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Jul 8, 2014 | 09:15 GMT

Stratfor's Third Quarter Forecast 2014

The jihadist war that has defined and confounded U.S. foreign policy for the past decade erupted again in the second quarter. Militants spread from eastern Syria to Mesopotamia in a bid to establish the emirate that Osama bin Laden could only dream of. But the United States is not about to be dragged into another sectarian conflict in the Islamic world. Washington cannot shut down the jihadist war through a direct military intervention, and it does not want to try again. The upheaval will not be confined to Iraq; weak governments from Damascus to Sanaa will struggle to quell the jihadists' call to arms.

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Applying the lessons of its recent wars, the United States will keep its distance from this conflict. Instead, it will use intelligence sharing and military support to strengthen indigenous forces and its war chest to draw local Sunnis away from the much more ambitious and destructive jihadist groups. As the jihadist war goes on, the world will see that it is no longer just between the jihadists and the United States. Distracted by larger foreign policy challenges farther afield, the United States will rely on regional players to manage the balance of power in the Middle East.

A key element of this strategy entails a U.S. settlement with Iran. We will not see a comprehensive deal this quarter, but with the Iraq conflict serving as another reason for cooperation between Washington and Tehran, progress will be made nonetheless. Though Russia has tried to keep the United States preoccupied with affairs in the Middle East, it has been unable to derail the U.S.-Iran negotiations. Moscow could also soon try to distract Washington in Iraq, but Russian meddling in the region will not deter the United States from shifting its strategic focus to the former Soviet region.

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In the next three months, the U.S.-Russia standoff will not be nearly as noisy as the events in the Middle East. As Stratfor's second quarter forecast predicted, the constraints on both Washington and Moscow have reduced their confrontation to a stable level. Russia will retain the option to increase or decrease pressure in its borderland with Europe but will be more restrained this quarter as it works to split the United States from its European partners and repair some of the damage done to the Russian economy. Romania and Poland are the key European players to watch as the United States tries to construct a regional alliance to counter Russia.

The Middle East will grab the headlines for now, but Stratfor is still tracking Europe's existential debate over how to balance national sovereignty and continental integration in a time of crisis. This question will be at the heart of the contest over European Commission appointments this quarter. The political process seems somewhat banal to observers outside Europe, but the debate points to much deeper fragmentation down the road.

At the same time, Russia will continue deepening its strategic connections with Asia to buffer itself against Europe and complicate the U.S. alliance network in the Asia-Pacific region. Enjoying this period of U.S. distraction, China will take additional steps to fortify its position in the South China Sea at the expense of Vietnam and the Philippines. Beijing will be careful to avoid a direct military confrontation yet will raise the risk of unintended collisions.

Latin America, meanwhile, is continuing along a more dynamic path. A developing U.S.-Cuba dialogue is raising the prospect of normalized relations between the United States and Venezuela down the line. Colombia is keeping the attention of investors as it moves ahead with peace talks, while Argentina is struggling to settle its debt with an eye toward more serious energy reform.

Middle East

Locator - Middle East - 2014

Middle East and North Africa

Iraq's Sectarian Challenge

Baghdad begins the quarter facing an emboldened Kurdish region, insurgent attacks and a growing dependence on Iran. Sustained by its strong base of operations in Syria, the Islamic State (formerly the Islamic State in Iraq and the Levant) has taken advantage of Iraq's porous border, sectarian tensions and an accommodating Sunni tribal network to further reduce Baghdad's tenuous hold on vast swaths of Iraq. The Islamic State and allied militant forces will remain a critical threat in Iraq's Sunni belt running from Anbar up to Ninevah and across to Salahuddin and Diyala provinces. Jihadists are unlikely to threaten the Kurdish north, Shiite south or the Iraqi capital militarily, though Baghdad will be vulnerable to insurgent attacks. Iraq's central and northern regions are at risk of fuel shortages this quarter, but oil production and exports in the south will remain insulated from jihadist activity.

Attempts to manage the threat will greatly hamper Iraqi government forces. Iraqi military forces securing the capital will shift their focus from limiting the Islamic State's moves in Anbar to pushing militants out of the region north of Baghdad, especially in and around Salahuddin province. This change in focus will only create more pockets for jihadists to spread across Iraq's Sunni territory. However, Baghdad will not be fighting this war solely with military means. The political negotiations with Iraq's Sunni tribal groups will be paramount this quarter as Baghdad and Washington work to undermine the Islamic State's local support network.

These talks are urgent, but Iraq's fractured political system will inevitably prolong the process of mobilizing a Sunni resistance strong enough to repel the Islamic State and its jihadist affiliates. Iraqi Sunni demands will cover such contentious issues as integrating Iraqi Sunnis into the military and security apparatus and securing a stake in oil production in disputed areas bordering the Kurdish region. Sunnis could also demand the removal of Iraqi Prime Minister Nouri al-Maliki, who will use the jihadist threat to fight for his political survival and delay the formation of a government. Regardless of who becomes Iraq's next prime minister, the resurgence of sectarian tensions caused by the Islamic State's offensive and Baghdad's deepening dispute with the Kurds will ensure that policymaking by any Shiite government in Baghdad will be highly polarizing.

With Baghdad sufficiently weak and distracted, the Kurds will offer security cooperation in exchange for greater autonomy over energy exports and acquiescence to their wider control over disputed areas in the north, particularly the oil-rich province of Kirkuk. Anticipating a threat from both Sunni jihadists and Iraqi government forces in this contested territory, Kurdish paramilitary forces known as peshmerga will preserve their strength this quarter and maintain a largely defensive posture in the north against the Islamic State. With Turkish backing, the Kurdistan Regional Government will try to increase northern oil exports through a pipeline running through Kurdish territory to the Turkish port of Ceyhan. Technical and political impediments will continue to limit these exports in the near term.

Besides an emboldened Kurdish north, Iraq's central authority is encountering a growing challenge in the Shiite south, where militias have mobilized with Iran's assistance to help repel the jihadist threat. Over time, the resurgence of Iraq's Shiite militias will exacerbate the fissures within the country's Shiite community. This dynamic will complicate Iran's efforts to consolidate Shiite power in Iraq under a strong, central authority and thus adds urgency to Iran's negotiations with the United States. 

Iran's Negotiations with the U.S. and Competition with the Saudis

Iran and Western powers face a looming deadline to either reach a negotiated settlement on Iran's nuclear program or agree to continue negotiations. We do not expect Iran and the P-5+1 group (the five permanent members of the U.N. Security Council plus Germany) to reach a final agreement by the initial deadline of July 20, but both sides will demonstrate enough progress in the negotiations to continue to work toward a comprehensive settlement. U.S. President Barack Obama will rely on his executive authority to reduce sanctions pressure on Iran, including relaxing enforcement of current trade and financial sanctions, in order to help Tehran's negotiating team maintain enough leeway within Iran to continue talks. Iranian energy exports could grow slowly toward the end of the quarter as Iran and its large Asian customers take advantage of the minor sanctions relief, but we still do not expect a wholesale lifting of oil sanctions on Iran or significant Western investment into Iran's energy sector this year.

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Saudi Arabia has had few occasions to scuttle the talks but has found opportunities to pressure Iran in Lebanon and Syria — and most recently in Iraq. We do not expect a shift on the battlefield in Syria that would either significantly strengthen or weaken the regime of Syrian President Bashar al Assad, though al Assad can be expected to use the threat of the Islamic State to try to maneuver into a negotiation with Washington via Tehran. While the Islamic State is focused on Iraq this quarter, the United States will be cautiously trying to prop up more moderate Syrian rebels in a strained effort to sever the group's supply line from its strongholds in eastern Syria. Hezbollah will maintain a large presence in Syria while preparing for another possible uptick in jihadist activity in Lebanon. The struggle between Riyadh and Tehran will continue to play out in Syria, Lebanon and Iraq even though the Saudis and Iranians have gingerly entered a diplomatic dialogue. The smaller Persian Gulf states, led by Oman, Qatar and Kuwait, will hold their own negotiations with Iran, independent of Saudi Arabia, as the region continues to evolve in anticipation of a U.S.-Iran deal.

Yemen could see an uptick in tensions along its northern border with Saudi Arabia. Amid growing sectarian and regional competition, clashes with jihadists in the area and Iran's support for al-Houthi rebels give Tehran another way to pressure Riyadh. Al-Houthi militancy, secessionist unrest in the south and al Qaeda in the Arabian Peninsula activity in the southeast will compound the already significant pressure on the government of President Abd Rabboh Mansour Hadi. Accompanying these security challenges are intensifying economic challenges: a growing deficit; regular shortages of diesel, food and water; countrywide electricity cuts; and attacks on oil and natural gas infrastructure carried out by disaffected tribesmen. Yemen is no stranger to high levels of instability, but the precarious security environment could clear the way for power grabs by former President Ali Abdullah Saleh and his loyalists, or by a combination of anti-government militants and tribes inspired by the Islamic State offensive in Iraq.

Turkey's Foreign Policy Comes with Risks

Turkey will tacitly back the Kurdistan Regional Government's territorial expansion in Iraq and northern oil exports, but it will also use the leverage it now has over Arbil to contain Kurdish ambitions for independence. Turkey already has a small military presence in northern Iraq that we expect will grow as Ankara draws a line between its strategic alliance with Arbil and its need to prevent the emergence of an independent Kurdistan. For now, Turkey's public endorsement of the Kurdistan Regional Government will work to the political advantage of the ruling Justice and Development Party, also known as the AKP, in the Aug. 10 presidential election. In his bid for the presidency, Prime Minister Recep Tayyip Erdogan will need Kurdish votes and a working relationship with Turkey's main Kurdish militant and separatist group, the Kurdistan Workers' Party, or PKK.

Iraq will naturally be the focus of Turkey's foreign policy this quarter, but other discussions on the Turkish periphery bear scrutiny. The United States wants to recruit Turkey as the southern anchor for a regional alliance to hem in Russia and thus will continue to help move along a slow-going negotiation in Cyprus that would reinvigorate Turkey's position in the eastern Mediterranean. Turkey will also continue to strengthen its relationship with Azerbaijan while reaching out to Turkmenistan, though discussions over energy links across the Caspian will not move beyond the preliminary stages.

Egypt Settles Down

For the rest of the year, Saudi Arabia and the United Arab Emirates will financially support newly elected Egyptian President Abdel Fattah al-Sisi. Their aid will help alleviate pressure on Egypt as it tries to move beyond the political uncertainties of the Arab Spring and into a stable working relationship between the military and its designated political leadership. This quarter, al-Sisi will try to form a civilian political establishment around his leadership while preparing for parliamentary elections. A few seats will likely be available for Islamist parties as the military, now more confident in its position, gradually begins to soften its stance on the Muslim Brotherhood.

Concentrating on getting its domestic stresses under control, the Egyptian government will have few means to influence another flare-up in the Palestinian territories. Israeli operations in the West Bank and Gaza, designed in part to keep the Palestinians divided, will undermine Cairo's effort to forge a Hamas-Fatah unity government. 

The military will stay focused on combating insurgents in Sinai and the Nile River Valley, but instability in Libya will also draw Cairo's attention. The chances of the Egyptian military moving large numbers of troops across its western border are remote. Instead, Cairo is likely to increase monitoring and counterterrorism operations along the border, especially if Tripoli begins to target militants more frequently to match rising regional pressure.

Security and Energy Challenges in the Maghreb

Libya's recently elected House of Representatives faces the daunting task of overseeing the drafting of the Libyan Constitution and organizing elections by the end of the year. With retired Gen. Khalifa Hifter's anti-Islamist movement shifting into a broader campaign against militants and with regional and tribal competition re-emerging across the Libyan political landscape, the body is more likely to focus on managing growing regional opposition and protests. The incoming government will trigger a new round of talks — and potentially a negotiated resolution — with rebel commander Ibrahim Jadhran, who has led longtime strikes at eastern oil terminals. Libya's propensity for strikes, protests and rejection of centralized authority will keep overall oil production and exports below capacity, and Tripoli will be incapable of guaranteeing stable oil production until the national government can secure oil fields and infrastructure on its own.

Algeria's outward focus for the quarter will be on managing the risks that the unraveling security situation in neighboring Libya poses. Algeria's security services have said Algiers' suspected involvement in backing Hifter's anti-Islamist campaign has increased the risk of a militant attack. While Algeria increases security operations along the Libyan border and in coordination with Tunisia, it will continue the negotiations with opposition political figures ahead of political and economic reforms that are expected to be announced by the end of the year. The government will especially focus on developing unconventional energy resources such as shale, but changes to hydrocarbon investment laws will likely be pushed beyond the time frame of the quarter. Any meaningful investment and exploratory work is likely to happen in 2015 at the earliest.

Former Soviet Union

Locator - FSU - 2014

Former Soviet Union

The economic and political repercussions of Russia's moves to defend its sphere of influence will begin catching up to it in the third quarter. Russia will still be able to apply pressure when necessary in its borderlands, particularly in Ukraine. During the next three months, however, Moscow will avoid a major escalation with the West to give itself time to repair its economy and will maintain a strong working relationship with France and Germany. 

Russia's Actions in Its Former Soviet Sphere

While still negotiating with Kiev and the West over the fate of Ukraine, Russia will continue to support low-level separatist activity in the country's east. Russia will pressure the Ukrainian leadership to grant more authority to the regions at the expense of the central government. Ultimately, Moscow will push for a neutral Ukraine, where Kiev makes no significant and lasting efforts to integrate with the West, including the European Union but especially NATO. How much the Ukrainian government concedes on these issues will determine the extent to which Russia will continue supporting separatists and using energy and other economic advantages against Ukraine.

Meanwhile, the European Union, Russia and Ukraine will continue to discuss the energy pricing standoff between Moscow and Kiev. The Kremlin can afford to drag out this negotiation ahead of the fall and winter months, when colder weather will boost consumption and Ukrainian and European customers downstream will need to refill their storage tanks. Russia will not, however, disrupt the supply of natural gas to the Europeans as the negotiation plays out over the quarter. 

Newly elected Ukrainian President Petro Poroshenko will attempt to shore up his own political support, primarily by moving forward with plans to call early parliamentary elections sometime in the coming months. Elections could shore up his position, but they also risk raising tensions among pro-Western factions and empowering eastern representatives who lost their influence in parliament with the ouster of President Viktor Yanukovich. Even without elections, Poroshenko will struggle to balance his pro-Western base, the more moderate pro-Russian elements in the east and the powerful oligarch class that supports said moderates. Overall, the Ukrainian government will remain hamstrung in its ability to cope with the country's economic pressures and anti-government forces on the ground, challenges that work to Russia's advantage.

Elsewhere in the former Soviet space, Russia will respond to the official signing of the EU association and free trade agreement by Georgia and Moldova at the end of the previous quarter. Moscow's reaction will include supporting opposition and protest movements in the countries, but demonstrations are unlikely to rise to the level seen in Ukraine. Moscow will also increase economic and security support in the countries' secessionist and autonomous regions, namely, Transdniestria and Gagauzia in Moldova and Abkhazia and South Ossetia in Georgia. Russia could go as far as offering the secessionist regions membership or associated membership in the Customs Union, but it will not annex the regions outright.

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Tensions will escalate this quarter in Central Asia. All of the Central Asian states are facing increasing economic problems, which will translate into security and political problems. As the Kazakh and Russian economies stagnate, the rest of the region, particularly Tajikistan and Kyrgyzstan, will feel the effects of higher inflation. The Kazakh government will introduce financial and investment measures in the third quarter to try to mitigate the country's economic slowdown, but there will be little impact this quarter. Meanwhile, with seasonal construction projects in Russia — typically a key source of employment for Central Asian workers — having slowed, Moscow has begun restricting Central Asian migrants from working in the country. Restrictions will translate into higher unemployment and fewer remittances for those Central Asian states. Border tensions and energy disputes are common among the Central Asian states, especially during the summer. As economic pressures grow, these flare-ups could be more serious than usual. Russia is busy in other parts of the former Soviet sphere, so any major instability in Central Asia will stretch Moscow's attention thin.

Russia's Interactions with Europe

Russia's political and economic relationships with France and Germany will help it prevent Europe from forming a united position on trade, security and energy ties with Russia. In informal negotiations with Germany over the future of Ukraine and NATO's role in Central and Eastern Europe, Russia has eased up on its opposition to countries such as Ukraine and Georgia signing the European Union's association and free trade agreement. At the same time, the emerging understanding between Russia and Germany is that Moscow will not tolerate a unified NATO response to Russian moves in the borderlands or any expansion of NATO in the region. The West will respect Russia's position this quarter, leading to more ambiguity than clarity about NATO's mission ahead of a NATO summit in Wales in September.

At the same, the United States will proceed with plans to increase troop rotations in Central Europe while the Baltic states, Poland and Romania actively push for a larger and permanent U.S. presence in the region. The U.S. presence throughout Central and Eastern Europe, while remaining narrow in scope, will spark more Russian military exercises and deployments in Moscow's sphere of influence.

The Europeans will continue to support limited political and economic integration with the likes of Ukraine, Moldova and Georgia. The European Union will also pay more attention to other former Soviet countries regarding energy diversification, particularly via the Southern Corridor. Azerbaijan and Turkmenistan, which the European Union has been lobbying to follow through with the long-discussed but politically controversial Trans-Caspian pipeline, will be key in this regard. Turkmenistan is reconsidering its position on sending energy supplies westward. Azerbaijan will continue balancing its energy relationship with Russia against its efforts to expand its Southern Corridor options. With both the West and Russia courting Baku, the Azerbaijani government will try to use the heightened attention to advance negotiations with Russian ally Armenia over the longstanding Nagorno-Karabakh dispute.

Russia's Internal Challenges

The other focus for Russia in the third quarter is its weakening economy. Russia is already feeling the financial effects of increased tensions with the West. Investment into Russia fell by 50 percent and capital flight exceeded $55 billion in the first half of the year. The Russian government has had to draw on its large currency reserves to stabilize the currency and markets. In the third quarter, the Kremlin will avoid significantly escalating tensions with the West, particularly with the Europeans, in an attempt to reinvigorate investment interest in Russia. In line with this effort, Russia will look toward nontraditional partners from Asia and the Middle East to invest in strategic sectors of the Russian economy.

Increased economic pressure will complicate Russia's ability to finance its large energy projects, particularly the Power of Siberia pipeline, the construction of which is set to begin this quarter. Russia will look to alternative plans for Power of Siberia, such as using a prepayment from China for natural gas deliveries to help finance the pipeline. The economic situation could also force the government to postpone plans to relaunch its privatization scheme in the second half of the year. Moscow is set in the third quarter to create a plan to tackle the country's regional debts, which have been skyrocketing. Such plans could involve either debt restructuring or bailouts. Finally, the bleak economic situation is exacerbating divisions among the Cabinet members and the security services. This will further distract President Vladimir Putin as he tries to take decisive actions at home and abroad.

Europe

Locator - Europe - 2014

Europe

The EU-Russia Standoff

Under pressure to balance between Russia and EU members in Central and Eastern Europe, Germany will continue its cautious approach in dealing with Russia. Berlin's reticence naturally will irritate some countries in Central and Eastern Europe, most notably Poland and Romania, that want more Western assistance. Poland and Romania are critical components of the slow-building Intermarium alliance in Central and Eastern Europe. During the quarter, Warsaw and Bucharest will continue to pursue a rapprochement with each other, but their engagement will be preliminary and rhetorical while Europe's conflict with Russia continues, albeit at a lower intensity.

To help strengthen Western, particularly American, interest in the country, Romania will begin the legislative process to reform the legal framework on the energy sector and attract foreign investment. The process will not conclude this quarter. Bucharest will be particularly concerned about events in Moldova, where Moscow will escalate political and economic pressure following Moldova's signing of the EU agreement. The Romanian government will increase its official and unofficial contacts with the Moldovan government to strengthen its influence in the country, but there is little Bucharest can do to prevent social unrest and protests in the country.

European concerns about Russia will continue to fuel the debate over defense spending in most countries from the Baltic Sea to the Black Sea. Proposals to increase spending will be mostly preliminary due to the summer recess, but a few countries such as Lithuania will actually approve increases in their military spending during the quarter.

NATO membership will be much debated during the electoral campaign in Sweden, but Stockholm is unlikely to join the military alliance. A similar scenario will play out in Finland, where the NATO debate will be high on the political agenda but will probably not be resolved in the next three months.

Europe's efforts at energy diversification away from Russia will not make much headway this quarter. The leadership transition in the European Commission, along with strong political support from several Central and Eastern European members for Russia's South Stream pipeline, will prevent Brussels from formally blocking the project. Negotiations between Russia, the European Union and the members of the South Stream project will continue despite Brussels' occasional threats. Russia will also be able to use political and legal means to effectively obstruct any preliminary plans for a Trans-Caspian route.

Rifts Widen as Euroskepticism Rises

The effects of the European Parliament elections, the most important EU-level political event this year, will continue to reverberate across the Continent in the third quarter. As Stratfor wrote in its annual forecast, the decision-making process at the EU level will be virtually frozen because national governments and EU lawmakers will spend most of the quarter negotiating and ratifying the new composition of the European Commission. At the national level, member states will be absorbing the political repercussions of growing Euroskepticism, while the summer recess will slow the legislative process.

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During the third quarter, the tussle over Europe's political direction will continue. In late June, EU members reached an agreement on their candidate for the next president of the European Commission. Each country will now have to appoint representatives to the commission. After holding hearings to vet them, the European Parliament must ratify the president and the commissioners. This process will lead to frictions between member states, and between member states and the continental legislature, over whether Europe should follow a more integrated path.

The ratification process will have lasting political effects in Europe. With the bloc struggling to strike a balance between national sovereignty and supranational integration, member states continue to drift apart. Countries in Northern Europe, led by the United Kingdom, will argue that the process of continental integration needs to be frozen, or even reverted in some areas, and that national governments need to recover some of the prerogatives that they gave up to Brussels. Other countries, most notably France and Italy, will push for deeper European integration to ensure more subsidies and softer fiscal targets on the Continent.

Germany will be trapped in the middle. Berlin needs to protect the eurozone and make sure that integration is not disrupted, but it is also interested in preserving the current process of economic reforms and fiscal consolidation measures in the European periphery. In the third quarter, these contradictory views on the future of Europe will continue to fragment the European Union.

The rise in Euroskepticism will also be felt at the national level. In countries such as the United Kingdom and Germany, the debate over the future of EU integration will be high on the agenda, especially as conservative parties become increasingly fearful of losing votes to their nationalist rivals. With elections in three German regions during the summer, the Euroskeptical members of the ruling Christian Democratic Union and Christian Social Union parties will push for an internal debate on whether to seek an alliance with the Euroskeptical opposition. Euroskeptical politicians in Germany — in the government and the opposition — will also criticize different aspects of the process of EU integration. Chancellor Angela Merkel will probably resist these forces but will come under increasing political pressure inside and outside of her government.

This will, in turn, affect EU policies. Italy is in charge of the European Union's rotating presidency during the second half of the year and will push for a renegotiation of Europe's policy regarding refugees from North Africa and the Middle East. The European Union is likely to provide more funds for countries in Mediterranean Europe, but substantial reforms of the Continent's policies on the issue are not expected. 

The third quarter will be relatively quiet for banks and financial markets. The debate over the value of the euro and unorthodox measures such as quantitative easing will still rank high on the EU agenda, but the European Central Bank is unlikely to apply additional measures during the quarter. The institution will wait to see the effects of the measures enacted in June, when it lowered its benchmark interest rate and applied negative deposit rates for banks, before deciding on further action. Despite the apparent calm in the financial markets, many Europeans will continue to face hardship. Credit conditions for small and medium-sized companies, particularly those in the European periphery, will remain weak, which will undermine the prospects for sustainable economic growth.

National Trends

At the national level, countries will have to deal with the consequences of high unemployment and rising anti-establishment sentiments while trying to clean up their economies. Italy and France will present structural reforms to try to reduce state bureaucracy and improve efficiency in public spending, with mixed results. Rome will make some progress in its plans to cut state bureaucracy, and a reform of the country's Senate will probably be approved during the quarter.

Reforms will be particularly difficult in France, where political and social tensions continue to mount. Paris' plan to reduce public spending and apply tax breaks for companies will lead to additional frictions within the ruling Socialist Party, while its plan to reduce the number of French regions will generate resistance in some of the regions affected. With unemployment still high in France, anti-establishment sentiments will result in anti-government protests and strikes in the quarter. The survival of the French government is not yet in question, but the government will be increasingly ineffective.

In Spain, the parliament will approve a fiscal reform program centered on reducing income taxes. The program is part of the government's effort to regain popularity after the European Parliament elections. The reforms will take effect in early 2015, an electoral year in Spain.

The summer season will bring some temporary relief to Southern Europe. Countries such as Greece, Spain and Portugal will benefit from political instability in competing tourist destinations, including Turkey, Egypt and Thailand. The increase in tourism will create some jobs in Southern Europe's formal and informal sectors. Most of the jobs will be temporary, however, and the summer season will not be enough to significantly improve unemployment in the European periphery.

Scotland will hold its independence referendum Sept. 18. We can expect London to promise additional devolution of powers, most notably on tax issues, if Scotland remains in the United Kingdom. Scotland is likely to vote against independence.

Sweden will hold general elections Sept. 14. We expect traditional, moderate political parties to dominate the elections. However, we also expect the far-right Sweden Democrats to perform well, improving on their 2010 performance, when they received 5.7 percent of the vote and made it into Parliament for the first time. This will not substantially modify Sweden's political landscape in the short term, but it will highlight the potential for anti-establishment parties' growth in Nordic Europe

East Asia

Locator - East Asia - 2014

East Asia

Asia is not actively caught up in the unrest and political uncertainty in the Middle East or on the Russia-Europe frontier. Nonetheless, the region is not immune to the implications. During the third quarter, Russia will continue to expand its economic and political outreach to Asia as a way to reduce its overdependence on Europe for investments and export markets and mitigate the strategic pressure on its Western flank. Seeing Washington once again focused on the Middle East and Russia, China will take additional steps to strengthen its position in the South China Sea and further erode Vietnamese and Philippine territorial claims. Japan, the often overlooked power in the region, is tempering its engagement with Russia so as not to concern its U.S. ally. However, Tokyo is continuing a diplomatic initiative toward North Korea designed to both help secure its northern flank and allow greater focus on China. As the competition to rebalance influence and power in the region continues, economic concerns will shape and constrain internal political situations, particularly in China.

Russia in Asia

The momentum Russia and China have accrued in their energy alliance could expand to the strategic sphere as Russia looks to engage less with the West and more with the East. Russia will also seek to re-engage with Japan, perhaps offering a more beneficial path to a resolution on the four disputed northern islands, paving the way for increased Japanese investment into Russia. Should Moscow make additional concessions, Tokyo would be hard-pressed to delay just to remain in line with U.S. and European punitive actions against Russia over Ukraine. Moscow is also recruiting Seoul through its work to keep North Korea in check and through offers of energy, natural resources and investment opportunities. These pursuits will continue through the quarter as Moscow works to complicate the U.S. alliance structure in the Asia-Pacific region.

Regional Maritime Tensions

China and Vietnam will continue their standoff over China's deployment of a deep-sea oil exploration rig in disputed waters near the Paracel Islands. The rig is not slated to leave until some time in August, and although both Beijing and Hanoi will try to avoid a major military confrontation, both will patrol the area with maritime security and civilian vessels, and the chances of an accidental confrontation remain high. Beijing is also accelerating land reclamation projects at several small islets and islands in the South China Sea and may begin bolstering its small outposts with additional buildings, supplies and airfields. This will further unnerve the Philippines, which will call for additional U.S. or Japanese assistance during the quarter and will increase the number of forces it keeps stationed on the Spratly Islands to match China's moves. Although the actual change is minor and all sides will keep their actions just below the threshold that would engender a stronger and more concrete response, the increased activity also raises the likelihood of accidental clashes. Moreover, China's increased air patrols along the edge of its newly expanded air defense identification zone will bring Chinese and Japanese aircraft into increasing proximity, raising the potential for a midair collision.

China Focuses on the Economy and Security

Two emerging developments will dominate China's third quarter. First, after months of weak industrial activity and facing mounting troubles in the real estate sector, Beijing will more proactively bolster the economy. It will do so by loosening certain controls on lending and increasing government spending on large infrastructure projects. Among the likely steps, Beijing will expand first-time homebuyers' access to credit, allow local governments to loosen controls on housing purchases for non-first-time homebuyers and, if these prove insufficient to revive market confidence, ease credit controls more broadly. In the meantime, the central government will boost spending on transport, water and energy infrastructure development to offset the impact of slumping property markets on pillar industries such as coal, steel and cement. While Beijing is temporarily easing credit controls in the property sector, it will continue to implement fiscal reforms designed to eventually reduce the likelihood and impact of a property crisis by reducing local governments' reliance on land sales. The recently announced municipal bond pilot program is too small to have a tangible effect on the property sector within the quarter.

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Second, after a spate of deadly attacks on Chinese civilians in the first half of the year, Beijing will intensify efforts to crack down on terrorism and religious extremism in Xinjiang and Han core regions while expanding its security footprint in politically sensitive cities. Uighur Muslim-affiliated groups operating in or around Xinjiang will remain the government's primary target throughout the quarter, but Beijing's crackdown will not be limited to ethnic and religious unrest among the Uighur population. A brutal killing in Shandong in May highlighted the growing security risks posed by the spread of underground cults, many of them Christian in nature, throughout rural Han China. These organizations do not seriously challenge central government control, but signs that they are developing cross-provincial networks and gaining ground among poor, undereducated rural populations will prompt Beijing to take pre-emptive measures to contain their proliferation within the quarter.

President Xi Jinping's anti-corruption campaign and attendant push to consolidate his influence within the Party leadership will continue, as will the central government's gradual rollout of fiscal reforms. However, the need to support economic growth, particularly to bolster the housing sector, may mean slower progress on both fronts this quarter.

Japan Looks Ahead and Abroad

Japan's "Abenomics" has had modest success lifting Japan out of its decadeslong economic slump. The consumption tax hike is contributing to a temporary rise in inflation, but the country may enjoy only a short pause before wage pressure and the deepening demographic crisis take their toll. For this reason, Tokyo will likely continue a policy of monetary injection while slowly increasing wages in the next quarter. Nuclear restarts may begin in the coming months amid concerns of energy shortages. Prime Minister Shinzo Abe will use his momentum to carry out shifts in Japan's collective defense, and Tokyo will seek to reinforce its position with Russia and North Korea as it secures its northern flank and shifts attention to the East China Sea.

Indonesia to Hold Steady After Elections

Indonesia will hold its presidential election July 9. Both candidates have sought a balance in their campaigns between resource nationalism and openness to foreign investment, so dramatic swings in market sentiment are unlikely regardless of who wins. Within the quarter, tangible changes to policy, particularly energy and mining policy, are unlikely — both candidates have expressed support for the mineral export ban, and the winner will not take office until October. Within the quarter, the president-elect will begin the process of bringing together a Cabinet and governing coalition.

Thailand Attempts to Stabilize

The Thai military will take more steps toward the establishment of an interim government during the quarter. First, however, alongside ongoing efforts to eliminate former Prime Minister Thaksin Shinawatra's influence, the military will broaden economic programs designed to appease Thailand's rural communities, the traditional support base for the ousted "Red Shirt" government. For the most part, the crisis in Thailand will remain internal, and neighboring countries will be reticent to openly support the opposition's attempts to create a resistance organization abroad. Small protests and sporadic violence are likely, but the military will prevent large-scale acts of resistance from taking root. The wild card is the status of the king and the complications a succession would bring to the military's transitory rule.

North Korea Expands International Ties

North Korea is working to diversify its international relations, particularly focusing on Russia and Japan, to ease external pressure. Although its work with these countries will not replace the significant role China plays in North Korea's economic survival, Russian activity inside the country will increase, as could Russian energy supplies to North Korea. Pyongyang and Tokyo are having a quiet detente similar to that seen during the administration of Junichiro Koizumi (2001-06). North Korea is willing to further discuss the status of kidnapped Japanese citizens with the expectation that doing so will ease restrictions on Japanese exports and repatriation of currency from overseas Koreans to North Korea. As usual, Pyongyang keeps things like nuclear and missile tests on reserve as a way to shape international perceptions and encourage talks but also as a way to strengthen its own national defense. We may also see more experiments with North Korean economic zones and minor adjustments to economic policies as Pyongyang continues to try to revitalize or at least awaken its slumbering economy.

South Asia

Locator - South Asia - 2014

South Asia

India's New Government Sets Priorities

India's new Bharatiya Janata Party government, led by Prime Minister Narendra Modi, will undertake a series of ambitious domestic reforms framed by the drafting of the upcoming 2014-15 budget, which is expected to reach parliament in July. The budget drafting process will serve as a bellwether for how far Modi is willing to go to rein in some of India's costly subsidies and energy pricing schemes. We expect the new government to focus on subsidies on fuels, electricity and fertilizers, especially urea. The central government is also likely to roll out strategies focused on easing land acquisition, coal and energy projects, and food distribution in response to India's overflowing and inefficient food storage systems. Success will be mixed, and public opposition will be loud and disorderly, as expected from India's entrenched protest culture. However, higher temperatures, an underperforming monsoon and a rising energy import bill will likely make government action a priority over public appeasement.

Rising electricity demand and potentially accelerating food price inflation will add to New Delhi's headaches, but the government is likely to concentrate on implementing difficult reforms early in its mandate rather than applying half-measures spread out over the course of its five-year term. New Delhi will also work to slowly increase its imports of Iranian crude oil during the quarter, hoping to hedge against an already high and rising oil import bill spurred by unrest in the Middle East.

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Beyond India's borders, the Modi government will look for foreign policy victories to balance against potential challenges to policy implementation at home. India and China will maintain a slow but steady diplomatic dialogue centered on normalizing border issues and increasing bilateral trade and investment. Similarly, India and Pakistan will continue a dialogue, but elements within each country's state and military bureaucracies and a persistent militant threat from Afghanistan and Pakistan will hamper any real progress. We expect New Delhi and Washington to begin improving bilateral ties, with Modi expected to visit the United States later in the quarter. In lieu of a breakthrough in relations with either Pakistan or China, India will strengthen bilateral ties with regional states such as Bhutan, Bangladesh and Nepal, especially in areas of security cooperation, and with India's traditional partners in the Pacific, Australia and Japan.

Afghanistan and Pakistan Continue to Fight Militants

Pakistan in the third quarter will be heavily preoccupied with Operation Zarb-e-Azb, the large military operation to retake North Waziristan from Taliban rebels. A jihadist insurgency has plagued the country for the past seven years. In an effort to counter the government's long-awaited offensive, the Tehrik-i-Taliban Pakistan is likely to carry out attacks across the country.

The Pakistani military operation will push many Tehrik-i-Taliban Pakistan fighters across the border into Afghan territory. From there, the fighters will escalate cross-border attacks on Pakistani soil and try to draw Pakistan's forces into Afghan territory. The Pakistani offensive will therefore influence the political transition taking place in Afghanistan, where a new president is due to take office in the early part of the quarter. It is likely that former Afghan Foreign Minister Abdullah Abdullah will win the second round of the presidential election and succeed outgoing President Hamid Karzai. Abdullah has been a staunch opponent of both Pakistan and the Afghan Taliban. Therefore, any spillover of the Pakistani offensive into Afghan territory could exacerbate tensions between the two countries.

Separately, the Afghan Taliban need to use the presidential transition to undermine Kabul, so they will be pushing ahead with their attacks. Diplomacy between the Afghan Taliban and the United States cannot be ruled out, but progress will be slow and uneven.

The Taliban have militant allies on Pakistan's borders with India and Iran who could be leveraged to create additional distractions for Islamabad. However, this transnational jihadist network's ability to coordinate successfully on multiple fronts is questionable.

Latin America

Locator - Latin America - 2014

Latin America

Paralysis in Venezuela and a U.S. Opening with Cuba

With protests at a manageable level going into the third quarter, Venezuelan President Nicolas Maduro's government will primarily focus on stabilizing the economy. A devaluation of the bolivar and the unification of the country's three exchange rates are possible in upcoming months. However, concerns about the declining popularity of the ruling United Socialist Party of Venezuela could delay the actual implementation of any reforms.

Caracas will continue to seek extra revenue to buttress its finances, most likely by cutting some public spending and modestly reducing the amount of oil sold through preferential agreements with other states in order to sell that oil to buyers who will pay more. Maduro will likely back off from more drastic cost-cutting actions such as significantly raising the price of Venezuela's heavily subsidized gasoline. Whatever measures the government enacts, inflation and food shortages will persist and will continue to erode Maduro's political support.

The Venezuelan government could choose to restart political dialogue with the country's opposition, but a negotiated solution will not occur. Without a meaningful negotiation, the opposition will continue to rely on protests as its principal means of pressuring the government, and further protests are likely across the country. Spiking inflation and periodic food shortages make another upsurge in protests possible this quarter. While the Venezuelan government remains effectively paralyzed in its attempts to improve its economic situation, it will be watching a developing dialogue between the United States and Cuba in order to gauge when and how to pursue its own diplomatic engagement with Washington.

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At the close of the second quarter, the United States offered to begin a dialogue with Cuba that will include, among other things, a discussion of the U.S. economic embargo on that nation. Some moves to help facilitate the dialogue, such as discussing the release of prisoners held by both countries, are possible in the coming months. Domestic obstacles in both countries will delay the start of more substantive negotiations.

Argentina Responds to Financial Concerns

For Argentina, Buenos Aires' reaction to the U.S. Supreme Court's refusal to hear arguments in a longstanding dispute with holdout bondholders will dominate this quarter. Argentina will negotiate with the holdouts but will attempt to find a solution that forestalls remaining holdouts or owners of previously restructured debt from being able to demand cash settlements on new terms. Negotiations with the holdouts are likely in the third quarter, but a final deal will not occur during this period. Because of a legal loophole, Argentina will be much less at risk of lawsuits from holders of restructured debt if it can delay a final agreement with the holdouts until 2015.

Significant progress to reform the legal framework surrounding the energy sector will be made in the third quarter. The reform is designed to make the regulatory environment in Argentina more consistent, with an eye toward attracting foreign investment. There will be political tension between the provinces and central government over provincial taxes on state energy firm YPF, the roles of provincial companies in oil projects and the length of concession periods.

Peace Talks in Colombia Move Ahead

Bogota's talks with Colombia's largest rebel group, the Revolutionary Armed Forces of Colombia, will progress in Cuba in the third quarter. The demobilization of the group, better known as the FARC, is the only issue left to negotiate, and a final peace agreement between the government and the rebels remains likely this year. However, implementation of any peace deal could take months or years.

The government will also continue preliminary peace discussions with the National Liberation Army, also known as the ELN. The sides will likely make progress in defining the principal points of negotiation for any eventual talks. 

Both militant groups will continue to launch attacks in their traditional areas of influence, particularly in Colombia's southwestern departments and along the eastern border with Venezuela. Oil infrastructure in these areas will remain at risk from militant attacks, and further disruptions in oil flows from Colombia remain likely.

Mexico Moves Forward with Reforms

Despite political infighting within the Senate, Mexico's legislature will likely use its extraordinary legislative sessions to approve the secondary legislation for the energy and telecommunications reforms by mid-July at the latest. Mexico will use the third quarter to get closer to implementing these agreements, making steady progress toward the creation of a political foundation to revive the country's energy sector.

Brazil Gears Up for Elections

Brazil's focus during the third quarter will be on the presidential election scheduled for Oct. 5. The ruling Workers' Party will probably maintain strong political support ahead of the vote. Social unrest associated with the World Cup was muted at the end of the second quarter and is unlikely to re-emerge in the third.

Brazil will take the global stage July 14-16 as Fortaleza in Ceara state hosts the sixth BRICS (Brazil, Russia, India, China and South Africa) summit. Dignitaries from the member countries are expected to announce the final details of a jointly funded development bank that would be designed to finance large investment projects. After the summit, BRICS will meet with the Union of South American Nations, which is made up of all the independent South American countries. The meeting will be the first of its kind and could present an opportunity for Russia to demonstrate influence in the United States' near abroad. Russia has much bigger commitments to attend to in its own periphery, however, so its engagement in Latin America will be largely symbolic.

Sub-Saharan Africa

Locator - Africa - 2014

Sub-Saharan Africa

Washington Reaches Out to Africa

The United States has scheduled the first U.S.-Africa leader summit in Washington on Aug. 5. Washington intends to use the event to provide meaningful political support for U.S. businesses to expand their engagement in Africa. The support is geared toward finding markets for U.S. exports and establishing an economic foothold in Africa in general. Moreover, Washington wants to go beyond the modest security assistance it currently provides to Africa and show that there are more substantial platforms for cooperation than national security interests. Although tangible investments from this particular initiative are unlikely this quarter, Washington's efforts will lay the foundation for a mercantile counter to Chinese economic activities in Africa.

Nigeria Prepares for Campaign Season

In Nigeria, the opposition All Progressives Congress party is likely to consolidate after its recent leadership convention, during which a politician from the south emerged as national chairman. The party will work to establish political inclusivity from all six regions of Nigeria in order to present a comprehensive alternative to President Goodluck Jonathan's People's Democratic Party, likely backing a politician from northern Nigeria as a presidential candidate. At the same time, the party and its supporters will be campaigning hard against Jonathan's re-election.

Jonathan and the ruling party will face rising pressure to hold a leadership convention and clarify Jonathan's re-election intentions. As the All Progressives Congress moves toward its presidential primaries, which will take place in the fourth quarter, Jonathan's party will face greater pressure to declare its presidential candidate as the parties begin trying to expand their patronage networks in the most densely populated areas of Nigeria. The People's Democratic Party, however, will try to put off its leadership convention as long as possible, likely until the fourth quarter. The party's hope is to delay and minimize the political and militant blowback and to retain Jonathan's influence within the party for as long as possible should he decline nomination for re-election.

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Throughout this political evolution leading up to the February 2015 national elections in Nigeria, Boko Haram will continue to pose a significant tactical threat to densely populated civilian targets, particularly Christian targets, in northern Nigeria. Militant activity in the south will remain low by comparison as Niger Delta militants continue to bide their time while they sort out the kind of patronage they can expect from whichever government emerges.

Vote Likely to Bring Violence to Mozambique

Mozambique will be moving toward its general elections scheduled for October. The opposition Mozambican National Resistance party, better known as Renamo, is likely to spend the third quarter campaigning via low-level intimidation and insurgent attacks against public and government infrastructure in central and northern Mozambique. Renamo is not a meaningful factor in the elections. However, sporadic attacks on transportation as well as civilian and government targets, if they disrupt governance and economic activity, could strengthen the party's demands for direct talks with the ruling Mozambique Liberation Front to discuss patronage and concessions.

South Africa's Government Starts a New Term

In South Africa, the ruling African National Congress will settle into its new five-year term. The government will see a need to reassure industry by minimizing disruptions resulting from the labor negotiation process after the recently ended five-month strike in the platinum sector. The end of that strike will not necessarily mean an end to strikes in general. Wage negotiations in the steel and engineering industries are taking place, and threats of a strike at state electricity provider Eskom have already been made. The government will try to minimize disruptions in other sectors, though it will still seek to appease its political allies in organized labor.

Negotiations Continue in South Sudan

In South Sudan, the slow pace of uncertain political negotiations between government and opposition authorities will mean the country will not regain a stable security environment in the third quarter. A 60-day ultimatum to form a national unity government, reintegrating rebel leader and former Vice President Riek Machar, will expire in early August. A resolution could lead to some stability, but the involved parties cannot guarantee control over all armed groups in the country. The unstable security environment will mean that any recovery in crude oil production may be short-lived and subject to ongoing threats of violence.

East African Militancy Persists, but Economic Projects Move Forward

In East Africa, al Shabaab will continue to pose a threat to soft targets in nearby countries that contribute military forces to the African Union's peacekeeping efforts in Somalia. In Kenya specifically, militants will use grenades and small improvised explosive devices against civilians to undermine confidence in the government; in particular, they want citizens to turn against governments for supporting Somali officials. The Kenyan government will struggle to prevent such activity, but the militant threat's effect on the country's tourism sector will become obvious during the tourist season in the third quarter. Kenya could thus escalate its crackdown on al Shabaab sympathizers, especially in the coastal region of the country.

The East African Community will move forward with its economic integration through the joint customs tax collection, which became operational July 1. Kenya, Uganda and Rwanda have been spearheading the system since April, but it should extend throughout the whole East African Community this quarter. The initiative is meant to lower barriers for imports and exports in the region as a whole and limit internal customs costs and delays among community members. The big U.S. investment push in August will draw considerable attention to East African development in particular.

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