Stratfor's Third-Quarter Forecast 2015

Jul 8, 2015 | 09:30 GMT

Stratfor said at the beginning of 2015 that this would be the year when Europe would be knocked out of complacency. The third quarter is when the harsh reality of an unraveling eurozone confronts Berlin and the eurozone at large. Germany will act tough while a divided camp of creditors press Berlin for a deal for fear of setting a dangerous precedent with a "Grexit." Germany needs a deal with Greece and can negotiate one, but it will come at a price that threatens the credibility of its leadership in the eurozone. The Greek government under Syriza is likely to fall, either from a banking crisis or from a rebellion within its own ranks upon signing a deal. And any deal struck between Greece and its creditors will be doomed; Greece will be unable to implement deep reforms, and Germany will be unwilling to release funds under these circumstances. There will be a great deal of commotion this quarter over face-saving measures to avoid a Grexit. Beneath the speeches, the path to a Grexit is already being paved.

But this is not the only crisis afflicting Europe. The standoff between Russia and the West will become more visible as Russia and the United States engage in conventional military posturing on the Continent. Russia's tightening relationship with China will meanwhile be on display as the two advance joint initiatives to develop economic alternatives to the West.


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China will not be immune to financial jitters either, as Beijing, for lack of better options, intervenes to prop up its stock market to avoid the political, social and financial consequences of an outright collapse. Beijing has the tools to manage a decline in its volatile stock market, but any moves it makes in the short term to tame the market without a reliable investment alternative come with the long-term consequence of slowing private consumption growth and thus upsetting its strategy to rebalance the economy amid a wider slowdown.

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In the Middle East, the United States will be juggling three tasks: seeing through a negotiation with Iran, reassuring its Sunni Arab allies and preventing countries such as Turkey from adopting a renegade foreign policy. As the Syrian rebellion gains momentum, so will talk of a post-al Assad power-sharing arrangement. Divisions on the battlefield and among rebel sponsors, however, will prevent any such negotiation from coming to fruition.

Between a deepening European crisis, potential increases in oil output from major Persian Gulf producers and high summer demand in the United States and China, supply and demand in global oil markets do not point to any major swings in price. Venezuela will still be under deep financial strain as it feels out a negotiation with the United States and offers limited concessions to the opposition in hopes of finding economic relief. Mexico will stay on course with its energy reforms, taking its first big step in auctioning off shallow-water offshore exploratory blocks while taming challenges to restructuring from the Petroleos Mexicanos labor union. To the north, Canada will further its commitment to link its energy resources to global markets if the British Columbian parliament votes as expected to approve Petronas' NorthWest liquefied natural gas venture, Canada's first LNG export facility. With Canadian national elections in October, campaigning is fixated on how far Canada should go in cementing its place in the energy world. 


Regional Map - Forecasts - Europe

Regional Map - Forecasts - Europe

The Greek Crisis Deepens

During the early part of the quarter, Athens and its creditors will continue negotiations. After the referendum that rejected austerity, the Greek government will center its negotiation strategy on the demand of debt relief. The Eurogroup, led by Germany, will be willing to offer only a vague promise of debt relief if a series of economic reforms are introduced.

The negotiations will coincide with Greece's lingering banking crisis. Despite Athens' promises to quickly lift capital controls, Stratfor believes that the restrictions will remain in place during the quarter. Germany and other countries, such as the Netherlands, Finland and Slovakia, will bet on a worsening of the Greek banking crisis, expecting the government in Athens to become desperate and soften its position. Moreover, these countries expect the Coalition of the Radical Left, or Syriza party, to seek support from moderate parties to stay in power or even call for early elections.

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In the likely case that there is not a deal by July 20, when a significant debt to the European Central Bank is due, Greece will have to introduce some form of parallel currency to pay pensions and public sector salaries. This is the point where Germany and the Eurogroup will need to find a balance between pressuring Athens and keeping Greece in the eurozone, even if only nominally. Greece could technically remain a member of the eurozone, but its membership would be suspended formally (by a legal document) or de facto (by the introduction of a second currency). The reality is that Greece will lack the political strength to implement reforms, and Germany's political tolerance for EU concessions is rapidly waning. Greece is on the path to a Grexit, but the path is long and extends well beyond this quarter.

During this entire process, the risk of Greece's financial instability spreading to other southern eurozone members will be limited. During the first half of the year, the Greek crisis led to marginal increases in bond yields in countries such as Spain, Portugal and Italy. Yet these changes were still manageable for Madrid, Lisbon and Rome, and Stratfor thinks this will still to be the case during the third quarter. The uncertainty over Greece will probably hurt Mediterranean Europe as bond yields go up slightly, but they are unlikely to reach the 2008 crisis levels. To smooth the process of a Grexit and reinforce the financial firewalls that have been erected, the European Central Bank could increase the size of its monthly bond purchases, but without a dramatic movement in the peripheral bond yields the increase is unlikely to be substantial.

In the meantime, Euroskeptic parties from both the right and the left (including France's National Front and Spain's Podemos) will use Greece as an example of the lack of solidarity in the European Union. But with no general elections scheduled in these countries during the quarter, their actions will have little real impact. The exception is Portugal, where the first round of general elections will be held Sept. 20 (the second round is scheduled for Oct. 11). The opposition Socialist Party, which criticizes the austerity measures imposed by the conservative government in Lisbon, will have a strong electoral performance.

The 10th round of negotiations over the Transatlantic Trade and Investment Partnership, a proposed free trade agreement between Europe and the United States, will take place in mid-July. Even though the emerging reality of a Grexit will add momentum to the European side of the negotiations in the medium term, the effect will not be felt strongly in this round.

The Immigration Crisis Lingers

The arrival of migrants in Southern Europe by sea will continue to generate friction within the European Union, especially as weather conditions improve during the summer and more migrants reach European shores. During the third quarter, Europe's reaction to the crisis will focus on patrolling international waters, rescuing migrants at sea and sharing intelligence on human smuggling networks. The European Union will not resort to force (e.g., the destruction of vessels and the apprehension of traffickers and smugglers close to the Libyan border) without a formal authorization from the United Nations, which is unlikely.

EU member states will debate how to deal with migrants, but a mandatory system of quotas will not be implemented, and the Dublin system, according to which the country of first entry is responsible for the asylum application, will not be reformed. The most the European Union can hope for in the current political environment is a system of voluntary distribution of migrants. In the meantime, the arrival of migrants will continue to threaten the survival of the Schengen agreement, which eliminated border controls between most EU members. Countries will sporadically strengthen border controls through actions such as increasing the police presence at borders and imposing more controls on train stations, but the Schengen agreement will not be suspended this quarter.

The immigration crisis also will have domestic consequences across the Continent, with nationalist parties such as Italy's Northern League and France's National Front demanding a tougher stance on immigration. The crisis also will be felt in the north, where the new Danish government will be under pressure from the nationalists to reduce benefits for immigrants, reintroduce border controls and opt out from EU-wide policies to address the crisis. Although Denmark is unlikely to leave Schengen, the government probably will not participate in new EU policies designed to address the immigration crisis.

The Eurozone's Fragile Politics

Europe's slow and uneven economic recovery, which was triggered in part by low oil prices and measures by the European Central Bank, will continue this quarter. It will not be enough, however, to prevent the political consequences of years of crisis, especially in the southern countries. The summer parliamentary recess will somewhat mitigate the threat of governments falling, but political tensions could lead to bigger problems later in the year.

A country to watch is Spain, where the ruling conservative government will struggle to remain popular. The Spanish economy is growing again, and unemployment is slowly going down (even if most of the new jobs are part-time and temporary work). However, years of recession and successive corruption scandals have hurt the popularity of the government in Madrid. Spain will hold general elections by the end of the year, and the conservative administration will try to recover some of its lost popularity by announcing measures such as lower taxes and higher salaries for the public sector. Many of these measures will actually be introduced when the budget for 2016 is approved in the fourth quarter.

The third quarter will also be important for the situation in the autonomous region of Catalonia, which will hold elections Sept. 27 with a heavy focus on independence. Pro-independence parties will perform well, but the key factor to watch is whether they receive enough votes to reach a majority in the regional parliament. Even if they do, friction within the secessionist camp will continue to undermine the independence process.

In Italy, Prime Minister Matteo Renzi will still struggle with friction within his government. Rome probably will approve a controversial reform in the education sector and will present proposals for fiscal and banking reform, but the process will continue to generate tension within the ruling Democratic Party. Renzi is likely to link some of the reforms to confidence votes, creating uncertainty about the future of his government. Although the government in Rome will not collapse during the third quarter, tension will continue escalating, weakening the government's ability to pass legislation.

In France, now that the Macron Law (which is meant to liberalize different sectors of the economy) has been approved, President Francois Hollande's focus will move away from reforms, though there could be some minor progress with limited labor and digital market reforms. Instead, Hollande will turn toward attempts to soothe the divisions within his own party. For instance, he will allow some leftist policy concessions, such as spending increases, as he prepares to run in the 2017 presidential election.

Trends Outside the Eurozone

In the United Kingdom, though disrupted by the August parliamentary break, there should be some progress in several of Prime Minister David Cameron's various new bills. The Referendum Bill, when the United Kingdom will vote on whether to remain in the European Union, will face some opposition in the House of Lords, and Cameron may have to grant the objectors some concessions, but the bill should ultimately progress. Cameron will also have to battle the Scottish National Party to limit the autonomy powers granted within the pending Scotland Bill.

During the third quarter, the diversification of energy supplies and routes will be high on the agendas of Central and Eastern European countries. The quarter will be defined by concrete actions and by negotiations to build regional interconnectors and participate in regional projects.

Some projects will make progress during the quarter. For example, Greece and Bulgaria will sign a formal agreement to build the Gas Interconnector Greece-Bulgaria and begin work on the project. The interconnector should be operational later in the decade. The Slovakia-Hungary interconnector, in the meantime, started formal operations in July. These are examples of regional efforts to ensure energy security, but the question of supply will remain problematic. Countries such as Bulgaria and Serbia will keep their options open, negotiating with both Russia and the European Union for their participation in competing pipeline projects.

With no end in sight for the conflict in Ukraine, and after EU members decided to prolong sanctions against Russia for six more months, several countries in Central and Eastern Europe will continue strengthening their relationship with NATO and the United States. The two largest countries in the region, Poland and Romania, will experience some domestic political turbulence during the quarter but not enough to bring about any significant changes in their foreign policies.

The political situation will remain volatile in Romania after Prime Minister Victor Ponta took sick leave only days after a corruption scandal broke. The opposition will try to boycott the Romanian government, which could delay the legislative process. However, Stratfor does not expect a significant political crisis in Romania during the quarter, and the lingering political scandals should not affect Bucharest's foreign policy priorities, which are deeply linked to NATO and EU membership. The same goes for Poland, where the government will try to regain the initiative before the general elections in October by lowering taxes and introducing changes in the Cabinet. But as in Romania, these events will not affect Warsaw's foreign affairs priorities.

Former Soviet Union

Regional Map - Forecasts - FSU

Regional Map - Forecasts - FSU

Tension Persists Between Russia and the West

With the European Union and United States already having extended sanctions until the end of the year, Moscow is not as pressured by sanctions deadlines to calm tension with the West or Ukraine in the third quarter. Instead, Russia will maintain its military support for eastern Ukrainian separatists and continue boasting about its nuclear capabilities, including talk of missile production and deployments.

The separatist conflict in eastern Ukraine will continue into the third quarter, though a full-scale military conflict is highly unlikely. Russia will use the separatists to try to maintain pressure on Kiev and will use any gains on the battlefield to make the separatist regions of Donetsk and Luhansk more viable as a permanent enclave Moscow could use to undermine the government in Kiev. Given the warm weather this quarter, the separatists could launch more attacks, particularly in hot spots along the line of contact such as Marinka, Shchastya and Avdiivka. However, Russia is likely to avoid any major military moves to prevent a large-scale military response or more sanctions from the West. Russia and the West will continue negotiating over Ukraine within the framework of the Minsk talks, the Normandy Group and U.S.-Russian backchannels, but the standoff is unlikely to de-escalate in the former Soviet sphere. Russia will use peripheral issues, such as a Syria negotiation, to bargain with the United States.

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Moscow and NATO will continue increasing the tempo of their military exercises and deployments of military hardware this quarter. Armenia, Belarus, Kazakhstan, Kyrgyzstan and Tajikistan will participate in more frequent and intense military exercises by the Russian-led Collective Security Treaty Organization as a counter to the NATO buildup in Central and Eastern Europe. In the meantime, the Baltics will continue to pursue a greater NATO — particularly U.S. — presence as a counter to Russia. The Moldovan breakaway territory of Transdniestria could see more exercises and weapons buildups within the Russia-West standoff, but any activity will fall short of military conflict.

The European Union's antitrust case against Gazprom will add to tension between the West and Russia. In the case, which the European Commission began in April, the commission accuses Gazprom of multiple violations, such as unfair pricing for certain states. Gazprom has until mid-September to defend its actions. Gazprom will likely argue that its pricing mechanisms are related to different market conditions in each country. A lengthy appeals process means that Gazprom probably will not face significant legal action in the third quarter. However, Gazprom (and by extension, Russia) has reacted to Europe's changing regulatory system by shifting its focus away from owning physical assets in Europe and accepting that within the European Union, skirting the Third Energy Package (a set of rules designed to increase competition in Europe's natural gas and electricity markets) and other regulations is not possible.

Meanwhile, Russia will launch construction of its Turkish Stream energy project later in the year. Russia will offer Turkey deep discounts in exchange for a political commitment to the first phase of Turkish Stream, which connects Russia to Turkey via pipeline under the Black Sea. The second phase of Turkish Stream, connecting Turkey to Europe, is not intended to begin until after 2017, though Russia will begin lobbying Central and Southern Europe for potential routes and destinations for Russian natural gas. Eventually Russia will court many countries, but this quarter it will focus on Greece, which is in the throes of financial crisis, and Serbia, which is exempt from the Third Energy Package. Russia will use the Greek financial crisis to try to lock Greece into the Turkish Stream project while pursuing strategic investments in Greece.

Internal Divisions Plague Russia

Russia's economy is relatively stable compared with its state in the first half of the year. A stimulus program, budgetary cuts, a small increase in oil prices, lower interest rates, increased tax revenues and renewed investment interest among some Western companies have helped bolster the Russian economy. However, economic fragility will still be a major concern in the third quarter for the Kremlin and the Russian people.

The Kremlin will continue to debate its 2016 budget amid deep divisions in the Kremlin strategy for future cuts and spending. The government does not have to finalize the 2016 budget until December, but the tough negotiations on defense spending, pension stability and continued government financial assistance will go on throughout the third quarter. Though minor sporadic protests over the economy will continue, the Kremlin will weather the financial stress, and President Vladimir Putin will maintain high popularity rates among the Russian public.

Rifts between the various clans within the Kremlin will endure. The primary disagreements in the third quarter will be between the financial and security clans over the budget and spending, and between the Federal Security Service and non-Federal Security Service clans over influence in domestic policy. Putin will continue to arbitrate between the groups and also defend his position in the third quarter. A relatively more stable economic environment will enable Putin to manage these fissures, but he will not be immune to challenges to his authority.

Ukraine Struggles With Domestic Issues

In addition to the conflict on the battlefield, Ukraine will continue to grapple with a number of difficult internal issues. One will be the security situation outside of eastern Ukraine, with pro-Russian elements likely to carry out terrorist attacks in areas such as Kiev, Kharkiv and Odessa in an attempt to destabilize these regions. Protests will also be a key challenge; right-wing groups such as Right Sector and groups affiliated with Ukraine's powerful oligarchs are likely to put additional pressure on the government. However, Ukraine's pro-Western government is unlikely to fall this quarter.

Another issue will be the management of the country's tenuous economic situation, including greater pressure to service Kiev's debts to its foreign creditors. The International Monetary Fund will press creditors to accept a haircut on Ukraine's debt. Negotiations will be held on the size of the haircut — whether it will be closer to the creditors' preferred 10 percent or the Ukrainian government's preferred 40 percent. Because these talks have the potential to drag on throughout the summer, the IMF will provide enough financial assistance keep Ukraine afloat even if the debt negotiations do not produce an agreement.

Ukraine will hold natural gas negotiations with Russia and the European Union this quarter. Ukraine stopped importing supplies from Russia at the beginning of July following an impasse over natural gas prices for the third quarter; Russia offered to extend the second-quarter price of $247 per thousand cubic meters, but Ukraine wants a lower price — about $200 per thousand cubic meters. Reverse flow imports from EU countries such as Slovakia and declining natural gas consumption overall have given Ukraine greater leverage in its talks with Moscow. A compromise will eventually be reached on pricing, but Ukraine has the means to hold out in negotiations at least for the quarter. Downstream flows to Europe are unlikely to be affected by Ukraine's current stoppage of imports from Russia.

Economic Difficulties Pervade the Region

Like Russia, the rest of the former Soviet Union will continue struggling economically this quarter as a result of low energy prices and the extension of EU and U.S. sanctions against Moscow. However, each state's economic position will vary, just as Russia's competition with the West for influence in the region will vary from state to state.

Economic problems will be particularly difficult in Moldova, where, in line with Stratfor's forecast, the government collapsed in the second quarter. Moldova will face greater financial difficulties as a result of a corruption scandal over bank asset seizures and a decrease in support from financial institutions such as the World Bank and the IMF. These challenges, combined with a deadlocked political system, play to Russia's interests insofar as they block Moldova's Western integration efforts. Georgia, too, will continue to experience economic weaknesses and internal divisions that will hamper its attempts to meaningfully integrate with NATO and the European Union, though to a lesser degree than Moldova.

Ahead of a presidential election in October, Belarus will strengthen its security and military ties with Russia as a means of securing greater financial assistance from Moscow while maintaining a small-scale economic relationship with the European Union. Armenia also will look to Russia for greater support in a bid to mitigate its economic challenges and for greater security against Azerbaijan in the Nagorno-Karabakh conflict. Azerbaijan will continue to pressure Armenia militarily over the breakaway territory, though the possibility of a full-scale military conflict is remote.

Azerbaijan will remain a key player in the Russia-West standoff this quarter as Baku continues pursuing cooperation with both Russia and the European Union without overwhelmingly committing to either. The European Union will court Azerbaijan and Turkmenistan to participate in Southern Corridor projects such as the Trans-Caspian Pipeline and will continue laying the groundwork to clear political and environmental obstacles to the project.

Central Asia will continue suffering economically in the third quarter; each state in the region has been a victim of either low energy prices, a depreciating currency, a decrease in remittance flows or all of the above. Kazakhstan will keep lobbying for increased foreign investment, though its constantly changing investment laws crafted by government circles that are more interested in protectionism will keep large-scale Western investment at bay. The threat of militancy, whether homegrown or from groups such as the Islamic State, will be an issue in the region. Russia and its Collective Security Treaty Organization will use the threat as a reason to expand its security presence and activities in Central Asia. However, the more pressing security concern in Central Asia will be social instability and protests as a result of the poor economic situation.

Russia Turns to the East

Amid persistent tension with the West, Russia will focus on developing relationships in East Asia in the third quarter. In July, Russia will host summits for BRICS (Brazil, Russia, India, China and South Africa) and the Shanghai Cooperation Organization, which consists of Russia, China and the Central Asian countries. At the BRICS summit, the member countries are expected to sign agreements to begin using the New Development Bank (formerly known as the BRICS Development Bank), a multilateral institution intended to invest in emerging economies' infrastructure. BRICS also will launch a program to provide financial assistance to countries (including BRICS members) in financial crisis in an attempt to rival IMF programs. However, with many of the BRICS members either plateauing or declining financially, the program will be limited.

Thus far, the Shanghai Cooperation Organization has not been anything more than a Russia, China and Central Asia talking shop (although Pakistan and India will launch their membership processes at the organization's summit in Russia). However, as China and Russia expand their economic relationship, and as China increases its economic activity in Central Asia, the group is becoming a platform for Beijing and Moscow to come to an understanding on balancing their influence in the region. In the past, Russia has maintained its influence in Central Asia's security and political spheres, while China has expanded economically in the region. But as Russia struggles with its economy and sanctions, China is taking financial and economic advantage of Russia's weakness not only to position itself to work with and within Russia but also to lay the groundwork for an increased presence in Russia's periphery, particularly Central Asia.

In August, Russia will also host the first Eastern Economic Forum in Vladivostok — an investment conference Moscow is hoping will rise to the importance of the St. Petersburg International Economic Forum but with Eastern investors interested in Russia. These meetings will culminate with Putin traveling to Beijing for China's celebrations of the end of World War II. Putin will be taking a large delegation of businessmen, ministers and military leaders with him. Earlier this year, Russia struck a string of non-dollar-financed energy deals with China, and it is negotiating increased Chinese investment in energy, transportation and the financial sector.

Moscow is also interested in normalizing relations with Japan, though Tokyo is constrained by the United States and its support for Western sanctions against Russia. Washington will pressure Tokyo with Trans-Pacific Partnership negotiations and other issues to keep Japan from moving toward normalizing relations with Russia. However, both Russia and Japan may begin exploring ways to increase their energy ties and compromise on the disputed Kuril Islands. 

Middle East and North Africa

Regional Map - Forecasts - Middle East and North Africa

Regional Map - Forecasts - Middle East and North Africa

Regional Powers Continue to Jockey for Influence

The extension of the U.S.-Iran negotiation pushes implementation of an eventual deal into the fall at the earliest following a 60-day U.S. Congressional review. But the timing of a U.S.-Iran nuclear agreement has also become largely irrelevant to the plans of regional states, especially Saudi Arabia and Turkey. As the Middle Eastern balance of power continues to mature, Riyadh and Ankara are operating on the assumption that Washington will recognize Iran's role in the region and are acting to limit the expansion of Iranian influence. This will be most obvious in Syria and Iraq, where proxies of the region's Sunni powers will continue their efforts to erode Iranian-backed institutions stretching from Mesopotamia to the eastern Mediterranean.

As the United States' traditional partners in the region adjust to its shifting involvement in the Middle East, limiting Iran's rise will become a common cause. None of these actors can afford to lose the United States as its primary security patron, but all will be eager to diversify their dependence by reaching out to other international actors to help secure the interests that a potential U.S.-Iran rapprochement threatens. Russia and even some Western states, such as France, will seek to benefit from these Middle Eastern states' attempts to work with new partners.

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Turkey Keeps Watch On Kurdish Activity

Turkey will be preoccupied this quarter as the ruling Justice and Development Party (AKP) struggles to cobble together a coalition with a highly demanding and polarized opposition. There is a high chance that the coalition talks will fail, leaving the AKP to form a minority government. Whether the AKP calls for snap elections pre-emptively or waits for a confidence motion in parliament, early elections appear inevitable. The process will extend beyond the quarter, but the unstable political climate will add to Turkey's economic fragility as an emerging market highly vulnerable to investment outflows — a frailty that will become more pronounced once the U.S. Federal Reserve raises interest rates.

Turkey will continue to pursue its regional interests despite political distractions at home. The spread of Kurdish-controlled territory in Syria will fuel nationalist sentiment in Turkey, undermining any hope of resurrecting a viable peace process with the Kurdistan Workers' Party militant group. The growing tension between Turkey and the Kurdistan Workers' Party will raise the threat of Kurdish militancy in Turkey and will weaken Turkey's relationship with the Kurdistan Regional Government in Iraq.

In Syria, Turkey's military involvement will deepen over time. Ankara's significant support for Islamist rebel factions in the north will continue as Turkey and Qatar try to position their proxies in negotiations over a post-al Assad government. Turkey will attempt to build a case for a conventional military push into northern Syria to establish a security buffer against both the Islamic State and the threat of Kurdish expansion. Though Turkey will struggle to find support among coalition partners for such a move, unilateral actions cannot be ruled out. Turkey will at the very least establish military options for itself to seal the Syrian border while relying — as far as it is able — on rebel proxies to balance against Kurdish expansion. Meanwhile, in Iraq, Turkey will continue to support northern Sunni Arab tribes as it works not only to carve out a limited sphere of influence along its borders but also to prepare for an assault on the Islamic State in Mosul.

Saudi Arabia and the Gulf States Counter Iran

Riyadh will enter the third quarter with two primary objectives: limit Iranian expansion and preserve domestic security. The Saudi-led coalition's efforts in Yemen achieved its primary goal in limiting space for Iranian influence in a conflict on Saudi Arabia's borders. Riyadh now must contend with a difficult and lengthy political negotiation process to restore a pro-Saudi government in Sanaa. This process will extend beyond the quarter, but Riyadh and its Gulf Cooperation Council neighbors will remain engaged in negotiations concerning Yemen and brokered by the United Nations and Oman.

Saudi Arabia also will continue providing support and training for Syrian rebels as it seeks to oust the pro-Iranian al Assad government from Damascus. Moreover, Riyadh will be backing Iraqi Sunni Arab tribes (with support from Jordan) and will find common ground with regional competitors Israel, Qatar and Turkey to push back against shared threats from Iran and the Islamic State. Saudi Arabia will maintain a strong security position at home, continuing with proactive arrests and expedited trials for Sunni militants suspected of being affiliated with the Islamic State, especially since these militants have attempted to spark sectarian violence by targeting Shiites in the oil-rich but restive Eastern Province. Riyadh will face an especially difficult time preventing Sunni Saudi militants from attempting sectarian attacks against Gulf Shiites and other sensitive targets within the broader Gulf Cooperation Council community; Saudi Arabia will work to maintain its self-described role as the security guarantor of its neighbors even as its citizens become an increasingly serious threat to regional security.

Saudi Arabia and its neighbors will have to contend with rising domestic energy consumption during the hot summer months. However, Saudi energy production, along with that of neighboring Kuwait and the United Arab Emirates, could increase in coming months as the Gulf states seek to secure a larger market share in Asia.

Developments in the Syrian-Iraqi Battle Space

With government forces on the defensive on multiple fronts, Syria will be a focal point for regional competition going into the quarter. Iranian and Russian economic and military sponsorship of Syrian President Bashar al Assad's government will endure, but the government is still unlikely to go on the offensive as long as it is stretched thin and lacking momentum. That said, a break point on the Syrian battlefield will not occur this quarter. Loyalist forces will be able to retain a weakening presence in the north in Aleppo while holding down a critical corridor running from Damascus up through Homs to the coast. Rebel forces will seriously threaten approaches to the government forces' core, particularly around Hama and from the south in Daraa.

Talk of a political arrangement after al Assad will gain momentum as the battle progresses. Russia and the United States appear to be working to identify ranking Alawite officers who would be part of such an arrangement — and critical to maintaining the institutions of the state — as well as rebel factions that would be willing to come to the negotiating table with al Assad's removal as a precondition. As we noted last quarter, Russia will play a big role in the negotiating effort, not only to try to maintain its influence in the Levant but also to build up a U.S. dependence on Moscow in the Middle East that Russia can use as leverage in its standoff with the West.

However, the effort alone does mean a power-sharing arrangement will come to fruition this quarter. The momentum will stay with the rebels on the battlefield during the next three months, and while some of the more pragmatic factions in the Sunni rebellion, such as the Free Syrian Army Southern Front, could take part in a preparatory dialogue on a post-al Assad arrangement, there is little incentive for them to slow their offensives. Moreover, competing interests among the biggest Sunni sponsors of the rebel factions, including Turkey, Qatar, Saudi Arabia and Jordan, concerning what Syria after al Assad would look like will snarl efforts to hold talks with rebels.

The Battle Against the Islamic State

The Islamic State will be mostly on the defensive in Iraq this quarter as it tries to hold onto its gains in the face of attacks by Iraqi security forces and the Popular Mobilization Forces (an umbrella group of various Shiite militias with strong Iranian influence). The Islamic State will encounter considerable pressure from the Iraqi government and allied militias along the Tigris River Valley from Beiji to Hawija. The Iraqi forces and militias will focus on retaking recently lost territory in Anbar province along the Euphrates River Valley and centered on the cities of Fallujah and Ramadi. However, the main effort will be concentrated on containing any sudden Islamic State offensives and continuing to build up and equip domestic forces that will be needed to launch offensives to retake the more entrenched and concentrated Islamic State positions.

Although the Islamic State will be able to limit Iraqi gains and may even deal Iraqi forces occasional setbacks, the group will continue to slowly but steadily lose territory over the next quarter. The Islamic State will also have to deal with potential dissent within its territory and the diversion of forces to the Syrian battle space, which will further constrain its efforts in Iraq.

In Syria, the Islamic State will focus on sustaining its hold over its de facto capital, Raqqa, and ensuring continued access to its remaining border crossings along the section of the Syrian-Turkish border running from Jarabulus to the rebel-held lines around Azaz. The Islamic State will continue to exert significant efforts across the rest of the country, including occasional powerful strikes toward Homs and Hama, the maintenance of its siege on Deir el-Zour, and pressure on the Kurds and the Syrian government forces in al-Hasaka. However, the overstretched Islamic State will at times have no choice but to cede territory.

Financial Stress Widens Fissures in Iraq

Financial strains brought about by lower oil prices will limit Baghdad's ability to combat the Islamic State and maintain an already fragile agreement with the Kurdistan Regional Government. Baghdad has asked JPMorgan Chase, Citibank and Deutsche Bank to handle a $5 billion bond sale anticipated in late July, Iraq's first debt sale in nearly a decade. Baghdad received $833 million from the International Monetary Fund in early June, a move the government hopes will boost investor confidence. Baghdad's restrictions on funds to the Kurdistan Regional Government will once again threaten its arrangement with Arbil on oil distribution and revenue sharing. At the same time, strains between Turkey and the Kurdistan Regional Government will limit Arbil's ability to unilaterally export oil. Economic constraints and the mutual Islamic State threat will prevent Baghdad and Arbil from rupturing the agreement altogether, though enduring friction between the sides on parallel issues, such as the status of Kirkuk province, could heighten as this working arrangement is stressed in the third quarter.

The Kurdistan Regional Government will be locked in its own internal debates ahead of anticipated local presidential elections scheduled for Aug. 20. KRG President Massoud Barzani's mandate likely will be extended again in return for political concessions to other Kurdish factions as the Kurdish government focuses on the immediate issues of combating the Islamic State and securing economic stability.

Egypt Focuses on Domestic Politics and Regional Power Plays

In Egypt, the process of revising a parliamentary electoral law has delayed parliamentary elections and is continuing at a plodding pace. With Egypt suffering from water and power shortages during the hot summer months, Cairo is unlikely to hold elections until the fourth quarter. Egypt's proposed budget also hints at slowing subsidy cuts; Egyptian citizens will welcome the move, which is likely aimed at securing public support for President Abdel Fattah al-Sisi, but Egypt's financial situation (especially considering LNG import costs) will remain precarious and dependent on aid from the Gulf monarchies.

Cairo will continue to assert itself in the region, albeit as a junior partner to Riyadh. Egypt will also maintain a close relationship with Russia as both countries try to shape a negotiation in Syria. At the same time, Egypt will prioritize its relationship with the United States. U.S. Secretary of State John Kerry will visit Egypt at the end of July for a strategic dialogue that will include discussions of potential Israeli-Palestinian negotiations, the future of Syria and the conflict in Yemen. The coming quarter will also see the joint Arab military force imagined this past March come closer to fruition; al-Sisi will present a draft protocol to the Arab League at some point during the quarter.

In response to a growing jihadist threat in the Sinai Peninsula, Egypt will probably move additional troops to the area, with political support from both Hamas — which sees this Islamic State franchise as a direct threat to its control in Gaza — and Israel. With expertise imported from the battlefields in Iraq and Syria, the Sinai jihadist threat is growing in both scale and sophistication. The seriousness of this threat will create an opportunity for Hamas to repair its relationship with Egypt and for Cairo's already close cooperation with Israel to increase.

Libya and Algeria Seek Political Stability

Feuding Libyan factions in Tripoli and Tobruk will probably reach a deal in U.N.-brokered national unity talks by the end of the quarter. The deal will lay the foundation for the resumption of the constitutional process and the eventual formation of structures between the Libyan government and outside institutions (such as the United Nations, NATO and the European Union) to combat militancy, rebuild the Libyan army and handle issues such as illegal immigration and organized crime. However, this process will be slow and difficult.

The first steps will be organizing local forces against several Islamic State positions across the country as well as securing important oil infrastructure and restarting production. Libya will not reach stable production at capacity in the third quarter, but we expect to see a stronger push against the Islamic State and other militant forces within the oil-rich Sirte Basin. Domestic tumult in Libya will keep Algeria and Egypt on alert, but we do not anticipate regional military involvement — either in the form of a sustained air campaign or ground troops — in the quarter, and especially not before a unity government deal is reached.

Algeria's political transition will take place against a backdrop of increased security along its eastern and southern borders, with a particular focus on oil and natural gas production areas. Algeria's political reform process has continued on a deliberate trajectory, with reforms coming later than the government originally anticipated. Having secured the backing of the military and important political parties, the administration of President Abdelaziz Bouteflika will work in the third quarter to gain support from mainstream Islamists for an initial reform package we anticipate before the end of the year. 

East Asia

Regional Map - Forecasts - East Asia

Regional Map - Forecasts - East Asia

A Risky Quarter for the Chinese Economy

China's economy enters the third quarter on a comparatively strong note, but risks to financial and economic stability abound. After a year of steady declines in home prices, home sales and real estate-related investment nationwide, recent months bring signs of a tentative recovery in the all-important real estate sector in large and medium-sized cities. Nonetheless, continued declines in real estate investment, growth and construction starts nationwide suggest that housing markets remain weak in many of China's smaller cities, most of which are not included in central government surveys.

Major first- and second-tier real estate markets will benefit from pro-growth measures such as interest rate and reserve requirement ratio cuts, eased mortgage restrictions and a new program that allows local governments to swap outstanding debt for local bonds. However, Stratfor expects slow to stagnant growth to remain the norm for the housing sector as a whole in the third quarter.

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As a result, industries that rely heavily on housing and construction-related activity, and the regions most reliant on those industries, will continue to experience a more pronounced slowdown than the rest of the economy. As in the second quarter, northern resource belt provinces such as Shanxi and northeastern heavy industrial hubs such as Heilongjiang, Jilin and Liaoning will be hardest hit. However, proactive government policies and China's inherent regional fragmentation will help ensure that whatever financial difficulties emerge in these regions will remain localized within the quarter. Meanwhile, stronger growth in services and household consumption — also a product, at least in part, of accommodative government fiscal and monetary measures — will underpin more stable economic activity in more heavily urbanized coastal and inland regions.

The main risk to China's economy in the third quarter comes from the country's increasingly volatile stock market. After a year of sharp gains, China's leading exchanges appear to be peaking. A drop in prices in late June could continue throughout the third quarter, albeit punctuated by periodic gains as government measures to stabilize the market take effect. Within the quarter, Beijing's core task will be to manage any financial problems that arise as volatile or falling stock prices give way to scares over defaults on margin loans (loans used to invest in stocks). At present, the volume of outstanding margin loans, both formal and "shadow," is approximately $500 billion — likely too small to undermine nationwide financial stability — but a wave of margin loan defaults could trigger cash crunches on key interbank loan markets. China's government has said it will allow rollovers for some margin loans, but this promise will not apply to the $150 billion or so in informal margin loans outstanding. Also notable is the potential for a decline or increased volatility in Chinese stocks to hit sentiment and prices in regional markets, particularly Hong Kong and Singapore.  

During the third quarter, China's anti-corruption body, the Central Commission for Discipline Inspection, will run its second round of inspections for the year, targeting nine central government agencies and 17 state-owned enterprises. The transportation sector is the center of this wave of investigations, but the list of targets is also notable for including key propaganda organs such as Chinese Communist Party mouthpiece People's Daily and Qiushi, the Party's flagship political journal. Although the anti-corruption body has shifted its sights, officials from the energy and electricity sectors, which were hit earlier this year, could still be subject to follow-on investigations.

Regional Trade and Defense Issues

Following the U.S. Congress' ratification of Trade Promotion Authority, talks between the negotiating parties on the Trans-Pacific Partnership are likely to proceed with renewed vigor in the third quarter. The primary focus of these talks will be securing an agreement with Japan, the largest negotiating party after the United States and the key country for bringing all the other negotiating parties aboard the trade agreement. Agricultural tariffs remain the strongest area of contention between Tokyo and Washington. However, Japan's powerful agriculture lobby will be preoccupied with an unplanned leadership transition brought on by the imminent agriculture reforms in Japan, diminishing its ability to organize pressure against the Japanese government as the negotiations enter the final stretch.

During the third quarter, Japan and the Philippines will likely accelerate efforts to expand maritime security cooperation with the United States and with each other, particularly in the South China Sea. Tokyo and Manila will continue to negotiate a Visiting Forces Agreement that would allow Japanese aircraft and ships to refuel in the Philippines while on missions in the South China Sea. The U.S.-Philippine Enhanced Defense Cooperation Agreement, delayed by the Philippine Supreme Court, will also likely see movement this quarter. However, neither the Philippine-Japanese agreement nor the U.S.-Philippine agreement is likely to be finalized soon. Tokyo and Washington will also discuss, and perhaps begin to finance and deliver, additional resources for the Philippine coast guard, particularly coastal defense ships but perhaps also some aircraft and longer-range cutters and the services required to maintain them.

Washington also will continue discussions with Hanoi on expanding U.S. arms sales to Vietnam, again initially focused on the coast guard. Despite Beijing's desire to avoid souring Chinese President Xi Jinping's planned visit to the United States in September, China will feel compelled to respond assertively to the deepening Japanese cooperation with the Philippines and other Southeast Asian countries, especially any measures that lead to an increased presence of Japanese ships and aircraft in the South China Sea. China will demand that the United States rein in the perceived Japanese aggression but most likely with only limited effect given the U.S. interest in shifting the burdens of maintaining regional security to its local allies.

China's continued construction on existing islets and the uptick in U.S. air and naval patrols in the South China Sea (along with the corresponding Chinese interception flights) will also keep tensions high, placing a premium on U.S. and Chinese efforts to establish effective crisis management mechanisms. These efforts to develop effective confidence-building measures are likely to result in the signing of a set of protocols in August to govern unplanned encounters between aircraft.

Meanwhile, China and Russia will cooperate more closely in the areas of energy, economics, politics and security, and China will become more active in Central Asia as the "One Belt, One Road" initiative gets underway. Much of this activity is likely to be in Kazakhstan, where China will begin work on some of the $23.6 billion of infrastructure deals signed with Astana in March.

Japan's Continuing Evolution

The third quarter will be busy for the Japanese legislature as the ruling coalition passes a record-breaking 95-day extension on the Diet session (now scheduled to end Sept. 27). This extension is necessary because of unexpectedly strong opposition to Prime Minister Shinzo Abe's collective self-defense reforms, which would expand the scope for Japan's use of its Self-Defense Forces and authorize them to provide logistical support to allies fighting in distant conflicts. This will be an uphill battle for the ruling coalition, which will need to spend time to court hawkish factions within the opposition, but ultimately the legislation is likely to pass. Despite difficulties with top priority defense reforms, the ruling coalition appears to be in a good position to pass two structural reform laws: a worker dispatch law, which will abolish the three-year time limit on the employment of temporary workers, and a law to divest Japan's powerful agricultural lobby of many of its special privileges.

Meanwhile, the Japanese economy has continued to recover from a monthslong contraction in mid-2014 triggered by the government's decision to raise the national sales tax from 5 to 8 percent. After stronger-than-expected growth in the first quarter, Japan's economy was expected to perform less well in the second, mainly because of diminishing inventories. Nonetheless, Japan's government and the Bank of Japan have taken action to set market expectations of slower growth in the middle of the year. This suggests that further increases in the Bank of Japan's quantitative easing program — though not impossible — are unlikely within the quarter.

Domestic Matters Draw Southeast Asia's Focus

In the third quarter, most Southeast Asian countries — with the possible exception of the Philippines and Vietnam — will turn their attention inward, toward emerging social, economic and political concerns. In Indonesia, President Joko "Jokowi" Widodo will have halting but tangible success in further streamlining and centralizing the country's complex permit requirements for foreign investment while funneling more of the government's expanded infrastructure budget into new projects. Thailand, meanwhile, will focus on bolstering its weakening economy while maintaining a tight grip on security in Bangkok and further sidelining groups in the north and northeast that support former Prime Minister Thaksin Shinawatra.

Malaysia's increasingly embattled prime minister, Najib Razak, will struggle to retain control of his party and government. Razak faces rising calls for his resignation, including from his one-time mentor and patron, former Prime Minister Mahathir Mohamad, over a scandal involving the alleged misappropriation of funds from a sovereign wealth fund. Razak is working to soften the impact of still-low energy prices on government finances. In Myanmar, the military and ruling party will work to maintain their strong hold over the country's political system while attempting — but not likely succeeding, at least within the quarter — to seal a peace deal with disparate ethnic rebel groups ahead of elections later this year.

Chinese-Japanese competition for diplomatic influence in Southeast Asia, mainly in the form of continued pledges of investment from both, will form the backdrop for these domestic struggles, as will the increased U.S. and Japanese focus on bolstering defense and security partnerships in the region. 

Latin America

Regional Map - Forecasts - Latin America

Regional Map - Forecasts - Latin America

Venezuela's Crisis Continues

In coming months, the Venezuelan government will attempt to balance the competing domestic priorities of saving dollars for paying foreign debts due in the fourth quarter of 2015 and funding social spending ahead of legislative elections Dec. 6. Venezuela will be able to tap limited sources of funding, such as government spending funds and central bank reserves, in an attempt to avoid future default. Despite the risk of further declines in President Nicolas Maduro's already low public approval ratings, the government also will continue to limit foreign currency allocations for imports to protect its dwindling stock of dollars. However, the Venezuelan government is unlikely to implement any major economic reforms, such as a currency devaluation or fuel price increase, in the third quarter because sharp economic adjustments prior to the election would further endanger the ruling United Socialist Party of Venezuela's popularity.

Increasingly dissatisfied citizens will hold a few isolated demonstrations in the third quarter, but widespread organized unrest promoted by the country's political opposition is unlikely. With an election date set, Venezuela's opposition parties will be focused on contesting legislative elections rather than spurring major demonstrations. Meanwhile, the Venezuelan government could implement measures — such as redistributing food or consumer goods from private firms to potential voters at a discount — to briefly raise its public approval ahead of the elections.

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With an attempt at political rapprochement between Venezuela and the United States in full swing, Venezuelan and U.S. officials will continue trying to re-establish diplomatic ties in the near term and avoid a messy economic and social crisis for Venezuela in the coming years. Because ongoing criminal investigations have given the United States some leverage over Venezuelan officials, leaders such as Maduro and National Assembly Speaker Diosdado Cabello will probably have to make concessions to the United States, such as releasing political prisoners. Maduro does not yet appear to have the influence within the Venezuelan government to purge officials exacerbating the economic crisis or to implement badly needed economic reforms. Cuban influence in the Venezuelan government and armed forces will likely continue unabated in the third quarter, since the Venezuelan government prioritizes its political relationship with Havana, even maintaining low-cost oil shipments to Cuba despite Venezuela's economic stress.

Colombian Peace Talks Make Progress

Despite increased violence on the battlefield, the Colombian government's peace negotiations with rebels are likely to make progress this quarter toward a final agreement. Negotiations will continue on the issue of transitional justice mechanisms to judge demobilized militants and on how the rebels will demobilize. Progress is likely on both issues, and a peace agreement this year seems increasingly likely. However, Revolutionary Armed Forces of Colombia (FARC) attacks against security forces and energy infrastructure across the country will continue at a swifter pace than in previous months as the group pressures the government on the remaining points of negotiation. A breakthrough in the remaining issues with the FARC could make a deal with the smaller National Liberation Army more likely. Further meetings between the government and the National Liberation Army aimed at opening formal peace negotiations could occur in coming months.

A Presidential Election Draws Argentina's Attention

During the third quarter, the Argentine government will remain focused on the presidential race, which will continue until the first round of the presidential election Oct. 25. With most of the government's attention and time focused on preparations for the election, negotiations with so-called holdout bondholders — the recalcitrant bondholders who refused to buy into a comprehensive debt restructuring with Argentina in 2005 and 2010 — will be mostly frozen during the third quarter. The primary election in which the final candidates will be selected will occur Aug. 9 and will involve the ruling Front for Victory's candidate, Daniel Scioli, conservative Republican Proposal candidate Mauricio Macri and dissident Peronist Renewal Front candidate Sergio Massa. The primary election will serve as a gauge of how much support each party has, particularly the opposition Republican Proposal and Renewal Front, which chose to run independently of one another rather than pooling their resources for the election.

Brazil's Domestic Concerns Take Center Stage

During the third quarter, Brazil will continue to concentrate on mitigating the domestic fallout of the Petroleo Brasileiro corruption scandal and on managing the economy. After overcoming political challenges in the second quarter, President Dilma Rousseff will continue to govern, though her approval ratings are low and political resistance from former ally the Democratic Movement Party of Brazil will increase. In the coming months, the most visible split between the ruling Workers' Party and the Democratic Movement Party of Brazil will be a disagreement over reforming the regulatory scheme for exploration and exploitation of Brazil's vast pre-salt oil reserves. There will be political wrangling in both houses of congress in the next quarter as the opposition and the ruling party negotiate changes that could amend the requirement that Petrobras hold a stake in and directly operate all pre-salt projects. The proposal will not significantly erode government control over Petrobras. In fact, Brasilia's control over the company is likely to increase as corruption investigations into Petrobras continue.

Separately, as the investigation of officials and companies involved in the Petrobras scandal continues, more executives at private firms involved in the scandal will likely be arrested as criminal cases develop. The investigations and suspended contracts resulting from the scandal will further delay the company's investment plans for the coming months.

Brazil will also continue seeking foreign trade partners beyond the trade limitations imposed by the Common Market of the South (Mercosur). The intent is to expand Brazil's potential export revenue and reverse the country's economic slowdown. In July, the Brazilian and Mexican governments will begin trade talks intended to increase bilateral trade outside of the restrictive Mercosur trade framework. Mercosur will continue diplomatic contacts with the European Union over a potential free trade agreement, but Argentina's reluctance will slow negotiations. Any benefit from the talks would not be felt until after the third quarter.

Ecuador's Protests Could Gain Momentum

Protests spearheaded by Ecuador's opposition political parties, such as Creando Oportunidades (CREO) and United Society Plus Action, and by the Unitary Workers' Front likely will persist. The various protest groups remain divided and, although they oppose specific measures such as pension cuts and presidential re-election, they do not have a common set of demands. But if these groups begin coordinating protests and coalesce their demands into a coherent political platform, they likely would become a credible challenge to the government. A more highly organized political opposition could choose to disrupt President Rafael Correa's attempt to remove term limits, a measure currently slated for a final vote in the fourth quarter. Without the removal of term limits, Correa's current term, ending in 2017, will be his last. The president is likely to resist the opposition's attempts to shift the re-election initiative away from congress because of its low popularity among Ecuadorian voters. This resistance will likely inflame demonstrations against him in the coming quarter.

Mexico's Reforms Spur Resistance

Mexico will make progress in its energy reforms in the third quarter with the July 15 auction of the first tranche of 14 shallow-water offshore exploratory blocks to private and public bidders. Mexico's initial energy auction has attracted significant interest from potential bidders; 34 companies have already registered to participate.

By Aug. 1, Mexican state-owned energy firm Petroleos Mexicanos and its main labor union will agree on a new collective contract. The new contract is likely to implement potentially unpopular measures intended to reduce Pemex's significant financial losses. These include reducing the workforce through attrition and firings. The Pemex union is too internally divided to mount a significant challenge to such changes. Moreover, the union leaders' ties to the ruling Institutional Revolutionary Party will probably ensure the implementation of Pemex decisions.

The intensity and frequency of demonstrations held by southwestern Mexico's teachers' unions opposing education reform will subside in the third quarter. The southwestern Mexican states of Guerrero, Michoacan, Chiapas and Oaxaca will likely continue to experience sporadic demonstrations in the coming months over other issues, but major protests such as those that occurred from late 2014 through the June 7 elections are likely over.

Sub-Saharan Africa

Regional Map - Forecasts - Sub-Saharan Africa

Regional Map - Forecasts - Sub-Saharan Africa

Nigeria's New Government Settles In

Nigeria's new president, Muhammadu Buhari, will continue putting his government together while setting out initial policy priorities this quarter. In delegating powers to the Cabinet, Buhari could keep some Cabinet responsibilities close to himself, particularly the energy portfolio. This would not be unusual, considering the relative importance of the portfolio and Buhari's stint as the federal commissioner of petroleum and natural resources in the 1970s. Moreover, because of the large amount of funds passing through this portfolio and the severe lack of transparency in the portfolio, such a move would fit within Buhari's anti-corruption agenda.

The main policy items for Nigeria in the immediate future are energy and security. However, significant legislative movement on the Petroleum Industry Bill this quarter is unlikely. Buhari has announced a substantial reassessment of the bill and could end up breaking it into several pieces of legislation. This would allow less controversial aspects of the bill, such as increasing taxation of oil operations, to eventually be introduced into law without being held back by the more controversial ones, such as the requirement for oil companies to put 10 percent of their revenue into a special fund set aside for oil-producing regions, a measure that non-oil-producing regions oppose. Separately, the government will devote much attention to the question of whether to maintain fuel subsidies. Eliminating the subsidies has been mentioned as a way to cut government spending, but it would not be a popular move. The subsidies are probably here to stay, though they could be reduced.

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On the security front, Buhari has demonstrated an increasing willingness to coordinate security operations with neighboring countries. The Multinational Joint Task Force, which includes Chad, Niger and Cameroon as well as Nigeria, is likely to make progress in the third quarter against the threat posed by the Islamic State's Wilayat al Sudan al Gharbi (the group formerly known as Boko Haram). The task force likely will not conduct large-scale operations, focusing instead on particular operations constraining Wilayat al Sudan al Gharbi militants' mobility both inside Nigeria and across its borders into these other countries. Wilayat al Sudan al Gharbi will continue to pose a threat through guerrilla-style raids and suicide bomber attacks. Although this strategy will increase the requirements for effective intelligence collection and sharing in combating the militants, the group no longer has the ability to oppose the Nigerian military in more conventional ways.

As far as the Niger Delta is concerned, Buhari will continue to cautiously deal with the interests of former militant groups and will maintain a line of communication to them through the former Bayelsa state governor, Timipre Sylva, who is an acceptable go-between to both sides. Buhari seeks stability and the militants require patronage, a situation that allows for loose but compatible interaction between them.

Labor Talks Take Center Stage in South Africa

For South Africa, labor negotiations are reaching a point where continued tension and potential strikes will be occurring through the first half of the quarter. Both sides will make some complex maneuvers. Labor obviously wants sizable wage increases, especially given the credibility issues at stake. The National Union of Mineworkers has new leaders, the National Union of Metalworkers of South Africa is attempting to establish a significant membership base in the mining sector, and dissent has arisen within the Congress of South African Trade Unions after the expulsion of the National Union of Metalworkers of South Africa.

However, the unions cannot easily accommodate the mining companies' constraints. These companies are still struggling with scarce capital, rising electricity costs and decreased demand and cannot grant large wage increases. The government will be expected to position itself more on the side of labor ahead of 2016 municipal elections, 2017 party elections and 2019 national elections. Given the weaknesses on all sides, with both the unions and mining companies still bearing the cost of previous disruptions, some accommodation between the stakeholders is expected this year.

Tanzania Focuses on Elections and Energy

Preparations for Tanzania's general elections, scheduled for Oct. 25, will require parties to select their presidential candidates in the third quarter. As campaigning begins, the government will make a more concerted effort focusing on a referendum on a new constitution. The elections and party primaries are hardwired events, but the constitutional referendum is not. The referendum has already been delayed because of a lack of funding and divided political interests behind the vote, and it is not certain that the referendum will be held before the general election. The controversy surrounding the referendum — which, among other things, will decide whether Zanzibar and Tanganyika become separate electoral units with their own parliaments within Tanzania — could compel the current government to leave the issue to its successor.

In the meantime, the legislature is likely to pass pending legislation, as demonstrated by the recently approved petroleum bill. The bill is designed to create new entities to help regulate the petroleum sector and establish new fiscal terms that are more beneficial to Tanzania than previous ones. Since signing previous deals with international oil companies such as Statoil and ExxonMobil, Tanzania has had a wave of significant discoveries of offshore natural gas resources that give the country the potential to become a major Indian Ocean-based liquefied natural gas exporter. Tanzania is now hoping that it can spin those discoveries into more lucrative contracts going forward as international interest in the country grows. However, the legislation does not mean a wave of investment will flow into Tanzania in the third quarter; energy companies are still dealing with depressed demand, tighter capital supplies, very high capital costs of greenfield projects like those in Tanzania, and fierce competition among established suppliers and start-ups like Tanzania.

Burundi's Aftershocks in the Region

In the aftermath of the failed coup in Burundi, instability remains a concern. Burundi itself is not of major global concern, but the issue of how African leaders in similar situations deal with the desire to acquire another term in office — or block a rival from getting another term in office — is important.

The most important factor is whether an incumbent leader enjoys the undivided support of the country's security forces, as was not the case in Burundi. The security apparatus in the Democratic Republic of the Congo, for example, is deeply divided, meaning President Joseph Kabila would face a mortal risk, on top of intense political opposition, if he chose to seek another term. Rwandan and Ugandan leaders have tried to banish dissident military officials. While elections are not occurring this year in these countries, the aftermath of the Burundi coup attempt will likely cause these leaders to reassess their positions and to either ensure their support within their countries' security forces or start working on succession plans.

Ugandan President Yoweri Museveni and Kabila are always battling dissent and opposition, and preparations are already well underway for both men to seek another term, although both are leaving the door open for an exit. The closer we get to elections in 2016, the harder it will be for Kabila to engineer another term because of the strong opposition movements in his country. Museveni, on the other hand, faces some opposition but is in a stronger position to engineer support for himself or his son, given his greater control over the judiciary, defense forces and parliament.

Sudan Changes Its Diplomatic Orientation

Earlier this year, Sudan began adjusting its posture toward the Gulf Cooperation Council countries, a trend that could continue in the third quarter. Sudan will probably not make radical moves, but the shift is important to note in the context of a potential rapprochement, or at least some level of accommodation, between Sudan and the West.

So far, Sudan has been moving closer to Saudi Arabia, the United Arab Emirates and Egypt and has significantly distanced itself from Iran. This plays a significant part in reshaping alliance structures in the Middle East ahead of an expected eventual U.S.-Iran nuclear deal. At the same time, Sudan has broadcast its intent to expand this diplomatic reorientation to include relations with Western countries. As the potential for diplomatic contacts between Washington and Khartoum increases, Sudan will look for ways to leverage its usefulness in counterterrorism efforts to further the dialogue. The International Criminal Court warrant for President Omar al Bashir's arrest will continue to limit relations between Sudan and other countries, although eventually interaction at lower government levels could bring about some cooperation in areas such as security.

South Asia

Regional Map - Forecasts - South Asia

Regional Map - Forecasts - South Asia

India's Uncertain Economic Position

The third quarter is traditionally monsoon season in India, and lawmakers in New Delhi will be monitoring rain levels as meteorologists warn of a deficient rainy season. Unseasonable rains earlier in the year, followed by last quarter's extended heat wave, have left the future of India's staple grain crops uncertain. Though India has considerable stocks of staple grains, New Delhi has already issued tenders for sizable deliveries of wheat as the government hopes to prevent localized shortages and especially rising food inflation should the monsoon deliver less rain than needed.

Anxieties about the monsoon's rain levels echo those about India's economic performance. Despite the government's frequent assertions that growth greater than 7.5 percent is possible through the end of the year, coal stocks at power plants and decreasing industrial output point to real concerns about extended underutilization in several sectors of the Indian economy. New Delhi's revision of how GDP is calculated is likely overstating Indian growth. However, we expect Indian economic growth to continue steadily — especially with lower crude oil and gold prices helping to keep India's trade balance in check — even if at a slower pace than currently reported. The Bharatiya Janata Party government of Prime Minister Narendra Modi is expected to introduce significant labor, real estate and urban rejuvenation bills during parliament's monsoon session. Opposition from within the ruling party could lead the government to delay reintroducing controversial amendments to the Land Acquisition Bill during the monsoon session; the bill is not likely to pass in the legislature's upper house this year. 

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Modi will visit several countries during the third quarter as he continues his aggressive travel schedule around July's Shanghai Cooperation Organization and BRICS summits in Russia. India will court Central Asian states as it seeks support for its plans to join the Shanghai Cooperation Organization. New Delhi can be expected to offer investments, particularly in extractive resources but also a limited spate of developmental and infrastructure deals. However, Central Asian investment is a long-term prospect. There is a strong chance that Modi will meet Pakistani Prime Minister Nawaz Sharif on the sidelines of the Shanghai Cooperation Organization summit for what could be a start to backroom negotiations aimed at restarting a long-halted peace process. India's counterterrorism activities, especially those in the northeast, will be an important component of the talks. The Modi government will need to establish strong anti-militant activities if it is to stifle domestic opposition ahead of formal talks with Islamabad. We expect New Delhi to increase cooperation with regional capitals, including Naypyidaw, to limit militant movement and access to supplies.

Sri Lanka Prepares for Elections

Sri Lanka will hold parliamentary elections in mid-August following the dissolution of parliament on June 26, months after the April date that Sri Lankan President Maithripala Sirisena campaigned on. The delay reflects the strong, persistent divisions on the island following the electoral ouster of former President Mahinda Rajapaksa. The country's Buddhist Sinhalese majority remains divided between the majority United People's Freedom Alliance of Rajapaksa and Sirisena and the ruling United National Front of Prime Minister Ranil Wickremesinghe. Rajapaksa has announced that he will run for the premiership, courting the support of his party's former allies who have become frustrated with Wickremesinghe's leadership and the demands of the island's emboldened minority groups. Rajapaksa has yet to announce if he will run under his former political banner or craft a new political party and coalition structure, but his attempt to re-enter political leadership will likely complicate an already difficult electoral and constitutional drafting process.

The elections will be only the first step of a long and difficult reconciliation process. After parliament reconvenes in September, the government will begin a drafting a new constitution — a process that will bring to the fore the competing demands of rival Sinhalese factions as well as minority Hindu Tamil and Muslim populations.

Violence Declines in Bangladesh

The long-awaited India-Bangladesh land swap deal, involving the exchange of 162 parcels of land and settling a decadeslong border dispute, will go into effect July 31. Dhaka will continue to press for a finalized water-sharing agreement focusing on the disputed Teesta River, an important domestic issue for the embattled government of Bangladeshi Prime Minister Sheikh Hasina. Violence carried out by opposition parties affiliated with the Bangladesh Nationalist Party have slowed as opposition leader Khaleda Zia has begun distancing herself and her party from the conservative Islamist Jamaat-e-Islami following several high-profile attacks against secular bloggers.

Garment exports are expected to rise slowly through the summer months as the slowing of protests and strikes allows economic activities to recover. We expect the ruling Awami League and the Bangladesh Nationalist Party to attempt quiet backchannel negotiations once again, especially now that the government has shown that it has remained resilient to the opposition's strike tactics.

The Islamic State and Afghanistan

The Islamic State will challenge the Taliban's position in Afghanistan in the third quarter. The Islamic State is leveraging a few advantages in the South Asian country. Afghanistan has experienced a sizable influx of foreign fighters recently, many of them fleeing the Pakistani offensives as Islamabad approaches the third and final phase of its anti-militant activities during the quarter. The incoming fighters have been far more amenable to flocking to the Islamic State banner than locals have, though the Islamic State also will be able to draw support from disenfranchised or disgruntled Taliban or ex-Taliban fighters. The Islamic State is also well financed at the moment, but we expect the group will struggle with finding new funding streams as the months pass.

These advantages are unlikely to translate into a substantial threat to the Taliban's hold over Afghanistan in the quarter. The Taliban initiated open hostilities with the Islamic State following their pre-emptive strike against Islamic State fighters in Farah province in May, and the Islamic State has been working to establish a stronger foothold in the country since then. The Islamic State will remain incapable of large-scale offensives against either the Taliban or Afghan National Security Forces in coming months, focusing instead on local recruitment and gaining local support. Things will gradually change as the Islamic State gets better traction, but despite reports of recent successes, the group will continue to encounter strong resistance throughout the quarter. Expect the Taliban to try to leverage their opposition to the Islamic State in its negotiations with the United States and with their traditional foes in the region, such as Iran and Pakistan. 

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