, they can all remain AAA because ratings are comparative.  However, what is required right now is to compare these AAA’s to lower-rated credits, for example, to such emerging markets as China and Singapore, Hong Kong, Korea and Saudi Arabia.  In spite of what a revision of the relative assessment of, say, the U.K. versus Kuwait might say for how wrong sovereign analysts were in the past, this reassessment must be done.

As for the U.S. and the U.K., the two economies experiencing the textbook example of the current crisis — with declining real estate values, indebted consumers, and failing banks — Fitch Ratings says they:

“possess strong capacity for adjustment, thanks partly to supply-side flexibility, a track record of fiscal consolidation, as well as exceptionally strong balance sheet and financing flexibility.”


 “Benchmark borrower and reserve currency status are two key features of this financing flexibility.”

 About the U.K. and the U.S., Moody’s says, they:

 “are being tested because of a shock to their growth model and large contingent liabilities. However, in our opinion, these countries display an adequate reaction capacity to rise to the challenge.”

Yet S&P a couple of weeks ago revised the Outlook on the U.K.’s AAA rating to Negative, saying that:  

“in light of the challenges to strengthen the tax base and contain public expenditures, the U.K. government debt burden could approach 100% of GDP by 2013 and remain near that level thereafter. The rating could be lowered if we conclude that, following the forthcoming general election, the next government’s fiscal consolidation plans are unlikely to put the U.K. debt burden on a secure downward trajectory over the medium term.”

S&P, in its report of June 4, forecasts the U.K.’s government debt burden to rise above most other AAA’s, including the U.S., by 2011.  Although the U.K.’s exposure to the current crisis is similar to America’s, its boom in credit to the private sector surpassed that which occurred in the US, with domestic credit to the private sector (and public corporations) representing approximately 200% of GDP in the U.K. versus approximately 150% in the U.S. and a AAA median closer to 130%.   The run-up in U.K. government debt is expected to be even more dramatic than in the U.S.   

Likewise, the U.K.’s GDP growth outlook looks worse in the coming years than its AAA peers’.

Paul Kennedy warned us that “The relative strengths of the leading nations in world affairs never remain constant, principally because of the uneven rate of growth among different societies and of the technological and organizational breakthroughs which bring a greater advantage to one society than to another.”  And, that history shows, “a very significant correlation over the longer term between productive and revenue-raising capacities on the one hand and military strength on the other.”

Kennedy argued that:  1) competition and commercial advances in western Europe in the centuries up to the 16th allowed this region to eclipse other power centers – Ming China, the Ottoman Empire, Mogul India, Muscovy, and Tokugawa Japan – which suffered from excessive centralization of authority; 2) the Habsburgs over-extended themselves militarily relative to their weakening economic base in the 150 years up to the mid 17th century; 3) Great Britain emerged as an economic superpower and a military power that could balance rivalries in Europe, by virtue of innovation in banking, shipping and manufacturing; 4) rapid shifts in economic power up through the turn of the 20th century made for unstable relationships among the rising and status-quo powers; and 5) the the U.S. economy has been in relative decline since the middle of the 20th century with the emergence of the rising powers. 

 The more rapid the shifts in relative power, the more unstable the international system can be – risking war – as the distribution of authority and responsibility rushes to catch up with power realities.  The relative decline of such powers as the U.S. and Europe over the long term cannot be avoided, as poorer nations such as China gain technological know-how to rapidly increase per capita income.  However, the speed and size of the relative decline and its management (i.e. through diplomacy) will determine how shocking this change will be (i.e. through war or through peace). 

Which is all to say that AAA sovereigns, such as the U.K. and U.S., would be well-advised to seek substantive fiscal consolidation (read: cut deficits, especially through spending cuts), once there is confidence the worst of the financial crisis is over.

See:  Standard & Poor’s report on the United Kingdom of June 4, 2009, Moody’s report “How Far Can Aaa Governments Stretch Their Balance Sheets” of February 2009, and Fitch’s report “High-Grade Sovereigns and the Global Financial Crisis” of March 17, 2009.

Are people happy in the Rising Powers?

May 11, 2009

OECD Quality of Life Ranking: Subjective Wellbeing.  % of respondents reporting high evaluation of their life, in the present and future.

Among residents of the BRIC nations, Brazilians are the happiest, followed by Russians, whereas the Chinese are the least happy, followed by the Indians, according to a recent OECD report.

The OECD released its 2009 Factbook with charts and tables of economic and social indicators for its 30 members, countries “committed to democracy and the market economy,”  as well as other countries, many of them applying for membership.  In it, the organization ranks countries based on the relative “happiness” of their citizens. 

The OECD used data from a Gallup World Poll conducted in 140 countries around the world last year, that asked respondents whether they had experienced six different forms of positive or negative feelings within the last day (per a Forbes article). Sample questions included: Did you enjoy something you did yesterday? Were you proud of something you did yesterday? Did you learn something yesterday? Were you treated with respect yesterday? In each country, a representative sample of no more than 1,000 people, age 15 or older, were surveyed. The poll was scored numerically on a scale of 1-100. The average score was 62.4.  The assessment was about happiness in the present and future.

Top ten OECD members in terms of life satisfaction were dominated by northern European countries:








New Zealand



High per capita income, low unemployment, a social safety net, a relatively short workweek, and democracy appear to be key determinants of happiness.  Yet culture could play a role as well, as does good family and community life.  One interesting aspect of the study was the divergence of present and future happiness perceptions in some cases (see chart), which could be a measure of a people’s optimism.  Brazilians appear to be an optimistic lot, with one of the highest evaluations of their future wellbeing among the 34 countries in the OECD report.

Wilsonianism Run Amuck?

May 8, 2009
Georgia, bounded to the west by the Black Sea, to the north by Russia, to the south by Turkey and Armenia, and to the east by Azerbaijan.  Abkhazia is the highlighted part of Georgia to the northwest.  Source:  Wikipedia
Georgia, bounded to the west by the Black Sea, to the north by Russia, to the south by Turkey and Armenia, and to the east by Azerbaijan. Abkhazia is the highlighted part of Georgia to the northwest. Source: Wikipedia
Since President Wilson enunciated his Fourteen Points during World War I, the principle of national self-determination has been an objective of the Western Powers.  The plethora of weak national states in Eastern Europe in the interwar years, and the temptation this gave a revanchist Germany to invade and a greedy Soviet Russia to divide the spoils tempered to some extent postwar Western support of national self-determination.  It remains a principle the world community supports…however selectively.

An interesting NYTimes article discusses the national aspirations of less than 100,000 ethnic Abkhaz in Georgia, a nation of 4.7 million (mostly ethnic Georgians), which finds itself hosting NATO exercises and therefore in a tense relationship with neighboring Russia.  Russia recognizes the independence of Abkhazia and South Ossetia.  Most every other nation in the world does not. 

The conflicts there are complex, with poor judgment taking place on both sides.  Abkhaz nationalists are seeking to attract some 500,000 Abkhaz living in Turkey to return and help build an independent state.  Ottoman Turkey invaded Abkhazia in the 16th century and converted the local population to Islam (versus the Orthodox Christianity of ethnic Georgians).  Interestingly, it seems much of the Abkhaz diaspora had fled Georgia in the 19th century to escape the rule of an expanding Czarist Russia.  Russia is now of course the principal benefactor of Abkhaz separatists.

So, where does our moralistic support of national self-determination of peoples begin and end?  The Abkhaz and South Ossetians? The Chechens? The Basques of Spain and France? The Kosovar Albanians?  The Palestinians?  The Tibetans and Taiwanese?  The Kurds, the Armenians, the Azeris?  The Sunni of Iraq?  The residents of Darfur and of southern Sudan? Kashmiri Muslims under Indian rule? Tamils in Sri Lanka?  German speakers in the Italian Sud Tirol?   Difficult questions affecting minorities in some Rising Powers, as well as the world’s other powers who have to formulate policies balancing the principle of national self-determination against other interests.

Nato: Keep your eye on the ball

May 7, 2009

NATO in Georgia.  Source: AFP

Little kids want to live in a world where they get everything they want.  Parents teach kids that they can control only so much.  In AA meetings, recovering alcoholics quote the “Serenity Prayer,” attributed to theologian Reinhold Niebuhr:

God grant me the serenity

To accept the things I cannot change;

Courage to change the things I can;

And wisdom to know the difference.

Let us add to this – use your scarce resources to change the things that are important to change.  This would be a good prescription for the leaders of the North Atlantic Treaty Organization.

NATO should focus on what really matters to Western interests over the coming half-century:  arresting the proliferation of WMD; stopping Iran from acquiring the above; anchoring the Great and Rising Powers (including Russia and China) into Western institutions in order to more effectively resolve regional conflicts and other global problems; and, gently pushing human development in the direction of Fukuyama’s End of History. 

Ensconcing Georgia in NATO and other Western institutions is expressly not on this list of priorities (see NYTimes article).  Sure, it would be nice to have Georgia in NATO.  Likewise it would be nice to have Russia in NATO, Kissinger’s point that alliances must be against someone notwithstanding.  But, as adults we must realize that we cannot have it all.  America’s unipolar moment of the nineties gave us a false sense of our power.  Let us therefore refocus our priorities on what is important.  We can debate the latter, but let us at least open the debate.  This is change we can believe in.

I understand the notion of not caving into Russia on every action they take in their so-called “near-abroad.”  However, I wonder if NATO could have quietly “postponed” the military exercises in Georgia (which are part of its Partnership for Peace program, a name that probably appears like doublespeak to the Great Powers not participating, much like Ronald Reagan’s MX “Peacekeeper” missile). 

Mikheil Saakashvili, the president of Georgia who behaved irresponsibly last summer in that country’s conflict with Russia, is bolstered by the seeming Western support of his objectives.  A report on NATO’s exercises in Georgia appeared on the front page of China’s Xinhua news agency’s web site.  Are these military exercises in Georgia critical to the security of NATO’s members, and by undertaking them, are we encouraging Russia and China to help us (the West) achieve our priorities?  Read what NATO has to say about its relations with Georgia.

Great Powers: Maintain sound public finances

May 4, 2009

Democracies with weak and/or fragmented party systems seem to produce sub-optimal public policies, including heavy government debt burdens.  From Israel to India, Italy to Japan, Brazil to Belgium, governing coalitions held together by paying off key constituencies have yielded chronic deficits and high debt.  By contrast, countries with a small number of strong political parties – usually ideologically-based — that can form stable governments have tended to mind the public purse better (e.g. the U.S., U.K., Germany, and Mexico are examples). 

Some countries with fragmented multi-party systems have been moving in the direction of two or three ideological groupings in recent years, which could be a positive development.  This has been the case in India, Italy and Japan, with some promising signs in Brazil.  This year the financial crisis will continue to unfold, and elections are taking place in such Rising Powers as India and Indonesia.  The conclusion that weak coalition governments produce fiscal irresponsibility will no doubt be tested. 

Recent debt/GDP ratios of selected countries:

India                77%

Brazil               65%

Indonesia        32%

Mexico            31%

Japan              180%

Israel               76%

Italy                103%

Belgium           88%

U.S.                  62%

U.K.                  50%

Germany         64%

Note: Debt/GDP ratios are not strictly comparable, as wealthier countries have a higher “debt tolerance.”

Weimar Germany was the poster child of a weak democratic system.  Electoral and legislative rules hindered the formation of stable governments, and therefore the public had little faith in democratic government.  To avoid the errors of the past, the architects of Germany’s postwar constitution, the 1949 Basic Law, erected a system that balanced fairness with effectiveness.  It was a mixed proportional representation/first-past-the-post system that excluded parties garnering less than 5% of the popular vote from the legislature and produced two large, ideologically-opposed parties of the right and the left.  Stable governing coalitions alternated in power. 

Konrad Adenauer, postwar Germany’s first chancellor


Konrad Adenauer, one of postwar Germany’s architects, and his Christian Democratic Union were able to govern West Germany democratically and effectively from 1949 till 1963, two years longer than his totalitarian predecessor.  His center-right CDU/CSU and the center-left SPD have largely governed Germany ever since.  Currently, these two strong parties cooperate (to some extent) in a grand coalition, but will head back to the polls this fall to see if they can oust their opponents from power.  Germany’s constitution has worked so well that democratic reformers the world over consider adopting portions of it.

The logic of the two-party, or nearly two-party, system is that if one party mucks up the economy while in power, the voters will “throw the rascals out.” Hence, the incentive to mind the public purse.  On the other hand, if a party’s survival in power is based less on success at the polls and more on maintaining complex coalitions, then the dominant coalition partner will be more interested in using the public purse to buy off smaller parties than in maintaining fiscal prudence. 

This is exactly how the State of Israel functions.  In its February 2009 election, the largest party, Kadima, only garnered 22.5% of the vote.  With twelve parties in the Israeli legislature, the six smallest obtained only 2.5%-3.4% of the popular vote apiece.  The German constitution (and by the way, newly reformed Italian electoral rules) wouldn’t even seat these parties.  It can be argued that Israel’s system is fairer, giving voice to the country’s diversity, but it is not very effective.  Only during Ariel Sharon’s popular rule beginning in 2001, when his party reached close to 30% of the popular vote (quite high in Israel), was his strong finance minister, Benjamin Netanyahu, able to implement reforms to public finances that reduced the deficit and got the debt/GDP ratio on a downward trajectory.

Italy functioned in much the same way until the reforms of the mid-1990s.  Belgium, Brazil and India have functioned this way as well, with public debt levels rising as a result.  Although Japanese politics has long been dominated by one party, the center-right LDP has for all intents and purposes engaged in coalition politics and a consequent public spending spree. The LDP is a collection of personality-based factions, interest groups, local constituencies, and patron-client relationships.  As a result, by opening up the public spigot, the LDP holds together these factions, keeping itself in power. 

Interestingly, the U.S. is embarking on a very large increase in its public debt, and this will occur in a two-party system with one party now overwhelmingly dominating two branches of government.  This must be seen as an aberration, however, an exception to the rule, given the size of the fiscal stimulus required to prevent a collapse of the financial system and to support sagging demand.  This unprecedented increase in public outlays is not being implemented in order to keep a coalition together.  Nevertheless, should the Democrats not act quickly, once the economy rebounds, to re-establish fiscal rectitude, an adjustment that will be very painful, then the government’s credibility will suffer, foreign investment will slow, the dollar will fall, interest rates will rise, and American voters will “throw the rascals out.”

As for India’s election, as spelled out by my colleague, David Kampf, the world’s largest democracy is in the midst of a month-long national election that will be tallied on May 16.  Some commentators believe that the two large parties, the center-left Congress Party and the center-right BJP Party, will lose ground to smaller and regional parties.  This will put pressure on the coalition leaders to spend their way into power.  Rulers of Rising Powers be forewarned: history shows that a sustained mismanagement of public finances often precedes the decline of nations.

Charm Offensive

April 1, 2009


 Source: The New York Times

Source: The New York Times

President Obama has a packed schedule of summit meetings.  Today he met with President Medvedev of Russia, reported on in the New York Times, and employed his considerable charm to try to move the Russians toward accepting the quid pro quo of the U.S. giving up missile defense in Eastern Europe in return for help from Russia in preventing an Iranian acquisition of a nuclear weapon.  Where Bush used bluster, Obama uses charm.  Thank God for our system’s alternation in power so we can try out new diplomatic strategies.  One risk with President Obama’s quid pro quo strategy with the Russians is that, in return for giving up missile defense, we may get vague promises on Iran, which we in fact already have.

You might do the same as Putin…

February 7, 2009

By  Roger M. Scher

January 25, 2008  

…if your empire had been dismantled and your great nation humiliated. 

It is common practice in the West to bemoan the autocratic, obstructionist bully that Putin’s Russia has become.  Yet there is another viewpoint policymakers would do well to acknowledge.  The FT article below is a piece I wish I had written, but alas Quentin Peel beat me to it.  It contains the Russian view on international relations in the post-Cold War period. 

According to this view, Western leaders have made a strategic blunder, missing an opportunity to work closely with post-Soviet Russia toward building an effective world order.  The West has been unable to resist the temptation to extract the maximum benefit from victory in the Cold War by signing everyone but Russia up to its clubs, NATO and the European Union. Russia’s long history as a great power, its grip on world energy resources, and its desire to be treated with respect have been dismissed by most Western leaders.  Instead of pursuing a foreign policy of goodwill, instead of playing the magnanimous victors, as the European powers did when they brought post-Napoleonic France into the Concert of Europe in 1818, the West could not resist extending its influence to Russia’s borders. 

The West’s assertive policy toward Russia has not only entailed bringing the Polands and Hungarys of central Europe into the fold, but also the Latvias and Estonias, former Soviet republics now NATO members.  NATO is attempting to station an anti-missile shield in Poland and the Czech Republic, despite opposition from Russia. Russia alone was not asked to join NATO.  Remember Kissinger’s remark a few years ago about NATO expansion: alliances are meant to be against somebody (i.e. Russia).   

Western meddling has likewise extended to the Ukraine and Georgia, where Russia has had claims for more than two hundred years.  The West has openly supported the Kremlin’s political opponents in and held out the prospect of NATO membership to these nations.  NATO has sought military bases and other defense arrangements in a number of central Asian republics on Russia’s eastern flank.  Anyone who has studied the Cold War and ‘the sources of Soviet conduct’ knows that, since the czars (and at least since the Crimean War in the mid-19th century when France and Britain brought Russia to its knees), Russia has been a little sensitive about being surrounded.  Add Napoleon’s and Hitler’s all-out invasions of Russia, Russian defeat by the Japanese in 1905, and Western intervention against the Bolsheviks in 1920, and you can perhaps understand Russian prickliness. 

No wonder Russia is selling sophisticated arms to Syria and Iran.  The failure of Western diplomacy to limit Iran’s acquisition of a nuclear weapon indicates just what a strategic blunder not cooperating with Russia has been.   

True, there is more to the story than a maltreated Russia, including the notion that Vladimir Putin has become a modern-day czar – inept and authoritarian.  Even so, policymakers in the West would be well-advised to study Peel’s article below, especially the quotes from Russian leaders, for insight into the current state of the Russian heart…


How Russia is reasserting itself

By Quentin Peel

Published: July 31 2007 19:18 | Last updated: July 31 2007 19:18

Vladimir Putin is not a man who pulls his punches in public. By all accounts the Russian president is a cautious bureaucrat in private, carefully weighing up all the options before reaching any decision. But in front of a domestic audience he often slips into harsh language, even street slang, to get across his message.Thus it was two weeks ago, when he received a delegation of leaders from Nashi, the pro-Kremlin nationalist youth movement, at his dacha at Zavidovo outside Moscow. Speaking of the diplomatic confrontation between Britain and Russia over Moscow’s refusal to extradite the suspected murderer of Alexander Litvinenko, the former Russian agent poisoned with radioactive polonium in London, Mr Putin suddenly switched from calm analysis to harsh words.

“They are making proposals to change our constitution, which is insulting for our nation and our people,” the president declared at the televised meeting. “It is their brains, not our constitution, that need to be changed.”

Mr Putin’s coarseness contrasted with his earlier dismissal of the affair as a “mini-crisis”. But it was in keeping with a much more assertive Russian stance on foreign policy. It also reflected the bitterness of the Russian elite at perceived western indifference, or even condescension, towards their efforts to reform the system and abide by a written constitution.

“We deserve to be treated as normal,” says a former top Kremlin official. “The US and the west have been making a fantastic mistake with Russia for the past 15 years. For a long time we were ready for normal co-operation. When we chose democracy and the market economy, we changed the world. We made it a safer place. But what did we get in return? The west pushed Russia aside. They did not understand it. It was a huge stupidity and a missed opportunity.”

Is it the west that has mishandled a Russia bent on becoming normal, or is it Russia that is falling into old Soviet habits – of mistrusting the outside world and seeing anti-Russian conspiracies on all sides? Russian liberals and western critics see the all-pervasive influence of the siloviki – present and former members of the security services, such as Mr Putin himself – as central to the new mindset. They see enemies all around. At the same time, Russian self-confidence has soared with rising revenues from oil and gas. So does the new nationalism represent a fundamental change, or is it just tactical – with an eye on parliamentary and presidential elections in the coming months?

The Russian perception of an ungrateful and unfriendly west was the focus of a private trip to meet senior US officials in Washington last year by Alexander Voloshin, former chief of staff to both Mr Putin and his predecessor, Boris Yeltsin. “Voloshin spelt out all the concessions made by Moscow,” says Dmitri Trenin, deputy director of the Carnegie Moscow Centre. They included closing its intelligence-gathering post in Cuba, another base in Vietnam, and – after September 11 2001 – giving a green light for the US to use air bases in central Asia to support the invasion of Afghanistan.

“He told them Putin was miles ahead of the pack in the Kremlin,” Mr Trenin says. “But in return, what did we get? Nato in Kosovo, the Orange Revolution in Ukraine and the Rose Revolution in Georgia. The US response to Voloshin was: ‘So what?’ They simply batted him away. That was the last straw for Putin. He decided that to get the attention of the US by continuing to play Mr Nice was a losing proposition. He stopped being Mr Nice and started playing Mr Nasty.”

That heralded Mr Putin’s speech to the Munich Security Conference in February, when he fiercely criticised US foreign policy, including the siting of missile defence units in Poland and the Czech Republic, and attacked Nato enlargement as a hostile gesture. Fyodor Lukyanov, editor-in-chief of Russia in Global Affairs, Moscow’s leading foreign policy periodical, sees the switch as a “completely new stage in Russian development, underestimated in the west. Since the Munich speech, or a little bit later, there is a new approach: that we do not compromise.”

He says that will be true of Russia’s rejection of the US- and European Union-backed plan for the independence of Kosovo and of Russia’s decision – announced by Mr Putin last month – to abrogate the Conventional Forces in Europe treaty. “The rejection is absolute,” he says. “There will be no movement.”

Mr Lukyanov thinks the new foreign policy stance goes beyond mere truculence. He sees an attempt by Mr Putin’s team in the Kremlin, and at the foreign ministry, to spell out a new ideology of international relations just as they are seeking to forge a new political platform for the forthcoming elections at home.

The turning point was the confrontation in April between Russia and Estonia, its tiny Baltic neighbour, when the Estonian government decided to move a Soviet-era war memorial and the bodies of the soldiers buried beneath it. At the time, members of Nashi attacked the Estonian embassy in Moscow and blockaded border posts. Russian oil stopped flowing through Estonian ports and an electronic blitzkrieg was launched against Estonian websites.

“Russia tried to demonstrate in this unfortunate way that there are values that we will defend. It was the first time when not just interests but values mattered,” says Mr Lukyanov.

The most substantial statement of the new thinking was given by Sergei Lavrov, foreign minister, in an article supposed to be published last month in Foreign Affairs, the US magazine, but then suddenly withdrawn by the minister amid accusations of US censorship (firmly denied by the editor). Mr Lavrov wrote that US unilateralism had failed and that Russia was competing with it in an international market of ideas. “As globalisation has extended beyond the west, competition has become truly global,” he wrote. “Competing states must now take into account differing values and development patterns. The challenge is to establish fairness in this complex competitive environment.”

Mr Lukyanov sees parallels with neo-conservative thinking in the US, including close ties to religion, in the shape of the Russian Orthodox church. He cites one passage edited out of the article as saying that unipolarity – having the US as sole superpower – is “contrary to God’s order”.

Says the Carnegie centre’s Mr Trenin: “There has been a rise in internal self-confidence. Putin is a real tsar. He does not have to look over his shoulder. The Kremlin is fully sovereign in the country and we are one of the few truly sovereign states around the world, along with the US and China.”

He says the confidence of Russia’s leaders now exceeds that even of the Soviet leadership in the 1970s, when the US finally accorded Moscow equal status in political and military affairs.

Russia wants respect for its differences – whether it is the system of “managed democracy” that has seen the creation of two artificial pro-Kremlin parties to dominate the State Duma, or the peculiar sort of market economy it has introduced, combining a free-for-all in wealth creation with rules favouring state-controlled companies. Both attract strong criticism in the west, where they are seen as falling far short of genuine democratic or market standards – quite apart from the underlying influence of the security services.

Is Moscow’s new self-confidence well-founded? The most important factor is Russia’s economic performance. Since he came to power in 1999, Mr Putin has presided over a remarkable period of recovery, which has seen per capita incomes return to the level they were in 1990, just before the collapse of the Soviet Union.

The international assertiveness is also a reflection of growing election fever, with a parliamentary poll for the State Duma in December followed by elections to choose a successor to Mr Putin next spring.

A third element in the equation, however, is an underlying uncertainty that stems from the lack of transparent rules in both politics and the economy. No one knows who Mr Putin’s successor will be. Whoever it is, any change in leadership is likely to mean not just a change in power but in the people with access to wealth in or close to the Kremlin.

There is uncertainty about the economic outlook, too. “This period [of Putin’s rule] has been one of easy growth,” says Yevgeny Gavrilenkov, chief economist at Troika Dialog, Russia’s largest investment bank. “We have had a very favourable external environment, with low global interest rates, high commodity prices, cheap domestic energy and excess labour.” As a result, Russia boasts a healthy twin surplus on both the current account and the state budget. Growth of gross domestic product was running at an annual rate of 7 per cent in the first half of this year.

Mr Gavrilenkov warns, however, that the medium-term scenario is much more precarious. “Growth is driven by external borrowing, which reached a total of nearly $400bn in the first half of 2007. State-controlled companies such as Gazprom, Rosneft and Russian Railways are the major drivers. It is largely a result of the central bank’s effective guarantee of rouble appreciation and it is not sustainable. It was intended to get domestic inflation down, but it did not succeed. Inflation was 9 per cent last year and we are expecting much the same in 2007.”

One weakness is the failure of the state energy companies – Gazprom and Rosneft – to invest enough to boost their production to keep up with rapid overall economic growth. Gazprom’s output is rising at 1-1.5 per cent, and Rosneft’s by 3 per cent at most, Mr Gavrilenkov says. “I’m very sceptical about their ability to restructure.”

The former senior Kremlin official says that Russian business may not look pretty but he insists there is no going back. “The transition period may look like the gangster capitalism of the US in the 1930s, but in Russia it is an accelerated process,” he says. “There were gangsters in every restaurant in Moscow in the 1990s. They did not even try to hide it. Ten years have passed and you can find none of them. Half have been killed and half have become normal businessmen. Our democracy and our economy are far from perfect, but they are for real.”

The worry is that Russia may have just exchanged one set of gangsters for another – the siloviki surrounding Mr Putin. “If some of them take money, tomorrow they will think how to protect the money they have stolen,” says the former Kremlin insider – now working in a state-controlled enterprise.

“It is really important who will be next president,” says Mr Gavrilenkov. “At the moment, the president is trusted. The elite is happy. The bureaucrats are happy.

“Leaders are chosen to preserve the status quo: Gorbachev was chosen to save the Communist party. Putin was chosen by the oligarchs to secure their future. But neither succeeded. The same may happen if the next president is chosen by the siloviki. They may run the country but they are not united.”