CAPSTONE 19-1 South Asia Field Study

Transcription

1 CAPSTONE 19-1 South Asia Field Study Subject Page Combatant Command... 3 Nepal India Bangladesh National Security Strategy

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3 Subject U.S. Indo-Pacific Command Page Admiral Philip Davidson... 5 History... 7 Area of Responsibility Posture Statement... 11

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5 Commander, U.S. Indo-Pacific Command Admiral Philip S. Davidson, U.S. Navy Photos Admiral Philip S. Davidson (Photo by File Photo) Adm. Phil Davidson is the 25th Commander of United States Indo-Pacific Command (USINDOPACOM), America s oldest and largest military combatant command, based in Hawai i. USINDOPACOM includes 380,000 Soldiers, Sailors, Marines, Airmen, Coast Guardsmen and Department of Defense civilians and is responsible for all U.S. military activities in the Indo-Pacific, covering 36 nations, 14 time zones, and more than 50 percent of the world s population. Prior to becoming CDRUSINDOPACOM on May 30, 2018, he served as the commander of U.S. Fleet Forces Command/Naval Forces U.S. Northern Command. He previously served as the commander, U.S. 6th Fleet, and the commander, Naval Striking and Support Forces NATO, while simultaneously serving as the deputy commander, U.S. Naval Forces Europe and U.S. Naval Forces Africa. A native of St. Louis, Missouri, Davidson is a 1982 graduate of the United States Naval Academy. He is a surface warfare officer who has deployed across the globe in frigates, destroyers, cruisers, and aircraft carriers.

6 His earlier sea commands included Carrier Strike Group 8/Eisenhower Carrier Strike Group, USS Gettysburg (CG 64), and USS Taylor (FFG 50). Ashore, Davidson has served in fleet, interagency, and joint tours as a flag officer; he was previously the director, Maritime Operations, U. S. Fleet Forces Command, the senior military advisor to the Special Representative for Afghanistan and Pakistan (SRAP) at the State Department, and the deputy director for Strategy and Policy in the Joint Staff/J-5. He served earlier in his career in policy, strategy, and operations billets on multiple tours with the U.S. Pacific Fleet staff, the Navy staff and the Joint Staff, and as the Navy s military aide to the vice president of the United States. He is a distinguished graduate of the U.S. Naval War College. He has a Master of Arts in National Security and Strategic Studies, and a Bachelor of Science in Physics. His decorations include the Distinguished Service Medal, the Navy and Marine Corps Commendation Medal with Combat V, a Superior Honor Award from the U.S. Department of State, and other personal, service, unit, and campaign awards.

7 U.S. I -P C ( ://.. /) ( Home ( : About USPACOM ( : History History of United States Pacific Command The U.S. Pacific Command was established as a unified command on January 1, 1947, and it is the oldest and largest of the United States' unified commands. The present U.S. Pacific Command (USPACOM) includes areas originally assigned to two other unified commanders. The Far East Command, which had been established on January 1, 1947, was disestablished on July 1, 1957, and all its responsibilities were assumed by the Pacific Command. That same day the command assumed some of the responsibilities of the Alaskan Command and individual Army and Air Force component commands for the Pacific also were established in Hawaii. In October 1957, the then Commander in Chief, Pacific Command (CINCPAC) headquarters moved from Makalapa to Camp H.M. Smith, which is also the headquarters of Commander, Marine Forces Pacific. CINCPAC also served concurrently as Commander in Chief, U.S. Pacific Fleet until January 1958, when the U.S. Pacific Fleet became a separate component with its own commander. Added responsibilities were assigned to CINCPAC on January 1, 1972, for military forces and elements in the Indian Ocean, Southern Asia, and the Arctic. Alaskan Command, one of the original unified commands established on January 1, 1947, was disestablished in 1975 and its responsibilities were transferred to the Pacific Command. The Pacific Command's area of responsibility was further expanded on May 1, 1976, to the east coast of Africa. This enlarged the Pacific Command to more than 50 percent of the earth's surface, an area of over 100 million square miles. Another enlargement of the USPACOM area took place in October 1983, when CINCPAC was assigned responsibility for the People's Republic of China, the Democratic People's Republic of Korea, Mongolia, and the Republic of Madagascar. CINCPAC was also redesignated Commander in Chief, U.S. Pacific Command (USCINCPAC). In 1986, the Goldwater-Nichols Reorganization Act expanded, as well as codified, the authority of the commanders of the unified commands to carry out their assigned missions and to employ combatant forces provided by the individual Services. A new Alaskan Command (ALCOM) was established on July 7, 1989, at Elmendorf Air Force Base, Alaska, as a subordinate unified command responsible to USCINCPAC. (There is no relationship to the original ALCOM, a unified command disestablished in 1975.) This placed the defense of Alaska and its surrounding waters under the leadership of one commander, providing a unity of command absent from the state since the early 1970s. From 1989 through 2000, three Unified Command Plans slightly reduced USPACOM's area of responsibility. With the focus of attention shifting to the Middle East, the August 16, 1989, plan assigned responsibility for the Gulf of Oman and Gulf of Aden to Commander, U.S. Central Command (USCENTCOM). The January 1, 1996 plan transferred the Seychelles and adjacent waters to USCENTCOM. On October 1, 2000, responsibility for Indian Ocean waters off Tanzania, Mozambique, and South Africa was transferred from USPACOM to U.S. European Command (USEUCOM). The Unified Command Plan changed as a result of the events of September 11, 2001, and the ensuing war on terrorism, as well as the new defense strategy articulated in the 2001 Quadrennial Defense Review. For the first time the entire surface of the earth was divided among the various unified commands. A new Northern Command (USNORTHCOM) was created for homeland security and other changes in the various commands' responsibilities resulted in significant changes for USPACOM. The West Coast of North America was reassigned from USPACOM to USNORTHCOM. While Alaska was included in the reassignment to USNORTHCOM, Alaskan Command forces remained assigned to USPACOM in the "Forces for Unified Commands Memorandum." Antarctica was also added to USPACOM's area of responsibility. Approved in April 2002, the new Unified Command Plan became effective October 1, Effective October 24, 2002, by direction of the Secretary of Defense, the title "Commander in Chief, U.S. Pacific Command" (USCINCPAC) was changed to "Commander, U.S. Pacific Command" (CDRUSPACOM). As stated by Secretary of Defense Donald Rumsfeld, there is only one Commander in Chief and that is the President of the United States. The 2008 Unified Command Plan, signed on December 17, 2008, documented the transfer of all areas of the Indian Ocean previously assigned to USPACOM west of 68 degrees east to the newly established U.S. Africa Command (USAFRICOM). As a result, four island countries off the east coast of Africa that were formerly assigned to PACOM were reassigned to AFRICOM: Comoros, Madagascar, Mauritius, and Reunion. USPACOM is the recipient of six Joint Meritorious Unit Awards. Skip to main content (Press Enter).

8 History of Camp H.M. Smith Camp H.M. Smith, home of the headquarters of Commander, U.S. Pacific Command and the Commanding General of Marine Forces Pacific, is located on Oahu's Halawa Heights at an elevation of about 600 feet above Pearl Harbor near the community of Aiea. Once covered with sugar cane fields, Camp Smith's location was approved by an Act of Congress on March 17, 1941 to be the site of a new Navy hospital. Initial investment for the acres of land was $912,000; improvements cost an additional $14 million. Hospital construction began in July Following the Japanese attack on Pearl Harbor on December 7, 1941, construction of the planned 1,650-bed facility was rushed to completion. When Admiral Chester W. Nimitz attended the commissioning ceremony for the "Aiea Naval Hospital" on November 11, 1942, expansion was already necessary. Throughout World War II, the Aiea Naval Hospital served as an interim treatment stop for thousands of wounded Sailors and Marines on their way home from the war in the Pacific. Following the battle for Iwo Jima in February - March 1945, the hospital was filled to overflowing with 5,676 in-patients, the highest number at any given time in its history. On June 1, 1949, the hospital was deactivated when Army and Navy medical facilities were consolidated at the new Tripler Army Medical Center. Vacant and being considered for sale, the Marine Corps selected the site as the "Home of the Fleet Marine Force Pacific" in The installation was renamed on June 8, 1955, in honor of the first commanding general of Fleet Marine Forces, Pacific and a highly regarded Marine leader during World War II, General Holland McTyeire Smith. The Marines took up residence in October 1955 and Camp H.M. Smith was in full operation two weeks before its dedication on January 31, In October 1957, Camp Smith also became the headquarters for USPACOM where they, too, were located in the old Aiea Naval Hospital. In February 2001, ground was broken for a new USPACOM headquarters building. Construction was completed and people began moving into the new Building 700 during the period February-April Although neither man had commanded the Pacific Command, the building was named in honor of two great leaders of World War II in the Pacific: Fleet Admiral Chester W. Nimitz, USN, and General of the Army Douglas MacArthur, USA. The Nimitz-MacArthur Pacific Command Center was formally dedicated on April 14, 2004.

9 U.S. I -P C ( ://.. /) ( Home ( : About USPACOM ( : USPACOM Area of Responsibility ** Click here to download the large Image (/Portals/55/Images/PACOM-MAP-Mar_2016.jpg) ** United States Pacific Command (USPACOM) is one of six geographic combatant commands defined by the Department of Defense's Unified Command Plan (UCP). As a geographic combatant command, USPACOM is in charge of using and integrating United States Army, Navy, Air Force and Marine Corps forces within the USPACOM area of responsibility (AOR) to achieve U.S. national security objectives while protecting national interests. The USPACOM AOR covers more of the globe of any of the other geographic combatant commands and shares borders with all of the other five geographic combatant commands. The commander of US Pacific Command reports to the President of the United States through the Secretary of Defense and is supported by multiple component and sub-unified commands including: U.S. Forces Korea, US Forces Japan, U.S. Special Operations Command Pacific, U.S. Pacific Fleet, U.S. Marine Forces Pacific, U.S. Pacific Air Forces and U.S. Army Pacific. There are few regions as culturally, socially, economically, and geopolitically diverse as the Asia-Pacific. The 36 nations comprising the Asia-Pacific region are home to more than 50% of the world's population, 3,000 different languages, several of the world's largest militaries, and five nations allied with the U.S. through mutual defense treaties. Two of the three largest economies are located in the Asia-Pacific, along with ten of the fourteen smallest. The AOR includes the most populous nation in the world, the largest democracy, and the largest Muslim-majority nation. More than one third of Asia-Pacific nations are smaller, island nations, including the smallest republic in the world and the smallest nation in Asia. The region is a vital driver of the global economy and includes the world's busiest international sea lanes and nine of the ten largest ports. The Asia-Pacific is also a heavily militarized region, with seven of the world's ten largest standing militaries and five of the world's declared nuclear nations. Given these conditions, the strategic complexity facing the region is unique. Skip to main content (Press Enter).

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11 STATEMENT OF ADMIRAL HARRY B. HARRIS JR., U.S. NAVY COMMANDER, U.S. PACIFIC COMMAND BEFORE THE HOUSE ARMED SERVICES COMMITTEE ON U.S. PACIFIC COMMAND POSTURE 14 FEBRUARY 2018

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13 Chairman Thornberry, Ranking Member Smith, and distinguished members of the committee, thank you for the opportunity to appear before you today. This is my third opportunity to present my posture assessment since taking command of U.S. Pacific Command (USPACOM) in May During my time at USPACOM, I have had the tremendous honor of leading the Soldiers, Sailors, Marines, Airmen, Coast Guardsmen, and Department of Defense civilians standing watch for the largest and most diverse geographic command. These men and women, as well as their families, fill me with pride with their hard work and devotion to duty. I m humbled to serve alongside them. Since its inception in 1947, USPACOM and the joint military forces assigned to it have served as a shield protecting the U.S., its territories, its people, and its interests throughout the Indo-Pacific region. To accomplish this, USPACOM works hand-in-hand with the other U.S. government agencies in this region to defend our homeland and our citizens. This is USPACOM s enduring responsibility and my #1 command priority. To enhance our efforts, USPACOM works with our allies and partners to improve stability in the region by promoting security cooperation, deterring aggression, responding to contingencies, and, when necessary, fighting to win. The path to security is based on our commitments to mutual interest and partnership, continuous military presence, and global readiness. The U.S. has a lasting national interest in the Indo-Pacific. As I stated last year, I believe America s security and economic prosperity are indelibly linked to this critical region, which remains at a precarious crossroad where tangible opportunity meets significant challenge. Of the five principal challenges that drive U.S. defense planning and budgeting China, Russia, Democratic People s Republic of Korea (DPRK), Iran, and violent extremist organizations four are found within the Indo-Pacific. To protect the homeland, the American people, and the American way of life, we must target threats at their source and confront them before they ever reach our borders or cause harm to our people. America cannot ignore these challenges and should not allow any nation or treacherous non-state actor to erode the rules-based security order that has yielded tremendous benefits for our nation and this region for the last seven decades. Following the upheaval of World War II, the rules-based international order or what the 2018 National Defense Strategy described as a free and open international order flourished to keep 1

14 the Indo-Pacific largely peaceful, creating the stability necessary for economic prosperity in the U.S. and countries throughout the region. Ironically, the country that has benefitted the most from regional stability is China. The collective respect for, and adherence to, international law and standards have produced the longest era of peace and prosperity in modern times. This was not happenstance. This was made possible by seven decades of robust and persistent U.S. military presence and credible combat power. America s security treaties with Australia, Japan, the Republic of Korea (ROK), the Philippines, and Thailand have buttressed this security order, which is consequently strengthened even further by growing partnerships with India, Indonesia, Malaysia, Mongolia, New Zealand, Singapore, Sri Lanka, and Vietnam. USPACOM recognizes the global significance of the Indo-Pacific region and that strong and independent states are the best hope for a peaceful world. Challenges are best met together; therefore, America will remain an engaged and trusted ally and partner committed to preserving the security, stability, and freedom necessary for enduring prosperity. A free and open order encompasses a number of critical principles: the rule of law; adherence to international law and other international standards; peaceful resolution of disputes; freedom of navigation for all civilian and military vessels and aircraft; and open access to the sea, air, space, and cyberspace domains. The outcomes of these principles are enhanced security and open, legitimate trade. Sustainable security requires effective and enduring institutions, both civilian and military, that are guided by these principles. Defense, diplomatic, and development efforts are intertwined and continue to reinforce each other to promote stability to build and sustain stable democratic states. The Indian and Pacific Oceans are the economic lifeblood that links the Indian Subcontinent, Australia, Southeast Asia, Northeast Asia, and Oceania with the U.S. Oceans that were once physical and psychological barriers keeping nations apart are now maritime superhighways that bring them together. Over half the global GDP comes from the region (including the U.S.) and roughly one-third of global shipping passes through the South China Sea. A quarter of U.S. exports go to the region, and exports to China and India have more than doubled over the past decade. This diverse region drives global growth and is home to the world's largest economies (U.S., China, and Japan) and six of the world's fastest growing economies (Cambodia, India, Laos, Burma, Nepal, and the Philippines). Unimpeded lawful commerce, fair market economies, 2

15 and free trade promote American prosperity and security, leading to a strong economy that protects the American people, supports our way of life, and sustains American power. The Indo-Pacific has the world s most populous democracy (India) and the world s largest Muslim-majority state (Indonesia), both of which we see as key U.S. partners in the region. The area is home to more than half the world s population. Eleven of the 15 largest militaries in the world are in or adjacent to the region, as are six of the nine countries that possess nuclear weapons. These regional characteristics merely reinforce the need for a strong and persistent U.S. presence in the region to preserve peace through strength. To be blunt, the stability of the Indo-Pacific matters to America. And the region needs a strong America, just as America needs a vibrant, thriving Indo-Pacific that remains both politically and economically free. It is not just history that necessitates our continued presence in the Indo-Pacific region; it is the future as well. The U.S. must maintain credible combat power across the region in order to defend against revisionist powers that seek to subvert democracy and undermine a free and open international order. It is to our long-term benefit to remain the region s security partner of choice by working closely with our allies and partners who share our commitment to uphold peace, economic prosperity, and security. We must not cede ground in this endeavor. What follows is USPACOM s strategic approach to the region, as directed by the National Defense Strategy, including my assessment of the regional security challenges, the key strategic opportunities, and the capabilities necessary to preserve a free and open Indo-Pacific. I will emphasize critical needs in order to seek your support for budgetary and legislative action to improve our position and military readiness in the theater. I will detail the value of U.S. strategic force posture and forward presence, and describe how these preconditions improve the readiness of our joint force to fight tonight, while simultaneously enhancing our ability to reassure allies and partners. Finally, I will discuss how USPACOM can advance U.S. foreign policy by strengthening our existing alliances and cultivating important partnerships, thereby yielding strategic benefits that improve USPACOM s readiness to protect and defend U.S. interests. 3

16 Overview Regional security and stability are threatened by a range of rogue and revisionist state and nonstate actors who are challenging U.S. influence and the free and open international order that has helped underwrite peace and prosperity for America and throughout the region for over 70 years. The Democratic People s Republic of Korea (DPRK) has rapidly advanced and improved its ballistic missile capability and its nuclear weapons program. Sanctions, international condemnation, and even increased pressure from China, to date, have not yet compelled the DPRK to end their unlawful nuclear and ballistic missile programs. And while tensions in the East China Sea between China and Japan have stabilized, China s provocative and destabilizing actions in the South China Sea continue unabated. China s historically unprecedented economic development has enabled an impressive military buildup that could soon challenge the U.S. across almost all domains. Key Chinese advancements include: significant improvements in missile systems; 5th generation fighter aircraft capabilities; and increased size and capability of the Chinese navy. A major initiative for that growing navy is China s first-ever overseas base in Djibouti. I am also deeply concerned about China s heavy investments into the next wave of military technologies, including hypersonic missiles, advanced space and cyber capabilities, and artificial intelligence if the U.S. does not keep pace, USPACOM will struggle to compete with the People s Liberation Army (PLA) on future battlefields. China s ongoing military modernization is a core element of China s stated strategy to supplant the U.S. as the security partner of choice for countries in the Indo-Pacific. Russia s interest and influence in the region continues to increase through national outreach and military modernization in both its conventional forces and nuclear strike capabilities. The threat of ISIS in the Indo-Pacific changed drastically from inspiration and support to direct action as ISIS-Philippines seized control of the city of Marawi in May. The Armed Forces of the Philippines recaptured the city after a long fight and scattered what was left of ISIS-Philippines, but the incident highlights the dangerous and difficult problem transnational terrorism presents to the region. Drug trafficking, human smuggling, piracy, weapons proliferation, natural disasters as well as illegal, unreported, and unregulated fishing further challenge regional peace and prosperity. The U.S. military remains the most powerful in the world, but our relative advantage and ability to counter these threats have declined. For USPACOM to continue to underpin U.S. diplomatic 4

17 efforts and deter future conflict against peer competitors, rogue states, and transnational threats, the joint force must maintain a clear ability to fight and win when called upon to do so. Strategic Approach The 2018 National Defense Strategy aims to Compete, Deter, and Win alongside our allies and partners. In support of these aims, USPACOM maintains a strategic approach to the region that encompasses four core elements: 1) Maintain credible combat power and work with the Services and Departments to build the right force of the future; 2) Maintain a network of like-minded allies and partners to cultivate principled security networks which reinforce the free and open international order; 3) Continue to fly, sail, and operate wherever international law allows and encourage others to do the same. Be ready to counter the coercive influence of regional competitors; 4) Counter transnational threat and challenges, including terrorism and illegal/illicit trafficking, and be ready to respond to natural disasters. USPACOM recognizes the global significance of the Indo-Pacific and understands that challenges are best through a unified approach. Thus, USPACOM actions are guided by two unifying concepts: 1) communicate effectively and truthfully; and 2) synchronize efforts outside of USPACOM across the DoD, the interagency environment, and internationally with likeminded allies and partners. Together, fully aligned with our interagency, joint, and combined partners, USPACOM will remain prepared to meet the following key challenges. Key Challenges Democratic People s Republic of Korea (DPRK): Last year I testified that the DPRK was our most immediate threat, and since then the level of that threat has increased significantly. The past year has seen rapid and comprehensive improvement in the DPRK s ballistic missile and nuclear capabilities, despite broad international condemnation and the imposition of additional United Nations Security Council sanctions. This includes the first-ever launches of two different intercontinental-range ballistic missiles (ICBM) during three separate ICBM tests and six 5

18 launches of an intermediate-range ballistic missile (IRBM). Pyongyang emphatically states its ICBMs are only designed to target the U.S. and its IRBMs are only designed to strike Guam. Two missile tests overflew sovereign Japanese territory, needlessly endangering Japanese citizens. Several commercial aircraft on standard flight routes also reported being close enough to see missiles in the air during tests, underscoring the DPRK s reckless research and development programs. The DPRK still holds the distinction of being the only nation to have tested nuclear weapons in the 21st century, and the DPRK detonated its sixth and largest nuclear device at its underground facility at Punggye-ri in September Senior DPRK officials then threatened to conduct an air burst of a nuclear warhead mated to one of its long-range ballistic missiles. Although this has not happened, Pyongyang could potentially do so to further demonstrate capability or to prove that its design and technical functions work. The international community has cautioned against doing so, and is certain to condemn such an act if it occurs, but Kim Jong Un has demonstrated over and over again his disdain for international norms, responsibilities, and prudent conduct. The combination of successful, or mostly successful, ballistic missile tests and the most recent nuclear test have advanced the DPRK s capabilities significantly. Following the 29 November 2017 Hwasong-15 ICBM test, Kim Jong Un declared with pride that they now have finally realized the great historic cause of completing the state nuclear force. While some in the U.S. might dispute both the reliability and quantity of the North s strategic weapons, it is indisputable that Kim is rapidly closing the gap between rhetoric and capability. Our two close allies in Northeast Asia the Republic of Korea and Japan have been living under the shadow of the DPRK s threats; now the shadow looms over the American homeland. USPACOM and the entire DoD fully support the President's maximum pressure campaign, led by the State Department. Nobody seeks or desires conflict with the DPRK, but the U.S. and its allies must prepare for the full range of military contingencies. Beyond the unanimous adoption of United Nations Security Council Resolutions (UNSCR) 2321, 2356, 2371, 2375, and 2397 in 2017, countries around the world are diplomatically and financially isolating the DPRK. In response to the efforts of Secretary Tillerson and other senior administration officials, the international community has drastically reduced trade with the 6

19 DPRK, frozen assets, expelled overseas DPRK workers, and more. China s actions are critical as China is the DPRK s largest trading partner (approximately 92% of all trade). To Beijing s credit, China has taken significant steps to enforce the various UNSCRs, but Beijing can and should do more. I am also concerned about Russia s limited contributions to the pressure campaign. While Moscow voted in favor of the recent Security Council resolutions, Russia has the capability to undermine the efforts of other countries, thereby playing the role of a spoiler as the DPRK approaches a full ICBM capability. Overall, the pressure campaign does appear to be affecting Pyongyang s calculus, but Kim Jong Un continues to channel his reduced resources to weapons programs and high profile morale projects that benefit only the elites, leaving the DPRK s citizens to suffer. The DPRK s grossly oversized conventional forces provide the regime additional coercive options. Pyongyang s active military force of almost 1.2 million is the fourth largest in the world, though the DPRK s population (approximately 24.5 million) ranks as only the 52nd largest worldwide. By contrast, the 53rd most populous country, Australia, fields an active force of under 60,000. The DPRK People s Army boasts a substantial inventory of long-range rockets, artillery, and close-range ballistic missiles aimed across the Demilitarized Zone at the Republic of Korea and U.S. forces stationed there. Many of these systems are capable of delivering chemical and biological weapons. The DPRK s well-trained, highly disciplined special operations forces are another asymmetric option for Kim Jong Un. Additionally, the DPRK is arming its navy with longer-range anti-ship missiles and is continuing to work on a submarinelaunched ballistic missile capability. I said last year that it was critical that the U.S. maintain a strong sense of resolve in order to bring Kim Jong-Un to his senses, not his knees. That is even more true today. China: The People s Liberation Army s (PLA) rapid evolution into a modern, high-tech fighting force continues to be both impressive and concerning. PLA capabilities are progressing faster than any other nation in the world, benefitting from robust resourcing and prioritization. During the 19th Party Congress in October 2017, Chinese Communist Party General Secretary Xi Jinping promised military development would remain a national priority, pledging to complete modernization by 2035 and to achieve world class status by On the current 7

20 trajectory, USPACOM assesses the PLA will likely attain these goals well ahead of the projected completion dates. In the past year, PLA forces have become more expeditionary and more integrated. The reorganization that created geographically-focused Theater Commands is now two years old and the PLA is exhibiting a rapid maturation of processes and structures. As tensions on the Korean Peninsula increased, Chinese and regional press began highlighting exercises and preparations underway in the Northern Theater the command responsible for Korean contingencies. Similarly, there was a variety of activities in the Western Command this past summer and fall during the standoff between Chinese and Indian forces at Doka La. While we assess the PLA will still face a number of challenges moving forward, the PLA has clearly embraced the need for increased joint interoperability. Perhaps nowhere is the PLA making more dramatic progress than in ballistic missiles. While the PLA is rapidly expanding the number, type, and sophistication of all of its missiles, China has made the most progress in intermediate-range ballistic missile (IRBM) technology, with IRBMs now constituting approximately 95 percent of the PLA s overall missile force. Chinese media routinely trumpets missile developments, carefully noting their missiles do not target any specific country. However, a simple comparison of missile ranges with geography suggests where Chinese missiles would most likely be targeted SRBMs against Taiwan and U.S. carrier strike groups operating at sea, IRBMs against U.S. bases in Japan and Guam, and ICBMs against the continental U.S. China s pursuit of advanced hypersonic missile technologies portends even greater challenges over the next few years. The PLA Navy (PLAN) is in the midst of a massive shipbuilding program. If this program continues, China will surpass Russia as the world s second largest Navy by 2020, when measured in terms of submarines and frigate-class ships or larger. The first Type 055 (Renhai) guided missile cruiser was launched in June 2017 the lead unit in a class of advanced multiwarfare ships that we expect will enter operational service next year. At least four more of these ships are under construction. Six Type 052 (Luyang III) Guided Missile Destroyers are operational, with another seven being built or fitted out. Amphibious capabilities are also growing. Four of an expected six Type 071 (Yuzhou) Amphibious Transport Docks have joined 8

21 the fleet in the past decade, and the first Type 075 Landing Helicopter Dock is under construction. In October 2017 China launched the lead ship in the Type 901 Fast Combat Support Ship class, the first logistics ship specifically designed to support China s aircraft carrier(s); the second PLAN carrier is in the water at Dalian and progressing toward sea trials. New submarines under construction include five more Type 039A (Yuan) and four more Type 093 (Shang) Nuclear Attack Submarines. All of these ships boast improved communications suites and defensive systems, as well as more lethal and longer-range weapons. The advances shown in the PLA Air Force (PLAAF) and Naval Air Force (PLANAF) are less focused on new aircraft though there are several noteworthy developments. Air and airdefense progress has been most evident in the increasing sophistication of operational training. When Chinese bombers began flying simulated strike profiles in the Philippine Sea, Sea of Japan, and South China Sea a few years ago, the exercises were very basic events. Now we see fighter escorts and supporting packages of other specialized aircraft, including aerial refuelers. Major training events are increasingly incorporating professional opposing forces, evaluators, and instrumentation to better challenge and assess capabilities. The J20 multi-role fighter program is progressing from development and prototypes into operational use. The J31 program appears to be advancing less quickly, but the two programs suggest a near-term capability for China to field 5th generation fighters within the next few years. At least two new heavy-lift transports (Y-20) are the leading edge of a fleet that will help the PLA overcome a long-standing inability to move troops and equipment anywhere in China or across the world. New and/or upgraded bombers, electronic warfare, command and control, and anti-submarine aircraft all expand PLA abilities to conduct a wide range of operations. PLA ground forces are still in the midst of a force-wide reorganization as the PLA Army (PLAA) moves from divisions to combined arms brigades as its basic combat formation. These more flexible, integrated formations will give the PLAA the ability to respond more precisely to a wider variety of contingencies. Forces are training in unfamiliar locations, under challenging environmental conditions, and with increased realism in an attempt to gain proficiency across a range of circumstances. The expansion of the PLAN-Marines continues as well, as the force has grown from two brigades to possibly eight, with two brigades each allocated to most of the 9

22 Theater Commands. A contingent of PLAN-Marines continues to garrison the PLA s first overseas base in Djibouti, having arrived late last summer. Following its establishment at the close of 2015, the PLA Strategic Support Force (PLASSF) has quickly matured to better manage and employ the PLA s impressive array of cyber, space, and other specialized capabilities. The PLASSF consolidates and employs specialized capabilities that could degrade or deny other countries the use of space, the electromagnetic spectrum, communications systems, and data networks. This joint organization reflects the PLA s emphasis on winning system versus system conflicts. To operationalize these new and expanded capabilities, Chinese forces especially the PLAN are operating in more locations, more often, leading to greater degrees of proficiency. The PLAN s counter-piracy deployment to the Gulf of Aden is now in its ninth year, and has provided invaluable experience to many of the PLAN s surface ships and crews. Chinese submarines have deployed to the Indian Ocean seven times in the past four years, and Chinese ships have conducted dozens of port visits across Europe, Africa, the Middle East, and Asia. This does not mean the PLAN has become a global navy, but its presence and influence are expanding. Much of this activity is linked to China s ambitious Belt and Road Initiative, which is meant to increase China s global influence through a China-centered trading network. The majority of this activity was expected, and is consistent with the actions of a rising power, but some activities and China s lack of openness about its plans are reasons for concern. When the base in Djibouti opened last year, the base was touted as a logistics outpost; yet within the base s first few months of operation, PLAN-Marines held several live fire drills involving armored combat vehicles and artillery. This suggests the base also functions as a forward deployed location for expeditionary capabilities, rather than as simply a logistics hub. Recent efforts to introduce clarifying legislation in the form of the Foreign Investment Risk Review Modernization Act (FIRRMA, aka CFIUS 2.0 ) seek to improve the national security focus of the Committee on Foreign Investment in the United States (CFIUS) and will help focus the lens on activities conducted by the Chinese. The economic stimulus of Chinese investment in the U.S. and across the Indo-Pacific region, including real estate transactions in the vicinity of military installations, threatens to undermine our national security objectives and those of our 10

23 allies and partners. I am fully supportive of these efforts, and believe we must view Chinese investment holistically to best understand Beijing s overall intent. Territorial Disputes and Maritime Claims: Overlapping and competing territorial and maritime claims remain a source of friction in the region. I am most concerned about China s ongoing actions in the South China Sea. In 2017, China took significant steps to further militarize its bases on disputed features. South China Sea: The U.S. takes no position on competing sovereignty claims to naturally formed islands in the South China Sea, but we do strongly call on all countries to ensure their claims and activities are consistent with international law. Specific to maritime claims and activities, countries should adhere to the law of the sea as reflected in the United Nations Convention on the Law of the Sea. The most significant territorial disputes in the South China Sea include: 1) the Paracel Islands, between China, Taiwan, and Vietnam; 2) Scarborough Reef, between China, Taiwan, and the Philippines; and 3) the Spratly Islands, where China, Taiwan, Vietnam, Brunei, Malaysia, and the Philippines each claim sovereignty over some or all of the land features. It is the last one that has drawn much of the attention in recent years. On September 25, 2015, Chinese Communist Party General Secretary Xi Jinping stated in a Rose Garden ceremony that China did not intend to militarize its outposts on the Spratly Islands. The plain fact is that China has built a number of clear military facilities and capabilities on all of their seven outposts, and China continues to build more. It is important to note that there are no military aircraft, air defense missile launchers, or antiship missile systems currently deployed to any of China s Spratly Island outposts. The only weapons present now are short-range defensive systems appropriate for close defense of the outposts. However, China has built a massive infrastructure specifically and solely to support advanced military capabilities that can deploy to the bases on short notice. The U.S. should assume Beijing plans to use these facilities for their clearly intended purposes at some point in the future. The Chinese also built the same sets of structures on each of its three largest outposts in the Spratly Islands (at Fiery Cross Reef, Mischief Reef, and Subi Reef), including: 11

24 10,000 foot runways capable of launching and recovering all military aircraft Fighter aircraft hangars Large aircraft hangars, capable of supporting larger aircraft such as bombers, AWACS, and transports Protected air defense launcher sheds Protected anti-ship missile launcher sheds Water and fuel storage tanks farms Ammunition storage facilities Barracks, communications systems, deep water pier facilities, military radars These bases appear to be forward military outposts, built for the military, garrisoned by military forces, and designed to project Chinese military power and capability across the breadth of China s disputed South China Sea claims. China s explanation that Beijing was forced to deploy these capabilities in response to an increased U.S. presence especially Freedom of Navigation Operations (FONOPS) is disingenuous. The U.S. Navy has been navigating and operating in the South China Sea, and has been peacefully exercising freedom of navigation operations all over the world, for decades. On the other hand, China only recently began island reclamation earlier this decade. The overall design and execution of the projects strongly suggests a master plan was in place from the start. In July 2016, an Arbitral Tribunal under the Law of the Sea Convention issued its ruling in favor of the Philippines South China Sea claims. Even though the Arbitral Tribunal is binding on both China and the Philippines, China has yet to abide by the ruling. The Philippines, preoccupied with the counter-terrorism fight on Mindanao and desirous of stable relations with China, has not pressed the issue since China is allowing Filipino fishermen some access to Scarborough. Across the South China Sea, China s air force, navy, coast guard, and maritime militia all maintain a robust presence. Routine patrols and exercises ensure Chinese forces are in and around all the features, not just the ones they occupy. China routinely challenges the presence of non-chinese forces, including other claimant nations and especially the U.S., often overstating its authority and insisting foreign forces either stay away or obtain Chinese permission to operate. 12

25 Since 1979, the U.S. Freedom of Navigation program has peacefully challenged excessive maritime claims by coastal states all around the world, including those of our friends and allies. This program consists of diplomatic communications and operational assertions, which are not provocative and are not a threat to any country. These operations are conducted globally to maintain open seas and skies, which underpins economic prosperity for the U.S. and all countries. East China Sea: Tensions between Japan and China over the Senkaku Islands have largely stabilized since last year, but there is no long-term resolution in sight. With substantive military and coast guard assets in the area from both countries, the situation could easily lead to miscommunication, miscalculation, and escalation. China persistently challenges Japan s administration over the islands by sailing Coast Guard ships near the Senkaku Islands and protesting Japanese reconnaissance flights. Chinese exercises prominently feature military actions focused on the Senkaku Islands, including exercises training for a possible future physical occupation of the islands and establishment of a maritime blockade to isolate the disputed areas. Clearly describing Beijing s intent to the U.S. and Japan, Chinese media prominently features stories that highlight those specific capabilities and actions. America s policy is clear and has not wavered: the Senkaku Islands are under the administration of Japan and, as such, are covered by Article 5 of the U.S. Japan Treaty of Mutual Cooperation and Security. The United States opposes any unilateral action that seeks to undermine Japan s administration of these islands. Russia: Russian operations and engagement throughout the Indo-Pacific continue to rise, both to advance their own strategic interests and to undermine U.S. interests. Russia intends to impose additional costs on the U.S. whenever and wherever possible by playing the role of a spoiler, especially with respect to the DPRK. Additionally, Moscow seeks to alleviate some of the effects of sanctions imposed following their aggression in Ukraine by diplomatically wooing select states in Asia. Russia also sees economic opportunities to not only build markets for energy exports, but also to build or in some cases rebuild arms sales relationships in the region. 13

26 Russia s strategic nuclear forces are modernizing and routinely practice nuclear strikes against the U.S. homeland. The Russian Pacific Fleet s two Borey (Dolgorukiy-class) nuclear ballistic missile submarines (SSBN) have been integrated into operations since their arrival in 2015 and 2016, augmenting older Delta III SSBNs and substantially bolstering Russia s modern nuclear strike capabilities. Tu-95 Bear bombers fly off the coasts of Canada, Alaska, and occasionally the northwest part of the continental U.S. in profiles designed to train their crews and assess U.S. and Canadian responses. Additionally Russia uses its long-range aviation forces for strategic messaging on other issues, for example, flying around Japan or off the Korean Peninsula. Most recently, a pair of Tu-95s deployed to eastern Indonesia, passing by Guam during their transits each way. Land-based nuclear missile forces similarly exercise and test-fire missiles oriented toward North America. Russian naval modernization is making their Pacific Fleet more capable and more lethal. The fleet is expected to receive as many as 10 new ships in 2018, including several combatants. The first Steregushchy-class guided missile corvette was commissioned in January 2017 with two more expected to arrive this year. This ship class is equipped with the advanced Kalibre missile system, a multi-functional weapons array that can fire a variety of long-range anti-ship and land attack missiles. The first of six modernized Project (Kilo) nuclear attack submarines is scheduled to arrive in late 2018 (though it could slip into 2019), with all six in the fleet by The Russian Pacific Fleet's five Project 949A (Oscar II) nuclear-powered guided missile submarines are being upgraded to incorporate the Kalibre system as well. This will make these submarines, whose wartime missions include attacking aircraft carriers and other priority land and sea targets, much more lethal. Ground and air modernization efforts continue as well, including state-of-the-art Bastion coastal defense cruise missiles, S-400 strategic air defense missiles, and new/upgraded helicopters and fighters. In 2017, Russian troops and warships held several combined training events with China and hosted India for their first tri-service bilateral exercise. Of particular note are Russian efforts to build presence and influence in the high north. Russia has more bases north of the Arctic Circle than all other countries combined, and is building more with distinctly military capabilities. 14

27 ISIS/Violent Extremist Organizations (VEOs): One event dominated the counter-terrorism fight in the USPACOM AOR in 2017: the siege by ISIS in the Philippines (ISIS-P) and recapture by government forces of the Philippine city of Marawi. The crisis began in May 2017, following a failed operation by the Armed Forces of the Philippines (AFP) to capture the leader of an ISISpledged group. A range of extremist actors, motivated by ideology, financial reward, clan ties, adventure, or other reasons descended upon Marawi, where they found a historically marginalized, predominantly Muslim population. ISIS-P became a focus for global ISIS media publications and statements, many of which encouraged additional supporters to flock to Marawi. A few tried, not many made it. USPACOM with Special Operations Command, Pacific (SOCPAC) in the lead provided counter-terrorism support and assistance to the AFP, enabling the Philippine Security Forces to disrupt ISIS-P activities in the southern Philippines. After a protracted fight, the AFP recaptured the city and killed or drove out what was left of ISIS-P. According to the AFP, 962 ISIS-P, 165 AFP, and 47 civilians were killed during the siege and recapture. Marawi underscores several important themes with regard to defeating ISIS in the Indo-Pacific. First, localized threats can quickly transform into international causes. Prior to Marawi, few, if any, ISIS leaders or media coordinators had ever heard of the location or key actors involved. Within weeks, Marawi was the cover story on ISIS flagship media product. An early and effective response is vital to control the fight and own the narrative. Second, despite such media attention and calls for support, few extremists from within the region responded, and even fewer came from outside the AOR. This underscores our assessments that most issues in the Indo- Pacific are local and the desire and ability to join someone else s fight are limited. Third, counter-terrorism operations are extremely challenging, and most regional forces are poorly equipped for such fights. Our engagement strategy and capacity-building efforts have remained and will continue to remain focused on enabling regional counter-terrorism (CT) forces to win whatever fights they face. USPACOM remains concerned about the potential for ISIS ideology to inspire terrorism in the Indo-Pacific, but cautiously notes that the number of successful attacks dropped significantly during the past year. The decline could be the result of an increased CT focus by governments 15

28 across the region, as well as more effective efforts by host nation intelligence and security services Indonesia, Malaysia and Bangladesh are among the places where authorities have successfully disrupted plots. The decline might also be due to the diminished stature of ISIS and its ideology following losses in Iraq and Syria. However, the region is still fertile for radicals and extremists looking to affiliate with the ISIS brand. Multinational partnerships represent the best method of countering VEOs across the region. USPACOM is engaging Malaysia, Indonesia, the Philippines, Australia, and New Zealand to degrade and defeat ISIS and other VEO threats. Many Indo-Pacific countries such as Australia, New Zealand, and Singapore have joined the coalition dedicated to ISIS complete destruction. Through multinational collaboration, like-minded nations can eliminate ISIS before it spreads further in the USPACOM area of responsibility. Countering violent extremism in the Indo-Pacific requires close collaboration with U.S. government interagency partners, such as the Department of State, the Department of Treasury, the Federal Bureau of Investigation (FBI), USAID, and the other agencies from the U.S. intelligence community. Through an interagency network reinforced by liaison officers embedded in USPACOM headquarters and Special Operations Command (SOCOM), we are able to leverage tools from across our government to fight terrorism and counter violent extremism. Transnational Crime: From finished opioids to industrial chemicals that support production of other illegal drugs, the Indo-Pacific is a key player the global supply chain for the illegal drug market. Transnational criminal organizations, operating across borders and across the globe, are responsible for the vast majority of the illicit activities that spill drugs and related violence into American communities. Characteristics of these threat organizations continue to evolve. They use technology as an enabler to further disperse and decentralize their organizations, thereby making effective targeting of these threats more challenging. The opportunistic nature of drug trafficking organizations enables them to stay ahead of law enforcement. 16

29 At the same time countries in the Indo-Pacific are wrestling with growing internal drug consumption challenges. In the Philippines, the scourge of drug use has had multiple destabilizing effects, at the family-level, community-level, and the national level, as President Duterte s efforts to address the problems have created relationship challenges with the U.S. and others. Amphetamine Type Stimulant (ATS) use continues to grow throughout East and Southeast Asia, while heroin demand remains steady. Consistently high prices for cocaine in Australia and New Zealand support a small but extremely lucrative trade for Western Hemisphere drug traffickers. Across the Pacific Island Nations, expanding ATS usage, concurrent with expanding crime and corruption, aptly demonstrates the symbiotic relationship between drugs and these corrosive effects. U.S. territories such as Guam and the Commonwealth of the Northern Marianas Islands (CNMI) face these same challenges. Many of the drug trafficking challenges on America s southwest border start with the precursor chemicals that are sold through licit commerce, predominantly from China, and to a lesser extent, India. Criminal entities with ties to Mexican and South American drug cartels use these licit chemicals to produce methamphetamine, cocaine, and heroin. Another drug, fentanyl-laced heroin, has been responsible for a spike in U.S. overdose deaths. Fentanyl, and its numerous analogs, originate almost exclusively from China. To combat these threats, the U.S. Government works closely with the government of the People s Republic of China in a Joint Liaison Group (JLG) on Law Enforcement Cooperation led by the Department of Justice. Cyber: The importance of cyberspace is growing rapidly as the world becomes increasingly interconnected and networked. National power and security depend on the ability to operate securely in and through cyberspace. The two most capable cyber actors worldwide are Russia and China. Both of these countries have incorporated cyber into their joint warfighting doctrine and routinely exercise these capabilities alongside more traditional elements as a force multiplier. In fact, China values cyber so highly it created the Strategic Support Force to integrate and synchronize cyber operations. Meanwhile, a provocative DPRK continues to 17

30 employ cyber operations against its adversaries. Last May, the DPRK deployed the WannaCry ransomware attack, affecting over 300,000 computers in 150 countries. As regional interaction becomes increasingly dependent on cyber activity, these threats to cyberspace will become more concerning. Proliferation: The Indo-Pacific has the busiest air and maritime ports in the world. Technological advances have outpaced many countries ability to effectively manage export controls to counter the proliferation of component technology. Trade includes dual-use technology, such as commercial items controlled by the nuclear, ballistic missile, and chemical/biological weapons control regimes, including manufactured or re-exported materials from other countries with limited export control enforcement. USPACOM s Countering Weapons of Mass Destruction (C-WMD) community supports Special Operations Command (SOCOM) global counter-proliferation strategy by addressing regional concerns through key leader engagements, combined and joint exercises, and international security exchanges focused on counter-proliferation activities. Since 2014, an enduring Proliferation Security Initiative (PSI) Asia-Pacific Exercise Rotation (APER) is held annually between PSI Operational Experts Group (OEG) states in the USPACOM AOR. The U.S., New Zealand, Singapore, Australia, Japan, and Republic of Korea rotate hosting the PSI exercises. This year, Japan is hosting the PSI APER followed by the Republic of Korea next year. Natural Disasters: The Indo-Pacific region continues to remain the most disaster-prone region in the world. About 75 percent of the Earth's volcanoes and 90 percent of earthquakes occur in the Ring of Fire surrounding the Pacific Basin. According to a 2015 UN report, disasters over the last ten years took the lives of a half a million people in the region, with over 1.5 billon people affected, and damages greater than 500 billion dollars. While disaster response is not a primary focus for USPACOM, a key element of USPACOM s Theater Campaign Plan (TCP) is building capacity with allies and partners to improve their resiliency and capability to conduct humanitarian assistance/disaster response (HA/DR). HA/DR cooperation is also an effective means to deepen and strengthen relationships. USPACOM s Center for Excellence in Disaster Management (CFE-DM) serves as a regional authority on best practices for HA/DR and helps prepare regional governments for HA/DR events. Our service 18

31 components are prepositioning HA/DR stocks to facilitate timely response and to build access in the region. When possible, U.S. military forces assist with their unique capabilities in the areas of air and sealift, infrastructure restoration, and emergency medical support. As just two examples, in 2016, USS SAMPSON (DDG 102) and Maritime Patrol and Reconnaissance Aircraft assisted New Zealand in its response to an earthquake on its South Island; and in 2017, USS Lake Erie (CG 70) supported Sri Lanka during flooding from a tropical cyclone and the rainy season. Workforce Challenges for Military Realignments in the Pacific: I appreciate Congress efforts in the FY18 NDAA to provide much-needed relief for DoD on the problem of construction worker shortages in Guam and Commonwealth of Northern Marianas Islands (CNMI). By extending the authority to grant H2B visas from 2018 to 2023 for military construction (MILCON) projects, Congress will help alleviate labor shortages in these areas that would otherwise drive cost increases and delays in key MILCON projects that support the realignment of U.S. forces in the region. However, the same labor shortages that threaten MILCON also threaten much needed civilian construction for these communities. Unless directly supporting a MILCON project, civilian construction efforts will not receive the same relief from H2B Visas. In addition to slowing the economic growth of Guam and CNMI, the insufficient number of workers is causing friction between the military and civilian communities. The local communities perceive that the U.S. has favored military construction at the expense of civilian construction. Budget Uncertainty: Fiscal uncertainty breeds a significant risk to USPACOM s strategic priorities. The Budget Control Act and yearly continuing resolutions (CR) interrupt USPACOM s ability to work with the Services, Unified Commands, and Sub-Unified Commands to effectively plan for the long-term mission. According to the Government Accountability Office s (GAO) September 2017 report, Budget Uncertainty and Disruptions Affect Timing of Agency Spending, we have had approximately 101 CR extensions between 1999 and This year added five more CR extensions. Under these conditions of perpetual uncertainty, we cannot efficiently and effectively plan and prepare our forces to meet today s challenges. This is no truer than in the Indo-Pacific. 19

32 Five years ago, sequestration cut almost every defense program equally. As a result, readiness and operational capability have suffered. While the recent tragedies in the Western Pacific involving surface combatants assigned to USPACOM were the direct result of gross negligence by the ships crews, multiple reports cited additional contributing factors. Both the Secretary of the Navy s Strategic Readiness Review and U.S. Fleet Forces Command s Comprehensive Review identified the imbalance in surface combatant capacity and operational requirements. In fact, the Comprehensive Review noted that, Under the Budget Control Act (BCA) of 2011 and extended Continuing Resolutions, the ability to supply forces to the full demand is and will remain limited. Additionally, the Strategic Readiness Review stated that, the lean fiscal environment, worsened by the BCA, coupled with a high operational demand for forces and reduced fleet levels, challenged the Navy even more, placing a heavy strain on the service. Coincidentally, as the BCA further constrained the fleet, it became clear that China was emerging as a peer Navy competitor. The lean fiscal environment, coupled with a high operational demand for forces and reduced fleet levels, challenged the Navy even more and placed a heavy strain on the service. As the 2011 BCA further constrained the fleet, it became clear that China was emerging as a peer Navy competitor. China s adoption of advanced technology, its increasingly dispersed operations, and its doctrinal writings make clear that it aspires to a more robust regional capacity and global reach. Our peer competitors like China and Russia are quickly closing the technological gap. I need weapons systems of increased lethality that go faster and further, are networked, are more survivable, and affordable. If USPACOM has to fight tonight, I don t want it to be a fair fight. If it s a knife fight, I want to bring a gun. If it s a gun fight, I want to bring in the artillery, and the artillery of all of our allies. I have said during my last two appearances before this Committee, that sequestration could reduce us to wielding a butter knife in this fight. This is unacceptable. We must not let that happen. In order to deter potential adversaries in the Indo- Pacific, we must build a more lethal force by investing in critical capabilities and harnessing innovation. We must develop a lethal, agile, and resilient force posture that decreases our vulnerabilities. The force posture must also reassure our allies and partners and encourage them to be full and cooperative partners in their own defense and the defense of the free and open international order. 20

33 Overall, I am grateful to Congress for the recent agreement on the DoD-budget caps for the next two years. The positive actions you took last week will help the DoD and USPACOM address many of the issues above, and I m optimistic that the DoD is approaching an era of fiscal certainty. Over the long-term, fiscal certainty will allow us to build and train a force that is best postured to overcome the external challenges that we face in the Indo-Pacific. Critical Capabilities The most technological, high-end military challenges America faces in the region continue to grow. While forward presence, alliances, and partnerships address these challenges, USPACOM requires our most technologically advanced warfighting capabilities to fully meet them. The critical capabilities in this section demand our attention and treasure. We must preserve our asymmetric advantages in undersea and anti-submarine warfare, and we must strengthen our abilities to counter strategies designed to limit our freedom of action. China has developed and fielded capability and capacity to challenge our regional maritime dominance. I need increased lethality, specifically ships and aircraft equipped with faster and more survivable weapons systems. Longer range offensive weapons on every platform are an imperative. We must also network this force and take advantage of man-machine teaming to improve our responsiveness. Pacing the threats we face in the region is not an option in my playbook. We must work hard and invest the money to outpace the competition by developing and deploying the latest technology to USPACOM. Examples include: Navy Integrated Fires and the AEGIS Flight III destroyer and its new Air and Missile Defense Radar (AMDR); rotational deployment of Air Force and Marine Corps 5th generation fighters; and new systems capable of defending our vulnerable bases from the full spectrum of current and emerging threats (e.g., hypersonic missiles and armed unmanned aerial systems). These tools are essential in today s complex operating environment. Munitions, Fuels, and Logistics Networks: Critical munitions shortfalls continue to be my top warfighting concern. Shortages in our munition inventories pose a significant threat to our 21

34 combat readiness and exacerbate the effects of the peer competitors who continue to modernize their weapon systems and expand their inventories. It is critical that we retain our capability to operate in contested environments, which requires dedicated investment in the industrial base and the development of new concepts and technologies. Additionally, we must continue to expand Intermediate Nuclear Force Treaty-compliant theater strike capabilities to effectively counter adversary Anti-Access/Area-Denial (A2/AD) capabilities and force preservation tactics. My priorities include multi-domain kinetic/lethal strike capabilities, including hypersonic, longrange strike, air-to-air missile, long-range precision fires, maritime strike, and integrated air and missile defense. Additional requirements include the command and control (C2) and integration of long-range, high-speed, lethal, survivable, and precision munitions capabilities in ships, submarines, patrol craft, land-based formations, bombers, and fighters. With respect to ship-toship and air-to-ship munitions that allow us to defeat an aggressor from greater range, we are pursuing capabilities similar to Long Range Anti-Ship Missile (LRASM) and Joint Air-to- Surface Standoff Missile Extended Range (JASSM-ER). In the air-to-air realm, I continue to seek advancements in munitions that will provide us an advantage in a denied environment, such as the AIM-120D and AIM-9X air superiority missiles. We must continue to modernize and improve our torpedo and naval mine capabilities to maintain our undersea advantage. I appreciate Congress efforts to address LRASM, JASSM, air-to-air missiles, and undersea warfare capabilities in the FY18 NDAA. Continued improvements in the capability and capacity of ballistic/cruise missile defense interceptors will further enhance homeland defense capabilities and protect key regional nodes from aggressive action. In support of the Korean Peninsula, the new policy on cluster munitions, signed 30 November 2017, helps to alleviate the capability gap created by the previous policy. However, I support efforts to acquire a replacement for cluster munitions we need an area effects munition now. As new inventory becomes available, storage capacity will become critical. As an example, we are beginning to see the storage capacity limitations play out as Services reposition munitions on the Korean Peninsula. Admittedly, this is a nice problem to have. Beyond the capacity challenges posed, our current, legacy storage locations are inadequate to store specific types of modernized munitions and meet the requirements of FY21 Department of Defense Explosive 22

35 Safety Standards. We are currently operating on waivers in many areas and assuming risk to meet mission requirements. Fuel is the lifeblood of operations, and without resilient resupply capability, our operational effectiveness is severely degraded. Crucial to our ability to operate in increasingly contested and austere locations is the velocity of fuels support from source of supply to the point of use. Strategic positioning is a key pillar of our logistics posture. Ensuring we have the right fuel, in the right amount, at the right location, at the right time, is vital to USPACOM's ability to project power throughout the Indo-Pacific under combat conditions. USPACOM is closely integrated with the Defense Logistics Agency and the Services, and I am encouraged by the progress being made. In fiscal year 2018, investments are planned to increase fuels supply/operations infrastructure, storage, and resiliency in Guam, Japan, and Australia. I remain committed to building the capacity of our prepositioned war reserve stocks of fuel, including resiliency of the facilities, infrastructure, and distribution capabilities on which these stocks depend. USPACOM's ability to project power is underpinned by strong airlift capabilities. Unfortunately, budget instability and ongoing continuing resolutions have driven inflexibility into these critical areas while the global strategic environment requires increased flexibility. In today's global competition for airlift, increased demand and limited resources hinder the joint force's ability to promptly achieve operational objectives. In war, this shortfall will result in greater loss of life, increased risk to USPACOM forces, and increased risk to our nation's credibility with partners and allies. Strategic sealift assets play a significant role in PACOM's success. Whether during a contingency or during peacetime, the ability to deliver forces and sustain them with timely equipment, critical logistics, and service support is essential. Our adversaries continue to strengthen their capabilities, while many of our assets and platforms are approaching the end of their service life, resulting in shortfalls which reduce our ability to maintain sea supremacy. In order to adequately support current operations and prepare for future warfighter requirements, it is crucial that we increase investment in strategic sealift assets. 23

36 As the Indo-Pacific region becomes more connected to other regions and more influential, we must be prepared to anticipate the need for key enablers that will ensure our influence in the region remains strong. Preparedness is underwritten by logistics and sustainment capability, capacity, resiliency, and agility. Our logistics capability is one of the U.S. military s key asymmetric advantages around the world. Unfortunately, due to budgetary pressures and decades of global engagement, our logistics systems and infrastructure are struggling to support the full range of military operations in the Indo-Pacific region. No one aspect of our logistics system is broken; but when examined as a system of systems, executed by logisticians, engineers, and medical experts, the overall logistics enterprise has become more vulnerable, or brittle, because the system has fewer redundancies. More specifically, risk against each key functional area in our logistics system has risen over the last decade. The slow erosion of our logistics system has been manifested in manpower cuts to key areas like maintenance manning or the consolidation of our engineers in the Pacific. Each service has made difficult choices balancing modernization with recapitalization and sustainment. Smaller munitions inventories mean the overall logistics enterprise must make up for that limitation by better, faster distribution processes to get the right munition to the right place at the right time to support operations. Additionally, the Services have consolidated and centralized important wartime materiel to better set the globe or have consolidated and reduced logistics staffs. Those changes have exacerbated the challenges associated with PACOM s tyranny of distance. The time consumed by logistically supporting operations from greater distances reduces my decision space in a very dynamic and fast paced crisis or contingency. Taken collectively, the complex problem of getting the right stuff to the right place at the right time in a contested environment is a vexing problem made worse by the slow erosion of capability, capacity, and agility. That reality requires that we make faster, more accurate logistics decisions to support operations. The Indo-Asia-Pacific Stability Initiative (IAPSI) is the single most important initiative that can reverse a dangerous trend toward an inevitably brittle Joint Logistics Enterprise in the Pacific, and I m thankful for Congress efforts to fund IAPSI. Our logistics systems, infrastructure, key supplies, and processes are in need of replenishment with new equipment, better infrastructure, additional trained professionals, and innovative logistics concepts to better prepare USPACOM for peer-level competition and large scale crises. 24

37 Air Superiority: For the last several decades the U.S. has enjoyed unmatched air superiority. The preponderance of aircraft ensuring this permissive air-domain has been 4th generation fighters and air-battle-management platforms, which have benefitted from a technology gap over any potential rival. Our potential adversaries, however, are rapidly closing this gap as both Russia and China have fielded their own versions of 5th generation fighters which threaten our ability to gain air superiority at a time and place of our choosing. In order to deter and defeat potential adversaries in the Indo-Pacific region, we must have the capability to quickly gain and maintain air superiority long enough to complete critical missions. The U.S. is now beginning to field 5th generation platforms in the Pacific; however, our legacy 4th generation platforms will be in our inventory for years to come, and we must be prepared to address future threats. While we continue to invest in 5th generation platforms, we must also find innovative ways to make our 4th generation aircraft and air-battle-management platforms more capable. Undersea Warfare: USPACOM must maintain its asymmetric advantage in undersea warfare capability including our attack submarines, their munitions, and other anti-submarine warfare systems like the P-8 Poseidon and ship-borne systems. Roughly 230 of the world s 400 foreign submarines are in the Indo-Pacific, of which approximately 160 belong to China, DPRK, and Russia. Potential adversary submarine activity has tripled from 2008 levels, requiring an increase of U.S. activity to maintain undersea superiority. This growth of regional submarine fleets, and increasing demand from other Combatant Commands for SSNs, will challenge the Joint Force to address our SSN requirements in the decade ahead. The SSN imbalance will only be aggravated as the global U.S. Navy SSN inventory drops and submarines are retired faster than replacements are constructed. China is improving the lethality and survivability of its attack submarines, building quieter, high-end diesel and nuclear powered submarines, and has placed in service four nuclear-powered Jin-class ballistic missile submarines (SSBNs). An armed Jin-class SSBN will give China an important strategic capability that must be countered. Russia is modernizing its existing fleet of Oscar-class multi-purpose attack nuclear submarines (SSGNs) and producing their next generation Severodvinsk Yasen-class SSGNs. Russia has also homeported their newest Dolgorukiy-class SSBN in the Pacific, significantly enhancing its strategic capability. Current counter undersea capabilities include the Integrated Undersea Surveillance System (IUSS), including the Surface Towed Array Sensor Systems (SURTASS). While these platforms have operated since the early 1980s, these systems, along with the new 25

38 autonomous Unmanned Underwater Vehicle technologies, play a key role in theater operations and must be resourced appropriately to ensure they remain relevant and capable. Maintaining pace with submarine activity growth is necessary and I support the Secretary of the Navy s 2016 Force Structure Assessment which calls for a 355-ship navy, including 66 attack submarines. Intelligence, Surveillance, and Reconnaissance (ISR): The challenge of gathering credible, deep, and penetrating intelligence cannot be overstated. The Indo-Pacific presents a dynamic security environment requiring persistent and intrusive ISR to provide indications, warning, and situational awareness across a vast geographic area. Our treaty allies rely on U.S. ISR capabilities to support mutual defense treaties. ISR is required to prevent strategic surprise, buy decision space for national leadership, accurately assess the security environment, and defeat adversaries, if necessary. The rapid modernization of our peer competitors requires additional advancements in how our intelligence is collected and processed, including the associated risks. Our ISR capabilities must be suited to our unique operating environment. Space and Cyberspace: USPACOM relies heavily on space-based assets for satellite communications (SATCOM), Intelligence, Surveillance, Reconnaissance (ISR), Missile Warning, and Positioning, Navigation, and Timing (PNT) capabilities to support missions across the range of military operations. USPACOM s region spans over half the globe and space-based assets are high-demand, low-density resources. As the electromagnetic spectrum grows increasingly congested and contested, our adversaries continue to develop means to deny our space-enabled capabilities. China continues to pursue a broad and robust array of counter-space capabilities, which include direct-ascent anti-satellite missiles, co-orbital anti-satellite systems, cyber-attack and exploitation capabilities, directed energy weapons, and ground-based satellite and PNT jammers. DPRK continues to develop and employ SATCOM and PNT jammers, while also continuing their development and testing of nuclear weapons and ballistic missiles despite UNSCR 1718 prohibiting such activities. USPACOM faces constant threats in the cyber domain from both state and non-state actors, such as China, DPRK, Russia, and criminal actors. The U.S. must ensure it has a robust and capable cyber force, as well as the equipment necessary to maintain command and control of our forces. 26

39 USPACOM requires an agile and defensible mission command network infrastructure to enable interoperability with our allies and mission partners to fully leverage our combined capacity. In addition, offensive cyber capabilities provide additional tools to use as part of tailored options that bolster multi-domain effects, but these capabilities must grow faster. As we work across the interagency environment to develop whole-of-government solutions, we require a workforce that strikes the right balance between cyber forces assigned in the theater, working directly for USPACOM and its subordinates, and forces assigned to USCYBERCOM and other U.S. government agencies at the national level. Integrated Air and Missile Defense (IAMD): USPACOM faces unique Integrated Air and Missile Defense (IAMD) challenges despite efforts to forward station additional IAMD sensors and weapons capabilities in the Indo-Pacific to protect our forces and allies. Hawaii, Guam, and our Pacific territories are part of our homeland and must be defended. Hawaii is currently protected from DPRK intercontinental ballistic missiles (ICBMs) by the Ground-Based- Midcourse Defense System. This system includes Ground-Based Interceptors in Alaska and California; ground-, sea-, and space-based sensors; and redundant command, control and communications systems. For the defense of Hawaii, the Homeland Defense Radar - Hawaii (HDRH) siting process is near complete. The Missile Defense Agency (MDA) plans to compete and award a Pacific Radar contract in FY18 and deliver an initial capability by FY23. The new radar will provide an enhanced ballistic missile sensing and discrimination capability in the Pacific, and will increase the capability of the Ground-Based Midcourse Defense System to defend the state of Hawaii. This radar is being built to stay ahead of potential future threats. DPRK s 3 September 2017 nuclear test, its KN-22 Hwasong-15 ICBM test launch on 28 November 2017, and DPRK s continuing research and development of submarine launch ballistic missile technology, demonstrates the DPRK s desire for greater technical performance and capability. Also, China and Russia continue to develop and operationally field advanced counter-intervention technologies which include fielding and testing of highly maneuverable reentry vehicle/warhead (i.e., hypersonic weapons) capabilities that challenge U.S. strategic, operational, and tactical freedom of movement and maneuver. China and Russia also present other notable challenges in the form of cruise missiles and small-unmanned aircraft systems (s- UAS) which fly different trajectories, making them hard to detect, acquire, track, and intercept 27

40 due to unpredictable low-flight profiles and high-potential use of countermeasures. I support MDA's intent to formally study the efficacy of putting an interceptor capability in Hawaii. USPACOM s IAMD priority is to establish a persistent, credible, and sustainable ballistic missile defense presence by forward deploying the latest advancements in missile defense technologies to the Indo-Pacific. Through their forward and persistent presence, these active missile defense capabilities help mitigate the risk to missile threats that USPACOM faces in the AOR. USPACOM continues to work with the Department of Defense (DOD), our academic institutions and industry to improve or deploy systems capable of countering the missile threat challenges in the Indo-Pacific. USPACOM maintains an active Terminal High Altitude Area Defense (THAAD) battery on Guam to protect our fellow citizens and strategic military capabilities from the threat of DPRK intermediate-range ballistic missiles (KN-17 and MUSUDAN). USPACOM also employs additional radars across the theater to support homeland defense and testing of the Ballistic Missile Defense System (BMDS). Additionally, USPACOM is supporting MDA s siting-study to identify a home for the new Homeland Defense Radar in Hawaii. USPACOM and USFK, with the support from the MDA and the DoD, deployed a Terminal High Altitude Area Defense (THAAD) battery to the Korean peninsula in 2017 that is fully operational. The U.S. Navy is moving forward with the port shift of the USS MILIUS from San Diego to Yokosuka, Japan this spring. This port shift provides the U.S. Seventh Fleet with improved capability to support the U.S.-Japan alliance. USPACOM will continue working with Japan, the ROK, and Australia to improve our level of staff coordination and information sharing with the goal of creating a fully-integrated Ballistic Missile Defense (BMD) architecture that addresses the increasing cruise missile threat. USPACOM continues to support MDA and the Services to develop and test emerging missile and counter-small UAS defense capabilities through modeling and simulation, as well as live-fire testing conducted at the Pacific Missile Range Facility, the Ronald Reagan Test Center at Kwajalein Island, Point Mugu, and other testing ranges located on the continental U.S. and Alaska. These tests encompass a number of developmental flight tests including: Standard 28

41 Missile-3 (SM-3) Block IB Threat Upgrades; Distributed Ground Tests to assess the performance of the Ballistic Missile Defense System; two Standard Missile-6 (SM-6) missiles against a complex medium-range ballistic missile target; and SM-3 Block IIA allowing longer flight times and engagements of more complex threats higher in the exo-atmosphere. USPACOM will continue to support future flight tests to help improve the Ballistic Missile Defense System performance against more complex threats. Going forward, USPACOM supports all efforts that improve the capability and capacity of ballistic missile, cruise missile, and UAS defense technologies to further enhance Homeland defense capabilities and protect key regional locations from aggressive action. The development of a credible and effective defense against advanced and future missile and UAS threats remains vital to our operational plans and critical to the continued defense of the U.S. Innovation: USPACOM increasingly relies on innovation to address USPACOM's capability gaps and maintain our military advantage. This includes testing and integrating new technologies, developing new capabilities, and exploring new concepts of operation and employment. This multi-pronged approach to innovation is paying dividends, and my innovators are getting these capabilities into the hands of the warfighters quickly in order to enhance our ability to fight tonight. Advances in man/machine teaming, artificial intelligence, machinelearning, hypersonic technology, autonomy, and command and control will enable the Joint Force to maintain a velocity of precision operations our adversaries simply cannot match. USPACOM s ability to conduct operationally realistic exercises where we can rigorously test our innovative ideas makes me confident we will continue to identify, test, evaluate, and integrate the best technology our industry offers. Capitalizing on the vast open spaces of the Pacific, USPACOM runs the most complex field exercises in the world. For example, the Joint Pacific Alaska Range Complex (JPARC) is a premier location to focus on joint air and electronic warfare exercises, while the Pacific Missile Range Facility and ranges near Guam provide excellent opportunities to test naval and missile innovations. USPACOM forces conducted over 50 more warfighting experiments in 2017 than any year before. I believe we can take this construct to the next level by combining innovation across multiple areas: operational planning, cutting-edge technologies, modeling and simulation, and execution of multi-combatant Command exercises. 29

42 Our innovation successes would not be possible without strong partnerships. USPACOM benefits from our continued relationships with organizations across the DoD, including the Defense Advanced Research Project Agency, the Defense Innovation Unit-Experimental, Service laboratories and innovation offices, national laboratories, university-affiliated research centers, and industry. USPACOM has also significantly increased its interaction with U.S. Special Operations Command, and we continue to work closely with the OSD Strategic Capabilities Office (SCO) to develop and field game-changing technologies for the Indo-Pacific. Fires Achieving Multi-Domain Battle (MDB): Multi-domain battle is the ultimate joint concept that allows commanders to achieve cross-domain effects while mitigating significant advancements in our adversaries ability to out-range and out-gun some of our most advanced platforms and systems. We have made significant progress in the past 12 months. This year, the Army and the Marine Corps signed out Version 1.0 of this warfighting concept in a document titled U.S. Army and Marine Corps Concept, Multi-Domain Battle: The Evolution of Combined Arms for the 21st Century. This concept describes how U.S. and partner forces organize and employ capabilities to project and apply power across domains, environments, and functions over time and physical space to contest adversaries in relative peace and, when required, defeat them in war. The concept of MDB seeks a common and interoperable capability development effort to provide Joint Force Commanders complementary and resilient forces to prosecute campaigns and further the evolution of combined arms for the 21st century. In execution, MDB broadens the options for Joint Force Commanders and poses a corresponding dilemma for our adversaries. Version 1.0 of this concept formally transitions emergent concepts and ideas to experimentation. The complementary capabilities described in this concept provide an initial set of ideas to test with regard to employment and capability requirements, while supplementary capabilities required for combined arms and maneuver serve as a starting point for common capability development efforts between the Army, Marine Corps and their joint partners. Our joint forces will revise this concept to Version 2.0, refining ideas and corresponding solution set by incorporating the results of experimentation, as well as other Service and Joint perspectives. 30

43 I recently asked the USPACOM component commands to test MDB operational concepts as part of our Joint Exercise Program, to include demonstrations in one of our major capstone events the Rim of the Pacific exercise (RIMPAC 18). Implementing a crawl-walk-run methodology, we will move from discrete events across domains to the fusion of joint capabilities across domains in a sensor to shooter agnostic environment that is both contested and integrated across the combined force. In keeping with the MDB concept vision we will progress from experimentation to validation of concepts, culminating in a validation and demonstration of the Army s new Multi-Domain Task Force during the RIMPAC 20 exercise. We will capitalize on the existing MDB capabilities resident in much of our force, but in order to maintain our competitive edge, we must continue our rapid pursuit of new technologies and approaches. One of the biggest capability gaps in terms of joint effects is the lack of complete connectivity and integration between the Services operational and tactical ISR, target acquisition, and fire control systems such as the Navy's Cooperative Engagement Capability (CEC), the Army s Advanced Tactical Field Artillery Target Data Systems, Army's THAAD and Patriot Systems, and the USMC's C2 systems. Together with the Services, USPACOM is working to solve these problems with the Joint Staff and OSD. Strategic Force Posture in the Indo-Pacific The Joint Force is forward-stationed throughout the Indo-Pacific region to deter conflict or to defeat adversaries should deterrence fail. The tyranny of distance, mobilization timelines for reserve component enablers, and strategic lift constraints hinder the ability to generate force flow early in a crisis. While USPACOM remains focused on fielding credible combat power, gaining access to new locations, upgrading existing operating locations, and encouraging whole-ofgovernment approaches to deter and confront regional adversaries are all critical to preserving our positional advantage in the region. As challenges in the Indo-Pacific region continue to evolve, the importance of infrastructure recapitalization and the fielding of advanced capabilities have increased. 31

44 Global Force Management (GFM): Credible combat power offers the greatest potential for meeting the Indo-Pacific region s complex security issues and enables our ability to prevail in combat. The DoD continues to strongly support USPACOM GFM priorities through the assignment of critical platforms and capabilities in Alaska and on the West Coast. USPACOM continues to prioritize forward stationing and deployment of 5th generation aircraft in the Indo- Pacific, to include the first Marine Corps F-35B Joint Strike Fighters to Japan in January 2017 and the first Air Force F-35A squadron to the Republic of Korea in November In addition, U.S. commitment to the Indo-Pacific is further evidenced by the deployment of our newest and most advanced aviation platforms such as the P-8 Poseidon, RQ-4 Global Hawk, MV-22 Osprey, EA-18G Growler, E-2D Hawkeye, and C-130J Super Hercules. The long-range capabilities of U.S. bombers are well suited for the Indo-Pacific region due to the vast distances and unique challenges. This mission enables Joint Force readiness and commitment to extended deterrence, offer assurances to our allies and partners, and strengthen regional security and stability in the Indo-Pacific region. In addition to the Pacific Pathways deployments and posture commitments, the Army is assessing existing U.S. inventories to prioritize requirements for focused readiness, critical munitions, sustainment stocks, mobility shortfalls, chemical defense, and facility operations within the region. The culmination of joint and combined force operations with our Service components and our partner nations in the Indo-Pacific region in 2017 was the three-carrier strike force exercise in the Western Pacific. USS Ronald Reagan (CVN 76), USS Nimitz (CVN 68), and USS Theodore Roosevelt (CVN 71) strike groups conducted coordinated operations in international waters to demonstrate the Navy s unique capability to operate multiple carrier strike groups as a coordinated strike force effort. Force Posture Initiatives: USPACOM s ability to execute national tasking and meet national objectives is reflected in military construction investments that support increased resiliency for the Joint Force via projects in Japan, Guam, the Commonwealth of the Northern Mariana Islands (CNMI), and Australia. The vast distances associated with the Indo-Pacific, coupled with the 32

45 short timelines to respond to crises, require investment in infrastructure to properly preposition capabilities and capacity throughout the region. Military construction supports critical capabilities to include Unmanned Aerial Vehicles for increased intelligence, surveillance and reconnaissance (Republic of Korea), Cyber Mission Force teams (Hawaii), Special Operations Forces (Japan), increased critical munitions storage capacity in Washington State, and quality of life investments for the Joint Force and their families in Guam, Republic of Korea, Japan, and the Republic of the Marshall Islands. Host country support at 23 established operating locations in the Indo-Pacific region remains robust overall. The U.S. military receives approximately $37 billion in new construction at a cost of less than $7 billion to the U.S. taxpayer in the Indo-Pacific region. The Government of Japan committed resources in 2013 that continue to assist in the strategic realignment of U.S. Marine forces from Okinawa to Guam and other locations as a part of the Defense Posture Realignment Initiative (DPRI). Additionally, the Government of Japan is supporting the airfield expansion work underway at the Marine Corps Air Station Iwakuni, Japan and the Futenma Replacement Facility. The Republic of Korea continues to support the work on the Land Partnership Plan and Yongsan Relocation Plan, which are estimated to be finished within the next four years. Outside of the above initiatives, Japan and the Republic of Korea continue to provide other funding and support, which play a critical role in sustaining U.S. presence in the region. USPACOM continues to execute five major force posture initiatives: (1) U.S.-Japan Defense Policy Review Initiative (DPRI) / USMC Distributed Laydown; (2) U.S. Forces Korea Realignment; (3) Resiliency; (4) Agile Logistics; and (5) Agile Communications. Defense Posture Realignment Initiative (DPRI)/USMC Distributed Laydown: DPRI is a vital part of the larger U.S. military Integrated Global Basing and Presence Strategy. A major goal of DPRI is to create an environment that is geographically distributed, operationally resilient, and politically sustainable to better support the enduring presence of U.S. forces in Japan. USPACOM maintains significant focus and effort on these initiatives. DPRI is one of the largest construction efforts since the end of the Cold War. Much work by both the U.S and Japan remain, but progress is being made towards realigning some U.S. Marines from Okinawa to 33

46 Guam and build-up of facilities at other locations such as Marine Corps Air Station (MCAS) Iwakuni, Japan. Military construction investments in the FY18 NDAA include projects for DPRI in Guam and Iwakuni. Another critical cooperative effort, the Futenma Replacement Facility (FRF) at Camp Schwab/Henoko will enable the U.S. to fulfill its security obligations to Japan while also enabling the return of MCAS Futenma to Okinawa. In the past year, top leaders from the U.S. and Japan have reaffirmed the commitment of both countries to construct the FRF. This solution maintains our presence at MCAS Futenma until the FRF is completed. USFK Realignment: The consolidation of U.S. forces in the Republic of Korea via the Land Partnership Plan (LPP) and Yongsan Relocation Plan (YRP) continues to progress as planned. Posture priorities remain the relocation of thousands of U.S. personnel to bases south of Seoul and setting conditions to support United Nations Command and the ROK-U.S. Combined Forces Command. The U.S. is committed to maintain the current level of U.S. military personnel assigned to the Republic of Korea through the next five years, at which point the Joint Force will become strategically flexible and exercise freedom of action throughout the AOR. Resiliency: The Joint Force remains ready to fight tonight across all domains in the Indo-Pacific. USPACOM ensures sustained power projection capabilities exist forward in theater, and generates resiliency through the dispersal of our capabilities and the decisive aggregation of effects. USPACOM resiliency efforts include investment in more robust infrastructure in ally and partner countries and the hardening of critical facilities. USPACOM also works to disperse critical enablers, including communication nodes, fuel repositories, medical readiness centers, and logistic support equipment. Agile Logistics: Combat operations in a contested environment require U.S. forces to disperse across multiple locations, both inside and outside the enemy s operational reach. We can no longer rely on the past strategy of consolidating in large, central locations that position combat capabilities close to the fight to maximize efficiency and time on target. To survive, our warfighters must move quickly in and out of enemy fire, placing a greater burden on the units that support them. Logistics plans can no longer construct central basing stockpiles of critical sustainment materiel without fear of attack. USPACOM must disaggregate those stockpiles, anticipate demand, and adapt to the speed of operational maneuver. Supported by other 34

47 Combatant Commands and strategic partners, USPACOM is working to develop an agile, resilient logistics network, to included sophisticated logistics decision support tools. Agile Communications: USPACOM must work with mission partners in order to further national objectives throughout the Indo-Pacific region. Five of seven U.S. Mutual Defense Treaties exist in the USPACOM area of responsibility (AOR), which translates to five alliances of national militaries that must operate together as a unified force on a daily basis and through all phases of planned operations. Similarly, USPACOM does not have formal agreements for exchanging information with many of the nation states or organizations within the USPACOM AOR, giving rise to the need for dynamic information technology capabilities to support the full spectrum of military operations. Agility with coalition information sharing environments that allow for the rapid addition or removal of mission partners must be available on short notice to adequately respond to natural disasters and contingencies in order to synchronize efforts, achieve synergistic results and to ensure forces do not interact with each other in a negative manner. As a result, we are not fully postured with the latest technology to interoperate with multiple partner combinations over all the phases of military operations. Furthermore, we will not have the communication capacity and sharable encryption capability to support the most modern warfighting platforms and associated weapon systems as they are built and deployed. Indo-Asia-Pacific Stability (IAPSI) Initiative: I m grateful for the inclusion of IAPSI in the FY18 NDAA. IAPSI supports a number of the force posture initiatives addressed in this section, including enhanced resiliency and increased logistical agility. Overall, IAPSI helps USPACOM fully leverage the capabilities of our allies and partners, while also signaling our persistent commitment to the region. Readiness: USPACOM is a fight tonight theater with short response timelines across vast spaces. Threats as discussed earlier require U.S. military forces in the region maintain a high level of readiness to respond rapidly to crisis. USPACOM s readiness is evaluated against its ability to execute operational and contingency plans, which place a premium on forwardstationed, ready forces that can exercise, train, and operate with our partner nations militaries and follow-on forces to respond to operational contingencies. Forward-stationed forces west of the International Date Line increase decision space and decrease response times, bolster the 35

48 confidence of allies and partners, and reduce the chance of miscalculation by potential adversaries. The ability of the U.S. to surge and globally maneuver ready forces is an asymmetric advantage that must be maintained. Over the past two decades of war, the U.S. has prioritized the readiness of deploying forces at the expense of follow-on-forces and critical investments necessary to outpace emerging threats. As a result of high operational demands, delayed maintenance caused by sequestration and ongoing Continuing Resolutions (CR), and training pipeline shortfalls, a shortage of ready surge forces limit USPACOM s responsiveness to emergent contingencies and greatly increases risk. These challenges grow each year as our forces continue to deploy at unprecedented rates. We are overstressing the force as the Services are unable to establish conditions to reset their force elements with the current fiscal instability. Past budget uncertainty degraded USPACOM s ability to plan and program, leading to suboptimal utilization of resources. Fiscal uncertainty forces the Department to accept risk in longterm engagement opportunities with detrimental strategic consequences to U.S. relations and prestige. Services must be able to develop and execute long-term programs for modernization while meeting current readiness needs. Constrained budgets over the last few years forced choices within the Services that have limited procurement and fielding of 5th generation fighter aircraft (F-35) in sufficient quantities and modernization of 4th generation aircraft (F-15, F-16, F/A-18) essential to prevent capability gaps and to maintain pace with potential adversary advancements. Much of the supporting infrastructure in the Pacific and on the West Coast of the continental U.S. was established during World War II and during the early years of the Cold War. The infrastructure requires investment to extend its service life but the Services struggle to maintain infrastructure sustainment, restoration, and modernization accounts at appropriate levels. Similarly, the shadow of budget uncertainty has exacerbated the industrial base s inability to meet and respond to increasing requirements to replace expenditures and field new systems and technologies. If funding uncertainties continue, the U.S. will experience reduced warfighting capabilities and increased challenges in pacing maturing adversary threats. 36

49 Allies and Partners U.S. national power depends on more than a robust economy and military strength: we need allies and partners. Our network of alliances and partnerships, established over the past 70-plus years, has contributed to the free and open order that we enjoy today. These countries do not follow U.S. lead on all issues, but allies and partners provide a foundation for like-minded nations to draw upon when dealing with major issues or crises. Australia, Japan, Republic of Korea, Philippines, and Thailand have all been long-standing allies, but Congress designation of India as a Major Defense Partner in 2016 provides USPACOM the opportunity to forge a new relationship with the world s largest democracy. A robust network of allies and partners creates an environment of cooperation to work together on shared challenges. USPACOM is directly connected to regional leaders. I am in frequent communication with my regional counterparts and appreciate the ability to reach out at any time to share perspectives. USPACOM maintains a close link with allies and partners through staff exchange and liaison officers, in addition to a series of formal bilateral mechanisms. In Australia, key engagements stem from the Australia-New Zealand-U.S. security treaty and are guided by USPACOM s principal bilateral event with Australia, the Military Representatives Meeting, which leads up to the Australia-U.S. 2+2 Ministerial Meeting with SecDef/SecState and their Australian counterparts. Similarly, the annual Joint Senior Leader Seminar guides USPACOM s militaryto-military relationship with Japan. The Military Committee and Security Consultative Meetings are the preeminent bilateral mechanisms that guide the U.S. alliance with the Republic of Korea (ROK). Each year USPACOM and the Armed Forces of the Philippines co-host the Mutual Defense Board and Security Engagement Board to deal with 21st-century challenges. USPACOM conducts annual Senior Staff Talks with Thailand to address security concerns and reinforce U.S. commitment to democratic principles. USPACOM also conducts annual formal bilateral activities with non-alliance partners throughout the region, including Bangladesh, India, Indonesia, Malaysia, Singapore, and Vietnam. Our multilateral cooperation is further enhanced by numerous Flag and General Officer (FOGO) exchange officers that work for the U.S. at USPACOM. These foreign officers from our Five Eye (FVEY) partners (Australia, Canada, New Zealand, and United Kingdom) serve under my 37

50 Command as fully integrated members of the USPACOM team. Our operations and intelligence watch centers are FVEY environments and FOGOs are embedded within USPACOM and our service components Bilateral and Multinational Partnerships with a Purpose : The future lies in multilateral security mechanisms. USPACOM is broadening key bilateral relationships into multilateral partnerships with a purpose that will more effectively address shared security concerns. For example, the U.S.-Japan-Republic of Korea multilateral coordination in response to the DPRK s provocative behavior, while challenging, is improving. The ROK and Japan each recognize that provocative actions by the DPRK will not be isolated to the peninsula and greater coordination and cooperation are required. Historical tensions between the nations remain, but cooperation and collaboration are slowly improving. The November 2016 signing of the Japan-Republic of Korea General Security of Military Information Agreement (GSOMIA) is a major accomplishment in improving bilateral relations between Seoul and Tokyo; the GSOMIA lays an essential foundation for expanding cooperation and enables the U.S. to work more closely with both allies. Recognizing the benefits of this bilateral agreement, in November 2017, the Republic of Korea and Japan renewed GSOMIA for another year. I look forward to increasing the frequency and complexity of multilateral information sharing while simultaneously enhancing multilateral security cooperation. To encourage multilateral cooperation, USPACOM hosts the Chiefs of Defense Conference (CHODs) annually. The CHODs conference location normally rotates between Hawaii and a regional partner. In 2017, 30 countries attended the CHODs conference in Victoria, Canada. USPACOM also participates in Australia-Japan-U.S. multilateral defense dialogues, including the Security and Defense Cooperation Forum (SDCF). The multilateral relationship between the U.S., Japan, and India is growing stronger as well. All three countries share democratic values, interests in protecting sea-lanes of commerce, and respect for international law. On the security front, all three countries participate in India s increasingly complex annual Malabar military exercise as well as the multinational Rim of the Pacific exercise. 38

51 In Southeast Asia, Indonesia, Malaysia and the Philippines formed a multilateral relationship aimed at countering violent extremists through coordinated maritime and air patrols. Additional Southeast Asia nations, such as Brunei and Singapore, and other Indo-Pacific regional nations, such as the U.S., Japan, and Australia are all supporting the multilateral initiative through various support missions. Allies Australia: The U.S.-Australia alliance anchors peace and stability in the region. Australia plays a leading role in regional security, capacity-building efforts and addressing disaster response. Australia is a key contributor to global security and a significant contributor to counter-isis efforts in Iraq and Syria and the Resolute Support mission in Afghanistan. With the implementation of force posture initiatives, the Marine Rotational Force-Darwin successfully completed its sixth deployment while maintaining a presence of 1,250 U.S. Marines. The seventh deployment begins in April 2018 and will consist of approximately 1,500 U.S. Marines with future growth informed by capability requirements and budget resource availability. The 2018 deployment will include ten MV-22 Osprey aircraft, providing a more robust capability. The deployment of USAF F-22s to Australia for integration with Royal Australian Air Force E/A-18G, F/A-18F, and/or E-7A as part of the Enhanced Air Cooperation force posture initiative will build upon the initial activities that occurred in 2017 by increasing the complexity of mutual tactics, techniques, and procedures. The U.S. and Australia are increasing collaboration in counter-terrorism, space, cyber, integrated air missile defense, and regional capacity building. Australia is procuring high-tech U.S. platforms that will further increase interoperability. These include the F-35A Lightning II, P-8 Poseidon, C-17 Globemaster III, EA-18G Growler, Global Hawk UAVs, and MH-60R helicopters. To enhance interoperability, the Australian Government provides a General Officer to USPACOM and a General Officer to U.S. Army Pacific on a fulltime basis. Australia has also set a goal of reaching 2% of its GDP on defense spending over the next decade. France: As a NATO ally, France has significant equities in the Indo-Pacific, and I welcome France s growing involvement in the region. The French territories in Polynesia and New Caledonia make France the sixth largest nation on the planet by area, which translates into an 39

52 Economic Exclusion Zone (EEZ) of over 166,000 square miles. The French navy maintains a professional military force in both territories, focused primarily on maritime security. But, France aims to become more involved across the Indo-Pacific writ large. Not only is France providing submarines to Australia and India, France is currently operating a combatant frigate (FF VENDEMIARE) in the East and South China Seas with U.S. Pacific Fleet. France also maintains a contingent of forces on New Caledonia and remains active in support or regional Humanitarian Assistance and Disaster Relief operations. During my recent visit to New Caledonia, the French military Commander indicated a strong desire to increase their training interaction with USPACOM forces, and we are developing opportunities for increased interaction. Overall, I am very excited about France s increased willingness to stand by the U.S. as we confront revisionist state and non-state actors across the region. Japan: The U.S.-Japan alliance remains the cornerstone for peace and stability in the Indo- Pacific region. Operational cooperation and collaboration between USPACOM and the Japan Joint Staff continue to increase. Japan's Peace and Security Legislation authorizing limited collective self-defense operations and the revised 2015 Guidelines for U.S.-Japan Defense Cooperation have significantly increased Japan s ability to contribute to regional stability more broadly. Japan continues to support USPACOM activities to maintain freedom of navigation in the South China Sea, and remains concerned about Chinese activities in the East China Sea. We are strengthening our alliance with Japan, including through reviewing our roles, missions and capabilities, to ensure seamless alliance responses across a full spectrum of situations amid an increasingly challenging regional security environment. Japan is procuring high-tech U.S. platforms that will increase interoperability such as the F-35B, E-2D Hawkeye, Global Hawk UAS, and MV-22 Osprey; it has also announced its intentions to procure AEGIS Ashore. Republic of Korea (ROK): The U.S.-ROK alliance is ironclad, and our commitment to the Republic of Korea is unwavering. We continue to work with our close friend and ally, as it moves toward obtaining the capabilities required under the Conditions-Based Operational Control (OPCON) Transition Plan (COT-P). In response to the evolving threat posed by the DPRK, the U.S. in coordination with the Republic of Korea, deployed a THAAD system to improve alliance missile defense posture. The Republic of Korea is also procuring high-tech 40

53 U.S. platforms that will further increase interoperability to include the F-35B, P-8 Poseidon, AH- 64 Apache, and Global Hawk UAS. The resumption of inter-korean dialogue in January and the North s decision to participate in this month s PyeongChang Olympic Games are encouraging developments, but any future talks with the DPRK must be focused on achieving a complete, verifiable, and irreversible denuclearization of the Korean peninsula. Accordingly, the alliance will maintain a high military readiness posture and will continue to provide support for the diplomatic pressure campaign through credible combat deterrence. The Philippines: The U.S.-Philippine alliance has demonstrated resilience through President Rodrigo Duterte s pursuit of an independent foreign policy. The tenor of our bilateral relationship has improved over the past year, due in part to the relationship-reset in President Duterte s personal interactions with President Trump. Through frank and frequent dialogue with Philippine leadership, we continue to maintain a robust defense relationship comprised of 261 activities for calendar year 2018, slowly expanding parameters of military-to-military cooperation. In particular, we have obtained Philippine commitment to resuming live fire exercises and close air support training. The attack on Marawi City in Mindanao by ISIS-P posed a significant challenge to the Armed Forces of the Philippines (AFP) and served as a reminder of the value of our alliance to Philippine security and stability. U.S. support, primarily in the form of providing Intelligence, Surveillance, and Reconnaissance (ISR), tactical advice, and the use of our Mutual Logistics Support Agreement (MLSA) to assist in the timely delivery of weapons and ammunition, proved crucial in the AFP s defeat of ISIS-P in Marawi. Our quick response to addressing AFP needs helped to bolster the bilateral relationship. Our military cooperation supports a broader whole-of-government approach to countering terrorism and building resiliency and capacity in Mindanao, as well as continuing to work together to modernize the AFP. While the government of the Philippines refocused attention on internal security to address short-term security and political challenges in Mindanao, we must not lose sight of the long-term objectives of building a territorial defense capability and creating a modern and self-sufficient AFP. Strategic patience has helped recalibrate the alliance relationship. I am convinced that the relationship pendulum will continue to swing in a positive direction and will continue to stabilize the region as it has for over 60 years. 41

54 Thailand: Our deep and longstanding military-to-military ties with Thailand go back to our 1950 Agreement Respecting Military Assistance between the Government of the United States of America and the Government of Thailand. Despite recent challenges, we remain close allies and important security partners. Our alliance is back on track at senior levels, capping off a year of re-engagement that included multiple 4-star visits, Secretary Mattis visit to Bangkok for the Royal Cremation, and POTUS hosting the Prime Minister at the White House. These discussions aimed to Reinvigorate the Alliance, and we have communicated that strengthening the alliance is a shared responsibility. Overall mil-to-mil engagements are also on a positive trajectory. Thailand facilitates world-class training opportunities for U.S. personnel across all services, and co-hosts Exercise COBRA GOLD with us, Asia s largest multinational military exercise. Thailand provides logistical nodes essential to our forces operating throughout the Indo-Pacific region. Funding for International Military Education and Training (IMET) and Foreign Military Financing (FMF) are currently restricted, but a Foreign Military Sales (FMS) and Direct Commercial Sales (DCS) relationship continues. Thailand has publicly committed to hold national elections in November 2018, and our continued engagement with military leadership remains the best way for the U.S. to promote regional security and healthy civilmilitary relations in Thailand. United Kingdom: I m excited about the trend of UK involvement in the Indo-Pacific. As a key NATO ally, the UK continues to support U.S. logistics and ISR operations across multiple Combatant Commands from the Indian Ocean territory of Diego Garcia. The UK is also looking to become more involved in maritime security in the Indo-Pacific. The HMS SUTHERLAND, a Type 23 Frigate, is currently conducting combined maritime operations with U.S. Pacific Fleet in Southeast Asia, and I expect this type of interaction will increase in the years to come. Partners India: The U.S.-India strategic partnership continues to advance at a historic pace and has the potential to be the most consequential bilateral relationship of the 21st century. The U.S. and India maintain a broad-based strategic partnership that is underpinned by shared democratic values, interests, and strong people-to-people ties, and I expect 2018 to be a significant and 42

55 eventful year in U.S.-India relations. The U.S. and India are natural partners on a range of political, economic, and security issues. With a mutual desire for global stability and support for the rules-based international order, the U.S. and India have an increasing convergence of interests, including maritime security and domain awareness, counter-piracy, counterterrorism, humanitarian assistance, and coordinated responses to natural disasters and transnational threats. India will be among the U.S. s most significant partners in the years to come due to its growing influence and expanding military. As a new generation of political leaders emerge, India has shown that it is more open to strengthening security ties with the U.S. and adjusting its historic policy of non-alignment to address common strategic interests. The U.S. seeks an enduring, regular, routine, and institutionalized strategic partnership with India. USPACOM identifies a security relationship with India as a major command line-of-effort. Over the past year, U.S. and Indian militaries participated together in three major exercises, executed more than 50 other military exchanges, and operationalized the 2016 Logistics Exchange Memorandum of Agreement (LEMOA). Defense sales are at an all-time high with India operating U.S.-sourced airframes, such as P-8s, C-130Js, C-17s, AH-64s, and CH-47s, and M777 howitzers. USPACOM will sustain the momentum of the strategic relationship generated by the POTUS- Prime Minister-level and the emerging 2+2 Ministerial Dialogue through strengthening our military-to-military relationship and working toward additional enabling agreements to enhance interoperability. At the moment, India is considering a number of U.S. systems for purchase, all of which USPACOM fully supports: the F-16 for India s large single-engine, multi-role fighter acquisition program; the F/A-18E for India s multi-engine, carried-based fighter purchase; a reorder of P-8Is; a potential purchase of SeaGuardian UAS; MH-60R multi-role sea-based helicopter; and F-35 Joint Strike Fighter. Indonesia: Indonesia plays an essential role as the maritime fulcrum of Southeast Asia. We maintain a robust defense relationship comprising over 200 annual activities as part of our Strategic Partnership. USPACOM continues to partner with Indonesia, particularly in maritime security. Indonesia desires to play a larger role in international economic and security issues. Their goal to provide 4,000 deployable peacekeeping troops by 2019 is another important area where we can engage. Indonesia continues to build and exercise in strategic maritime border areas to bolster its defense capabilities, and has concerns with Chinese activities in the vicinity of the Natuna Islands. The money spent on professional military education and technical training in 43

56 Indonesia has borne fruit in terms of Foreign Military Sales of excess defense article F-16s and new AH-64 Apaches. The Government of Indonesia is also considering the F-16 for the recapitalization of the Indonesian Air Force s aging fleet of fighter aircraft, most of which are of Russian origin. Malaysia: Our close security ties with Malaysia are based on our Comprehensive Partnership. Malaysia s regional leadership role, technologically advanced industry, sizeable economy, and capable military make it an important partner in securing peace and prosperity in Southeast Asia. Over the past year, Malaysia has implemented air and maritime patrols in the Sulu and Celebes Seas in accordance with a multilateral arrangement with the Philippines and Indonesia due to increased security concerns in East Malaysia. We have worked closely with Malaysia as cochairs of ASEAN s Humanitarian Assistance and Disaster Relief (HADR) working group. Malaysia also has an on-going dispute with China with respect to the Luconia Shoals, which China also claims. Malaysia has demonstrated the capacity and resolve to contribute to regional security, and we continue to support Malaysia s emerging security requirements. Malaysia recently selected MD-530 attack helicopter, and the U.S. is also providing Malaysia with secure communications equipment to increase interoperability in maritime security and counterterrorism missions. Mongolia: Mongolia endures as a small, yet strong, partner in Northeast Asia and continues to demonstrate staunch support for U.S. regional and global policy objectives especially those linked to the Global Peace Operations Initiative and security operations in Afghanistan. The government engages with the U.S. and other countries as part of their Third Neighbor policy. Mongolia also markets itself as a model for emerging democratic countries such as Burma, Nepal, and Timor Leste. My deputy visited Mongolia last summer and spoke at the Exercise KHAAN QUEST 2017 closing ceremony, reaffirming that USPACOM s goals are to assist the Mongolian Armed Forces through their defense reform priorities. These priorities include: development of professional military education for officers and non-commissioned officers; developing a professional NCO corps; and developing an Air Force and ready reserve force. The Mongolians punch above their weight and we should continue to support them where we can. 44

57 New Zealand: The U.S.-New Zealand partnership remains on solid footing and continues to evolve. New Zealand is increasing its leading role in regional security and capacity-building efforts while addressing disaster response in the South Pacific and Antarctica. New Zealand is a key contributor to global security and a significant contributor to counter-isis efforts in Iraq and Afghanistan. The U.S. is thankful for the New Zealand Defense Force s gracious offer of the Royal New Zealand Navy ship Te Kaha to replace the USS Fitzgerald after she was involved in an unfortunate mishap in summer 2017 during the USS Nimitz Carrier Strike Group deployment. We commend New Zealand s commitment to planned defense capability improvements identified in their 2016 Defense White Paper. These improvements acknowledge the threats posed by the rise of China s strategic influence in the Indo-Pacific, an escalation of military spending across Southeast Asia, and increasing challenges to the rules-based international system. Military-to-Military relations and defense engagements with New Zealand remain strong. New Zealand is procuring the P-8 Poseidon continuing the strong legacy of interoperability among Maritime Patrol and Reconnaissance Aircraft with the U.S. Singapore: Singapore remains a steadfast partner in Southeast Asia with a strong commitment to promoting a free and open Indo-Pacific. We owe Singapore our sincere gratitude for its assistance in the aftermath of the USS John McCain accident and timely aviation support to Hurricane Harvey relief efforts this past year. Singapore leaders believe the U.S. plays an indispensable role in bolstering the region s economic and security frameworks. Though not a formal treaty ally, Singapore provides us invaluable access to the strategically located entrance of the Malacca Straits and South China Sea. Singapore also hosts Littoral Combat Ships, rotational Maritime Patrol Aircraft, and Seventh Fleet s Logistics Force headquarters, while maintaining training detachments in the United States for Singapore Air Force F-15SGs, F- 16C/Ds, CH-47 Chinooks, AH-64 Apache helicopters, and the Singapore Army s High Mobility Artillery Rocket System. We conduct dozens of high level and increasingly complex military exercises with Singapore each year to increase our interoperability. Furthermore, Singapore officers regularly attend U.S. professional military education at all levels, developing relationships that span careers. The combination of a shared outlook on regional security and prosperity, strong support for U.S. presence, and a deep and broad defense relationship enables the U.S. to promote our interests abroad and focus on shared regional challenges. Overall, we remain their defense partner of choice despite intense Chinese pandering of economic influence. 45

58 USPACOM was excited to support Singapore s request for an F-22 and an F-35B static display at the 2018 Singapore Air Show in February a great opportunity as the Government of Singapore considers a purchase of F-35B in the future. Sri Lanka: The trajectory of U.S.-Sri Lanka relations continues to ascend, with Sri Lanka emerging as a significant strategic partner in the Indian Ocean region. Despite recent political turmoil, President Sirisena, elected in January 2015, remains committed to reforms and addressing Sri Lanka's human rights issues. Over the last year he continued Sri Lanka's path toward reconciliation and democracy following its multi-decade civil war. I believe it is in America's interest to continue to increase military collaboration and cooperation with Sri Lankan forces. Accordingly, USPACOM expanded bilateral defense ties, military leadership discussions, rule of law training, increased naval engagement, and focused security cooperation efforts on defense institution building in areas such as demobilizing, peacekeeping, and military professionalism. In October 2017, the USS Nimitz became the first U.S. aircraft carrier to visit Sri Lanka in over thirty years. This visit, along with granting Sri Lanka an excess U.S. Coast Guard cutter, underscores the deepening relationship between the U.S. and Sri Lanka. Vietnam: Vietnam is currently our boldest regional partner in standing up to China s provocative behavior in the South China Sea. A series of high-level bilateral visits in 2017 helped deepen our partnership, including visits to the U.S. by Prime Minister Phuc in May and Defense Minister Lich in August, as well as President Trump s travel to Vietnam in November and Secretary Mattis visit in January. In March 2018, the USS Carl Vinson will make an historic port visit to Da Nang, Vietnam an indication of the significant progress in the bilateral security relationship. Last year, we transferred a 378 foot former U.S. Coast Guard High Endurance Cutter to the Vietnam Coast Guard. Over the next few years, we expect to continue to assist the Vietnamese to build their capacity for maritime domain awareness. In addition, we signed the Cooperative Humanitarian and Medical Storage Initiative (CHAMSI) Memorandum of Understanding in May When implemented, CHAMSI will allow USPACOM to store humanitarian assistance and disaster relief equipment in Vietnam increasing our mutual ability to train for, and respond to, natural disasters in Vietnam. 46

59 Other Key Actors Oceania: Maintaining strategic relationships in Oceania is becoming ever more important to U.S. national security. The provisions included in the Compacts of Free Association with the Federated States of Micronesia, the Republic of the Marshall Islands, and the Republic of Palau are important mechanisms that guide the relationships, including U.S. obligations for their defense. In return, these agreements provide assured access to the three Compact Nations in a contingency situation. They also give the U.S. authority to grant or deny access to another nation s military forces, which allows the U.S. to maintain a clear strategic line of communication across the Pacific. I am grateful to Congress for fully authorizing the 2010 Palau Compact Review Agreement in the FY18 NDAA and would ask that Congress appropriate all required funds. The implementation of this legislation will have a significant impact on our defense relationship with Palau, and will provide a measurable advantage in our strategic posture in the Western Pacific. Continued U.S. commitment to defend the Compact Nations and to partner with other Pacific island countries enhances American influence and sends a strong message of reassurance throughout the region. ASEAN: ASEAN turned 50 last year and the U.S. commemorated its 40th year of U.S.-ASEAN dialogue relations. The U.S. and ASEAN share the common principles of a rules-based order, respect for international law, and the peaceful resolution of disputes. The ten ASEAN member states, under the chairmanship of the Philippines last year and Singapore this year, continue to seek ways to improve multilateral security engagements and advance stability in the Indo- Pacific. During this past year, the U.S. strengthened its commitment to ASEAN with engagements at the Secretary of Defense and Presidential levels where we reached agreement on whole-of-government approaches to shared challenges in areas of maritime security and maritime domain awareness. USPACOM is committed to strengthening regional institutions such as ASEAN, ASEAN Defense Ministers Meeting-Plus, the East Asia Summit, and the ASEAN Regional Forum. Over the course of the last year, USPACOM participated in ASEAN exercises, key leader engagements, and practical multilateral cooperation related to the spectrum of shared transnational challenges. The U.S. is postured to support Singapore s Chairmanship priorities for 2018 in the areas of Counterterrorism (CT), Chemical, Biological, Radiological, and Nuclear (CBRN), and Confidence Building Measures. Malaysia and the U.S. co-chair the 47

60 ASEAN Defense Ministers Meeting (ADMM)-Plus Experts Working Group on Humanitarian Assistance and Disaster Relief over the next two years. A key objective will be to support ASEAN s effort to operationalize the ASEAN Military Ready Group to multilaterally respond to natural disasters. USPACOM s approach is to promote multilateral partnerships of sub-regional ASEAN nations to strengthen a rules-based international order. This includes USPACOM support to the Indonesia-Malaysia-Philippines multilateral Cooperation Arrangements and the Cambodia-Malaysia-Thailand-Vietnam Gulf of Thailand Initiative. USPACOM looks forward to supporting the ASEAN Defense Ministers Meeting-Plus that Singapore will host in October. Burma (Myanmar): Our engagement with Burma s military is extremely limited and is expected to remain so considering the ongoing crisis and human rights violations by the military in the Rakhine State. The primary goal of our engagement is to encourage a professional military that operates under democratic standards of civilian control, transparency, and accountability, while also complying with international law, including international human rights law and international humanitarian law, as applicable. We underscore these points in all of our limited engagements. In addition to the humanitarian rights violations, I am also concerned about Chinese involvement in the country. Beijing is attempting to move into Burma while other countries are taking a step back, and Chinese support comes with no string attached. China: While the United States has an economic relationship with China, in my opinion, our two nations are in clear competition for influence and control of the Indo-Pacific. As the President commented in his recent State of the Union Address, China is now our rival, and I wholeheartedly agree with this assessment. For the last few years, I have advocated for dealing with China realistically as it is, and not as we would wish it would be. In other words, our relationship with China should be based on candor and clear-eyed pragmatism instead of yearning and misty-eyed optimism. Some view China s actions in the East and South China Seas as opportunistic. I do not. I view Chinese actions as coordinated, methodical, and strategic. Beijing is using its military and economic power to coerce its neighbors and erode the free and open international order. As I have previously stated, I believe the Chinese are building up combat power and positional advantage in an attempt to assert de facto sovereignty over disputed maritime features and spaces in the South China Sea, where they have fundamentally altered the physical and political landscape by creating and militarizing man-made bases. While the U.S. 48

61 has no claims in the South China Sea and it is our policy not to take positions on sovereignty over the disputed land features the U.S. resolutely opposes the use of coercion, intimidation, threats, or force to advance claims. These differences should be resolved peacefully and consistent with international law. This increasingly competitive environment necessitates continued mil-to-mil dialogue between the U.S. and China to improve understanding and reduce risk. USPACOM remains committed to a constructive, results-oriented relationship with China, so while we rightfully call out China for its aggressive behavior in some areas, we should also seek its support for shared security goals, such as the denuclearization of the Korean Peninsula. We will continue to cooperate with China where we have shared interests, such as military medicine and disaster response. USPACOM conducted numerous bilateral and multilateral engagements with China last year, and co-led the U.S.-China Military Maritime Consultative Agreement (MMCA) plenary and working group focused on operational safety. Encounters between our forces at sea and in the air are generally safe, but the MMCA provides a forum for continuous dialogue to identify and address safety issues when they arise. For USPACOM, my goal remains to convince China that its best future comes from peaceful cooperation and meaningful participation in the current free and open international order. China has the potential to emerge as a net security provider for the region, but to do so, Beijing must honor its international commitments. After all, the Chinese economic miracle could not have happened without the stability that emerged from the rules-based order an order that Beijing now seeks to undermine. But I ve also been loud and clear that we will not allow the shared domains to be closed down unilaterally, so we ll cooperate where we can but remain ready to confront where we must. Taiwan: Taiwan s open economy and its prosperous, free, and democratic society reflect the shared values between Taiwan and the U.S. In accordance with our One China Policy, based on the three United States-China Joint Communiques, the U.S. does not maintain diplomatic relations with Taiwan. Yet, we maintain a substantive and robust relationship with the people of Taiwan based on the Taiwan Relations Act of In line with this policy, USPACOM will continue supporting Taiwan's efforts to develop a credible, resilient, and cost-effective deterrent 49

62 and self-defense capability. Continued, regular arms sales and training for Taiwan s military are an important part of that policy and help ensure the preservation of democratic institutions. As the military spending and capability of the PRC grow every year, the ability of Taiwan to defend itself decreases. We must continue to help Taiwan defend itself and demonstrate U.S. resolve that any attempt by China to force reunification on the people of Taiwan is unacceptable. USPACOM has supported extensive security cooperation activities with Taiwan in air and missile defense, maritime security, logistic support and joint operations and training. Recent sales of anti-ballistic missiles, anti-aircraft weapons, logistics helicopters, surveillance radar, Perry-class Frigates, and amphibious assault vehicle (AAV-7), and electronic warfare systems continue to improve their self-defense capabilities. Activities, Direct Reporting Units, and Mission Partners Interagency: USPACOM collaborates with a broad group of interagency partners that bring diplomatic, economic, reconstruction and stabilization, intelligence, law enforcement, health, national security, and scientific expertise to the discussion. This allows us to address key national security issues through a whole-of-government approach, synchronizing all instruments of power. Our interagency partners help USPACOM maintain relationships with key allies and partners in this region. Our interagency collaboration has yielded success in supporting the DPRK pressure campaign; supporting humanitarian efforts in the aftermath of natural and manmade disasters; countering transnational threats, including transnational crime; preparing for potential pandemics; and, in supporting traditional military-military engagements and in nontraditional security cooperation. Our emerging and complex problems will increasingly require whole-of-government solutions, and USPACOM stands ready to support interagency-led efforts where we are needed. Global Engagement Center (GEC): The GEC is a key USPACOM partner in facilitating interagency collaboration and coordination of efforts to counter foreign propaganda and disinformation in the Indo-Pacific. While we work to address the propaganda that terrorist organizations use to recruit new followers, we must also address the serious threat that foreign state-sponsored disinformation poses to U.S. national security. To address these threats in the information environment, it is more critical than ever that the U.S. government has a 50

63 comprehensive, whole-of-government approach to informational power. In support of this effort, USPACOM has embedded a GEC officer within the Command and is actively prioritizing information related capabilities in its planning, operations, and activities. Security Cooperation and Capacity Building: USPACOM s Security Cooperation approach focuses on building partner readiness, reducing partner capability gaps, and building partner capacity. To effect change in these endeavors USPACOM is working to fully employ the consolidated Security Cooperation authorities in the FY17 NDAA. The Section 333 Global Train and Equip authority, introduced in the 2017 NDAA, consolidates older train and equip authorities such as 2282 and 1004, leading to significant benefits, such as a global approach to planning and greater visibility across lines of effort. We see great promise in advancing partners readiness and capabilities. USPACOM continues to follow a Theater Security Cooperation planning process that identifies partners priorities, to which the various authorities can be applied in concert. Additionally, the State Department is involved in the joint planning and development of Section 333 programs, and the Secretary of State must concur on any Section 333 program prior to Congressional notification. USPACOM greatly appreciates the State Department s foreign policy review of our global train and equip programs. USPACOM is also focused on improving partner-nation maritime domain awareness, which directly contributes to increased maritime security across the region. The FY16 NDAA Section 1263 Southeast Asia Maritime Security Initiative (MSI) is effectively enhancing maritime domain awareness and improving the maritime capacities and capabilities of partners and allies in Southeast Asia. Additionally, the Philippines, Australia, and the U.S. continue to discuss regional maritime security best practices through partnership workshops. These workshops facilitate whole-of-government discussions on maritime challenges that support creation of a regional maritime domain awareness network to share information between Southeast Asian partners. We need to go beyond maritime domain awareness and use an initiative like IAPSI to improve our partners and allies multi-domain awareness and increase their domain denial capability so that they can better protect their territory and enforce their maritime rights. USPACOM is also grateful for the State Department s long-standing Foreign Military Financing (FMF) and International Military Education and Training (IMET) programs. FMF enables 51

64 USPACOM to meet regional challenges to include border security issues, disaster response, counterterrorism and maritime security, and IMET offers long-term relationship building and sustainment. Global Peace Operations Initiative (GPOI): Countries of the Indo-Pacific provide 31% of the world s uniformed peacekeepers to UN peacekeeping operations worldwide, and of these peacekeepers, 20% come from the 12 GPOI partners in the Indo-Pacific. These 12 countries support 13 of the 15 UN peacekeeping missions, as well as three political missions. GPOI builds the capability and capacity of our partners to deploy ready forces and is centered on providing high-quality, action-oriented, challenging scenario-based training so that peacekeepers are better prepared to implement UN Security Council Resolutions of protecting vulnerable civilians, halting conflict-related sexual violence, working to put a stop to the use of children soldiers, addressing misconduct, and trying to bring long-term peace and security to conflict torn regions. In 2018, USPACOM and Bangladesh will cohost a multinational peacekeeping exercise called SHANTI DOOT, which focuses on preparing personnel for deployment to UN peacekeeping missions. We expect participation in this exercise from 32 nations who recognize the value of working with other peacekeeping nations in a very demanding training environment. Many of our partners are meeting program goals, with six of twelve partners achieving a self-sustained indigenous training capability while the others continue to make progress toward this milestone. We continue to emphasize a train-the-trainer approach enabling standardization and interoperability to work within United Nations guidelines. USPACOM will continue improving partner military peacekeeping skills and operational readiness, as well as provide limited training facility refurbishment. This program not only supports our efforts to improve UN peacekeeping, it is also helping to strengthen interoperability with U.S. forces and builds the trust required to improve interoperability in other relevant areas. Joint Exercise Program: USPACOM s Joint Exercise Program is vital for improving the operational and warfighting readiness of assigned Pacific Theater and partner nation forces, ensuring joint force readiness for crises and contingency operations while providing a visible and tangible deterrent to aggression. This important program is essential for advancing Combatant Commander Campaign Plan objectives including strengthening regional alliances and partnerships and deepening interoperability through combined training. Combatant Commander 52

65 Exercise Engagement Training Transformation (CE2T2) program funding enables our Joint Exercise Program, helping to enhance the readiness of our assigned forward deployed forces. Joint Interagency Task Force-West (JIATF-W): The drug trade in the Indo-Pacific threatens regional stability as drug trafficking organizations continue to utilize new supply chains and develop troubling partnerships across the globe. As USPACOM s Executive Agent for counternarcotics activities in the AOR, JIATF-W combats drug trafficking in the region by disrupting flows of drugs and precursor chemicals that transit the region, and by hardening the theater against the expansion of transnational criminal organizations. JIATF-W continues to build partner capacity to counter illicit trafficking of narcotics in the coastal areas of Philippines, Vietnam, Indonesia, Malaysia, and Sri Lanka; and the border regions of Bangladesh and Thailand. In order to develop cooperative solutions and procedures to address the transnational criminal threats in the region, bilateral and multilateral cooperative engagements are also a focus in building the capacity of our partner nations. The global nature of illicit trafficking means that problems that exist in this area of the world may have their start on the other side of the globe, or vice versa. For example, some of the problems we are dealing with on the Southwest border of the U.S. with drug trafficking start with the precursor chemicals that are being sold through licit commerce, predominantly from China; and to a lesser extent, India. Criminal entities with ties to Mexican and South American drug cartels use these licit chemicals to produce methamphetamines, cocaine, and heroin. Another drug, fentanyl-laced heroin, has been responsible for a spike in U.S. overdose deaths. Fentanyl and its numerous analogs originate almost exclusively from China. To combat these threats, the U.S. Government works closely with the government of the People s Republic of China in a Joint Liaison Group (JLG) on Law Enforcement Cooperation led by the Department of Justice. JIATF-W collaborates with U.S. Government interagency partners to support the JLG. To date, China has agreed to list over 100 precursor chemicals on their controlled substance list. JIATF- W works with U.S. Government partners to facilitate information sharing and interagency efforts to disrupt the opioid scourge that is so quickly claiming over 100 U.S. lives every day. In fiscal year 2017, JIATF-W identified and tracked chemical flows resulting in the disruption of roughly 116,000 kilograms of methamphetamine precursor chemicals. JIATF-W also continues 53

66 to work closely with U.S. and partner-nation agencies throughout the South Pacific, to include the French Armed Forces in Polynesia, as well as both Australian and New Zealand law enforcement, military, and intelligence services. With these partners, JIATF-W assists in the disruption of the lucrative drug trade in the region. In 2017, JIATF-W s efforts contributed to the interdiction of 16.6 metric tons of methamphetamine precursor chemicals, nine small vessels carrying cocaine or methamphetamine, the seizure of approximately 6.5 metric tons of cocaine, and 1.5 metric tons of methamphetamines, resulting in the removal of over 1.5 billion dollars in revenue from the trafficking organizations. Center for Excellence in Disaster Management and Humanitarian Assistance (CFE-DM): CFE-DM increases the capacity of U.S. and partner nation military forces to respond effectively to disasters and humanitarian emergencies, as well as enhances regional civil-military coordination through its education and training programs, regional civil-military engagements, and applied research and information sharing programs. The Center trains approximately 8,000 military and civilian personnel annually, including through bilateral and multilateral exercises focused on humanitarian assistance and disaster relief. CFE-DM also trains deployable U.S. forces and foreign audiences. Regional partnerships with key civilian international humanitarian community and military responders enhance cooperation on regional disaster response and preparedness, increase civil-military collaboration, and encourage a robust collection of best practices for future relief efforts. The Daniel K. Inouye Asia-Pacific Center for Security Studies (DKI APCSS): While DKI APCSS is no longer a Direct Reporting Unit to USPACOM, I have formally designated it as a Mission Partner to underscore its importance to the USPACOM mission set. DKI APCSS builds and sustains key regional partnerships, improves partner nation capacity, and enhances cooperation on regional security challenges. The Center s courses, workshops, dialogues, and alumni engagements directly support OSD-Policy and USPACOM priorities and are integrated into USPACOM s Theater Campaign Order. Focus areas include: rule-of-law based governance emphasizing civilian oversight of militaries, defense institution building, maritime security, and enhancing regional security architecture; collaborative approaches to maritime security, domain awareness, and counterterrorism; and improved capability and cooperation in HADR. DKI APCSS has major competitive advantages in its location, credibility, convening power, and 54

67 alumni network. APCSS has now graduated 12,000 students many now serve in key leadership positions in nations throughout the Indo-Pacific. Those advantages, and the Center s focus on substantive and sustainable outcomes, have broadly improved security sector governance. Specifically, this organization is leading the DoD in the implementation of UNSCR 1325 (Women, Peace, and Security) and the U.S. National Action Plan to achieve greater inclusion of women in the security sector. Joint Enabling Capabilities Command (JECC): USPACOM continually benefits from the expertise and responsiveness the U.S. Transportation Command s (USTRANSCOM) JECC provides to Combatant Commanders world-wide. JECC recently demonstrated the ability to respond effectively to time sensitive, real-world operational requirements of USPACOM and U.S. Forces Korea (USFK), specifically with surge support of dynamic targeting and contingency planning efforts related to DPRK provocations. JECC s deployable support teams remain critical to USPACOM's ability to establish joint force headquarters rapidly, fulfill Global Response Force (GRF) responsibilities, and bridge joint operational requirements by providing mission-tailored, ready joint capability packages. JECC supports real-world contingencies, operational plans, and exercises, to include USPACOM's high-end PACIFIC SENTRY series. Logistics Support Agreements (LSAs): USPACOM continues to view LSAs as critical Theater Security Cooperation (TSC) enablers, with 16 logistics agreements in the region. We continue to actively work with eligible but as yet uncommitted partners to conclude as many of these agreements as possible, and I personally stress their importance in my engagements with partner country leadership. The logistics agreement with Japan was especially useful during the Kumamoto earthquake disaster in 2016, and the logistics agreement with the Philippines was absolutely crucial in our support to the Marawi counter-terrorism operations last year. I often share these success stories with our partners and ensure they understand that the ability of U.S. forces to provide support during a crisis or disaster is limited without an LSA in place. Pacific Area Senior Officer Logistics Seminar (PASOLS): PASOLS is an annual forum that brings together senior logisticians from 30 countries in the Indo- Pacific. The goal is to strengthen regional cooperation, improve interoperability, and develop partner capacity to 55

68 cooperatively address regional challenges. The Republic of Korea hosted PASOLS 46 in September PASOLS is our most important annual logistics engagement event. Conclusion U.S. interests in the Indo-Pacific are real and enduring, while the growing challenges to our interests are daunting and cannot be overstated. In order to deter potential adversaries in the Indo-Pacific, America must continue to invest in critical capabilities, build a force posture that decreases our vulnerabilities and increases our resiliency, and reassure our allies and partners. Simultaneously, we must also encourage our allies and partners to be full and cooperative partners in their own defense and the defense of the free and open international order. America s resolve is strong, and it is imperative we continue to show our resolve and commitment to the region in the years to come. I ask this committee to continue support for future capabilities that maintain our edge and prevent would-be challengers from gaining the upper hand. Thank you for your enduring support to the USPACOM team and our families who live and work in the Indo-Pacific a region critical to America s future. 56

69 Subject Nepal Page Chargé d Affaires Mike Gonzales Economist Intelligence Unit Country Report... 73

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71 U.S. Embassy in Nepal Chargé d A aires, a.i. Michael C. Gonzales Mike Gonzales arrived in Kathmandu on August 4, 2016 as the Deputy Chief of Mission at the U.S. Embassy. He is a career member of the Senior Foreign Service of the United States. Prior to coming to Nepal, Mike served as the Deputy Chief of Mission and Chargé d Affaires at the U.S. Embassy in Malawi from , shepherding bilateral relations through an election crisis and corruption scandal while increasing U.S. assistance to the Southern African country. As the Counselor for Political and Economic Affairs at the U.S. Embassies in Harare, Zimbabwe and Addis Ababa, Ethiopia, Mike led efforts toward promoting bilateral commercial linkages, protecting human rights, and broadening political space. Mike s previous assignments include service as the Horn of Africa Unit Chief in the State Department in Washington; Deputy Public Affairs O cer in Kampala, Uganda; Information O cer and Embassy Spokesman in Addis Ababa, Ethiopia; and Environment, Science, and Technology O cer in Dhaka, Bangladesh. Prior to joining the Foreign Service, Mike was an economic analyst with the Antitrust Division of the U.S. Department of Justice. He is a four-time recipient of the Department of State s Superior Honor Award, and the 2009 recipient of the William R. Rivkin Award for Constructive Dissent from the American Foreign Service Association. Mike received a Master of Arts degree in international development from American University and a Bachelor of Arts degree in Diplomacy and World Affairs from Occidental College. He has studied Spanish, French, Italian, and Bengali. Mike is married to Carol Jenkins with whom he has two daughters. This is the o cial website of the U.S. Embassy in Nepal. External links to other Internet sites should not be construed as an endorsement of the views or privacy policies contained therein.

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73 Country Report Nepal Generated on September 6th 2018 Economist Intelligence Unit 20 Cabot Square London E14 4QW United Kingdom

74 The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For 60 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group. London The Economist Intelligence Unit 20 Cabot Square London E14 4QW United Kingdom Tel: +44 (0) Fax: +44 (0) eiucustomerservices@eiu.com New York The Economist Intelligence Unit The Economist Group 750 Third Avenue 5th Floor New York, NY 10017, US Tel: Fax: eiucustomerservices@eiu.com Hong Kong The Economist Intelligence Unit 1301 Cityplaza Four 12 Taikoo Wan Road Taikoo Shing Hong Kong Tel: Fax: eiucustomerservices@eiu.com Geneva The Economist Intelligence Unit Rue de l Athénée Geneva Switzerland Tel: Fax: eiucustomerservices@eiu.com This report can be accessed electronically as soon as it is published by visiting store.eiu.com or by contacting a local sales representative. The whole report may be viewed in PDF format, or can be navigated section-by-section by using the HTML links. In addition, the full archive of previous reports can be accessed in HTML or PDF format, and our search engine can be used to find content of interest quickly. Our automatic alerting service will send a notification via when new reports become available. Copyright 2018 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it. ISSN Symbols for tables "0 or 0.0" means nil or negligible;"n/a" means not available; "-" means not applicable

75 Nepal 1 Nepal Summary 2 Briefing sheet 3 Basic data 5 Political structure Economic structure 7 Annual indicators 7 Quarterly indicators Outlook for Political stability 9 Election watch 10 International relations 10 Policy trends 11 Fiscal policy 11 Monetary policy 11 International assumptions 12 Economic growth 12 Inflation 12 Exchange rates 13 External sector 13 Forecast summary Recent analysis Politics 14 Forecast updates Economy 17 Analysis Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

76 Nepal 2 Briefing sheet Editor: Sarthak Gupta Forecast Closing Date: August 14, 2018 Political and economic outlook The Economist Intelligence Unit expects the political situation to become more stable in the forecast period ( ) under the new government led by a single political party, the Nepal Communist Party. This marks a departure from Nepal's coalition-party politics. We expect an improvement in the business environment, through the swifter passage of business-friendly legislation and expedited policymaking under the new government, owing to its large majority in both houses of the parliament. China and India will compete for influence in Nepal. Although this may be beneficial in terms of reconstruction efforts and foreign-aid inflows, it will be tricky for Nepal to balance its relations with its two powerful neighbours. We expect real GDP to grow by an annual average of 6.6% in fiscal years 2017/ /19 (July 16th-July 15th), driven by a resurgence in investment activity and accelerated earth-quake reconstruction activity. We forecast that inflationary pressures will return in , as higher global oil prices will raise imported inflation. Higher price pressures will also be underpinned by a stronger inflationary environment in India, which is Nepal's largest source of imports. In the current-account deficit will widen owing to a rise in merchandise imports driven by higher demand for capital goods. In addition, debt repayments related to infra-structure projects will add to the pressure on the external accounts. Key indicators 2016 a 2017 a 2018 b 2019 b Real GDP growth (%) c d 6.8 Consumer price inflation (av; %) Government balance (% of GDP) 1.4 d -3.1 d -5.8 d -6.2 Current-account balance (% of GDP) Money market rate (av; %) Exchange rate NRs:US$ (av) a Actual. b Economist Intelligence Unit forecasts. c Fiscal years ending July 15th. d Economist Intelligence Unit estimates. Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

77 Nepal 3 Key changes since May 11th We have revised our fiscal policy forecast in the light of the budget announcement for 2018/19 (July 16th-July 15th). We now expect a wider fiscal deficit, equivalent to 6.2% of GDP in 2018/19, up from 5.1% previously. We have revised our inflation forecast owing to weaker than expected consumer price inflation in the first quarter of We now expect consumer prices to increase by an average of 5.1% in 2018, compared with a previous forecast of 5.5%. We have revised our forecast for the Nepali rupee in line with changes to our forecast for the Indian rupee. We now expect the currency to average NRs107.1:US$1 in 2018, compared with NRs104.9:US$1 previously. We have revised our external sector forecast owing to stronger than expected merchandise imports in the first quarter of We now expect a current-account deficit equivalent to 7.2% of GDP in 2018, compared with 4.6% previously. The quarter ahead August 30th 31st BIMSTEC summit: Nepal will host the fourth summit of the Bay of Bengal Initiative for Multi-Sectoral Technical and Economic Co-operation (BIMSTEC) in its capital, Kathmandu. BIMSTEC is an inter-governmental organisation that aims to enhance connectivity and co-operation among member states in South and South-East Asia. Basic data Land area 147,181 sq km Population 29.3m (2017; IMF) Main towns Population in 000 (2011 census) Kathmandu (capital): 1,745 Morang: 965 Rupandehi: 880 Jhapa: 813 Kailali: 776 Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

78 Nepal 4 Climate Varies from cool summers and severe winters in the north to subtropical summers and mild winters in the south (extreme cold at high altitudes) Weather in Kathmandu (altitude 1,337 metres) Hottest month, July, C (average daily minimum and maximum); coldest month, January, 2 23 C; driest month, December, 3 mm average rainfall; wettest month, July, 373 mm average rainfall Languages Nepali (official). There are other languages, and English is widely used in commerce Measures Metric system; local units also used include 1 seer = kg; 1 maund = 40 seer; 1 ropani = ha; 1 bigha = ha Currency Nepali rupee (NRs) = 100 paisa. Since 1993 the currency has been subject to a de facto peg to the Indian rupee at the rate of NRs1.6:Rs1. Average exchange rate in 2017: NRs104.5:US$1 Fiscal year July 16th-July 15th Time 5 hours 45 minutes ahead of GMT Public holidays January 30th (Martyrs' Day); February 13th (Maha Shivaratri); February 19th (National Democracy Day); April 14th (Nepali New Year); September 19th (Constitution Day); October 16th-21st (Dashain); November 7th (Laxmi Puja); November 9th (Bhai Tika); various other holidays for religious groups Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

79 Nepal 5 Political structure Official name Federal Democratic Republic of Nepal Form of state Republic. Nepal was a constitutional Hindu monarchy until parliament approved an interim constitution in The latest constitution, which was ratified in September 2015, confirms the country as a secular democratic republic. Under the 2015 constitution, Nepal formally adopted a bicameral parliament with the change of government in February 2018 Head of state The president, Bidhya Devi Bhandari, was elected by parliament in October 2015 The executive The prime minister, Khadga Prasad Sharma Oli, began his term of office in February 2018; the cabinet is chosen by the prime minister in consultation with their party and any coalition partners National legislature Nepal has a bicameral legislature. The House of Representatives (the lower house) has 275 members 165 elected through the first past the post system from single seat constituencies and 110 through proportional representation. The National Assembly (the upper house) has 59 members, of which 56 are elected through an electoral college comprising members of each state assembly and three are nominated by the president Legal system Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

80 Nepal 6 The Supreme Court acts as the court of appeal and review, and has powers of original jurisdiction. It presides over 16 appellate courts and 75 district courts National government The ruling party is the Nepal Communist Party (NCP) formed by the merger of the Communist Party of Nepal (Unified Marxist-Leninist), or CPN (UML), and the Communist Party of Nepal (Maoist-Centre), or CPN (MC) into a single party National elections Elections for both houses of parliament were held between November 2017 and February The so called Left Alliance comprising the CPN (UML) and the CPN (MC) joined to form the NCP, won a majority of seats in both polls. The next elections will be held in 2022 Main political organisations NCP; Nepali Congress (NC); Rashtriya Prajatantra Party; Madhesi Jana Adhikar Forum (Loktantrik), or MJF (L); Tarai-Madhesh Loktantrik Party; Rastriya Janata Party-Nepal Government Prime minister, minister for urban development, health & population: Khadga Prasad Sharma Oli Key ministers Agriculture, land management & co-operatives: Chakrapani Khanal Culture, tourism & civil aviation: Rabindra Prasad Adhikari Defence: Ishwor Pokhrel Energy, water resources & irrigation: Barsaman Pun Finance: Yuba Raj Khatiwada Foreign affairs: Pradip Kumar Gyawali Home affairs: Ram Bahadur Thapa Industry, commerce & supplies: Matrika Prasad Yadav Labour, employment & social protection: Gokarna Bista Physical infrastructure & transport: Raghubir Mahaseth Central bank governor Chiranjibi Nepal Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

81 Nepal 7 Economic structure Annual indicators 2013 a 2014 a 2015 a 2016 a 2017 a GDP at market prices (NRs bn) b 1, , , , ,642.6 GDP (US$ bn) Real GDP growth (%) b Consumer price inflation (av; %) Population (m) c 29.3 c Exports of goods fob (US$ m) , Imports of goods fob (US$ m) -6, , , , ,000.4 Current-account balance (US$ m) 1, , Foreign-exchange reserves excl gold (US$ m) 5, , , , ,171.6 c Exchange rate (av) NRs:US$ a Actual. b Fiscal years ending July 15th. c Economist Intelligence Unit estimates. Origins of gross domestic product 2016/17 ab % of Components of gross domestic product total 2016/17 ab % of total Agriculture, forestry & fishing 27.0Private consumption 76.2 Industry 13.5Government consumption 11.7 Services 51.5Fixed investment 33.8 Stockbuilding incl statistical discrepancy 8.7 Exports of goods & services 9.8 Imports of goods & services 42.0 Principal exports 2016/17 ac % of % of Principal imports 2016/17ac total total Carpets & other textile floor coverings Mineral fuels, mineral oils & products of their 10.4 distillation 14.2 Coffee, tea, mate & spices 9.6Iron and steel 9.5 Man-made staple fibres Nuclear reactors, boilers, machinery & 9.6 mechanical appliances 8.3 Apparel and clothing accessories 8.4Vehicles 8.1 Main destinations of exports % of % of 2016/17 ac Main origins of imports 2016/17ac total total India 57.0India 65.2 US 12.3China 13.2 Turkey 5.7UAE 3.0 Germany 4.2France 1.4 UK 3.5Indonesia 1.2 a Fiscal years (ending July 15th). b Central Bureau of Statistics. c Department of Customs. Quarterly indicators Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Prices Consumer prices (av; 2005=100) n/a Consumer prices (% change, year on year) n/a Financial indicators Exchange rate NRs:US$ (av) Exchange rate NRs:US$ (end-period) Discount rate (av mid-month figure; %) n/a Government bond yield rate (av mid-month figure; %) Treasury-bill rate (av mid-month figure; %) n/a M1 (middle of last month of period; NRs bn) n/a n/a n/a n/a M1 (% change, year on year) n/a n/a n/a n/a M2 (middle of last month of period; NRs bn) 2,278.22,389.52,457.82,504.6 n/a n/a n/a n/a Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

82 Nepal 8 M2 (% change, year on year) n/a n/a n/a n/a Foreign payments (US$ m) Merchandise trade balance fob-fob -1,822-2,057-2,206-2,326-2,241-2,388-3,084 n/a Services balance n/a Primary income balance n/a Net transfer payments 1,812 1,911 2,028 2,249 1,980 1,830 2,181 n/a Current-account balance n/a Reserves excl gold (end-period) 8,260 8,498 8,637 n/a n/a n/a n/a n/a Source: IMF, International Financial Statistics. Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

83 Nepal 9 Outlook for Political stability The Economist Intelligence Unit forecasts that political stability will improve in , owing to a more stable government under the Nepal Communist Party (NCP), which was formed in May 2018 by the amalgamation of the Communist Party of Nepal (Unified Marxist-Leninist), or CPN (UML), and the Communist Party of Nepal (Maoist-Centre), or CPN (MC). We expect the new government to serve out its full term in office, which ends in The NCP's majority in both houses of parliament will help to improve the business environment, through the quicker passage of business-friendly legislation and expedited policymaking. Its dominance in both chambers will also lead to a more stable administration in Nevertheless, there are risks to the stability of the new administration. Power jostling between Pushpa Kamal Dahal, the co-chairman of the NCP, and Khadga Prasad Sharma Oli, the new prime minister and co chairman of the party, poses a serious risk to the partnership s future. The two leaders agreed to head the government by taking turns; a similar arrangement was in place under the previous administration, between Mr Dahal and the former prime minister, Sher Bahadur Deuba of the Nepali Congress (NC). There is a low risk that Mr Dahal, along with his supporters in the NCP, may withdraw support to the government if their interests are not taken care of by the new government. In addition to jostling for power among political players and disputes between the judiciary, the legislature and the executive, social tensions will pose high risks to political stability over the forecast period. Communal tensions, which have been severe in the past few years, are likely to flare up again and result in demonstrations. We expect further protests by ethnic-madhesi-based parties demanding greater representation of Terai districts in parliament. Despite the risks that such protests pose to stability, we believe that the police, along with the possible deployment of the army, will manage to maintain law and order. Election watch Nepal successfully held elections for all three levels of government (local, provincial and national) in Polls for the National Assembly (the upper house of parliament) were held in February The CPN (UML) emerged as the largest party in all three elections. It won the largest number of seats in the local polls that were held in three phases over May September The NC the largest party following the 2013 parliamentary elections won the second highest number of seats, followed by the CPN (MC). Subsequently, the CPN (UML) and the CPN (MC) formed an alliance and won a landslide victory in the provincial assembly and the parliamentary elections that were held between November 2017 and February With the change in government, the country also moved from a unicameral to a bicameral legislative system. The next parliamentary elections will be held in Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

84 Nepal 10 International relations We expect Nepal's foreign policy over the next few years to be characterised by a balancing act between India and China. The relative generosity of both India and China in terms of reconstruction aid reflects the strategic rivalry between the two for influence over Nepal. We expect to see a deepening of engagement with China in terms of trade and infrastructure projects, mainly owing to the Nepali government's policy of expanding its international reach ever since the blockade by India in 2015, which further damaged an economy already crippled by earthquakes. India will also make efforts to rebuild ties with Nepal. In line with this view, we expect high-level visits from officials of both countries over the forecast period, with the aim of enhancing bilateral ties. China will emerge as an important development partner in under the new administration led by Mr Oli, who is seen as leaning more towards China than India. In August 2017 China extended internet connectivity to Nepal, ending India's monopoly in providing internet services to the country. China also plans to extend its Tibet railway to the Nepali border by In addition, the two countries signed a framework agreement in May 2017 to strengthen ties under China's Belt and Road Initiative, a project that India views with suspicion owing to concerns over China's increasing strength in the region. In the long term, Chinese assistance and infrastructure funding will reduce Nepal's reliance on India for the great bulk of its imports. It is also worth noting that India is still the source of around 65% of Nepali imports, meaning that it will remain Nepal's most important trade partner in Policy trends Reconstruction efforts will continue to dominate the policy agenda in , as large parts of the country and its infrastructure were devastated following the 2015 earthquakes. Although foreign governments and multilateral insti-tutions were forthcoming in pledging financial and technical support in the two years following the earthquake, progress on reconstruction has been held back by political squabbling and a shortage of capacity and skills within the bureaucracy. For example, the National Reconstruction Authority began to disburse rebuilding funds only in mid Nevertheless, with a more stable administration in place in we expect reconstruction works to be expedited. Another important part of the policy agenda in will be rapid development of energy and transport infrastructure. Connectivity in Nepal remains poor, with an inadequate road network and only one international airport. The country continues to face an energy deficit, as its potential for hydropower generation remains untapped. The administration's aim of improving energy and transport infrastructure will be supported by inflows of investment and loans from China and India. Although most of these infra-structure projects will be completed beyond our forecast period, investment inflows and a pick-up in related construction activity will drive economic growth in Similar to the previous administration, we expect the new government to focus on development of the tourism sector, owing to its potential to raise employment and contribute to economic growth. According to the World Travel and Tourism council, tourism earnings accounted for 4% of GDP in We expect earnings from the tourism sector to rise further as infrastructure and connectivity improves and as post-earthquake reconstruction gathers pace. Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

85 Nepal 11 Fiscal policy In fiscal year 2017/18 (July 16th-July 15th) we estimate that the budget deficit widened markedly to the equivalent of 5.8% of GDP from an estimated 3.1% of GDP in 2016/17. This is owing to an expansionary budget that was introduced ahead of the parliamentary elections, as well as the unrealistic pace of revenue expansion assumed in the budget for 2017/18. Looking ahead, we do not expect the government to be able to rein in spending owing to excessive distributive schemes implemented by the previous administration, as well as its own programmes promised as part of its election campaign. We expect economic growth in 2018/19 to be slower than the government's target of 8%, which will also result in weaker fiscal inflows. We also believe that the projected foreign-loan inflow of NRs253bn in 2018/19 (up from NRs74.9bn in 2017/18) is too optimistic. Most foreign-loan disbursements are anchored on execution of the project or programme for which financing has been agreed and we expect these only to move forward in a lagged fashion. Furthermore, we expect domestic revenue to fall short of the government's target as the pace of growth assumed in the 2018/19 budget is overly ambitious (16.4%, compared with our forecast of 15%). Overall, we anticipate that the fiscal deficit will widen to the equivalent of 6.2% of GDP in 2018/19. Monetary policy Monetary policy is conducted by Nepal Rastra Bank (NRB, the central bank) but is constrained by the wider policy of maintaining the Nepali rupee s peg to the Indian rupee at a rate of NRs1.6:Rs1. As we believe that the Indian rupee will weaken against the US dollar in , this will also result in a gradual depreciation of Nepal's currency. We expect the NRB to raise interest rates in line with India's monetary policy stance, but in a lagged fashion. This will result in a gradual increase in interest rates in 2019 (interest rates will remain unchanged in 2018). However, as capital flows are not fully liberalised, NRB has a degree of independence regarding monetary policy, and interest-rate movements in Nepal and India display occasional divergence. International assumptions International assumptions summary (% unless otherwise indicated) GDP growth World US China EU Exchange rates US$ effective (2010=100) :US$ US$: Financial indicators US$ 3-month commercial paper rate month money market rate Commodity prices Oil (Brent; US$/b) Gold (US$/troy oz) 1, , , ,262.5 Food, feedstuffs & beverages (% change in US$ terms) Industrial raw materials (% change in US$ terms) Note. GDP growth rates are at market exchange rates. Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

86 Nepal 12 Economic growth We expect the economy to expand by 6.8% in real terms in 2018/19, compared with 6.3% in 2017/18 (according to provisional data released by the Central Bureau of Statistics). Economic growth in 2017/18 has mainly been driven by strong investment activity in the manufacturing and construction sectors. We believe that post-earthquake reconstruction work and large-scale infrastructure projects will continue to drive growth in these subsectors in 2018/19. Continued strong growth in investment in 2018/19 will be supported by a relatively stable political outlook. We also expect quicker passage of business-friendly reforms and an easing of regulatory burdens, which will support overall economic growth. Overall, total fixed investment is expected to grow by 14.5% in 2018/19 and will continue to be the primary driver of economic expansion. Private consumption will grow by a much more modest rate of 3.2% in 2018/19, but will remain the largest component of GDP (measured on an expenditure basis). This will be supported by strong inflows of remittances and continued economic recovery after devastating floods in Government consumption spending will remain high owing to expenses related to ongoing large infrastructure projects. However, growth in this component will moderate to 8.5% in 2018/19, from an estimated 9.4% in 2017/18, as the government attempts to rein in the fiscal deficit after a year of heavy election-related spending. Imports will continue to exceed exports, as the country will remain heavily dependent on imports of fuel and capital inputs for infrastructure development. However, since a majority of imports will be used in manufacturing and enhancing the capital base, we do not expect the rise in imports to offset the positive impact of increased investment in the economy. Inflation We expect consumer price movements in Nepal to mirror those in India, owing to the currency peg with that country. Consumer price movements in India will also creep in through imports as Nepal continues to rely on India for almost two-thirds of its import needs. Consumer price inflation was relatively weak in 2017, owing to a resilient agricultural sector as well as muted demand-side pressures. Nevertheless, we expect price pressures to return in 2018 owing to higher global oil prices, which will push up local fuel costs. Inflation in the first quarter of 2018 was 5%, which, although lower than our expectations, still points to an uptick in price pressures compared with Furthermore, we expect private consumption growth to increase to 3.2% in 2018/19 after growing at a modest rate of 1.5% on average in 2015/ /18. With an anticipated pick up in this component, demand-side pressures are likely to build. In addition, currency depreciation will also fuel higher inflation in the forecast period. Overall we expect consumer price inflation to average 5.4% a year in Exchange rates The Nepali rupee will remain pegged to the Indian rupee at NRs1.6:Rs1 over the forecast period. We expect the local currency's value to average NRs108.9:US$1 a year in , in line with our forecast for the Indian rupee and down from an average of NR104.5:US$1 in Contributing to the currency's depreciation will be a worsening external trade balance in nominal terms. Imports have been rising at a rapid pace since 2016, mainly owing to increased imports of industrial goods and machinery for post-earthquake reconstruction and infrastructure development. A weaker currency will, however, prove to be a boon for the tourism industry. Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

87 Nepal 13 External sector The merchandise trade deficit will expand in nominal terms in , owing to the need to import inputs for flood and earthquake reconstruction work as well as infrastructure development, putting added pressure on the balance of payments. Higher global oil prices in will further drive up Nepal's import bill. Nepal s export performance will continue to be weighed down by low labour productivity and poor infrastructure connectivity. Furthermore, interest payments on long-term debt incurred to finance large-scale infrastructure projects will increase outflows from the primary income account. Meanwhile, inflows of workers' remittances (mainly from the Middle East, a major destination for Nepalis working abroad) will continue to grow steadily in However, they will be hit slightly in 2019 by the US's removal of an immigration scheme in June of that year. Nepal remains heavily reliant on remittance inflows, and this exposes its external sector and growth outlook to the possibility of adverse shocks. Nevertheless, we expect remittance inflows and foreign grants to continue to cover a large part of the trade shortfall in However, this will be insufficient to prevent the current-account balance from remaining in the red. We forecast that the current account will record a deficit equivalent to 7.8% of GDP on average in We expect the import cover provided by international reserves to average 8.3 months in , well above the three-month threshold that is generally regarded by the IMF as the minimum to mitigate balance-of-payments risks. Over the longer term, the broader question of how Nepal can wean itself off its dependence on remittances will remain unaddressed. Forecast summary Forecast summary (% unless otherwise indicated) 2016 a 2017 a 2018 b 2019 b Real GDP growth c d 6.8 Gross fixed investment growth c d 14.5 Consumer price inflation (av) Lending interest rate 8.9 d 11.3 d Exchange rate NRs:US$ (av) Exchange rate NRs:US$ (end-period) Exchange rate NRs: 100 (av) Exchange rate NRs: (av) a Actual. b Economist Intelligence Unit forecasts. c Fiscal years ending July 15th. d Economist Intelligence Unit estimates. Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

88 Nepal 14 Recent analysis Generated on September 6th 2018 The following articles were published on our website in the period between our previous forecast and this one, and serve here as a review of the developments that shaped our outlook. Politics Forecast updates India's prime minister concludes two-day trip to Nepal May 14, 2018: International relations Event On May 12th India's prime minister, Narendra Modi, concluded a two-day visit to Nepal. The focus of this visit included increasing co-operation on trade and infrastructure. Analysis This was Mr Modi's first visit to Nepal since India's unofficial blockade in 2015, which severely hurt bilateral relations, and follows a visit to India by Nepal's prime minister, Khadga Prasad Sharma Oli, in April. One of the main issues raised by the Nepali government during the visit was its large bilateral trade deficit, and both sides agreed to work on increasing Nepal's access to Indian markets. India will also send a survey team to Nepal to lay the groundwork for a rail link between the capital, Kathmandu, and a town in eastern India, Raxaul. This Indian-financed project, announced in April, is expected to support trade by easing the dependence on poor-quality roads and hilly terrain. It is also part of India's efforts to counter China's growing influence in the region; China has been at the forefront of major infrastructure investments in India's South Asian neighbours. Mr Modi and Mr Oli also laid the foundation stone for 900-MW hydroelectric power project. Mr Modi's visit included a trip to a Nepali town, Janakpur, which has religious significance for Hindus. There he announced Rs1bn (US$15m) worth of assistance to develop Janakpur. This is part of an effort to leverage India's close cultural ties with Nepal, at a time when the latter's relations with China are deepening. Although India remains Nepal's largest trading partner, Chinese investments in Nepal, particularly in the infrastructure sector, have risen significantly in recent years and we expect this relationship to strengthen further in the coming years. Therefore, Nepal will continue to try and balance its ties with both India and China, even as India continues to make efforts to counter China's growing influence in Nepal. Impact on the forecast This development supports our view that Nepal's foreign policy in will be characterised by a balancing of ties between China and India. No change to this forecast is required. Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

89 Nepal 15 Nepal and China sign agreement on trans-himalayan railway July 2, 2018: International relations Event On June 24th Nepal's prime minister, Khadga Prasad Sharma Oli, concluded his six-day visit to China. During the trip the two countries signed a few important agreements, including a Memorandum of Understanding (MoU) on co-operation in railway connectivity. Analysis China is planning to extend the Qinghai-Tibet railway up to Kerung, which is about 25 km north of the Rasuwagadhi border point in Nepal, by A pre-feasibility of the railway by a team of Chinese experts is expected to be completed by August. Although the complete details of the agreement have not yet been revealed, Nepal has agreed to accept Chinese technology and personnel training. China is also expected to provide all financing for the project in the form of loans. The two countries also reached an understanding to finalise the protocol for operationalising the Agreement on Transit Transport, which was signed during Mr Oli's first state visit to China in Symbolically, this will end Nepal's sole reliance on India for third-country trade, but practically it will not alter the movement of goods over the medium term, as India remains the largest market for Nepal for both exports and imports. Nonetheless, China is the largest source of foreign direct investment commitments for Nepal, and provides the second-highest number of tourists. Apart from the railway and transit transport agreement, six more deals were signed in the areas of hydropower, development of industrial capacity and trade. Impact on the forecast The latest infrastructure agreements with China will be significant in terms of improving crossborder connectivity. This will lead to increased bilateral economic co-operation, as well as a rise in investment and tourist inflows. No changes to our forecast are required. Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

90 Nepal 16 India and Nepal foresee a reset of bilateral treaty July 6, 2018: International relations Event On June 30th the Eminent Persons' Group (EPG) on Nepal-India relations, which comprises four experts and diplomats from each country, held a meeting and finalised a report recommending changes to the 1950 Indo-Nepal Treaty of Peace and Friendship. Analysis The joint report will soon be submitted to the prime ministers of the two countries. Nepal has been calling for changes in what it calls "unequal" provisions of the treaty, particularly the one that requires all arms and ammunitions that Nepal purchases from any country to be routed through India. According to early media reports, the joint report incorporates this demand and also recommends regulation of the open border between the two countries through identity cards (something being pushed for by India). The current treaty's provision regarding reciprocal rights of property and residence of citizens is also expected to be amended. The EPG was formed in 2016 with the mandate to review bilateral treaties and agreements, and produce a joint document to reset ties between the two countries. We believe that most of the changes recommended in the report will be incorporated in a new bilateral agreement. This will see a shift in the nature of relations between the two countries. Historically, India has had a large influence on Nepal, dictating most of its foreign policy decisions. However, we do not expect this arrangement to continue under Nepal's new prime minister, Khadga Prasad Sharma Oli, who is seen as leaning more towards China. Interestingly, the latest announcement comes days after Mr Oli's state visit to China in June. His trip to India in April was seen as a diplomatic reset between India and Nepal after the relationship saw a setback in 2015 owing to India's unofficial blockade of the country. We have long said that Nepal's economic engagement with China will increase under the new government led by Mr Oli. However, this does not imply a corresponding deterioration of ties with India in the forecast period. Healthy relations with India will be underpinned by strong trade and cultural ties. Impact of the forecast The latest development is in line with our forecast. We retain our view that even with increasing economic engagement with China, India-Nepal relations will remain robust in Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

91 Nepal 17 Malaysia hints at labour agreement with Nepal August 7, 2018: International relations Event In early August the Nepalese government invited representatives from its Malaysian counterpart to discuss the manpower crisis that the latter has been facing ever since the former enforced a halt on worker departures to Malaysia in May 2018, in a bid to crack down on illegal migration agencies. Analysis Malaysia has since been asking Nepal to ease the ban, given the country's huge dependence on expatriate workers to tackle labour shortages. At nearly 500,000, Nepalis constitute the secondlargest migrant worker population in Malaysia (after Indonesians). Nepal's interest in resuming the recruitment of its workers was expected, since more than 30% of its GDP comes from remittances sent by migrant workers. In regard to this, the Malaysian human resources minister, M Kulasegaran, talked recently about establishing a government-to-government model of recruitment between the two countries, eliminating the need for middlemen or intermediary firms. In addition to direct recruitment by the Malaysian government, the pact is also expected to include provisions on minimum wages, maximum working hours, gratuities and accommodation and health services. Nepal had expressed its dissatisfaction over what it called Malaysia's "restrictive" immigration requirements, including costly security and medical check-ups. The Nepalese government also shut down several domestic firms that recruited workers on behalf of foreign companies. There is still no official proposal in place, and talks seem to be at a preliminary stage. Nevertheless, we expect expedited progress to be made on the signing of a government-togovernment labour pact, as it is in the interest of both countries to resume the flow of workers. Nepal has already signed labour pacts with Bahrain, Jordan, Qatar and South Korea, and is expected to sign more such agreements with other Middle Eastern countries which are also important sources of remittances for Nepal in Impact on the forecast Continued immigration from Nepal to Malaysia will support bilateral ties in As a result of persistent shortages in its labour market, Malaysia will continue to depend on foreign workers to carry out many low-wage and low-skilled jobs in the country. Economy Analysis Government presents overambitious budget for 2018/19 June 20, 2018 The budget for fiscal year 2018/19 (July 16th-July 15th) fails to address implementation issues that have kept spending below target in previous years. Local governments have been given more autonomy over spending, but they lack the institutional support or expertise required to formulate effective development plans. Despite these issues, which will hold back spending, we expect the budget deficit to widen sharply in 2018/19 as the pace of revenue mobilisation assumed in the budget is too optimistic. This is the first federal budget since the coalition government comprising the Communist Party of Nepal (Unified Marxist Leninist) and the Communist Party of Nepal (Maoist Centre) came into office in February (The two parties have subsequently merged to form the Nepal Communist Party.) The latest budget projects an expenditure outlay of NRs1.32trn (US$12.6bn), 25.7% higher than the revised expenditure estimate for 2017/18. Recurrent and capital spending make up 64.3% and 23.9% of the 2018/19 spending total respectively, with financial provisioning accounting for Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

92 Nepal 18 the remainder. The government plans to meet 63% of its financing needs for the budget from fiscal revenue, 13% from domestic borrowing and the rest from foreign grants and loans. It expects total revenue including grants to grow to NRs945bn (US$9bn), 29.8% higher than the revised figure for 2017/18. Substantial transfer to subnational governments Almost half of the total expenditure outlay is in the form of grants to local and provincial governments. The constitution also mandates the government to share 30% of value-added tax (VAT) revenue and internal excise duties, and 50% of royalties from natural resources, with subnational governments. The subnational governments will incorporate these into their budget plans, which are due to be drawn up before the start of 2018/19. Despite their generous allocation, local and provincial governments have criticised the finance minister, Yuba Raj Khatiwada, for not allocating more resources to them and for not delegating local-level project management to them. Executing the budget will be a challenge The major challenge for the government will be to ensure full and timely execution of the budget. Despite prioritising full implementation of the budget in 2017/18, actual spending is expected to be just 82.4% of planned spending. In the case of capital spending, the ratio of actual to planned outlays is estimated at just 71.2%. We believe that the budget does not directly address most of the core issues that have led to chronically low capital spending. These include low project readiness, inter- and intra-agency bureaucratic hurdles regarding project approvals and spending authorisation, poor project management and weak contractor capacity. Project implementation at subnational level is also subject to high levels of corruption and rampant political interference at both management and operational levels, which complicates budget execution. Meanwhile, the nascent subnational governments do not have the required capacity to prioritise, assess, plan and implement projects on their own. Given these factors, it is likely that actual expenditure in 2018/19 will be well below that targeted in the budget. There was a disappointing lack of transformative projects in the budget or decisive measures to ease rigid regulations governing investment and business. The budget took mobilising revenue to finance expenditure as its central theme, rather than rolling out concrete plans for economic development and accelerating industrial activity. Income tax rates were increased, and three income tax bands were introduced: at 10% for incomes of NRs350, ,000 (US$3,300-4,300); 20% for incomes of NRs450, ,000; and 30% applying to incomes of between NRs650,000 and NRs2m (US$19,000). In addition, VAT has been applied to small businesses and excise duty has been raised on daily and luxury goods. The budget balance is expected to deteriorate The government's economic growth target of 8% for 2018/19 appears overly ambitious. Against a background of waning private-sector confidence and subdued remittance inflows, we expect real GDP to expand by only 6.8% in 2018/19. Slower growth will result in weaker fiscal inflows. We also believe that the projected foreign-loan inflow of NRs253bn in 2018/19 (up from NRs74.9bn in 2017/18) is too optimistic, as most foreign-loan disbursements are anchored on budget execution, which will fall short of the planned goals. If the government fails to meet its domestic revenue growth target and foreign aid is less than expected, then the fiscal balance will deteriorate. We forecast that the fiscal deficit will widen to the equivalent of 5.1% of GDP in 2018/19, from an estimated 4.1% in 2017/18. Twin deficits on the fiscal and current accounts will mean that shortterm macroeconomic risks remain high for Nepal in Country Report 3rd Quarter Economist Intelligence Unit Limited 2018

93 Subject India Page Ambassador Kenneth Juster Economist Intelligence Unit Country Report... 97

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95 U.S. Embassy & Consulates in India U.S. Ambassador to India Kenneth I. Juster Kenneth I. Juster was unanimously con rmed by the U.S. Senate on November 2, 2017 and appointed by the President on November 3, 2017 to be the 25 th United States Ambassador to the Republic of India. He presented his credentials to the President of India on November 23, Mr. Juster has almost 40 years of experience as a senior business executive, senior law partner, and senior government o cial. Mr. Juster previously served from January to June 2017 as the Deputy Assistant to the President for International Economic Affairs and Deputy Director of the National Economic Council. He was a senior member of both the National Security Council staff and the National Economic Council staff. In this role, Mr. Juster coordinated the Administration s international economic policy and integrated it with national security and foreign policy. He also served as the lead U.S. negotiator ( Sherpa ) in the run-up to the G7 Summit in Taormina, Italy. Prior to that, Mr. Juster was a Partner and Managing Director, from , at the global investment rm Warburg Pincus, where he focused on a broad range of issues, including geopolitical risk, global public policy, and regulatory matters relating to the Firm s investment activities and portfolio companies. From , Mr. Juster was Executive Vice President of Law, Policy, and Corporate Strategy at salesforce.com, a software company that pioneered cloud computing for business enterprises Mr. Juster served as U.S. Under Secretary of Commerce from , in charge of the Bureau of Industry and Security. In that capacity, he oversaw issues at the intersection of business and national security, including strategic trade controls, imports and foreign investments that affect U.S. security, enforcement of anti-boycott laws, and industry compliance with international arms control agreements. Mr. Juster co-founded and served as the U.S. Chair of the U.S.-India High Technology Cooperation Group, and was one of the key architects of the Next Steps in Strategic Partnership initiative between the United States and India. That initiative helped provide the foundation for the historic civil nuclear agreement between the two countries. Upon completion of his term at the Commerce Department, Mr. Juster received the William C. Red eld Award, the Department s highest honor. From , Mr. Juster served as the Counselor (Acting) of the U.S. Department of State, and from as the Deputy and Senior Adviser to Deputy Secretary of State Lawrence S. Eagleburger. Mr. Juster was one of the key o cials involved in establishing and managing U.S. assistance programs to Central and Eastern Europe and the former Soviet Union, including setting up the initial Enterprise Funds for the region. He also was part of the ve-man team, led by Deputy Secretary Eagleburger, that traveled to Israel prior to and during the rst Gulf War to coordinate with the Israelis regarding their posture during the war. Upon completion of his term at the State Department, Mr. Juster received the Distinguished Service Award, the Department s highest honor. From and , Mr. Juster practiced law at the rm Arnold & Porter, where he became a senior partner and his work involved international arbitration and litigation, corporate counseling, regulatory matters, and international trade and transactions. Among his noteworthy cases was the representation of the Government of Panama-in-exile against the Noriega regime. The President of Panama subsequently awarded him the Vasco Núñez de Balboa en el Grado de Gran Cruz Decoration and Medal. Mr. Juster also has served as a Visiting Fellow at Harvard s Kennedy School of Government in 2010, a Member of the President s Advisory Committee for Trade Policy and Negotiations from , a Visiting Fellow at the Council on Foreign Relations in 1993, a law clerk in to Judge James L. Oakes of the U.S. Court of Appeals for the Second Circuit, and at the National Security Council in In addition, he has served as the Chairman of the Advisory Committee of Harvard s Weatherhead Center for International Affairs, the Chairman of Freedom House, and the Vice Chairman of the Asia Foundation. He is currently a member of the Council on Foreign Relations and the American Academy of Diplomacy. Mr. Juster holds a law degree from the Harvard Law School, a Master s degree in Public Policy from the John F. Kennedy School of Government at Harvard, and a Bachelor of Arts degree in Government (Phi Beta Kappa) from Harvard College. This is the o cial website of the U.S. Embassy and Consulates in India. External links to other Internet sites should not be construed as an endorsement of the views or privacy policies contained therein.

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97 Country Report India Generated on September 6th 2018 Economist Intelligence Unit 20 Cabot Square London E14 4QW United Kingdom

98 The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For 60 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group. London The Economist Intelligence Unit 20 Cabot Square London E14 4QW United Kingdom Tel: +44 (0) Fax: +44 (0) eiucustomerservices@eiu.com New York The Economist Intelligence Unit The Economist Group 750 Third Avenue 5th Floor New York, NY 10017, US Tel: Fax: eiucustomerservices@eiu.com Hong Kong The Economist Intelligence Unit 1301 Cityplaza Four 12 Taikoo Wan Road Taikoo Shing Hong Kong Tel: Fax: eiucustomerservices@eiu.com Geneva The Economist Intelligence Unit Rue de l Athénée Geneva Switzerland Tel: Fax: eiucustomerservices@eiu.com This report can be accessed electronically as soon as it is published by visiting store.eiu.com or by contacting a local sales representative. The whole report may be viewed in PDF format, or can be navigated section-by-section by using the HTML links. In addition, the full archive of previous reports can be accessed in HTML or PDF format, and our search engine can be used to find content of interest quickly. Our automatic alerting service will send a notification via when new reports become available. Copyright 2018 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it. ISSN Symbols for tables "0 or 0.0" means nil or negligible;"n/a" means not available; "-" means not applicable

99 India 1 India Summary 2 Briefing sheet Outlook for Political stability 4 Election watch 5 International relations 5 Policy trends 6 Fiscal policy 6 Monetary policy 7 International assumptions 7 Economic growth 8 Inflation 8 Exchange rates 8 External sector 9 Forecast summary 10 Quarterly forecasts Data and charts 11 Annual data and forecast 12 Quarterly data 13 Monthly data 14 Annual trends charts 15 Quarterly trends charts 16 Monthly trends charts 17 Comparative economic indicators Summary 17 Basic data 19 Political structure Recent analysis Politics 22 Forecast updates 25 Analysis Economy 27 Forecast updates 34 Analysis Country Report September Economist Intelligence Unit Limited 2018

100 India 2 Briefing sheet Editor: Shreyans Bhaskar Forecast Closing Date: August 22, 2018 Political and economic outlook The Economist Intelligence Unit expects the National Democratic Alliance (NDA) government to secure a second five-year term in the parliamentary election due in April-May 2019, although anti-incumbency sentiment will reduce its margin of victory. Given the NDA's victories in state polls since 2014, it is on course to gain a majority in the Rajya Sabha (the upper house) after This, coupled with its anticipated majority in the Lok Sabha (the lower house), will enable it to pass legislation unchallenged. There will be some policy improvements in the business environment over the next five years. The NDA administration will also focus on enhancing macroeconomic stability through fiscal and monetary policy reforms. Real GDP growth will average 7.6% a year in fiscal years 2018/ /23 (April-March), underpinned by robust private consumption growth and a recovery in gross fixed investment as the business environment improves. The Reserve Bank of India (RBI, the central bank) will continue to prioritise inflation-targeting over GDP growth in its policy framework. As a result, consumer price inflation will remain within the RBI's target range of 2-6% over the next five years. The current account will remain in deficit, averaging the equivalent of 2.5% of GDP in , driven by a surge in the value of imports as oil prices remain high. The growth in exports will be insufficient to offset the rising import bill. Key indicators 2017 a 2018 b 2019 b 2020 b 2021 b 2022 b Real GDP growth (%) c Consumer price inflation (av; %) Government balance (% of GDP) c Current-account balance (% of GDP) Money market rate (av; %) Unemployment rate (%) 8.5 d Exchange rate Rs:US$ (av) a Actual. b Economist Intelligence Unit forecasts. c Fiscal years (beginning April 1st of year indicated). d Economist Intelligence Unit estimates. Country Report September Economist Intelligence Unit Limited 2018

101 India 3 Key changes since July 23rd We now expect the RBI to sanction three 25-basis-point increases in its policy rate, the repurchase rate, in 2018, compared with two previously, in order to offset additional imported inflationary pressures brought on by a depreciating rupee. We now expect exports of goods and services to increase by 5% in 2018/19, up from 4.8% previously. This will give a slight boost to GDP growth, and we now forecast that the economy will expand by 7.4% in 2018/19, up from 7.3% previously. Given recent strong data, we now expect producer prices to rise by 3.9% a year on average in , up from 3.7% previously. Based on the recent strong depreciation of the rupee, we have revised our forecast and now expect the currency's exchange rate to average Rs67.4:US$1 in 2018, compared with Rs67.1:US$1 previously. The month ahead August 31st GDP data (Q1 2018/19): These figures will indicate whether the strong acceleration in GDP growth in the fourth quarter of 2017/18 has been sustained. September 6th US India dialogue: The deliberations between senior defence and foreign officials on both sides will signal whether efforts to defuse trade tensions between the two countries are bearing fruit. September 13th Consumer price data (August): The statistics will show whether the moderation in food price pressures in July has been sustained. Major risks to our forecast Scenarios, Q Probability Impact Intensity Conflict breaks out between India and Pakistan High Very high 20 Growing protectionism in the US results in a trade war between India and the US High High 16 Street protests result in a localised breakdown of basic law and order High High 16 Flooding causes major losses for businesses High Moderate 12 The concentration of power severely weakens policymaking High Moderate 12 Note. Scenarios and scores are taken from our Risk Briefing product. Risk scenarios are potential developments that might substantially change the business operating environment over the coming two years. Risk intensity is a product of probability and impact, on a 25-point scale. Source: The Economist Intelligence Unit. Country Report September Economist Intelligence Unit Limited 2018

102 India 4 Outlook for Political stability The Economist Intelligence Unit expects the ruling National Democratic Alliance (NDA) to remain in a strong position politically in The NDA has been in office since 2014 and is dominated by the centre-right Bharatiya Janata Party (BJP). NDA constituent parties control 20 of the country's 29 states, including some of the largest, such as Maharashtra and Uttar Pradesh. The prime minister, Narendra Modi, is proving to be the country's most influential political leader in decades, and we expect him to remain in a strong position to pursue his political and economic agenda after the 2019 election for the Lok Sabha (the lower house of parliament). The NDA's position in parliament will strengthen after 2020, when we expect the alliance to take control of the Rajya Sabha (the upper house). Lawmakers in the Rajya Sabha are elected by members of state assemblies. However, changes in the composition of state assemblies have a delayed impact on parties' strength in the Rajya Sabha, as a third of the upper-house members are elected every two years on a rotating basis. Once the NDA assumes control of the Rajya Sabha, it will be able to pass legislation without the consent of opposition parties. The BJP's tightening grip on power has resulted in a backlash from other political parties, including from within the NDA, as the BJP has narrowed the space for other groups to have a say in policymaking. This will continue to create tensions between junior NDA partners and the BJP, and between the NDA and the opposition in , but will not have a significant impact on political stability. Over the forecast period political stability could be compromised by rising sectarian tensions stoked by far-right affiliates of the BJP. These groups have long been pushing for India to be recast as a Hindu state a view that puts them at odds with minority groups, particularly Muslims. Economic distress in the agricultural sector resulting from weak monsoons could also lead to volatility in rural areas. However, given the electoral influence of farmers, both central and state governments will be quick to mollify any large protests by providing subsidies and sops, including waiving bad loans. Election watch We expect the NDA to win another term in office at the parliamentary election scheduled for early 2019, albeit with a reduced majority. Recent by-elections have brought mixed results for the ruling alliance, indicating some anti-incumbency sentiment, which will adversely affect the NDA's margin of victory in the 2019 national poll. Meanwhile, opposition parties are increasingly collaborating ahead of the election in a bid to check the NDA's electoral dominance, and are attacking the government on issues such as rising agrarian distress, persistent unemployment challenges and mounting social and communal tensions. It is highly likely that several regional opposition parties and the de facto national-level opposition party, the Indian National Congress, will enter into an electoral pact ahead of the lower-house poll. Collaboration is being led by strong regional leaders who enjoy significant popularity in their respective states, such as Mamata Banerjee, the chief minister of West Bengal. It is likely that an opposition alliance will coalesce around a popular regional figure like Ms Banerjee, rather than around the Congress president, Rahul Gandhi, who has struggled to counter the popularity of Mr Modi. Any such alliance would make gains in the upcoming election, particularly as even small vote swings can alter results in India's first-past-the-post electoral system. However, the opposition alliance's overall electoral success would be constrained by ideological contrasts and rivalries between the leaders of its constituent parties. In November 2018 four states will hold elections to their assemblies. Three are currently controlled by the BJP and are crucial to its electoral plan for We expect the BJP to secure another term in office in two of these states Madhya Pradesh and Chhattisgarh. Rajasthan is likely to see a very close fight, possibly ending in a hung assembly. Unexpected electoral setbacks for the BJP in these polls would heighten the risks to the NDA's chances in the 2019 national election. Country Report September Economist Intelligence Unit Limited 2018

103 India 5 International relations India will continue to push for a closer relationship with the US in , partly to counter China's growing influence in South Asia. To this effect, India has boosted security co-operation with the US in recent years. Nevertheless, although India-US ties will remain warm in , trade disputes will linger, as a protectionist trade agenda is being pushed by the US under Donald Trump's presidency. In recent weeks these trade tensions have flared, with tariffs being imposed from both sides. Although the current tensions are unlikely to escalate into a serious deterioration of relations, and we expect negotiations to ease the situation to some extent, some disputes will persist throughout and will slow the expansion of US-India bilateral trade. After a period of tensions with China, in recent months Mr Modi has moved to improve ties with the country. However, China's growing presence in South Asia, particularly its close relationship with Pakistan, will continue to irk India. Moreover, long-standing border disputes between China and India will fester in the next five years. Consequently, bilateral ties will remain fairly brittle in Meanwhile, India will also continue to seek closer ties with other countries with significant economic or military heft, such as Japan and Russia, in an attempt to buttress its international standing in the face of a rising China. Border disputes with Pakistan will linger in A major conflict is unlikely, but minor crossborder military engagements will persist. The NDA government will continue to deepen ties with countries in the Middle East, particularly Israel, which is an increasingly important source of arms for India. Policy trends As the 2019 general election approaches, the NDA government will shift gears from improving the business environment to a more populist agenda, in a bid to garner support from voters. This move will include efforts to improve both the design and the effectiveness of welfare programmes, as well as expanding the reach of these schemes. That said, throughout we also expect the government to focus on improving the quality of infrastructure. However, high levels of corruption, the limited capacity of the state machinery and land-acquisition obstacles will impede progress on this front. We expect the government's focus to return to less popular economic reforms after the 2019 election. These will entail greater fiscal consolidation, as well as relaxing restrictions on foreign direct investment, streamlining tax laws and simplifying regulations on doing business. The government has implemented piecemeal labour reforms, such as allowing all businesses to hire workers on fixed contracts. However, more significant changes to problematic labour laws such as the Industrial Disputes Act are unlikely because of strong opposition from trade unions. Similarly, a substantial relaxation of land-acquisition laws is also unlikely in , owing to strong opposition from farmers. More broadly, the government will continue to prioritise preserving its electoral appeal among voters during the forecast period, and is unlikely to push for reforms that are highly politically contentious. We expect significant economic reforms to take place at state level. However, the extent of these reforms will be uneven, with some states, such as Gujarat, Maharashtra and Tamil Nadu (traditionally considered more business-friendly), continuing to adopt noteworthy reforms while other states lag behind. Country Report September Economist Intelligence Unit Limited 2018

104 India 6 Fiscal policy Tax reform is one of the NDA's key policy agendas, and efforts towards greater formalisation of the economy and a broadening of the tax base will gather pace in fiscal years 2018/ /23 (April-March). However, given the complexities in India's tax system, as well as high levels of corruption, these efforts are likely to yield mixed results. As collections for the goods and services tax (GST) gather pace, the government will continue to simplify the GST's structure and cut rates in order to provide a fillip to business activity and consumer spending. Meanwhile, strong economic growth will support healthy progress in both direct and indirect tax collection. The government will increase spending on infrastructure in the next five years, as well as on subsidies and welfare payments to boost support from voters in As a result, it will record a persistent fiscal deficit, averaging the equivalent of 3.2% of GDP in 2018/ /23. In 2018/19 an expansionary budget will preclude any reduction in the fiscal deficit, which will reach 3.6% of GDP. However, the government will revert to a path of modest fiscal consolidation after the 2019 election, and the budget deficit will narrow gradually to 2.9% of GDP by 2022/23. This improving picture masks the large deficits being recorded by several state governments, which are not included in the national figure. The deep fiscal deficits of some states, such as Punjab, pose downside risks to GDP growth by potentially crowding out private investment. Monetary policy The Reserve Bank of India (RBI, the central bank) will keep inflation-targeting as the cornerstone of its monetary policy framework in the next five years. This means that it will look to contain consumer price inflation within the 2-6% range and close to its optimum target of 4% throughout the forecast period. Price pressures have mounted in 2018 owing to a rapid recovery in global oil prices. In response, the RBI undertook two consecutive rate increases earlier this year, which have brought the policy interest rate, the repurchase (repo) rate, to 6.5%. We expect the central bank to sanction a further 25-basis-point rise in the repo rate in the fourth quarter of The RBI is concerned about domestic inflationary pressures generated by strong internal demand conditions in the economy and a narrowing of the output gap, as well as imported inflation brought on by a depreciating rupee. Following three increases in the repo rate in 2018, the RBI will move to a neutral stance in 2019, before adopting a more accommodative monetary policy in 2020 to offset the disinflationary impact of a slowdown in the US economy in that year. The easing cycle will be completed by 2021, and the RBI will revert to a tightening stance in as growth in domestic demand accelerates. Rising instances of bank fraud and a lack of transparency in the regulatory oversight of state-run banks will lead to disputes between the Ministry of Finance and the RBI over the regulatory role of the central bank. Nevertheless, the RBI will continue to enjoy a high degree of independence in setting the monetary policy agenda. Country Report September Economist Intelligence Unit Limited 2018

105 India 7 International assumptions Economic growth (%) US GDP OECD GDP World GDP World trade Inflation indicators (% unless otherwise indicated) US CPI OECD CPI Manufactures (measured in US$) Oil (Brent; US$/b) Non-oil commodities (measured in US$) Financial variables US$ 3-month commercial paper rate (av; %) month money market rate (av; %) Exchange rate: :US$ (av) Exchange rate: Rs:US$ (av) Exchange rate: US$: (av) Economic growth We forecast that real GDP growth will average 7.6% a year in 2018/ /23. Economic expansion will be supported by robust increases in private consumption, averaging 7.8% annually in the next five years and making the largest contribution to headline growth. In addition, the economy will receive support from accelerating gross fixed investment, which will grow by an average of 8.8% a year in 2018/ /23. This will be underpinned by progress in recapitalising the banking sector, although a lack of broader reforms in the sector will continue to place constraints on lending activity. Other efforts aimed at improving the business environment, such as tax reforms and increased digitisation of government-to-business services, will also enhance investor sentiment. Public spending ahead of parliamentary and state elections will be a key source of support in the early part of the forecast period, with government consumption growing by 10.4% a year on average in 2018/ /20. However, government spending will moderate over the latter half of the forecast period. In factor-cost terms, real GDP will be driven by growth in the services sector, which will expand by an average of 9.2% a year over the forecast period. The sector will make the largest contribution to headline growth, accounting for nearly 50% of nominal GDP by the end of the forecast period. Meanwhile, industry will benefit from the improving business environment and healthy investment, with output growing by 8.5% a year on average in 2018/ /23. The agricultural sector will remain hostage to the vagaries of the monsoon. Its sluggishness will continue to dampen potential income growth in rural areas. Economic growth (%; fiscal years beginning Apr 1st) 2017 a 2018 b 2019 b 2020 b 2021 b 2022 b GDP Private consumption Government consumption Gross fixed investment Exports of goods & services Imports of goods & services Domestic demand Agriculture Industry Services a Actual. b Economist Intelligence Unit forecasts. Country Report September Economist Intelligence Unit Limited 2018

106 India 8 Inflation Prices of food and oil will remain the chief factors driving consumer price pressures in Food and beverages have a weighting of about 45% in the consumer price index, and so any volatility in agricultural output will adversely affect price stability. The rate of consumer price inflation will accelerate to 4.9% on average in 2019, from 4.7% in 2018, amid still-high energy costs and demand-side pressures driven by strong economic growth and increased government spending in the run-up to next year's election. Meanwhile, the sustained weakening of the rupee will increase imported inflationary pressures. However, the RBI's monetary policy tightening in 2018 will ensure that consumer price inflation remains within the central bank's target range of 2-6%. As the rupee strengthens, cooling imported inflationary pressures, and crude oil prices dip, annual average inflation will moderate to 4.6% in Economic growth will subsequently strengthen in , and upward demand-side pressures on consumer prices will increase again. A weakening rupee in will add to these inflationary pressures. Meanwhile, producer prices will rise by 3.6% a year on average in , up from 1.6% in , on the back of higher global crude oil prices. Exchange rates We have revised down our forecast for the rupee and now expect its value to average Rs67.4:US$1 in Tighter monetary policy conditions in the US and growing risks in emerging markets are weakening investor appetite for assets in economies such as India. Equity inflows have weakened considerably in 2018 in year-on-year terms, and the widening current-account deficit is also acting against the local currency. More broadly, the downward pressure on the rupee is exacerbated by persistent dual deficits on the current and fiscal accounts, which keep investors cautious. Consequently, we expect the RBI to intervene in foreign-exchange markets to support the currency in order to avoid a steep crash in the rupee's value. The broader trend of depreciation will persist in 2019 and the currency will weaken to Rs69.1:US$1 on average in that year. However, we expect the rupee to appreciate against a weakening US dollar in 2020 as the US economy experiences a slowdown in that year. As oil prices pick up again from 2021, the rupee will lose value against the US dollar. We expect this depreciatory trend to persist in 2022, when the rupee's exchange rate will weaken to an annual average of Rs72:US$1. Depreciatory pressures could be exacerbated by capital outflows if investor confidence in India or emerging markets were to weaken. However, we believe that India's relatively healthy macroeconomic outlook, combined with the central bank's high level of foreign-exchange reserves, will limit the risk of significant exchange-rate volatility. External sector India's trade deficit will remain wide in , with rising prices of crude oil (the country's largest import item in value terms) serving to drive merchandise imports. Exports will grow, but the rate of expansion will remain unflattering when compared with imports. Increasing protectionism in the US will exacerbate trade tensions with that country, which is India's largest export market, and inhibit the pace of growth in exports of both goods and services. Moreover, increasing competition from other countries will hurt India's information-technology and business-process outsourcing services exports in the forecast period. Although the services balance will remain positive in , the rate of expansion in services exports will be relatively tempered, particularly in 2020, when growth in the US will weaken. Overall, the wide imbalance on merchandise trade will keep the current account in deficit, equivalent to an average of 2.5% of GDP, in Country Report September Economist Intelligence Unit Limited 2018

107 India 9 Forecast summary Forecast summary (% unless otherwise indicated) 2017 a 2018 b 2019 b 2020 b 2021 b 2022 b Real GDP growth c Industrial production growth Unemployment rate (av) 8.5 d Consumer price inflation (av) Consumer price inflation (end-period) Short-term interbank rate Government balance (% of GDP) c Exports of goods fob (US$ bn) Imports of goods fob (US$ bn) Current-account balance (US$ bn) Current-account balance (% of GDP) Total foreign debt (US$ bn; year-end) d Exchange rate Rs:US$ (av) Exchange rate Rs:US$ (end-period) Exchange rate Rs: 100 (av) Exchange rate Rs: (av) a Actual. b Economist Intelligence Unit forecasts. c Fiscal years (beginning April 1st of year indicated). d Economist Intelligence Unit estimates. Country Report September Economist Intelligence Unit Limited 2018

108 India 10 Quarterly forecasts Quarterly forecasts Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr GDP % change, quarter on quarter % change, year on year Private consumption % change, quarter on quarter % change, year on year Government consumption % change, quarter on quarter % change, year on year Gross fixed investment % change, quarter on quarter % change, year on year Exports of goods & services % change, quarter on quarter % change, year on year Imports of goods & services % change, quarter on quarter % change, year on year Domestic demand % change, quarter on quarter % change, year on year Consumer prices % change, quarter on quarter % change, year on year Producer prices % change, quarter on quarter % change, year on year Exchange rate Rs:US$ Average End-period Interest rates (av; %) Money market rate Long-term bond yield Country Report September Economist Intelligence Unit Limited 2018

109 India 11 Data and charts Annual data and forecast 2013 a 2014 a 2015 a 2016 a 2017 a 2018 b 2019 b GDP c Nominal GDP (US$ bn) 1,856 2,040 2,102 2,273 2,600 2,703 3,015 Nominal GDP (Rs bn) 112, , , , , , ,792 Real GDP growth (%) Expenditure on GDP (% real change) c Private consumption Government consumption Gross fixed investment Exports of goods & services Imports of goods & services Origin of GDP (% real change) c Agriculture Industry Services Population and income Population (m) 1,279 1,294 1,309 1,324 1,339 1,354 1,369 GDP per head (US$ at PPP) 5,249 5,675 6,130 6,571 7,059 d 7,631 8,288 Fiscal indicators (% of GDP) c Central government revenue Central government expenditure Central government balance Net public debt d Prices and financial indicators Exchange rate Rs:US$ (av) Consumer prices (av; % change) Producer prices (av; % change) Stock of money M1 (% change) Stock of money M2 (% change) Lending interest rate (av; %) Current account (US$ m) Trade balance -162, , , , , , ,146 Goods: exports fob 319, , , , , , ,897 Goods: imports fob -482, , , , , , ,042 Services balance 70,441 76,077 73,635 65,896 75,924 78,877 84,747 Primary income balance -21,801-24,945-23,360-27,362-26,424-29,333-28,803 Secondary income balance 64,814 65,601 64,154 56,827 60,467 63,140 68,294 Current-account balance -49,123-27,316-22,456-12,114-38,168-75,082-70,908 External debt (US$ m) Debt stock 427, , , , ,756 d 533, ,355 Debt service paid 38,717 92,247 49,745 77,145 58,810 d 71,013 71,435 Principal repayments 28,931 80,774 38,773 65,972 47,460 d 55,410 52,776 Interest 9,785 11,473 10,973 11,173 11,349 d 15,603 18,659 International reserves (US$ m) Total international reserves 296, , , , , , ,091 a Actual. b Economist Intelligence Unit forecasts. c Fiscal years (beginning April 1st of year indicated). d Economist Intelligence Unit estimates. Source: IMF, International Financial Statistics. Country Report September Economist Intelligence Unit Limited 2018

110 India 12 Quarterly data Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Central government finance (Rs m) Revenue 3,942 3,888 4,713 2,090 4,412 4,278 4,730 2,786 Expenditure 5,159 4,420 5,051 6,507 4,985 5,498 4,437 7,076 Balance -1, , , ,290 Output GDP at constant 2004/05 prices (Rs bn) a 30,300 30,586 31,142 31,581 32,181 32,749 33,543 n/a Real GDP (% change, year on year) n/a Industrial production index (2004/05=100) Industrial production (% change, year on year) Prices Consumer prices (2010=100) Consumer prices (% change, year on year) Wholesale prices (2004/05=100) General index Fuel Manufactured goods Financial indicators Exchange rate Rs:US$ (av) Exchange rate Rs:US$ (end-period) Deposit rate (av; %) Lending rate (av; %) month money market rate (av; %) M1 (end-period; Rs bn) b 28,286 19,946 26,820 27,010 28,730 28,863 32,673 31,891 M1 (% change, year on year) M2 (end-period; Rs bn) b 124,900120,058127,919127,585131,843132,087139,626140,032 M2 (% change, year on year) BSE Sensex (end-period; 1978/79=100) 27,866 26,626 29,621 30,922 31,284 34,057 32,969 35,423 BSE Sensex (% change, year on year) Sectoral trends Production index (2004/05=100) Manufacturing Mining Electricity Foreign trade (US$ m) Exports fob 66,058 67,483 76,385 71,537 74,456 76,897 80,605 81,754 Imports cif , ,559106,456114,169108,023120,921121,374127,355 Trade balance -24,391-35,076-30,072-42,632-33,567-44,024-40,768-45,601 Foreign payments (US$ m) b Merchandise trade balance fob-fob -25,612-33,273-29,722-41,936-32,454-44,023-41,623 n/a Services balance 16,294 17,780 18,526 18,309 18,377 20,712 20,164 n/a Primary income balance -8,051-6,377-5,563-5,843-8,550-6,468-7,820 n/a Net transfer payments 13,919 13,906 14,205 14,504 15,684 16,074 16,231 n/a Current-account balance -3,449-7,964-3,433-14,966-6,944-13,704-13,047 n/a Reserves excl gold (end-period) 351,667341,145350,924366,987379,771389,350403,751 n/a a At market prices. b Reserve Bank of India. Sources: IMF, International Financial Statistics; Centre for Monitoring Indian Economy, Monthly Review of the Indian Economy; Financial Times; Reserve Bank of India. Country Report September Economist Intelligence Unit Limited 2018

111 India 13 Monthly data Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Exchange rate Rs:US$ (av) n/a n/a n/a n/a n/a Exchange rate Rs:US$ (end-period) n/a n/a n/a n/a n/a Money supply M1 (% change, year on year) n/a n/a n/a n/a n/a Money supply M3 (% change, year on year) n/a n/a n/a n/a n/a Money market rate (end-period; %) n/a n/a n/a n/a n/a Lending rate (av; %) n/a n/a n/a n/a n/a n/a n/a Industrial production (% change, year on year) n/a n/a n/a n/a n/a n/a BSE Sensex stockmarket index (end-period; 1978/79=100) ,871 23,002 25,342 25,607 26,668 27,000 28,052 28,452 27,866 27,942 26,653 26, ,656 28,743 29,621 29,918 31,146 30,922 32,515 31,730 31,284 33,213 33,149 34, ,965 34,184 32,969 35,160 35,322 35,423 37,607 n/a n/a n/a n/a n/a Consumer prices (% change, year on year; av; seasonally adjusted) n/a n/a n/a n/a n/a Wholesale prices (% change, year on year; av; seasonally adjusted) n/a n/a n/a n/a n/a Total exports fob (US$ m) ,199 20,846 22,912 20,863 22,407 22,656 21,692 21,597 22,769 23,361 20,066 24, ,356 24,727 29,302 24,578 23,946 23,013 22,540 23,353 28,563 22,831 26,234 27, ,408 26,031 29,167 25,643 28,966 27,145 25,770 n/a n/a n/a n/a n/a Total imports cif (US$ m) ,867 27,419 27,310 25,689 28,286 30,917 29,305 29,303 31,840 34,495 33,462 34, ,261 34,248 39,947 38,835 38,279 37,055 33,990 36,071 37,963 37,500 41,390 42, ,701 37,871 42,801 39,604 43,456 44,294 43,790 n/a n/a n/a n/a n/a Trade balance fob-cif (US$ m) ,668-6,573-4,399-4,826-5,879-8,261-7,613-7,706-9,071-11,134-13,396-10, ,905-9,522-10,645-14,257-14,333-14,043-11,450-12,717-9,400-14,669-15,156-14, ,293-11,841-13,634-13,962-14,491-17,149-18,020 n/a n/a n/a n/a n/a Foreign-exchange reserves excl gold (US$ m) , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,850 n/a n/a n/a n/a n/a n/a n/a Sources: IMF, International Financial Statistics; Haver Analytics. Country Report September Economist Intelligence Unit Limited 2018

112 India 14 Annual trends charts Country Report September Economist Intelligence Unit Limited 2018

113 India 15 Quarterly trends charts Country Report September Economist Intelligence Unit Limited 2018

114 India 16 Monthly trends charts Country Report September Economist Intelligence Unit Limited 2018

115 India 17 Comparative economic indicators Basic data Land area 3,287,263 sq km (including Indian-administered Kashmir); of the total, 57% is agricultural land and 16% is forest area Population 1.34bn (2017; UN) Country Report September Economist Intelligence Unit Limited 2018

116 India 18 Main towns Population of metropolitan areas and regions in millions (2011 census) New Delhi (capital): 21.8 Mumbai (Bombay): 20.8 Kolkata (Calcutta): 14.6 Chennai (Madras): 8.9 Bangalore: 8.7 Hyderabad: 7.7 Climate Varied: humid subtropical in Ganges basin, semi-arid in the north-west, tropical humid in northeast and most of the peninsula, tundra in the Himalayas. All areas receive rain from the south-west monsoon in June-September; the south is also served by the north-east monsoon in January- March Weather in New Delhi (altitude 218 metres) Hottest month, May, C (average daily minimum and maximum); coldest month, January, 7 21 C; driest month, November, 4 mm average rainfall; wettest month, July, 180 mm average rainfall Languages Hindi is the official language and the primary tongue of 30% of the population. English is an additional language used for official purposes and also used widely in business circles. Individual states may legislate an official language, and several have done so Religions Hindu (79.8% in 2011 census); Muslim (14.2%); Christian (2.3%); Sikh (1.7%); Buddhist (0.7%); Jain (0.4%) Measures Metric system. Numbers are often written in lakhs (100,000) and crores (10m) Currency Rupee (Rs); Rs1 = 100 paisa. Average exchange rate in 2017: Rs65.1:US$1 Fiscal year April 1st-March 31st Time 5 hours 30 minutes ahead of GMT Public holidays Republic Day (January 26th); Independence Day (August 15th); Mahatma Gandhi s birthday (October 2nd); also major Hindu, Muslim, Christian and other religious holidays Country Report September Economist Intelligence Unit Limited 2018

117 India 19 Political structure Official name Republic of India Form of state Country Report September Economist Intelligence Unit Limited 2018

118 India 20 Federal republic, with 29 states and seven union territories Head of state The president, Ram Nath Kovind, was elected in July 2017 for a five-year term by the members of the central and state legislatures The executive The prime minister presides over a Council of Ministers chosen from the elected members of parliament (MPs) National legislature Bicameral. The Lok Sabha (the lower house) has 545 members 543 elected from single member constituencies (79 seats are reserved for "scheduled castes" and 40 for "scheduled tribes") and two representatives of Anglo-Indians appointed by the president. The Rajya Sabha (the upper house) has 245 members 233 elected by weighted votes of the elected MPs and the legislative assemblies of states and union territories, and 12 appointed by the president State legislatures Unicameral or bicameral, with elected members; state governors are appointed by the president Legal system Based on the 1950 constitution and English common law National government The National Democratic Alliance, a coalition led by the Bharatiya Janata Party (BJP), won the largest number of seats at the parliamentary election held in April-May 2014 and formed a government National election The most recent election for the Lok Sabha was held in April-May 2014; the next is scheduled to take place by May 2019 Main political organisations BJP; Indian National Congress; All India Anna Dravida Munnetra Kazhagam (AIADMK); Trinamool Congress (TMC); Biju Janata Dal (BJD); Shiv Sena (SHS); Telugu Desam Party (TDP); Telangana Rashtra Samithi (TRS); Communist Party of India (Marxist), or CPI (M); YSR Congress Party (YSRCP); Nationalist Congress Party (NCP); Lok Janshakti Party (LJP); Samajwadi Party (SP); Aam Aadmi Party (AAP); Rashtriya Janata Dal (RJD); Janata Dal (United); Bahujan Samaj Party (BSP); Dravida Munnetra Kazhagam (DMK) Key ministers Prime minister: Narendra Modi (BJP) Agriculture: Radha Mohan Singh (BJP) Civil aviation: Ashok Gajapathi Raju Pusapati (TDP) Communications & information technology: Ravi Shankar Prasad (BJP) Defence: Nirmala Sitharaman (BJP) External affairs: Sushma Swaraj (BJP) Finance: Arun Jaitley (BJP) Health & family welfare: Jagat Prakash Nadda (BJP) Home affairs: Rajnath Singh (BJP) Power: Rajkumar Singh (BJP) Country Report September Economist Intelligence Unit Limited 2018

119 India 21 Railways & coal: Piyush Goyal (BJP) Rural development: Narendra Singh Tomar (BJP) Urban development: Hardeep Singh Puri (BJP) Central bank governor Urjit Patel Country Report September Economist Intelligence Unit Limited 2018

120 India 22 Recent analysis Generated on September 6th 2018 The following articles were published on our website in the period between our previous forecast and this one, and serve here as a review of the developments that shaped our outlook. Politics Forecast updates Assam releases draft National Register of Citizens August 3, 2018: Political stability Event On July 30th India's north-eastern Assam state published the updated draft of the National Register of Citizens (NRC), which excluded about 4m residents of the state. Analysis The NRC is the list of people residing in Assam whom the Indian government recognises as its citizens. The document, created in 1951, is a highly contentious political issue in Assam, which shares a border with Bangladesh and has seen an influx of immigrants from the country. Many locals have expressed concerns about this influx, including fears of demographic change on religious and ethnic lines. Among the most controversial provisions of the NRC is the requirement that individuals prove that they lived in Assam prior to March 24th 1971 two days before Bangladesh declared independence. Over 4m residents of the state who applied to be on the NRC were left out of the final draft, and have a one-month-long window of appeal before the draft is finalised. This move by the Assam government led by the Bharatiya Janata Party (BJP), which also dominates the National Democratic Alliance (the ruling coalition at central level) is likely to have political ramifications in the run-up to the 2019 general election. The BJP has been vocal about curbing illegal immigration. The vast majority of migrants from Bangladesh belong to the Muslim community, and this has led critics to claim that the NRC survey is intended at targeting that community. The BJP's right-wing affiliates have long stoked communal tensions, in particular directed at the large minority Muslim community a strategy that has also yielded electoral dividends by polarising voters on religious grounds. On August 1st India's ambassador to Bangladesh, Harsh Vardhan Shringla, assured journalists that this is an "internal issue" that would not affect relations with Bangladesh. However, we anticipate that the issue will lead to some frictions in bilateral relations. Although the process is still under way and the exclusion of 4m alleged immigrants from the NRC is not final, there is a risk that relations between India and Bangladesh could become strained, particularly if the former presses for the return of these people to the latter country. Impact on the forecast Communal tensions will become pronounced ahead of India's 2019 general election, and the updated draft of the NRC will lead to temporary political instability in Assam. We will raise the risk of tensions between India and Bangladesh over the issue in our next monthly assessment. Country Report September Economist Intelligence Unit Limited 2018

121 India 23 Rajya Sabha election points to opposition fissures August 10, 2018: Election watch Event On August 9th the Rajya Sabha (the upper house of parliament) held an election for the position of deputy chairman. The candidate of the ruling National Democratic Alliance (NDA), Harivansh Narayan Singh, secured victory in the poll. Analysis The deputy chairman of the Rajya Sabha plays a crucial role in determining the legislative agenda in the house, and officiates during the absence of India's vice-president (the ex-officio chairman of the Rajya Sabha). However, the importance of this election was magnified for another reason. It was seen as a litmus test of the unity of opposition parties ahead of the upcoming general election scheduled for April-May 2019, as the NDA lacks a majority in the Rajya Sabha. The Bharatiya Janata Party (BJP, the dominant constituent party of the NDA) has come under criticism from opposition groups over a range of issues, including rising social tensions, and there have been calls to unify opposition groups to take on the ruling alliance. However, a non-nda regional party, the Biju Janata Dal, voted in favour of the NDA candidate, while several other regional parties abstained, enabling an NDA victory. Moreover, this follows a no-confidence motion in which several regional groups backed the NDA. This indicates that, despite efforts by leaders of the main opposition Indian National Congress party, a pan-india coalition against the NDA remains unlikely. Rather, alliances opposing the NDA are likely to form only in some states, driven by local electoral considerations. Meanwhile, the election of Mr Singh a member of the Janata Dal (United), a BJP ally indicates that the BJP (which secured a majority in the 2014 parliamentary election) recognises that repeating its electoral performance in 2019 will not be easy, given rising anti-incumbency sentiment in its northern and western bastions. Therefore, the party will be keen to accommodate allies in order to shore up its support ahead of the ballot. Indeed, the possibility of some non- NDA regional parties joining the alliance ahead of the 2019 election cannot be ruled out. Impact on the forecast Our forecast, that the NDA will secure re-election in 2019, albeit with a reduced majority, remains appropriate. Country Report September Economist Intelligence Unit Limited 2018

122 India 24 China s defence minister visits India August 28, 2018: International relations Event On August 24th China's defence minister, Lieutenant-General Wei Fenghe, concluded a four-day visit to India. This was the first bilateral meeting of senior defence officials from the two countries after the border stand-off in Analysis General Wei's trip, which included meetings with the prime minister, Narendra Modi, and the Indian defence minister, Nirmala Sitharaman, was part of efforts to improve diplomatic engagement between the two countries. Relations between the two were strained in August 2017 over a border stand-off in Doklam, a disputed area between China and Bhutan. The two defence ministers decided to expand the engagement between their armed forces relating to training, joint exercises and other professional interactions, and also to draft a new bilateral memorandum of understanding (MoU) on defence exchange and co-operation, to replace the existing MoU signed in They also agreed to expedite the process of starting a hotline between the armed forces of the two countries, proposed earlier this year, although unresolved details remain India wants a single hotline between the two military headquarters, while China wants multiple hotlines between operational commands. These efforts at reconciliation are encouraging. Stronger channels of dialogue and more regular communication should help to reduce the risk of conflict, including for low-level spats similar to the Doklam dispute. Certain issues of mutual interest, such as rising global protectionism, could also provide an opportunity for both countries to co-operate to some extent. However, this type of modest engagement will not be enough to defuse the larger geopolitical frictions underlining their bilateral relationship. India will continue to resent China's growing military and economic clout in South Asia, particularly via its Belt and Road Initiative and increasing Chinese economic ties with Pakistan. China, in turn, will be wary of India's moves to pursue closer ties with Japan and the US under the Indo-Pacific strategy, which it views as a containment strategy for China's rise. Although the recent overtures mean that another military stand-off or outright conflict is unlikely, we expect relations between China and India to remain strained over the forecast period. Impact on the forecast Ties between India and China will remain strained over the next five years. No change to our forecast is required. Country Report September Economist Intelligence Unit Limited 2018

123 India 25 India and Pakistan hold talks on water sharing August 30, 2018: International relations Event On August 28th Indian and Pakistani officials met in Lahore, a city in Pakistan, to discuss implementation of the Indus Waters Treaty. Analysis The Indus Waters Treaty is a water distribution treaty between India and Pakistan that was ratified in Its provisions grant Pakistan control of the Indus River's three western tributaries Indus, Jhelum and Chenab although the portions of these rivers which flow into Indian territory are under Indian control. Similarly, the treaty gives India control over the River's three eastern tributaries Ravi, Beas and Sutlej while also giving Pakistan control of the portions of the tributaries that flow into Pakistani territory. The demarcation of control, however, has raised questions on issues related to water use and the potential of downstream disruptions. India, for example, plans to construct a hydropower plant along its (upper riparian) portion of the Pakistani-controlled Chenab River, although progress has thus far been delayed, owing to technical details and other differences. To date, however, these issues have not significantly threatened either country's adherence to the treaty, and the latest talks are part of a regular meeting mandated under its framework. This co-operation on water issues is one of the few bright spots in India-Pakistan ties, which remain strained over a variety of issues, the most prominent being the disputed territory of Kashmir. Moreover, despite initial positive overtures, we expect Pakistan's new administration to maintain the current state of ties with India. The new government's tolerance of hardline Islamist leaders, who are associated with militant groups, will also be an obstacle to improving bilateral ties. Meanwhile, India's government retains a relatively nationalistic and inflexible approach to border disputes, which also weighs on any significant improvement in relations. Moreover, minor clashes between the security forces of both countries persist; several instances have been reported by both sides this year. These factors will impede any normalisation of ties in Impact on the forecast Relations between India and Pakistan will remain strained in A major conflict is unlikely, but minor crossborder military engagements will continue. No change to our forecast is required. Analysis Setting the stage for the 2019 election August 14, 2018 Political campaigning will pick up pace in the coming months as the National Democratic Alliance (NDA) government, led by the Bharatiya Janata Party (BJP), steps up its efforts to secure a second term. The campaign season is likely to see increased emphasis on emotive social issues, as well as greater populism. Given weakness in the opposition ranks, the NDA is likely to secure another term in office, albeit with a reduced majority, after which economic reforms will regain priority. On August 15th the prime minister, Narendra Modi of the BJP, will give the last Independence Day address of his current term. His statement is likely to provide indications of his party's electoral strategy for the 2019 general election. The ballot is scheduled to be held in April- May 2019, but campaigning will start several months in advance of this. Politics is heating up In recent months opposition parties have stepped up the pressure on the ruling NDA, of which the BJP is the main component party, particularly over unemployment, rising social tensions and ineffective implementation of government policies. This culminated in a no-confidence motion Country Report September Economist Intelligence Unit Limited 2018

124 India 26 against the government in the Lok Sabha (the lower house of parliament) in July, which was ultimately defeated. Against this background, the monsoon session of parliament, which concluded on August 10th, was relatively uneventful from the perspective of economic legislation. The winter session of parliament, which will be held in November-December, and will be the last full session under the current administration, is unlikely to see significant headway on such legislation either. This will be because the government's attention will be focused firmly on electioneering in the coming months. The BJP will be careful to ensure that opposition parties do not consolidate against it in the coming months. The party secured a majority of its own in the 2014 parliamentary election, but it is unlikely that it will repeat this performance in the coming poll. The BJP peaked in many of its stronghold states in the 2014 election, winning all seats in the states of Rajasthan, Delhi, Uttarakhand, Himachal Pradesh and Gujarat. In the state of Uttar Pradesh (which accounts for the largest proportion of seats in the lower house), the BJP and its regional ally, Apna Dal, secured 73 out of 80 seats. Although the party remains popular, the margin of its lead in these states has declined owing to rising anti-incumbency sentiment, and it is unlikely to win as many seats as it did in The BJP is therefore looking to bolster its support in regions where it has historically been weaker, such as the south and the north-east. However, these efforts are yielding mixed results. Although it has made gains in the north-east, the party has faced electoral setbacks in the southern states as well as in West Bengal. However, this does not mean that the NDA is facing electoral defeat. The alliance still enjoys a lead over the opposition for several reasons. First, the BJP is in a considerably stronger position than the dominant national opposition party, the Indian National Congress, which lacks an appealing electoral agenda and is still hamstrung by perceptions of corruption related to its previous term in office. The Congress leadership has failed to mount an effective challenge to Mr Modi's leadership, and the prime minister still commands considerable support among voters. Second, despite increasing efforts to forge a pan-india alliance between Congress, non-nda regional parties and possibly the communist parties (which govern the state of Kerala in a coalition), the chance of such a "rainbow coalition" remains low. There are wide ideological differences between these parties, which are likely to derail coalition talks. Moreover, many regional parties enjoy significant support in their respective states, and given their strength would attempt to dominate the terms of any anti-nda alliance. However, Congress would oppose this, seeking to retain its identity as a national party. Third, by voting alongside the government in a vote in the Rajya Sabha (the upper house) in August, some regional parties have indicated that they are not averse to joining the NDA. The BJP will seek alliances with these regional parties in an effort to offset the seat losses it is likely to endure in the upcoming polls. Populism and religion The BJP's electoral campaign is likely to have a three-pronged approach. It will focus on Mr Modi's appeal among voters, particularly at a time when opposition groups have been struggling to find a leader that can challenge him at national level. The BJP-led administration is also adopting a more populist stance ahead of the election, announcing tax cuts as well increased subsidies to farmers. This strategy is likely to benefit the BJP by appealing to urban tax payers, as well as those in rural areas. In addition, the party is likely to adopt a more Hindu-nationalist agenda ahead of the election. The BJP has recently upped the ante on illegal immigration from Bangladesh, largely of Muslims. It has used this contentious topic to increase its appeal to the region's Hindu majority. Further appeals to majoritarian sentiment on controversial issues are likely ahead of the election. Moreover, farright allies of the BJP are likely to pressurise the government to take a more hardline stance on a host of communal issues. Campaigning by some far-right Hindu groups has resulted in isolated instances of mob violence against minorities, a widespread ban on beef consumption in many states and a near-exclusion of minority groups from positions of influence. (Not one of the 273 elected BJP members in the Lok Sabha belongs to India's largest minority, the Muslim community). Country Report September Economist Intelligence Unit Limited 2018

125 India 27 Hindu groups are also likely to put pressure on the government over the Ayodhya land dispute issue. Despite such pressure, basic law and order will be maintained during the run-up to the election. What happens after? We expect the NDA to secure another majority in the lower house in the election next year, although the margin of its victory is likely to be diminished compared with the last vote. The BJP is unlikely to secure a majority of its own. However, the party will emerge as the largest in the Lok Sabha and Mr Modi will continue to be prime minister. This outcome will be positive from the perspective of policy stability. Moreover, after the election the NDA administration will turn its attention back to reform legislation. Given the challenges faced by the banking sector, financial reforms will be a priority for the new government. Moreover, fiscal consolidation measures will be reprioritised. Corporate tax rates are likely to be gradually reduced under the next government, but efforts will be made to widen the tax net and we expect this to ensure a continued narrowing of the fiscal deficit over the next few years. Moreover, the government will make efforts to improve the business environment further, to support private investors. These trends will gather momentum after 2020, when we expect the NDA to secure a majority in the Rajya Sabha, allowing the government to pass legislation without opposition support. Despite its smaller majority, its majority in the upper house will mean that the next NDA government is in a stronger political position than the current one. Economy Forecast updates RBI tightens monetary policy again August 2, 2018: Monetary policy outlook Event On August 1st the Reserve Bank of India (RBI, the central bank) increased its benchmark policy interest rate, the repurchase (repo) rate, by 25 basis points to 6.5%. The reverse repo rate and the bank rate were also increased by 25 basis points each, to 6.25% and 6.75% respectively. Analysis The RBI's decision was driven by a broad-based uptick in inflationary pressures, as evidenced by a sustained strengthening in core inflation (which strips out food and fuel prices). This is largely an indicator of increasing capacity utilisation, as output gaps are narrowing and the economy is growing at a brisk pace. Manufacturing units have reported higher input costs, which are likely to be passed on to consumers. Moreover, the central bank remains concerned about the impact of increased government-guaranteed support prices for crops, which are likely to fuel demand-side price pressures in the coming months by boosting farm incomes. In recent months imported inflation has been exacerbated by a depreciating rupee. However, the currency seems to have stabilised in recent weeks, which reduces the risk of an imported inflationary shock from a drastic slide in the rupee's value. Moreover, a recent cut in the goods and services tax (GST) rate for 88 items will have a dampening effect on prices and a good monsoon will act to constrain the pace of increase in food prices. Consequently, the RBI is likely to maintain the repo rate at 6.5% at its next monetary policy meeting. The monetary policy committee's decision to increase the repo rate was not unanimous, and in the coming months the consensus is likely to sway towards holding off from a further rate increase. Impact on the forecast The increase in the benchmark interest rate was in line with our expectations. We continue expect the RBI to hold off from any more increases in the repo rate this year. Country Report September Economist Intelligence Unit Limited 2018

126 India 28 Industrial output growth will accelerate in coming months August 6, 2018: Economic growth Event The Nikkei India manufacturing purchasing managers' index (PMI, a barometer of manufacturing sector performance) slipped to 52.3 in July, from 53.1 in June, according to data published on August 1st. A reading below 50 suggests contraction. Analysis The PMI reading in July was the second strongest since January, indicating strong underlying support for expansion of manufacturing activities in the forthcoming quarters. Nevertheless, a sustained strengthening of inflation in recent months softened factory output, as rising input prices are squeezing margins. The latest PMI reading indicates that input price pressures eased slightly in July, despite remaining relatively high. Meanwhile, growth in the index of eight core industries accelerated to 6.7 % year on year in June, from an upwardly revised 4.3% in May. The rebound in June was due mainly to a sharp recovery in production of steel and refinery products, which rose by 4.4% and 12% respectively. In the coming months strong export growth will support stocking activity by exporters, and drive demand for manufactured goods. Moreover, stronger consumer demand, led by a spike in farm incomes (owing to increases in government-mandated support prices for certain crops and a good monsoon) will boost demand for farm-related goods, including agricultural equipment. Furthermore, in the coming months demand for consumer goods will spike owing to the onset of the festive season, supporting faster growth in manufacturing output. Consequently, the modest softening in orders observed since June is likely to be temporary. Impact on the forecast The latest data are in line with our expectations, and we maintain our forecast that industrial production will grow by 5.9% in Country Report September Economist Intelligence Unit Limited 2018

127 India 29 GST Council announces rebate for digital payments August 7, 2018: Fiscal policy outlook Event At a meeting on August 4th, the Good and Services Tax (GST) Council introduced a pilot scheme to incentivise digital payments. Analysis The Council decided to offer a 20% rebate on digital payments of GST, subject to a cap of Rs100 (US$1.5) per transaction, as part of its efforts to simplify tax filing. The plan, to be rolled out by state governments on a trial basis, will provide this incentive on payments made using digital apps. The government expects the rebate scheme to draw more of the informal economy into the GST tax net, ultimately boosting revenue inflows. However, in the short term it may result in a net cost as the cashback scheme will cut the bill for those that opt to use digital payments. The Council also set up a committee to look into GST-related issues faced by smaller enterprises. According to the latest data on government finances, the deficit for the first three months of fiscal year 2018/19 (April-March) stood at 68.7% of the budgeted full-year target. This was better than the 80.8% figure recorded during the same period in 2017/18. This was partly owing to healthy revenue collection, especially on account of the GST. Tax revenue in the first quarter represented 16% of the budgeted full-year total, up from 14.5% in the first quarter of 2017/18. However, spending is likely to ramp up as the 2019 general election approaches. The increase in minimum crop purchase prices for farmers, announced in July, is unlikely to be the last populist measure that the government unveils in the run-up to the ballot. Impact on the forecast Despite the positive fiscal numbers for April-June, we continue to forecast a budget deficit equivalent to 3.6% of GDP in 2018/19, above the government's target of 3.3%. Country Report September Economist Intelligence Unit Limited 2018

128 India 30 Industrial production accelerates to five-month high in June August 13, 2018: Economic growth Event Industrial output expanded by 7% year on year in June, compared with an upwardly revised 3.9% in May, according to data released by the Ministry of Statistics and Programme Implementation on August 10th. Analysis Broad-based growth in all segments of industrial activity prompted a rebound in June, following an easing in growth in May. Manufacturing activities in particular rose by a sharp 6.9%, up from the 3.7% recorded in May. However, growth in June benefited from a low base in the year-earlier period, when the economy was hit by the after-effects of the demonetisation drive in Output of machinery and equipment and heavy transport equipment remained robust, indicating continued strong business sentiment. Similarly, growth in the output of basic metals, the largest item on the index of industrial production, accelerated mildly to 4.3%. In the coming months strong export growth and wage increases in the public sector will support manufacturing activity. Furthermore, demand for consumer goods will spike in the coming months, owing to the onset of the festive season, supporting faster growth in manufacturing output. Moreover, an increase in farming incomes owing to increases in government mandated support prices for certain crops and a good monsoon will boost demand for farm related goods, including agricultural equipment. Moreover, input costs, which have increased sharply in recent months and weighed on industrial output, are expected to soften slightly in the coming months. This will support expansion in industrial output. Impact on the forecast We retain our forecast for industrial production to grow by 5.9% in 2018 as a whole. Country Report September Economist Intelligence Unit Limited 2018

129 India 31 Inflation eases marginally in July August 16, 2018: Inflation Event Consumer price inflation eased to 4.2% year on year in July, compared with 4.9% in June, according to data released by the Central Statistics Office on August 13th. Analysis Although prices rose by 0.9% month on month in July their fastest pace this year the jump was mostly accounted for by seasonal factors, and the July data point to easing inflationary pressures. Satisfactory monsoon conditions across the country continue to support agricultural production, cooling food prices. The food and beverages index, which has a weighting of 45.9% in the consumer price index (CPI), increased by just 1.7% year on year in July. Growth in the wholesale price index, released by the Office of the Economic Adviser on August 14th, also eased, to 5.1% year on year in July from 5.8% in June, although it remains fairly rapid. The drop was owing mainly to the easing of food prices, but producers continue to experience inflationary pressures owing to increased fuel prices. Fuel and power prices were up by 18.1% in July. Higher minimum support prices for monsoon season crops will serve to boost prices again in the coming months. Meanwhile, the high price of oil and the impact of the depreciating rupee in pushing up import prices will provide further underlying price pressures. Nevertheless, the Reserve Bank of India (RBI, the central bank) is likely to hold off on further policy interest-rate increases in 2018, unless downward pressure on the rupee intensifies. Impact on the forecast The rise in consumer prices in July was weaker than we had expected and we will revise down our forecast that such inflation would average 4.8% in We maintain our forecast that producer price inflation (wholesale price inflation) will average 3.8% in We continue to believe that the RBI will avoid raising rates further in 2018, but the risk of another increase has been heightened by the rupee's recent weakness. Country Report September Economist Intelligence Unit Limited 2018

130 India 32 Widening trade deficit adds to pressure on rupee August 16, 2018: External sector Event Merchandise exports grew by 14.3% year on year to US$25.8bn in July, according to data published by the Ministry of Commerce and Industry on August 14th. Imports rose by 28.8% to US$43.8bn during the same period. Analysis A rebound in exports of gems and jewellery, a sector that has experienced challenging business conditions owing to tighter regulation in the wake of a major bank fraud, was the main factor driving the rise in overall exports in July. Gem and jewellery shipments grew by 24.6% year on year in July, up from 2.7% in June. Meanwhile, exports of petroleum products and chemicals rose by 30.1% and 19.9% respectively, sustaining their recent strong performance. Sales of engineering goods, another key export category, rose at a slower pace, while exports of electronics spiked in July, albeit from a low base. By contrast, shipments of readymade garments continued to decline in year-on-year terms. High global prices of crude oil remain a key driver of the growth in imports, with oil payments up by a sharp 57.4% year on year to US$12.3bn in July. Higher prices for commodities such as coal, iron and steel also helped to lift the import bill. More broadly, the import trends confirm a picture of improving domestic industrial demand, suggesting strong economic growth prospects in the coming months. The widening of the trade deficit is likely to add to downward pressure on the rupee, which has fallen sharply as the decline of the Turkish lira has added to existing concerns about several emerging-market currencies. According to IMF data (which form the basis of our forecasts), the rupee stood at Rs69.47:US$1 on August 13th, a decline of 1.2% since the start of the month and 8% since end Impact on the forecast The latest trade data were stronger than expected, and so we will revise up our forecasts for average export and import growth in 2018 from their current levels of 9.5% and 15% respectively. We will also factor in additional depreciation for the currency, which we currently forecast to average Rs67.1:US$1 in 2018, although there is likely to be some appreciation from current levels as markets stabilise later in the year. Country Report September Economist Intelligence Unit Limited 2018

131 India 33 Modi's Independence Day speech focuses on healthcare August 16, 2018: Policy trends Event The prime minister, Narendra Modi, made a commitment to expand state-provided healthcare insurance a policy known in Hindi as Ayushman Bharat or in English as the National Health Protection Scheme (NHPS) a key part of his speech to mark India's independence day on August 15th. Analysis The prime minister's scheme, inevitably dubbed "Modicare", is not in fact new. In the February 2018 budget the government unveiled the NHPS, aiming to extend healthcare insurance cover worth up to Rs500,000 (US$7,450) per family annually to 100m poor families, or 500m people. The money will be available to help to pay for hospital care. According to Mr Modi's speech, the government will begin rolling out the scheme on September 25th. The promise of additional state support for healthcare costs will be popular. The Economist Intelligence Unit estimates that India spent around 1.2% of GDP on public healthcare in 2017, a low level by global standards, and access to quality care for many poor families is limited. The government aims to raise public healthcare spending to 2.5% of GDP by The government will face two key challenges implementing the policy. The first will be its cost. Earlier official estimates suggested that the NHPS would cost about Rs167bn (US$2.5bn) in its first two years, with the central government providing 63% of the funds. This would be tolerable, but some independent estimates have put the cost much higher. The second challenge will be implementing such a complex programme across the country's hospital system. The government is likely to struggle to incentivise hospitals to engage with the NHPS. Impact on the forecast The NHPS is already factored into our budget forecasts, which will thus remain unchanged. We believe that the NHPS will form a key plank of the government's policy platform in the 2019 general election. We continue to expect the National Democratic Alliance government to secure another term in office. Country Report September Economist Intelligence Unit Limited 2018

132 India 34 Floods cause severe damage in Kerala August 21, 2018: Economic growth Event According to a forecast released by the India Meteorological Department on August 19th, weather conditions are expected to improve in the southern state of Kerala in the next few days. Floods and landslides in the state have killed over 370 people since August 8th. Analysis Several parts of Kerala have experienced severe flooding and landslides since August 8th, and have displaced over 700,000 people. In addition, the floods are estimated to have caused damage to property and crops worth US$2.7bn, according to a report by the Financial Times. The agricultural sector, which comprises a large chunk of the state's economy, has been severely affected with rains destroying standing crops of banana, cardamom and rubber. The most immediate impact is expected on the prices of natural rubber, as the state accounts for around 85% of the total natural rubber production in the country. Meanwhile, road and civic infrastructure has been crippled by severe damage to road networks and houses in many districts in Kerala. Public spending on reconstruction will increase in the coming months; the larger share of this spending will be done by the state government; however, the central government will also increase its spending in the state in the wake of this tragedy. Nevertheless, this is likely to have only a minuscule effect on the total expenditure of the central government. Kerala's economy is unique in that it is highly dependent on remittances from the Gulf countries, where many of the state's residents are employed. The floods will not affect this flow; indeed, remittances are likely to emerge as a significant source of reconstruction in the aftermath of the floods. Impact on the forecast The impact of these floods on domestic agricultural commodity prices, particularly rubber, will be clearer once the extent of the damage is known. Nevertheless, a temporary spike in rubber prices is likely. However, these floods are unlikely to affect overall growth prospects significantly in the country. Therefore, our forecasts remain unchanged. Analysis EIU global forecast - US-China trade war will damage growth August 16, 2018 Since the start of 2018 trade policy has become the biggest risk to The Economist Intelligence Unit's central forecast for global economic growth. We now expect this risk to materialise in the form of a bilateral trade war between the US and China, with negative consequences for global growth. Although the trade dispute between the US and the EU has paused for now, the dispute between the world's two largest economies only shows signs of escalation. It seems likely that the administration of Donald Trump, the US president, will move ahead with the vast majority of tariff increases on a further US$200bn-worth of Chinese imports. As the economic effect of these tariffs, and those already imposed in the trade dispute, increases over the remainder of 2018, we expect the Trump administration to come under increasing pressure to refrain from further tariff increases. This political pressure, combined with the Republicans' loss of the House of Representatives in the November mid-term elections, which is our expectation, will cause the Trump administration to rethink its trade strategy. At the heart of the dispute between China and the US is a disagreement over intellectual property and China's technology transfer practices, although the US trade team is divided on this issue, with Mr Trump also focusing on the US's trade deficit with China. Given this, discussions thus far between the two countries have failed to solve the dispute, and a resolution looks unlikely in the short term. By 2019 this will dampen growth in both economies and act as a drag on growth in the wider global economy. We had already anticipated a slowdown Country Report September Economist Intelligence Unit Limited 2018

133 India 35 in the global economy in 2019, as political uncertainty and market turbulence is putting a brake on growth in Latin America. As a result of the trade war, we now expect the slowdown in growth to be more pronounced, at 2.8% (2.9% previously). Growth in the US and China will slow more than expected in 2019 The trade war comes at a challenging time for the Chinese economy. Concerns over the strength of domestic demand have returned, as momentum in both private consumption and investment has weakened. Central to this slowdown is the deleveraging campaign that began in The effects of tighter monetary policy, corporate deleveraging efforts and a crackdown on shadow financing have become more apparent in the economy this year, having raised the cost and availability of capital for both firms and consumers. The trade war will lessen the focus on deleveraging, with authorities needing to take measures to support growth in the short term. We are likely to see a moderate easing in fiscal policy, such as cuts to taxes and fees, together with an easing of reserve requirements from the People's Bank of China (China's central bank). There is recognition from policymakers, however, that capacity to support the economy will be limited by China's debt profile. On these assumptions, we have revised China's growth in 2019 down to 6.2%, from 6.4% previously. Although we expect growth to be maintained to reach the government's target of doubling real GDP this decade, the trade war has again raised the spectre of China's financial vulnerabilities, which will cloud the economy's outlook for the foreseeable future. The trade war will also affect the US economy, which has so far had a stellar year in We have revised up our forecast for real GDP growth in 2018, to 2.8% (from 2.7% previously), to reflect faster than anticipated growth in the second quarter, of 4.1% in annualised terms, driven by rising domestic demand and a temporary surge in exports. The economy continues to receive support from the Trump administration's fiscal policies, as well as the ongoing strength in the labour market. However, the escalating trade dispute with China will start to weigh on growth later in 2018 and into 2019 we now expect growth to slow in 2019 to 2.2% (2.5% previously). The US manufacturing and agricultural sectors, in particular, will be hit by the trade dispute, and rising interest rates will cause private consumption to slow. Growth will continue to slow in 2020, reaching a nadir of 1.3%, as the lingering effects of the trade dispute, higher interest rates and softening corporate balance sheets result in a business-cycle slowdown. A mild recovery will take place in as these effects unwind, with growth averaging 1.8%. US protectionism threatens the multilateral system The Trump administration's protectionist trade strategy has also raised tensions with the US's traditional allies, threatening to upend the multilateral system. Initially, when the US announced import tariffs on steel and aluminium in March, Canada, Mexico and the EU were given exemptions. The exemptions were removed by the Trump administration on June 1st, sparking a round of retaliatory tariffs from these traditional US allies. Reaffirming his transactional approach to US allies, Mr Trump deepened divisions in the G7 on June 8th-9th when he failed to agree to the joint communiqué in support of a rules based trading system. Mr Trump's European trip in mid-july further demonstrated his lack of concern for the US alliance system. Despite signing a communiqué in support of the NATO alliance, Mr Trump sharply criticised Germany's imports of Russian gas and publicly berated member countries for their contributions to the NATO budget. Given this approach to traditional US alliance structures, we do not expect the Trump administration's transactional approach to trade to differ greatly towards long-standing US allies. Following the withdrawals from the Paris climate accord, the Iran nuclear deal and the Trans- Pacific Partnership, the outcome of the G7 meeting and related trade tensions with key US allies again demonstrate that Mr Trump's "America First" policies do not align with a multilateral system of global governance. The rest of the world is adjusting to US protectionism by developing regional trade agreements and diversifying their trade partners. The Comprehensive and Progressive Agreement for Trans- Pacific Partnership (CPTPP) will come into effect in early 2019, after Japan became the second country to ratify the agreement, and additional countries have expressed their interest in joining. We expect more countries to join the CPTPP in the coming years. Japan became a central player in the push to finalise the deal after the US withdrew from the agreement. Further demonstrating the country's commitment to trade liberalisation, Japan signed the world's largest free-trade agreement Country Report September Economist Intelligence Unit Limited 2018

134 India 36 with the EU this year. The main elements of the deal include the near-elimination of tariffs on Japanese goods entering the EU, but those applied to EU goods by Japan will be reduced in a phased manner. The next stage is for Japan and the EU to ratify the accord. Countries in Latin America, Africa and Asia are also looking to develop regional trade integration. We expect more countries to develop trade ties with new partners, risking the isolation of the US economy and the market share of US exporters. Global monetary conditions will tighten, but at a slower pace Heightened international risks will cause some central banks to delay or slow their plans to normalise monetary policy. However, the Federal Reserve (Fed, the US central bank) remains committed to raising interest rates. With US unemployment reaching new lows, but inflation remaining contained, we expect the Fed to continue to raise rates at a steady pace. Reflecting the revised outlook for US growth stronger this year and weaker next year we expect a total of four rate rises this year, followed by another three in 2019 as the Fed balances the risks of rising inflation against slowing growth. We expect the Fed to embark on an easing cycle in Most emerging-market economies should be able to weather this pace of economic tightening, provided that their trading conditions remain favourable. However, investors are on the alert for financial, economic or political weaknesses. The turbulence experienced by Argentina and Turkey in mid is a reminder of how difficult it can be for policymakers to regain market confidence where external imbalances are large and macroeconomic policy frameworks fragile. For now, a full-blown emerging-market crisis should be averted, but we expect the number of countries seeing their currencies come under pressure to rise over the next two years. It is likely that we will see periods of volatility as the global trade dispute interacts with the shift away from easy money. Geopolitical risks foreshadow greater volatility We also note the economic risks posed by the complex and deepening tensions in the Middle East. Various proxy conflicts between Iran and Saudi Arabia have the potential to further destabilise the region. Mr Trump's decision to withdraw the US from the Iran nuclear deal is another signal that the US is inclined to offer stronger support to its traditional allies in the region, Israel and Saudi Arabia, in the coming years. We expect regional security in the Middle East to deteriorate following the US withdrawal. The move gives hardliners in Iran the upper hand over their moderate counterparts, which is likely to lead to a more confrontational foreign policy. Most worryingly, a proxy conflict between Israel and Iran in southern Syria has a significant chance of escalating. Heightened geopolitical risk in the Middle East increases the likelihood of volatility in global energy markets. The rebalancing of the oil market pursued by OPEC over the past 18 months means that geopolitical developments now have a more pronounced effect on prices. News of the US's withdrawal from the Iran deal sent prices above US$75/barrel for the first time since Ismail Kowsari, a senior officer in Iran's Islamic Revolutionary Guards Corps (IRGC), stated on June 4th that Iran would prevent other nations' oil from being exported through the Strait of Hormuz, should its own oil exports be blocked by US sanctions. Although we do not expect Iran to close the Strait of Hormuz, the likelihood of this scenario unfolding will rise as Iran's oil exports decline in , and this risk will continue to be incorporated in crude oil prices. World economy: Forecast summary Real GDP growth (%) World (PPP a exchange rates) World (market exchange rates) US Euro area Europe China Asia and Australasia Latin America Country Report September Economist Intelligence Unit Limited 2018

135 India 37 Middle East & Africa Sub-Saharan Africa World inflation (%; av) World trade growth (%) Commodities Oil (US$/barrel; Brent) Industrial raw materials (US$; % change) Food, feedstuffs & beverages (US$; % change) Exchange rates (av) :US$ US$: a Purchasing power parity. Source: The Economist Intelligence Unit. Turkey-style crisis not on horizon for Asia August 23, 2018 As interest rates in developed markets rise from ultra-low levels, investors are becoming less forgiving of countries with financial, macroeconomic or political vulnerabilities. A combination of weak policy credibility, large external financing needs, high foreign-currency-denominated debt in the private sector and geopolitical issues has led to a currency crisis in Turkey, with risk-averse behaviour spreading across some financial markets out of fear of contagion. Nevertheless, Asian economies appear generally well positioned to ride out this period of market turbulence. In fact, the biggest threat to some of the healthier Asian economies arises from the intensifying trade war between the US and China. The currency crisis in Turkey highlights how such a sell-off can turn into a more serious crisis in investor confidence in countries where external imbalances are large and the credibility of monetary and fiscal frameworks remains fragile. An additional factor, which is unique to Turkey at present, is the country's poor international relations with its traditional Western allies, and especially the US. As a consequence, Turkey finds itself in a difficult position to ask for financial assistance from the IMF which would seek unacceptable conditionalities from the Turkish government's point of view or its traditional backers from the Gulf Co operation Council. In Asia, examples of economic mismanagement, private-sector indebtedness and foreign-exchange reserve problems can be found. However, most of the countries where these problems apply do not have all of them to the same degree, and so they are more likely to be able to ride out shortterm market stresses. Moreover, the region as a whole is in a much better position to manage capital outflows than was the case when it last experienced a full-blown currency crisis, in Looking at the countries potentially affected by contagion from the crisis in Turkey, we find that, for the more robust Asian economies, the bigger threat to financial market stability stems from the escalation in the US-China trade dispute, while others in the region are being supported by sturdy domestic fundamentals or bail-out possibilities. The good: South Korea and Taiwan South Korea and Taiwan are among the more resilient economies that have been affected by the Turkish currency crisis. South Korea's stockmarket index (KOSPI) has fallen by almost 4.5% year on year since August 13th (when the Turkish lira was collapsing) and Taiwanese stocks have buckled at a similar pace. However, both countries have healthy reserves and strong financial sectors to enable them to ride out short-term financial market incursions. A more menacing risk is presented by these countries' structural dependence on trade and deep integration into the global supply chain, which will be threatened as the trade war between China and the US continues to escalate. Both South Korea and Taiwan have traditionally been highly dependent on electronics exports, but face challenges from significant shifts in supply-chain dynamics. In addition to rising competition from China, exporters in South Korea and Taiwan are Country Report September Economist Intelligence Unit Limited 2018

136 India 38 highly exposed to the slowdown in growth in the Chinese economy. In the event of a sharper slowdown in China the primary destination for their goods exports than we currently forecast for , South Korea and Taiwan would be more severely affected. For this reason, the current trade conflict between the US and China represents the greatest threat to the performance of these countries' external sectors. The risk that investors have attached to the two countries' assets is therefore more likely to stem from concerns about trade, rather than from fears of contagion from the Turkish currency crisis. The bad: Indonesia and India A slightly contrasting picture is presented by two larger, emerging market economies India and Indonesia. Both boast healthy growth rates and a growing middle-class population. Their stockmarkets have surged in recent years as investors piled into growth stocks. But both India and Indonesia have been hit by the collapse of the Turkish lira against the US dollar, as investors see similar risks: on August 20th the Indian rupee had plummeted to an all-time low, while the Indonesian rupiah had weakened by an average of 9.2% year on year. Both economies carry dual deficits on their fiscal and current accounts. Although Indonesia has a constitutionally imposed cap of 3% of GDP on its fiscal deficit, India's deficit has hovered around 3.5-5% of GDP in recent years. As net oil importers, both countries began to record narrower current-account deficits from 2014, when global commodity prices started to fall. As this trend reversed in late 2017, so did the narrowing of the deficits. Despite their vulnerabilities, however, both India and Indonesia are in a position to defend themselves against market jitters. Bank Indonesia (Indonesia's central bank) has managed to rescue the rupiah to some extent by aggressively tightening its monetary policy stance, while the Reserve Bank of India (India's central bank) has made similar moves. Ultimately, these countries' ample foreign-exchange reserves certainly compared with those of Turkey, where they represent only four to five months of imports as well as competent policy decisions by their central banks, will help to restore investors' confidence. The ugly: Pakistan and Sri Lanka The weakest economies in the region are those suffering from domestic political instabilities that have hampered policymaking. Pakistan is facing an impending balance-of-payments crisis, as it has struggled to fund a rising current account deficit the shortfall widened to 5.8% of GDP in the 2017/18 financial year (July 1st-June 30th), from 4.1% of GDP in 2016/17 and 1.7% in 2015/16. The high volume of imports has been driven by loose fiscal policy, high global oil prices, and capital needs related to the China-Pakistan Economic Corridor. This depleted Pakistan's reserves to US$11.7bn at end May insufficient to cover even two months' worth of goods and services imports. Pakistan has been hesitant to seek funding from the IMF, owing to its poor relations with the US. Nevertheless, it has a strong benefactor in China: a loan from that country in July will provide some immediate relief to the newly elected government. Pakistan is likely to also introduce much tighter controls over imports and to cover its current-account deficit through bond issuance and borrowing from commercial and a few bilateral partners. By contrast, the Sri Lanka rupee has held up well in the current risk-off environment, even though its economic fundamentals suggest that the currency should be at risk of contagion from the Turkish crisis. Technical and financial assistance from the IMF, which is scheduled to be completed by June 2019, has helped to shield the rupee from the country's deteriorating fundamentals: a widening current-account deficit and slowing economic growth. Although Sri Lanka's gradual progress on its IMF programme will shield it from entering a contagioninduced financial crisis in the short term, its longer-term future looks problematic. When the IMF programme is completed, the country could see a return of the fiscal mismanagement and populist governance that caused it to seek a bail-out in the first place. On the whole, however, Asia is well placed to see out the market turbulence caused by contagion from the Turkish currency crisis. The trade war between the US and China will prolong the financial market troubles being faced by countries such as South Korea and Taiwan, which are deeply integrated into global supply chains; however, they have plenty of policy space and financial buffers to defend their currencies, should the need arise. Meanwhile, weaker Asian economies will rely on ongoing reforms and will seek to strengthen their economic management. Country Report September Economist Intelligence Unit Limited 2018

137 India 39 Falling short on infrastructure? August 29, 2018 Weak infrastructure development has been one of the primary obstacles to improving India's business environment. Difficulties in land acquisition notwithstanding, we expect some progress on this front in the forecast period ( ). Nevertheless, the overall quality of infrastructure will remain poor in the next five years, acting as a drag on economic growth. According to a government report released in April, India currently has 1,332 infrastructure projects under way, worth at least Rs1.5bn (US$22m) each. Of these, 343 are classified as megaprojects, with costs beyond Rs10bn each. Around one-fifth of the total projects and a third of the mega-projects are running behind schedule. The delays have significantly increased the cost of their completion. The government expects to spend almost 14% more than the original estimate for these projects. Procedural hurdles Among the main reasons for the delays is the lengthy land-acquisition process, which often involves judicial intervention. In addition, for certain projects, the acquisition process requires coordination between the state and the central government, a process sometimes fraught by conflicting policy priorities. This is most evident in road transport and railway projects, which constitute the bulk of the delayed schemes. For instance, the first phase of the Delhi-Mumbai Industrial Corridor, which will pass through the states of Uttar Pradesh, Haryana, Rajasthan, Gujarat and Maharashtra, has overshot its 2017 deadline and is now expected to be completed only by Power projects also account for many of the delays and cost overruns. More than half of the power projects have exceeded their initial deadlines, and many have overrun their original budgets. In addition to issues of land acquisition, many of these projects have faced protests by local residents over potential environmental impact as well as contractual problems with private project partners. A promising trend Despite the statutory and administrative hurdles, the government has made infrastructure expansion a priority. Budgetary allocation for the sector has increased significantly over the past two decades, and in the budget for fiscal year 2018/19 (April-March) the government announced a near-21% increase in expenditure allocated to infrastructure development compared with the budget for 2017/18. In the next decade alone, the government is seeking US$1.5trn in infrastructure investment and aims to secure nearly half of this amount from private investors. The government's policy of allowing 100% foreign direct investment in infrastructure projects will ease foreign funding, even though a significant number of the projects will be under the publicprivate partnership model, with some state participation. However, private infrastructure investment has been low owing to delays and associated cost overruns. Sectors such as power, where private investors typically show greater interest, have also suffered from low corporate credit ratings, dissuading potential investors. Moreover, the accumulating bad debts of the power sector are weighing on the ability of existing private operators to reinvest in the expansion of capacity. Nonetheless, the government continues to push for promising, if overambitious, new large-scale projects. The National Democratic Alliance government's flagship Bharatmala highway project which aims to build 83,677 km of roads and add 44 new economic corridors to the existing six is a case in point. These economic corridors will be an improvement of the existing roads, which currently carry a high volume of traffic and connect major industrial or urban centres. When complete, these corridors are expected to boost trade and business between these centres. Overall, the Bharatmala project, when complete, will almost double the length of India's national highway network. The government approved the first phase of the project at the end of 2017, with the target of constructing almost 35,000 km of roads by However, it has already lowered its target for contracts to be awarded in 2018/19, likely anticipating a longer land-acquisition process and tight funding. This means that unless the government significantly increases the contract award targets over the next two years, it is likely to miss its targets for the Bharatmala project. Country Report September Economist Intelligence Unit Limited 2018

138 India 40 More money is needed Still, given the need for robust infrastructure to drive economic growth, the government has little choice but to make up the shortfall in investment in these projects. An enhanced infrastructure network is crucial to boosting the manufacturing sector, which struggles to compete internationally owing to high logistics costs and inadequate power supply. Despite an improvement in the score for the infrastructure category in The Economist Intelligence Unit's latest business environment rankings, India remains a laggard globally, and is ranked 78th out of 82 countries in our assessment for This reflects our view that demand for infrastructure will continue to far outstrip supply in the forecast period, acting as a dampener on domestic and foreign private investment in manufacturing and services more generally. Country Report September Economist Intelligence Unit Limited 2018

139 Subject Bangladesh Page Ambassador Marcia Bernicat Economist Intelligence Unit Country Report

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141 U.S. Department of State Diplomacy in Action Marcia Bernicat U.S. Ambassador to Bangladesh Term of Appointment: 01/06/2015 to present Ambassador Marcia Stephens Bloom Bernicat, a career member of the Foreign Service, Class of Minister-Counselor, was nominated in 2014 by President Obama to be the Ambassador to Bangladesh. She assumed her position in January The Ambassador previously served in a number of senior leadership positions, most recently as the Deputy Assistant Secretary in the Bureau of Human Resources at the Department of State, a position she held since She was previously Ambassador to Senegal and Guinea-Bissau from 2008 to She served in the Department of State as Office Director for India, Nepal, Sri Lanka, Maldives and Bhutan in the Bureau of South Asian Affairs from 2006 to From 2004 to 2006, she was the Senior-Level Director and Career Development Officer in the Bureau of Human Resources at the State Department. Ambassador Bernicat also served as Deputy Chief of Mission at the U.S. Embassy in Bridgetown, Barbados from 2001 to 2004, and as Deputy Chief of Mission at the U.S. Embassy in Lilongwe, Malawi from 1998 to She was Principal Officer at the U.S. Consulate in Casablanca, Morocco from 1995 to 1998, Deputy Political Counselor at the U.S. Embassy in New Delhi, India from 1992 to 1995, and Desk Officer for Nepal and India in the Bureau of Near East and South Asian Affairs from 1988 to Earlier in her career, she was Special Assistant to Deputy Secretary of State John Whitehead, Consular Officer in Marseille, France, and Political/Consular Officer at the U.S. Embassy in Bamako, Mali. Ambassador Bernicat received a B.A. from Lafayette College and an M.S. from Georgetown University.

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143 Country Report Bangladesh Generated on September 6th 2018 Economist Intelligence Unit 20 Cabot Square London E14 4QW United Kingdom

144 The Economist Intelligence Unit The Economist Intelligence Unit is a specialist publisher serving companies establishing and managing operations across national borders. For 60 years it has been a source of information on business developments, economic and political trends, government regulations and corporate practice worldwide. The Economist Intelligence Unit delivers its information in four ways: through its digital portfolio, where the latest analysis is updated daily; through printed subscription products ranging from newsletters to annual reference works; through research reports; and by organising seminars and presentations. The firm is a member of The Economist Group. London The Economist Intelligence Unit 20 Cabot Square London E14 4QW United Kingdom Tel: +44 (0) Fax: +44 (0) eiucustomerservices@eiu.com New York The Economist Intelligence Unit The Economist Group 750 Third Avenue 5th Floor New York, NY 10017, US Tel: Fax: eiucustomerservices@eiu.com Hong Kong The Economist Intelligence Unit 1301 Cityplaza Four 12 Taikoo Wan Road Taikoo Shing Hong Kong Tel: Fax: eiucustomerservices@eiu.com Geneva The Economist Intelligence Unit Rue de l Athénée Geneva Switzerland Tel: Fax: eiucustomerservices@eiu.com This report can be accessed electronically as soon as it is published by visiting store.eiu.com or by contacting a local sales representative. The whole report may be viewed in PDF format, or can be navigated section-by-section by using the HTML links. In addition, the full archive of previous reports can be accessed in HTML or PDF format, and our search engine can be used to find content of interest quickly. Our automatic alerting service will send a notification via when new reports become available. Copyright 2018 The Economist Intelligence Unit Limited. All rights reserved. Neither this publication nor any part of it may be reproduced, stored in a retrieval system, or transmitted in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, without the prior permission of The Economist Intelligence Unit Limited. All information in this report is verified to the best of the author's and the publisher's ability. However, the Economist Intelligence Unit does not accept responsibility for any loss arising from reliance on it. ISSN Symbols for tables "0 or 0.0" means nil or negligible;"n/a" means not available; "-" means not applicable

145 Bangladesh 1 Bangladesh Summary 2 Briefing sheet Outlook for Political stability 5 Election watch 5 International relations 6 Policy trends 6 Fiscal policy 7 Monetary policy 7 International assumptions 8 Economic growth 8 Inflation 8 Exchange rates 9 External sector 9 Forecast summary Data and charts 10 Annual data and forecast 11 Quarterly data 12 Monthly data 13 Annual trends charts 14 Monthly trends charts 15 Comparative economic indicators Summary 15 Basic data 17 Political structure Recent analysis Politics 20 Forecast updates 22 Analysis Economy 24 Forecast updates Country Report August Economist Intelligence Unit Limited 2018

146 Bangladesh 2 Briefing sheet Editor: Sarthak Gupta Forecast Closing Date: July 30, 2018 Political and economic outlook The ruling Awami League (AL) party will dominate parliament until the general election in end The Economist Intelligence Unit believes that the AL will win the next poll, helped by patronage at local level and because it has overseen solid economic growth. The risk of political unrest will increase in the run-up to the parliamentary election. Along with opposition-backed protests, the threat of terrorist attacks, labour strikes and public demonstrations against the rising cost of living will pose risks to political stability. Increased spending on infrastructure projects and slow progress on expanding the tax base will result in a budget deficit equivalent to 4.5% of GDP on average in fiscal years 2018/ /22 (July-June), wider than the 3.9% average over the preceding four years. We expect Bangladesh Bank (BB, the central bank) to keep the repurchase (repo) rate and reverse repo rate at 6.75% and 4.75%, respectively, in the second half of 2018 and through-out From 2020 BB will ease monetary policy in order to stimulate economic growth. We forecast that real GDP will grow by an average of 7.3% a year in 2018/ /22, bolstered by strong increases in private consumption and investment. Government spending, particularly on infrastructure, will also support headline economic growth. The current account is expected to record a deficit equivalent to 1.6% of GDP on average in , owing in large part to increased imports of inputs for infrastructure develop-ment as well as oil imports. However, we forecast that the shortfall will narrow gradually. Key indicators 2017 a 2018 b 2019 b 2020 b 2021 b 2022 b Real GDP growth (%) d c Consumer price inflation (av; %) Government balance (% of GDP) d c Current-account balance (% of GDP) Money market rate (end-period; %) e Unemployment rate (%) Exchange rate Tk:US$ (av) a Actual. b Economist Intelligence Unit forecasts. c Economist Intelligence Unit estimates. d Fiscal years (ending June 30th). e End-period. Country Report August Economist Intelligence Unit Limited 2018

147 Bangladesh 3 Key changes since July 17th We now expect the Bangladesh Nationalist Party to boycott the parliamentary polls that are due to be held in end Members of the party will resort to large-scale protests to secure the release of their leader, Khaleda Zia, raising risks to political stability in Owing to stronger than expected service exports in the first five months of the year, we have revised up our forecast for Therefore, we now expect a narrower deficit on the current account in 2018, equivalent to 2.3% of GDP, compared with 2.7% previously. The month ahead August TBC Monetary policy statement (July December 2018): BB releases its monetary policy statement twice a year. It will be an important indicator of the bank's expectations for inflation and growth in Major risks to our forecast Scenarios, Q Probability Impact Intensity Attacks on foreigners rise Moderate High 12 Dysfunction in the legal system increases Moderate High 12 Refugee inflow from Myanmar leads to an increase in Islamist extremism Moderate High 12 The government removes tax incentives available to foreign companies Moderate High 12 A cyber-attack affects the banking sector Low Very high 10 Note. Scenarios and scores are taken from our Risk Briefing product. Risk scenarios are potential developments that might substantially change the business operating environment over the coming two years. Risk intensity is a product of probability and impact, on a 25-point scale. Source: The Economist Intelligence Unit. Country Report August Economist Intelligence Unit Limited 2018

148 Bangladesh 4 Outlook for Political stability The Economist Intelligence Unit expects that the Awami League (AL) party, which has been in office since 2009 and secured an overwhelming victory at the 2014 general election, will win a majority of parliamentary seats in the poll scheduled for the end of Nonetheless, we caution that the remainder of the AL's term and most of its next one will be marked by ongoing risks to political stability. The most immediate and demanding of these risks will be the threat of large-scale protests and demonstrations by the opposition. Khaleda Zia, the de facto leader of the Bangladesh Nationalist Party (BNP) the unofficial opposition party, which holds no parliamentary representation, as it boycotted the last national elections held in 2014 was convicted of graft by a lower court in February 2018 and handed a five-year jail term. This in effect disqualified her from contesting in the parliamentary polls due to be held by the end of Although Mrs Zia has appealed to the High Court, we do not expect her conviction to be overturned. The judiciary in Bangladesh is heavily influenced by the executive, and so the AL will urge the courts to keep the opposition leader behind bars to ensure that it gets a smooth re-election. This means that BNP members and supporters will resort to large-scale rallies and demonstra-tions to demand the release of their leader. There is a risk of these protests turning violent and security forces may be deployed to maintain order. Overall, the AL-BNP rivalry will keep the political environment tense. Apart from opposition-backed demonstrations, the risk of terrorist attacks will remain high in Although the security forces have been successful in thwarting recent attempts, any increase in occurrences of terrorism could contribute to broader political instability, fuelling dissatisfaction with the government and raising the risk of further social unrest. Such attacks would also have an economic impact, as each episode has negative effects on the confidence of foreign investors. We believe that the Rohingya refugee crisis will remain severe over the next few years. The crisis started in August 2017, when military operations against insurgents in neighbouring Myanmar drove around 700,000 people into Bangladesh. We do not expect the refugees' planned repatriation to be completed within our forecast period. In early June Myanmar signed an initial deal with the UN to begin repatriating some of the refugees. Despite the latest agreement, the prospect of a swift and safe return for the Rohingya refugees is distant. The verification process adopted by Myanmar requires refugees to present identity documents issued by the Burmese government in order to return. This is likely to prove a major impediment to the repatriation process, as most refugees were never issued with such documents. Many Rohingya refugees have said that they have no intention of returning to Myanmar, because they are likely to be resettled in designated areas far from where many of them had lived. As the crisis drags on, there is a risk that terrorist organisations in Bangladesh may seek to recruit refugees, as conditions in the refugee camps are poor. This will raise security concerns for Bangladesh and its neighbours. Domestically, potential social unrest and protests by various interest groups pose a risk to political stability. Minimum-wage adjustments are due to take place in 2018 (adjustments are made every five years) and negotiations are underway. There will be a rise in the incidence of strikes and labour protests, at least in the short term, if wage adjustments are delayed or are below workers' expectations. Country Report August Economist Intelligence Unit Limited 2018

149 Bangladesh 5 Election watch The next general election is due to be held in late 2018, and we expect the AL to maintain its majority in parliament. This is partly owing to the party's well-entrenched system of patronage at local level, as well as the fact that it has overseen a period of solid economic growth. With the opposition leader jailed, Bangladesh is moving closer to a de facto one-party state. We do not expect the BNP to participate in the ballot, as it is unlikely to dent the AL's prospects of reelection. Therefore, the BNP is likely to boycott the election in order to undermine its legitimacy. There are already concerns in the international community regarding the fairness of elections in Bangladesh, and the BNP is likely to use this to mobilise pressure from international observers on the government to release Mrs Zia. The BNP has no parliamentary representation (it boycotted the 2014 elections), and so it has little to lose if it chooses not to participate again. International relations Bangladesh s foreign policy will continue to centre on its neighbours, with both China and India vying for influence. Ties with India will continue to strengthen throughout Most recently, the visit of India's home minister, Rajnath Singh, in mid-july led to the signing of an updated visa agreement, which provides longer-duration employment and student visas to Bangladeshis seeking to work or study in India. The bilateral dispute over the sharing of the Teesta river waters is likely to be put on the backburner until 2019, when India goes to elections, after which we expect Bangladesh and India to make renewed attempts to negotiate an agreement. We also expect economic engagement with China to deepen in in view of the rising number of Chinese backed infrastructure projects in Bangladesh. China is already Bangladesh s largest source of imports and its main supplier of military equipment. Overall, we expect Bangladesh to continue to exploit its strategically important location on the Bay of Bengal to extract concessions and economic assistance from India, China and Japan. Bangladesh's relationship with Myanmar will continue to be tense over the medium term. The Rohingya refugee crisis will remain severe, at least in the early part of our forecast period, and will persist at an elevated but more stable level thereafter. Country Report August Economist Intelligence Unit Limited 2018

150 Bangladesh 6 Policy trends The policy agenda will focus on incentives to encourage investment and improve security during the remainder of the government's term and beyond. We expect the AL to win the next general election, allowing for a continuation of the status quo. This will be vital to sustaining foreign investment, but will also support the administration's drive to expand and deepen private-sector participation in the economy. The authorities will continue to accord a high priority to achieving the UN's post-2015 development agenda, or Sustainable Development Goals (SDGs). The government will view any progress on this front as a step closer to meeting its long-term goal of transforming Bangladesh into an upper-middle-income economy by However, incomes would have to rise by almost threefold from their current level for Bangladesh to move into the next income bracket (defined by the World Bank as a country with gross national income per head of at least US$3,956 for the 2018 fiscal year) a feat that we do not believe will be achieved according to the government's timeline. As Bangladesh is set to graduate from "least developed country" status (LDC, a UN classification based on economic and social development) in 2024, it will steadily lose some forms of concessional aid, as well as preferential market access that LDCs typically benefit from. As a result, we expect that the government will seek to mitigate the impact of withdrawal of such benefits by working to secure bilateral trade and financing agreements with major economic partners in The more fundamental challenge for policymakers is the need to increase electricity supplies; demand has outstripped supply for decades. To overcome this mismatch quickly, the government is turning to coal and liquefied natural gas (LNG). The government is building many such plants, with financial and technical support from foreign governments and firms. It will also continue to make efforts to increase the share of renewables in the country's energy mix, with a target of meeting 10% of Bangladesh's energy needs through renewable sources by We do not expect this target to be met, but authorities will come close to achieving it within the forecast period. Overall, the government plans to increase power generation to almost 24,000 MW by In addition, in December 2017 the government started the construction of Bangladesh's first nuclear power plant, with the assistance of Russia and India. However, this plant is expected to start gene-rating power only by Fiscal policy The country will continue to record budget deficits throughout fiscal years 2018/ /22 (July- June), as it struggles to engineer a significant expansion of the tax base. According to the government's revised estimates, in 2017/18 the budget deficit widened to the equivalent of 4.8% of GDP, from 3.4% in 2016/17. The government projects that revenue collection will total Tk3.4trn in 2018/19, representing an ambitious 30.7% rise over the revised estimates for 2017/18. On the expenditure side, the government targets a spending increase of 25.1%. Consistent with the trend in previous years, we do not expect the government to meet either its revenue or expenditure targets in 2018/19. Overall, we expect the fiscal deficit as a proportion of GDP to remain constant at 4.8% in 2018/19 slightly larger than the government's target of 4.7% as the government will be reluctant to rein in expenditure this year ahead of the election. We forecast that the budget deficit will narrow to the equivalent of 4.2% of GDP by 2021/22, helped by the introduction of the new VAT rate (expected in 2019/20) and a widening of the tax net. The modest reduction in the fiscal shortfall reflects our view that the government will still need to maintain a high level of spending growth to tackle numerous challenges, ranging from the need to invest in power and water infrastructure to the necessity of raising spending on education and healthcare. Country Report August Economist Intelligence Unit Limited 2018

151 Bangladesh 7 Monetary policy In early April Bangladesh Bank (BB, the central bank) cut one of its key policy rates, the repurchase (repo) rate, by 75 basis points to 6%, while keeping the other, the reverse repo rate, unchanged at 4.75%. The unscheduled monetary policy decision was taken, alongside a slew of other policy decisions, to resolve a liquidity crisis faced by private banks since the beginning of this year. We expect the central bank to raise the repo rate back to 6.75% in the coming few months to restore the status quo as the short-term liquidity issues are resolved. BB will then hold both policy interest rates until 2020 when inflationary pressures ease slightly, giving the central bank room to sanction interest-rate cuts to support economic growth. Furthermore, as the Federal Reserve (the US central bank) starts to cut its rates from that year onwards until mid-2021, depreciatory pressures on the taka will fade, which will also allow for a more accom-modative monetary policy stance. International assumptions Economic growth (%) US GDP OECD GDP World GDP World trade Inflation indicators (% unless otherwise indicated) US CPI OECD CPI Manufactures (measured in US$) Oil (Brent; US$/b) Non-oil commodities (measured in US$) Financial variables US$ 3-month commercial paper rate (av; %) Exchange rate Tk:US$ (av) Exchange rate US$: (av) Country Report August Economist Intelligence Unit Limited 2018

152 Bangladesh 8 Economic growth We expect real GDP growth to average 7.3% a year in 2018/ /22. Growth over the next four years will be driven mainly by a rapid increase in private consumption and gross fixed investment. Provisional data from the Bangladesh Bureau of Statistics show that real GDP grew by 7.7% in 2017/18. Strong private consumption and invest-ments in infrastructure projects supported overall growth, even as burgeoning demand for imports exerted a drag on the headline figure. We expect capital flows from international partners and multilateral institutions to continue over the next few years. Consequently, we forecast that gross fixed investment and private consumption will grow by an average of 9% and 7.5% a year, respectively, in 2018/ /22. These compare with respective averages of 9.5% and 6.3% in the preceding four-year period. Although agriculture will account for just 12.5% of GDP in 2018/ /22 on average, it will remain the largest source of employment and the main provider of income for around half the working population. On a factor-cost basis, economic growth will continue to be driven by services and industry. The growth of industry will continue to outpace that of services: the former will account for 34.1% of GDP by 2021/22, up from 30.4% in 2017/18. Economic growth (%; fiscal years ending Jun 30th) 2017 a 2018 b 2019 c 2020 c 2021 c 2022 c GDP Private consumption Government consumption Gross fixed investment Exports of goods & services Imports of goods & services Domestic demand Agriculture Industry Services a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts. Inflation We expect consumer prices to increase by an average of 5.7% this year, equal to last year's inflation rate. We expect inflationary pressures to remain firm in 2018 as demand-side pressures build amid strong growth in private consumption. This will be despite an easing of food price pressures resulting from a normalisation of agricultural production. Inflation had spiked in 2017 owing to flash floods in parts of the country that led to spiralling food prices. A high average level of inflation in will also be underpinned by an increase in global commodity prices, including oil (a major import). We expect global oil prices (dated Brent Blend) to average US$73.1/barrel a year in , compared with an average of US$49.2/b in In addition, we expect the taka's depreciation against the US dollar to exacerbate the effects of higher global commodity prices on inflation. We forecast that consumer price inflation will average 5.7% a year in Exchange rates We expect the taka to continue weakening against major currencies as Bangladesh continues to run a wide deficit on the trade account. The deficit is the result of the country's high import needs, related to the govern-ment's plans for infra-structure development to drive growth. Depreciation against the US dollar will also stem from a narrowing interest-rate differential with the US in We forecast that the taka will weaken to an average of Tk87.6:US$1 by 2022, from Tk83.6:US$1 in Total international reserves are forecast to increase to US$37.5bn by the end of 2022, from US$33.4bn at end We expect import cover to average around 6.6 months in , which is more than sufficient for the central bank to manage any excessive and short-term exchange-rate volatility. Country Report August Economist Intelligence Unit Limited 2018

153 Bangladesh 9 External sector Despite an expected slowdown in food imports which increased sharply in 2017 owing to floods that destroyed several food crops we expect the merchandise trade deficit to remain wide in 2018 as the country starts to import large amounts of LNG to compensate for declining domestic production. A further rise in global oil prices, from US$54.4/b in 2017 to US$73.6/b in 2018, will also contribute to the wide trade deficit. In the medium term, growth in exports will be helped by the ongoing shift in low-cost manufacturing away from China and continued healthy demand for garments from major export markets such as the US and the EU. Bangladesh also stands to gain from the redistribution of trade that will happen as a result of trade frictions between China and the US. This will contribute to a narrowing merchandise trade deficit over the forecast period, shrinking to US$12.4bn by 2022, from US$15bn in This modest narrowing, amid an expected pick-up in export earnings, reflects Bangladesh's heavy reliance on imports of fuel, inputs for the export-oriented garment sector and capital goods for infrastructure development. After a weak showing in 2017, workers' remittances have bounced back in In the first half of 2018 remittance inflows rose by 21.9% year on year, to US$8bn, and we expect them to continue growing in 2018, as manpower exports to Gulf Co-operation Council countries (which are major employers of Bangladeshi workers) will increase in line with a recovery in oil prices. From 2019 onwards we expect growth in remittances to be more modest, owing to an anticipated softening of oil prices in , the adoption of fiscal consolidation measures and stricter immigration rules in the Gulf region. Nevertheless, remittances will still continue to offset a large proportion of Bangladesh's deficits on the trade, services and primary income accounts. We expect the currentaccount deficit to average the equivalent of 1.6% of GDP in Forecast summary Forecast summary (% unless otherwise indicated) 2017 a 2018 b 2019 b 2020 b 2021 b 2022 b Real GDP growth c d Industrial production growth e 9.1 d Gross agricultural production growth c d Unemployment rate (av) Consumer price inflation (av) Short-term interbank rate Government balance (% of GDP) c d Exports of goods fob (US$ bn) Imports of goods fob (US$ bn) Current-account balance (US$ m) -6, , , , , ,828.9 Current-account balance (% of GDP) External debt (end-period; US$ bn) 50.3 d Exchange rate Tk:US$ (av) Exchange rate Tk:US$ (end-period) Exchange rate Tk: 100 (av) Exchange rate Tk: (end period) a Actual. b Economist Intelligence Unit forecasts. c Fiscal years (ending June 30th). d Economist Intelligence Unit estimates. e From 2014 onwards EIU calculation. Country Report August Economist Intelligence Unit Limited 2018

154 Bangladesh 10 Data and charts Annual data and forecast 2013 a 2014 a 2015 a 2016 a 2017 a 2018 b 2019 b GDP c Nominal GDP (US$ bn) d Nominal GDP (Tk bn) 11,989 13,437 15,158 17,329 19,758 22,385 d 25,702 Real GDP growth (%) d 7.7 Expenditure on GDP (% real change) c Private consumption d 7.9 Government consumption d 12.0 Gross fixed investment d 10.0 Exports of goods & services d 5.2 Imports of goods & services d 10.5 Origin of GDP (% real change) c Agriculture d 3.5 Industry d 11.6 Services d 6.1 Population and income Population (m) d GDP per head (US$ at PPP) 2,935 3,132 3,336 3,580 3,869 d 4,197 4,565 Recorded unemployment (av; %) Fiscal indicators (% of GDP) c Public-sector expenditure d 16.8 Public-sector balance d -4.8 Net public debt d Prices and financial indicators Exchange rate Tk:US$ (end-period) Exchange rate Tk: (end period) Consumer prices (av; % change) Consumer prices (end-period; % change) Stock of money M1 (% change) d Stock of money M2 (% change) d Lending interest rate (av; %) Current account (US$ m) Trade balance -6,362-7,482-6,120-6,231-12,256-14,991-13,457 Goods: exports fob 28,638 29,925 31,736 34,048 35,302 37,420 39,478 Goods: imports fob -35,001-37,406-37,856-40,279-47,558-52,411-52,935 Services balance -3,571-4,638-4,486-4,252-5,404-4,578-4,904 Primary income balance -2,508-2,727-2,583-2,680-2,718-2,996-3,107 Secondary income balance 14,499 15,603 15,769 14,091 14,013 16,385 15,938 Current-account balance 2, , ,365-6,179-5,531 External debt (US$ m) Debt stock 33,995 35,663 38,689 41,126 50,261 d 54,419 59,781 Debt service paid 1,914 1,977 1,662 1,776 1,848 d 2,471 2,730 Principal repayments 1,601 1,646 1,337 1,367 1,344 d 1,726 1,853 Interest d International reserves (US$ m) Total international reserves 18,092 22,311 27,493 32,279 33,424 33,932 34,712 a Actual. b Economist Intelligence Unit forecasts. c Fiscal years (ending June 30th). d Economist Intelligence Unit estimates. Source: IMF, International Financial Statistics. Country Report August Economist Intelligence Unit Limited 2018

155 Bangladesh 11 Quarterly data Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr Prices Consumer prices (2005=100) Consumer prices (% change, year on year) Financial indicators Exchange rate Tk:US$ (av) Exchange rate Tk:US$ (end-period) Deposit rate (av; %) n/a Money market rate (end-period; %) n/a n/a Lending rate (av; %) n/a M1 (end-period; Tk bn) 2,014 2,044 2,026 2,401 n/a n/a n/a n/a M1 (% change, year on year) n/a n/a n/a n/a M2 (end-period; Tk bn) 9,315 9,541 9,648 10,161 n/a n/a n/a n/a M2 (% change, year on year) n/a n/a n/a n/a Foreign trade (Tk bn) Exports fob n/a Imports cif n/a Trade balance n/a Balance of payments (US$ m) Merchandise trade balance fob-fob -1,325-2,609-2,220-2,131-3,320-4,585 n/a n/a Services balance -1,026-1,157-1,179-1,136-1,449-1,640 n/a n/a Primary income balance n/a n/a Net transfer payments 3,383 3,087 3,117 3,711 3,457 3,728 n/a n/a Current-account balance 322-1, ,019-3,211 n/a n/a Reserves excl gold (end-period) 30,984 31,776 31,830 33,121 32,432 32,849 31,996 n/a Sources: IMF, International Financial Statistics; Bangladesh Bank, Economic Trends. Country Report August Economist Intelligence Unit Limited 2018

156 Bangladesh 12 Monthly data Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Exchange rate Tk:US$ (av) n/a n/a n/a n/a n/a n/a Exchange rate Tk:US$ (end-period) n/a n/a n/a n/a n/a n/a Deposit rate (av; %) n/a n/a n/a n/a n/a n/a n/a Lending rate (av; %) n/a n/a n/a n/a n/a n/a n/a Money supply M1 (% change, year on year) n/a n/a n/a n/a n/a n/a 2018 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Money supply M2 (% change, year on year) n/a n/a n/a n/a n/a n/a 2018 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Consumer prices (av; % change, year on year) n/a n/a n/a n/a n/a n/a Total exports fob (Tk bn) n/a n/a n/a n/a n/a n/a n/a Total imports cif (Tk bn) n/a n/a n/a n/a n/a n/a n/a Trade balance fob-cif (Tk bn) n/a n/a n/a n/a n/a n/a n/a Foreign-exchange reserves excl gold (US$ m) ,647 27,694 27,909 28,751 28,449 29,771 29,631 30,766 30,984 31,517 31,028 31, ,375 32,175 31,830 32,134 31,868 33,121 32,617 33,193 32,432 33,071 32,236 32, ,288 32,962 31,996 32,501 31,767 n/a n/a n/a n/a n/a n/a n/a Sources: IMF, International Financial Statistics; Haver Analytics. Country Report August Economist Intelligence Unit Limited 2018

157 Bangladesh 13 Annual trends charts Country Report August Economist Intelligence Unit Limited 2018

158 Bangladesh 14 Monthly trends charts Country Report August Economist Intelligence Unit Limited 2018

159 Bangladesh 15 Comparative economic indicators Basic data Land area 147,570 sq km Population 164.7m (2017; UN) Country Report August Economist Intelligence Unit Limited 2018

160 Bangladesh 16 Main towns Population in 000 (2011 census): Dhaka (capital): 26,335 Chittagong: 15,023 Rajshahi: 6,300 Khulna: 5,388 Climate Tropical monsoon Weather in Dhaka (altitude 3 metres) Hottest month, July, C (average daily minimum and maximum); coldest month, January, C; driest months, December and January, 5 mm average monthly rainfall; wettest month, July, 567 mm average monthly rainfall Languages Bengali, Urdu and Hindi are minority languages, and English is also used Religion Muslim (89.7% in 2001 census); Hindu (9.2%); Buddhist (0.7%); Christian (0.3%); others (0.1%) Measures Imperial system. Local measures include: 1 tola = g; 1 seer = 80 tolas = 932 g; 1 maund = 40 seers = kg Numbers are commonly expressed in crores and lakhs; 1 crore = 10m, written 1,00,00,000; 1 lakh = 100,000, written 1,00,000 Currency Taka (Tk); Tk1 = 100 paisa. Average exchange rate in 2017: Tk80.4:US$1 Fiscal year July 1st-June 30th Time 6 hours ahead of GMT Public holidays February 21st (International Mother Language Day); March 17th (Birthday of Sheikh Mujibur Rahman); March 26th (Independence Day); April 14th (Bengali New Year); May 1st (Labour Day); June 15th-17th (Eid al-fitr); July 1st (bank holiday); August 15th (National Mourning Day); August 21st-23rd (Eid al-adha); October 19th (Durga Puja); November 21st (Birth of the Prophet); December 16th (Victory Day); December 25th (Christmas Day); December 31st (bank holiday); plus religious holidays that depend on lunar sightings and optional holidays for various religious groups Country Report August Economist Intelligence Unit Limited 2018

161 Bangladesh 17 Political structure Official name People s Republic of Bangladesh Form of government Country Report August Economist Intelligence Unit Limited 2018

162 Bangladesh 18 Bangladesh has been a parliamentary democracy since a constitutional amendment in 1991 Head of state The president, Abdul Hamid, was reappointed to his post in February 2018 for a second term. The president is elected by members of parliament. The next presidential election is due in 2023 The executive The prime minister is chief executive and head of the Council of Ministers (the cabinet), and selects its members. The presidency is a largely ceremonial role, although the president appoints members of the cabinet and judiciary and has the power to dissolve parliament National legislature A unicameral parliament, consisting of 300 seats occupied by members directly elected from geographical constituencies for five-year terms, plus 50 seats reserved for women appointed by political parties with numbers in proportion to the party s vote National elections The most recent general election was held in January Governments serve maximum terms of five years. The next general election is scheduled to be held in late 2018 National government The Awami League (AL) won three-quarters of the seats in parliament at the 2014 election, which was boycotted by most opposition parties Main political organisations AL; Bangladesh Nationalist Party; Jatiya Party (Ershad); Jatiya Samajtantrik Dal; Workers Party of Bangladesh; Bangladesh Tarikat Federation; Jamaat-e-Islami; Bangladesh Jatiya Party (Manju) Key ministers Prime minister & minister of defence: Sheikh Hasina Wajed Agriculture: Matia Chowdhury Civil aviation & tourism: AKM Shahjahan Kamal Commerce: Tofail Ahmed Education: Nurul Islam Nahid Finance: Abul Maal Abdul Muhith Fisheries & livestock: Narayon Chandra Chanda Food: Qamrul Islam Foreign affairs: Abul Hassan Mahmood Ali Industries: Amir Hossain Amu Law, justice & parliamentary affairs: Anisul Haq Local government, rural development & co-operatives: Khandaker Mosharraf Hossain Planning: AHM Mustafa Kamal Power, energy & mineral resources: Nasrul Hamid Road transport & bridges: Obaidul Quader Shipping: Shajahan Khan Textiles & jute: Emaj Uddin Pramanik Water resources: Anwar Hossain Country Report August Economist Intelligence Unit Limited 2018

163 Bangladesh 19 Central bank governor Fazle Kabir Country Report August Economist Intelligence Unit Limited 2018

164 Bangladesh 20 Recent analysis Generated on September 6th 2018 The following articles were published on our website in the period between our previous forecast and this one, and serve here as a review of the developments that shaped our outlook. Politics Forecast updates India's home minister visits Bangladesh July 18, 2018: International relations Event On July 15th India's home minister, Rajnath Singh, concluded a three-day visit to Bangladesh, during which the two countries signed an agreement for a liberalised visa regime. Analysis Mr Singh and his Bangladeshi counterpart, Asaduzzaman Khan Kamal, co-chaired the sixth meeting of the India-Bangladesh home minister-level talks in the capital, Dhaka. During the meeting they discussed a range of security-related concerns, including border management, counter-terrorism, capacity building and increased co-operation between security agencies, as well as crossborder crimes and illegal activities such as drug- and human-trafficking and fake currencies. Mr Singh also met Bangladesh's prime minister, Sheikh Hasina Wajed. The two countries also signed a revised travel arrangement for 2018, amending the 2013 accord and liberalising the bilateral visa regime. Under the new agreement, India will provide longerduration employment and student visas, as well as five-year multiple-entry visas to people aged 65 and over and to "freedom fighters". The two home ministers also inaugurated a new integrated India visa application centre in Dhaka, India's largest worldwide, to better serve the estimated 3m Bangladeshis visiting the country annually. The new centre will issue an average of 5,000 visas per day and by end-august will replace the four existing visa application centres in Dhaka. The latest state visit highlights continuing strong relations between the two countries. India is the second-largest source of imports for Bangladesh after China. Furthermore, both China and India are crucial development partners for Bangladesh and hold significant interest in the region owing to the country's strategic location. As these countries compete for influence in South Asia, balancing ties with each of them will be a key challenge for Bangladesh in the forecast period ( ). Impact on the forecast The latest development is in line with our expectations that Bangladesh will have cordial relations with India in owing to strong economic and cultural ties. Country Report August Economist Intelligence Unit Limited 2018

165 Bangladesh 21 Protests likely on minimum-wage revision July 23, 2018: Political stability Event On July 17th workers in the readymade garment (RMG) sector rejected a proposal by the Bangladesh Garment Manufacturers and Exporters Association (BGMEA) to raise minimum wages in the sector to Tk6,360/month (US$76), from the current Tk5,300/month. Analysis Minimum wages are set every five years by the National Minimum Wage Board on an industryby-industry basis. Although Bangladesh has a formal wage negotiation process, the unions are weak and the lobbying power of garment manufacturers is strong. This means that the outcome of negotiations tend to be a function of political power rather than a metric of time and inflation as was the case in 2013, which was the last time minimum wages were revised. On July 16th the workers' representative, Shamsun Nahar Bhuiyan, proposed that the BGMEA raise the minimum wage to Tk12,020, but the workers themselves opposed it, as this figure was lower than their original demand of Tk16,000. We expect protests demanding a higher minimum wage to take place over the next few days, as pressure builds on the BGMEA to heed the workers' demands. Bangladesh is accustomed to crippling labour strikes (hartals), which have occurred for many years at a huge cost to the economy. However, these have become less frequent over the past year. The most likely outcome is a face-saving deal in which manufacturers agree to raise the minimum wage, but it will probably not be as high as Tk16,000/month. This will be to improve workers' living conditions in the short term, and to appease international buyers who face allegations of not paying enough and neglecting working conditions in garment factories. For many companies, Bangladesh is the biggest sourcing country for RMG after China. There is a risk that the government, as it has done in the past, uses the conflict over wages to crack down on workers, which may lead to a worsening of the political situation. In late 2016 thousands of RMG workers were sacked because they went on strike demanding a trebling of pay. However, a general election is scheduled for the end of 2018 and the ruling Awami League will want to pacify workers. It will also be keen not to give opposition parties an opportunity to find an issue around which to rally support against the government. Impact on the forecast We had already accounted for protests and disturbances related to minimum-wage negotiations in our forecast for political stability. No change to our forecast is required. Country Report August Economist Intelligence Unit Limited 2018

166 Bangladesh 22 BNP holds rally to demand leader s release July 24, 2018: Political stability Event On July 20th the Bangladesh Nationalist Party (BNP, the unofficial opposition party) held a rally in the capital, Dhaka, for the release of its leader, Khaleda Zia, who is in jail over her conviction in a graft case. Analysis The party has also made it clear that it will not participate in the general elections, which are scheduled to be held towards the end of 2018, if Mrs Zia is not released. However, without participating, the party runs the risk of being deregistered as a political party. The BNP boycotted the previous general elections that were held in 2014; according to Bangladesh's constitution, any party that boycotts two successive elections should be dissolved. Boycotting elections for a second time appears to be a high-risk strategy, but the BNP has little to lose. The party is weak and has not had any legislators in parliament since Mrs Zia is unlikely to be able to lead an election campaign from jail, or even while free with multiple cases still pending. Even if the prosecution were to drop all other court cases against her which we do not expect the BNP may not run. Mrs Zia's party demands that the army be deployed during the forthcoming ballot and that parliament be dissolved before the poll (Bangladesh is one of the few countries in the world where parliament is dissolved only after the election). Finally, the BNP wants the Election Commission, which it says is biased towards the ruling party, to be reconstituted. The ruling party, the Awami League (AL), is unlikely to surrender any of these institutionally enshrined powers. It is the government's prerogative to decide on army deployment during the election. The BNP sees the deployment of troops as the only way to prevent AL activists from intimidating opposition supporters on polling day. However, the AL strongly opposes army deployment. There is some pressure from international observers to hold participatory polls, but the AL is unlikely to make concessions that would weaken its chances of securing a third consecutive term. Impact on the forecast We no longer expect the BNP to participate in the ballot, as it would lend some level of legitimacy to the elections, which is something that the AL would want. We retain our forecast of an AL victory. Furthermore, we expect BNP-led protests to intensify in the run-up to the elections. Analysis Crisis looming in Cox s Bazar July 31, 2018 The secretary general of the UN, António Guterres, visited Bangladesh in early July to assess the refugee situation in the country. Mr Guterres's visit helped to bring the grim circumstances of the 700,000 Rohingya in refugee camps to the attention of the international community, but the refugees will face more difficulties as monsoons approach. We expect the refugee crisis to persist for years owing to complications regarding the terms of repatriation. This is likely to hurt political stability in the country, especially in view of the national elections that are due by the end of Since August 2017 some 700,000 Rohingya refugees have poured into Bangladesh to escape a crackdown by the Burmese army following attacks by Rohingya insurgents in the northern part of Myanmar's Rakhine state. The UN labelled the resulting violence as "ethnic cleansing", while human rights groups reported mass abuses, which the government of Myanmar denies, insisting that it was only countering terrorism. Including the Rohingya that were already living in refugee camps in Bangladesh before August 2017, around 1m people belonging to this ethnic community now live in Bangladesh's southern port city, Cox's Bazar, and aid agencies report that they are Country Report August Economist Intelligence Unit Limited 2018

167 Bangladesh 23 struggling to assist them. Increasing pressure on Myanmar After visiting the camps, Mr Guterres described Myanmar's response to the insurgent attacks as probably one of the most "tragic stories" of "systematic violation" of human rights ever recorded, while praising Bangladesh's support to the refugees. Mr Guterres also met Bangladesh's prime minister, Sheikh Hasina Wajed, and pledged continued support to her government. He also promised that the UN would continue to apply pressure on Myanmar. Sheikh Hasina pointed out that Myanmar had not yet implemented its part of the November 2017 Rohingya repatriation agreement between the two countries. In early June Myanmar also signed an initial deal with the UN to encourage at least some Rohingya to return, but it reportedly incorporates no guarantee of citizenship or freedom of movement outside the Burmese state of Rakhine. Mr Guterres reiterated the UN's stance on the matter, stressing that the organisation would continue to press for the refugees' return to Myanmar and for that country to ensure the safety of the refugees and the respect of their rights. Need for enhanced support from the international community Mr Guterres also called on the international community to act on its supportive rhetoric, by contributing fully to the UN's US$951m joint rescue plan. As at June this year, the fund had received only 18% of the rescue plan target. Mr Guterres was accompanied by Jim Yong Kim, the president of the World Bank Group, which in June announced nearly US$500m in grant-based support to help Bangladesh address the refugee situation. In May the EU promised to increase its humanitarian support to Bangladesh on the Rohingya refugee issue and provided an additional 40m (US$48m). In late 2017 the Bangladesh government had asked the World Bank for a grant, saying that US$250m was required to support the refugees for six months. However, considering that the crisis is expected to drag on for much longer, we expect the assistance required to rise as well. Although we expect most of the requests for assistance to be met by bilateral and multilateral partners, we believe that conditions in the camp will remain poor, owing to overpopulation and inadequate sanitation facilities. Moreover, the risk of an epidemic breaking out in the camps looms as the monsoons approach. Meanwhile, China also assured Bangladesh that it would help when the Chinese and Bangladeshi foreign ministers, Wang Yi and Abul Hassan Mahmood Ali, met in Beijing in June. The two later held an informal meeting with Myanmar's minister of the Office of the State Counsellor, U Kyaw Tint Swe. Monsoon will worsen conditions in the camps The onset of the monsoon in Bangladesh has worsened the situation, raising the risks ofcyclones, flash floods and landslides. The refugee campsites, which have only makeshift shelters, also face the risk of inundation due to heavy rains. Furthermore, there is a risk of diseases breaking out in the area owing to inadequate sanitation. Another cause for concern is the risk of extremist terrorist organisations in Bangladesh taking advantage of the refugees, especially if the conditions in the camps fail to improve. The concentration of highly vulnerable people in the refugee camps could serve as a platform for recruitment by Islamist extremists, raising security concerns for Bangladesh and its neighbours. The Rohingya themselves are reluctant to return without guarantees of safety, rights and livelihoods. Only a small number of them have been repatriated to new, specially built facilities in Rakhine. Overall, we expect the refugee situation to persist at least in the early part of the forecast period ( ) as the repatriation process gets delayed owing to complications regarding the terms of repatriation. This will negatively impact political stability in Bangladesh and will continue to weigh on the country's bilateral relations with Myanmar. Awami League's prospects remain strong Bangladesh is set to hold general elections in late Although the government's support for the Rohingya has been well received by the general public across Bangladesh, the local community in Cox's Bazar is likely to become less tolerant towards the Rohingya. This could Country Report August Economist Intelligence Unit Limited 2018

168 Bangladesh 24 generate negative sentiment towards Sheikh Hasina and her party, and risks sparking claims that the government is prioritising the needs of the Rohingya over those of the local community. Bangladesh is already very overpopulated: in 2017 its population density was 1,265 people per sq km, as estimated by the World Bank. This compares with 450 for India, 256 for Pakistan and 342 for Sri Lanka. The influx of 700,000 refugees has increased pressure on the country's already scarce resources. Food prices have remained elevated since the second half of 2017, when the country was hit by a series of devastating floods. Furthermore, there is likely to be a fear among the locals that the refugees are threatening their job prospects. Evidence of this occurring could considerably shift locals' perception of the refugees. Despite these risks, our core forecast remains that the ruling Awami League (AL) is set to secure re-election in the parliamentary polls. The party's election prospects will be supported by the period of strong economic growth that it has overseen during its tenure. Moreover, the only credible yet weak threat to the AL is the Bangladesh Nationalist Party, which remains in disarray owing to the conviction of its leader, Khaleda Zia, on corruption charges. Economy Forecast updates Trade deficit widens in May July 20, 2018: External sector Event According to data released by Bangladesh Bank (the central bank), merchandise imports grew by 28.6% year on year to US$5.2bn in May, outpacing goods exports, which rose by 15.6% to US$3.3bn. Analysis The goods trade deficit for the first five months of 2018 stood at US$8.6bn, compared with US$4.9bn in the year-earlier period. This widening is attributable to a rapid expansion in imports, which have recorded double-digit growth rates since the second half of Numerous factors have driven up the import bill, which rose to US$24.2bn in January-May. These include a surge in demand for imports of capital machinery for the implementation of several large infrastructure projects, including the Padma Multipurpose Bridge Project and the Rooppur Nuclear Power Plant, as well as an increase in demand for imports of raw materials, such as cotton yarn and other textile articles, for the export-oriented readymade garments sector. Furthermore, rising global oil prices have made fuel imports more expensive. The surge in imports has not been matched by growth in exports, which have increased only marginally, by 7.8%, in the first five months of Readymade garments remained the largest category of Bangladesh's export earnings in May and we expect it to continue growing robustly over the rest of the year, buoyed by the continued shift in low-cost manufacturing away from China. However, given the continued need to import capital and intermediate goods, as well as rising global oil prices, we expect imports to continue to outpace exports by a significant margin in We expect the wide merchandise trade and current-account deficits to persist during the remainder of These shortfalls will continue to exert downward pressure on the local currency against the US dollar, which will contribute to a further rise in the import bill in the coming months. Impact on the forecast We have amended our forecast in the latest review and now expect a wider trade deficit than before. We now expect the trade deficit in 2018 to amount to US$15bn, compared with US$12.3bn previously. Country Report August Economist Intelligence Unit Limited 2018

169 Bangladesh 25 Consumer price inflation moderates July 31, 2018: Inflation Event According to data released by the Bangladesh Bureau of Statistics, consumer prices rose by 5.5% year on year in June, slower than the average increase of 5.8% in the first five months of Analysis The latest data are broadly in line with our expectations. All the categories making up the consumer price index recorded year-on-year gains. The biggest jump in prices was in the clothing and footwear category, which grew by 10% year on year, while the slowest annual increase was recorded in the recreation, education and cultural services category, which grew by 1.2%. Consumer price pressures were weaker in rural parts of the country compared with urban areas. The differential reflects the greater affordability of food in Bangladesh's villages. The slight moderation in the headline inflation rate is attributable to moderating food prices, a trend that has been in place since the start of Food prices increased by 5.3% year on year in June, slower than the average inflation for food prices of 6.7% in the first five months of We expect food price inflation to moderate further during the remainder of Nevertheless, we expect consumer prices to increase by an average of 5.7% in 2018, the same rate as in The increase for the year as a whole reflects the impact of a weaker exchange rate, loose monetary policy and an expected increase in domestic energy prices as a result of rising global oil prices. Impact on the forecast The latest data are in line with our expectations. Our consumer price inflation forecast of an average 5.7% increase in 2018 remains appropriate. Country Report August Economist Intelligence Unit Limited 2018

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171 National Security Strategy of the United States of America DECEMBER