To give or forgive

Economics focus

Jun 16th 2005
From The Economist print edition

The G8 wants to wipe clean the debts of impoverished nations. Erasing poverty will be harder

MISERS may be disliked, but usurers are despised. This may explain the remarkable success of the long-running campaign by churches, charities and celebrities to have the debts of poverty-stricken countries written off. Even when aid budgets were especially tight—roughly speaking, from 1993 to 2001—the campaign shamed the governments of the G7 rich nations into cancelling much of their bilateral debt. Reluctant to give money to poor countries, rich countries' governments became equally chary of collecting debts from them.

On June 11th, the debt-relief campaign won another triumph. At a meeting in London hosted by Gordon Brown, Britain's chancellor of the exchequer and a strong advocate of debt relief, the finance ministers of the G8 (the G7 plus Russia) agreed to cancel all the debts that 18 heavily indebted poor countries owe to three multilateral lenders, the World Bank, the International Monetary Fund (IMF) and the African Development Bank (AfDB).

The beneficiaries are Guyana, Honduras, Nicaragua, Bolivia and 14 African countries. The debts in question have a face value of about $40 billion, on which an annual average of $1 billion-1.5 billion is paid in debt service. Nine other countries may benefit within a few years, and a further 11 would be eligible if their governments were not so inept and corrupt.

To understand how the London agreement works, you have to follow the money. Next year, for example, Rwanda was due to pay at least $4.5m in debt service to the Bank and the AfDB and a further $2.9m to the IMF. Assuming the G8 proposal is passed and implemented promptly, Rwanda will no longer need to do that. However, the loans or grants it receives from the Bank and the AfDB in 2006 will be “adjusted” (ie, cut) by $4.5m, the same amount it saves on servicing its debts to them. So in the first instance it will have just $2.9m extra—the money it would have paid to the IMF—to spend on health care, education and so forth.

Some—notably, America—would have been happy to leave it at that. But at Britain's insistence, the new agreement goes further. The G8 acknowledges that, by freeing Rwanda and its sort of their debts, it is depriving the Bank, Fund and AfDB of loan revenue. The IMF will have to take the loss on the chin. But the Bank and the AfDB will be reimbursed. The two can then pass this new money on to poor countries, as they see fit. Rwanda might well see some of this extra money, but it need not.

There is one last twist in the money trail: from where will the G8 countries get the money to refund the Bank and the AfDB? They could raise it from their taxpayers. They could divert it from funds already allocated to their own aid budgets. Or they could deduct it from money they might otherwise have given the Bank and the AfDB. Their donations to the Bank have already been settled for the next three years, so any such diversion will be easy to spot in the short term. But in the future, there will be no way to know how much the G8 would have given the Bank in the absence of 100% debt relief. So one cannot know whether the money promised in London will come in addition to, or instead of, the money they would have given anyway.

Give and take

There is thus less to the London agreement than first meets the eye. Rich countries are often accused of giving with one hand and taking with the other. That said, in general, what donors take in debt repayments, they give back several times over in aid. Mozambique, for example, paid $71.8m on its debts in 2003. But the aid it received from all donors, multilateral and bilateral, amounted to about 14 times that figure. Admittedly, that includes the value of debt relief itself, and Mozambique's experience is extreme. But on average, reports the Bank, in the 1990s the heavily indebted poor countries received about twice as much in aid as they paid in debt service.

In a recent article*, Raghuram Rajan, chief economist at the IMF, teases out the implications of these two-way flows. Suppose a country pays $100m a year in debt service, but receives $200m in aid. How does its situation differ from a debt-free country that receives $100m in aid a year? The annual net inflow of money is the same; only the stock of liabilities differs.

Under certain circumstances, Mr Rajan notes, this stock of debts can cast a shadow over a country's prospects. It may deter private investment, because investors fear the government will overtax their profits to repay its creditors. A lack of investment will stunt growth, further diminishing the country's ability to service its debt. Debt relief is then in the interest of creditors and debtors alike.
It will increase the real value of the creditors' claims, because it restores the confidence of investors and thus the economy's ability to meet its obligations.

However, Mr Rajan doubts the relevance of this idea to the beneficiaries of the G8's proposal. There are many reasons why private investors might be deterred from an impoverished African country: corruption, insecure property rights, fragmented markets, lousy infrastructure. Debt is the least of them.

Mr Brown sees debt relief as but one step in increasing the resources that are made available to fight poverty. Aid budgets have already been rising; and Mr Brown and Britain's prime minister, Tony Blair, are pushing for another big increase in aid at the Gleneagles G8 summit in July. But Mr Brown's American counterpart, John Snow, sees debt relief as the last turn in a long-running “cycle of lend and forgive”. Efforts to ease Africa's official debts date back at least as far as 1987. Since then, Mr Snow points out, donors have repeatedly lent poor countries fresh money to help repay old loans gone sour. This month's deal should go some way to achieving Mr Snow's objective. But it will do little by itself to secure Mr Brown's.

* “Debt Relief and Growth”. Finance and Development, June 2005.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.

Old and new media part ways

Viacom

Jun 16th 2005
From The Economist print edition

To revive its growth in a digital world, Viacom is confounding many of its media rivals by splitting into two

VIACOM, the world's third-largest media company, is extraordinarily good at what it does: feeling the pulse of popular culture and making programmes that get people hooked. Viacom's profits depend on this ability, whether these are earned by CBS, its broadcast-television network; its radio stations; its cable channels such as MTV; or by Paramount, its movie studio. Last year Viacom had sales of $22.5 billion, and its market capitalisation is $51 billion. There is no sign that the firm has lost its creative edge.

Nevertheless, Viacom is about to break itself up and start all over again. This week it formally announced its split into two publicly traded firms. Sumner Redstone, its 82-year-old controlling shareholder, will divide the group into a slow-growing company, to be called CBS Corporation, and a fast-growing one which will keep the Viacom name. The idea is to hive off Viacom's traditional “old” media assets and create a smaller, nimbler version of the company to manoeuvre more easily in a world of “new” digital media, such as the internet, mobile phones and video games. “Sometimes divorce is better than marriage,” reasons Mr Redstone.

“Lunacy”, says an executive with a rival American media firm. “They'll lose a lot of their scale and their market power.” Viacom and the other three big media giants—Time Warner, the Walt Disney Company and News Corporation—have been built on a principle that size matters in media businesses. But times are changing.

The main reason why Mr Redstone has taken such a bold step is that Viacom's overall rate of growth has slowed and its shares have fallen by 23% since the beginning of 2004 (see chart). America's market for advertising on TV and radio is still valuable, but it is mature. Advertising contributed 60% of Viacom's revenues last year, but the market grew at a compound annual rate of just 3% during 1998-2003, according to Veronis Suhler Stevenson, a New York investment bank.

Other parts of the media industry are growing more quickly. Revenue at Viacom's cable networks rose 16.5% last year, though this is likely to slow. Advertising on the internet, video games, satellite radio and selling content to people on their mobile phones are growing the fastest. But Viacom has comparatively little presence in these fields. And even if it did, their relative size would be overshadowed by its traditional media interests.

By making the fast-growing businesses more visible Mr Redstone hopes that the stockmarket will value the two different parts of his empire at more than the whole. The high-growth company's main assets will be the cable networks; Paramount Pictures, a movie studio; and Paramount Home Entertainment. Its boss will be Tom Freston, currently co-chief operating officer of Viacom and who already oversees cable and Paramount. The new Viacom will have a balance sheet designed to allow it to acquire other high-growth assets.

CBS Corporation, on the other hand, will be made up of CBS; UPN (a smaller broadcast-television network); TV stations; radio and outdoor-advertising businesses; Showtime, a cable channel; the CBS, Paramount and King World television-production operations; Paramount's theme parks; and Viacom's publishing firm, Simon & Schuster. Its boss will be Leslie Moonves, currently co-chief operating officer and responsible for CBS, radio and some other operations. CBS Corporation is expected to take on most of Viacom's current debt and will return cash to shareholders through dividends and share buybacks.

Underlying the split is the change in traditional television and radio advertising as consumers spend more time with new media such as the internet.
Companies are having to think of new ways to reach consumers. Procter & Gamble and General Motors, America's biggest advertisers, are both shifting more of their marketing budgets this year away from TV in favour of new-media channels and other forms of promotion. At the same time, Americans are becoming accustomed to avoiding advertisements, whether by skipping through them with a personal video recorder, watching video-on-demand or subscribing to advert-free satellite radio.

Sibling rivalry

To some extent, the split simply reverses the $43 billion merger in 1999 that created Viacom. Back then, Mr Redstone merged his group of companies—including MTV and other cable networks, the Paramount movie studio and Blockbuster, a video-rental chain—with CBS, a broadcast-television company which also owned radio and outdoor-advertising businesses.

Yet many media executives outside Viacom reckon it is a mistake to undo that merger. Mr Redstone could boost growth without breaking up the firm, they say. And because Viacom owns mostly content and little distribution, it relies on the quality of its programming to get access to the airwaves. A break-up deepens the risk that a powerful distribution firm, such as Comcast, might either dump its least popular content or, more likely, beat its prices down. Viacom's main defence against this happening—a powerful one—is to keep producing must-see programmes.

Another fundamental reason not to break up a media conglomerate is the supposed synergy between the different bits. This notion has been partly discredited, but there remain some real examples. Owning CBS, for instance, means that cable and satellite-TV firms have to give something valuable in return for the right to broadcast the network's content. In the past, Viacom used this clout to help get distribution for new cable channels. Now, it says, it has extracted most of the value from these synergies.

A theory among some media insiders is that the split is simply Mr Redstone's way of dealing with succession. His plan until now was to pick Mr Freston or Mr Moonves to replace him as chief executive of the group, but now he can avoid choosing. This week he appointed his daughter, Shari Redstone, aged 50, to occupy a new position as non-executive vice-chairman. Messrs Freston and Moonves are expected to be named as chief executives of their respective companies in the coming months, and Mr Redstone will be chairman of both companies.

Of Viacom's offspring, Mr Freston's company has the hardest task. It has to produce the dizzying growth to justify Mr Redstone's decision. It plans to buy more cable networks, one or more video-gaming businesses and other digital-media businesses to help it grow.

It will be able to count on loyal staff. “The people who work for Tom Freston admire him so much, it's like they're part of a cult,” says an executive at a broadcast-TV network in New York. As chairman of MTV Networks, a position which Mr Freston held until Viacom's former chief operating officer, Mel Karmazin, resigned last year, he managed to achieve the hardest thing in the media business: giving creative freedom to his employees and making consistently large profits at the same time. It is crucial, he says, to keep things vibrant in an enormous factory of a company. “Consolidation can lead to mediocrity,” he says. Running a smaller Viacom should suit him well.

Getting into digital media and video games will not be easy or cheap, however, since every other big media company wants to do the same. The strategy is a risky one, says a report by Richard Bilotti, media analyst at Morgan Stanley, an investment bank, especially given the fact that in the past Viacom made massive acquisitions that earned it less than its cost of capital. Late last year, the company wrote $10.9 billion off the balance-sheet value of its radio business and $7.1 billion off its outdoor-advertising business.

Some of the new Viacom's aim of growing on the internet can be realised organically. As a whole, Viacom earned $100m of income from the web last year, and expects to double that in 2005. This month MTV Networks announced the launch in Japan of “Flux”, an internet and mobile-phone subscription service selling clips of Japanese content as well as MTV Networks material, such as “Dirty Sanchez”, a show about a group of Welsh skateboarders. In April, MTV Networks launched MTV Overdrive, an internet-based entertainment and news service.

For the immediate future, the fortunes of Mr Freston's company will rest largely on the health of its long-established cable networks. Cable television has already seen its best growth from advertising and fees from cable and satellite-television firms. Few in the media industry, however, doubt that MTV Networks will continue to thrive. Despite being almost 24 years old, the original music channel, MTV, has managed to maintain its appeal to fickle teenagers and young adults in America, as well as in over 160 countries around the world.

One guiding creative principle at MTV Networks is that good ideas are allowed to rise from the bottom up. Also vital, says Mr Freston, is frequent consumer research and changing the channels' content before the popularity of a particular type of programming passes its peak. MTV started the reality-television genre back in 1992 with a programme called “The Real World” when it saw that back-to-back music videos were losing their novelty. But now the reality genre “has a sameness”, says Mr Freston, “and we're trying to move away from it”.

Right now, MTV Networks' consumer research also suggests that the generation gap between young people and their parents has mostly disappeared. The mood of “I want my MTV”, and friction between generations has passed, says Betsy Frank, executive vice-president of research and planning at Viacom. Today young people even see their parents as heroes, she says. Moreover in America and elsewhere most young people are extremely tolerant of sexuality, and indifferent to ethnic origin, says Mr Freston.

A priority for MTV Networks is to increase its profits overseas. At the moment, Viacom earns 16.5% of its revenue from outside America. Along with America's other big media firms (apart from News Corporation, which earns about two-fifths of its sales overseas), it relies heavily on its domestic market. Of its overseas revenue (most of it from MTV Networks), 83% comes from Europe and Canada. MTV Networks wants to earn more from farther afield, especially in Asia.

Whether or not the new Viacom will be able to meet Mr Redstone's high expectations will also depend on Mr Freston's ability to turn around Paramount Pictures, which has had few hit movies in recent years compared with other studios. This year Viacom daringly hired as Paramount's new boss Brad Grey, a talent agent who previously ran his own management business but who has no experience of running a studio. Under Mr Grey, Paramount is trying to shed its reputation for creative conservatism, and is more welcoming to actors, directors and producers. It is also developing films for a younger audience and is working with MTV Films, whose successful movies include “Jackass: The Movie”. An easier way to generate cash will be to release more of its collection of films and TV shows on DVD. Up to now, Paramount has exploited its library far less than other studios.

“I am happy to be the underdog,” says Mr Moonves. Though responsible for the sort of traditional media that bloggers love to mock—including the business that has done more to drag down Viacom's growth than any other, radio—Mr Moonves is unlikely to sit back and remain content with slow growth. Indeed, one media executive predicts that the two companies are unlikely to stick to the growth characteristics that Mr Redstone seems to expect, and that CBS Corporation may do better than the market expects.

Here to infinity

Infinity Broadcasting, the radio division of Viacom, performed brilliantly when the government allowed the industry to consolidate during the late 1990s, which coincided with sharp increases in advertising revenue from the pharmaceutical industry and dotcom firms. But Mr Karmazin is said to have extracted all the growth he could while neglecting content. “What I found in the radio division was that they were starved and burning the furniture,” Mr Moonves told investors recently.

To stop listeners switching to satellite radio and their iPods, Infinity is replenishing its schedules. It is also rolling out a popular new format called “Jack” which it first launched at some stations more than two years ago. Designed to sound like an iPod on shuffle, “Jack FM” plays randomly from 1,200 familiar songs from the past three decades with less interruption from DJs. Another new initiative is the first podcasting radio station, with content taken entirely from listeners' submissions.

The other big chunk of the slower-growth business is CBS. For years, network TV's audience has been declining as viewers shift to cable. But CBS now has the biggest audience, and has trounced the long-established leader, General Electric's NBC. That is a huge achievement, even compared with the success of Viacom's niche cable-channels, says Michael Wolf, head of McKinsey's global media and entertainment practice, because CBS has had to win over a massive audience in middle America. CBS is also positioned well to grow in digital media. It has been particularly aggressive among the broadcast networks in using content from its shows to build a popular presence on the internet.
Viewers of its “Big Brother” reality show, for instance, flock online to watch live webcasts.

Mr Redstone's rivals will be watching events closely to see which of the two companies does best, because they face very similar challenges. If the new two-part Viacom performs as expected, even the bloggers may have to admit that a stodgy old media firm can duck and weave like a digital upstart.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.

The end of Purcell's troubled reign

Jun 13th 2005
From The Economist Global Agenda

Philip Purcell, the embattled chief executive of Morgan Stanley, is to quit following a blistering campaign against him by former executives of the investment bank. His downfall may presage the unravelling of Morgan Stanley’s merger with Dean Witter, which has mired the combined firm in culture clashes since the day they united

PUBLICISTS for merging companies often like to talk of a “merger of equals”, implying that there will be no winners or losers in the new firm, no conquerors or conquered—just happy co-workers. In practice, this sort of blissful union is rarer than hen’s teeth. The 1997 merger between Morgan Stanley, an aristocratic Wall Street investment bank, and Dean Witter, a proletarian retail brokerage, was typical in both the glowing rhetoric about harmonious fusion and the quick domination of one firm by the other that followed.

In the case of Morgan Stanley Dean Witter, it was a dictatorship of the proletariat, led by Philip Purcell, the former head of Dean Witter, who took the helm of the combined firm. Mr Purcell rapidly consolidated his power and by 2001 had pushed out John Mack, the former Morgan Stanley chief, even though he was widely believed to have been promised that the chief executive’s job would be passed to him within a few years, to get him to agree the merger terms. Since then, critics charge that Mr Purcell has surrounded himself with Dean Witter loyalists, making the investment bankers—who generate the bulk of the profits—into distinctly second-class citizens of the Morgan Stanley empire.

In recent months Mr Purcell has suffered a blistering campaign to unseat him, led by the “group of eight”, a collection of former Morgan Stanley investment bankers, now shareholders, while the bank itself has suffered waves of defections among senior staff. And, on Monday June 13th, Mr Purcell gave in to the pressure from his critics and announced that he would be stepping down as chief executive as soon as a replacement was found.

The group of eight stepped up its campaign against Mr Purcell after he announced in March that he was promoting two of his supporters, Stephen Crawford and Zoe Cruz, to co-presidents, putting them in line for the succession—and thereby triggering the exodus of five members of the management committee. The dissident group has been pushing a plan that would essentially undo the 1997 merger, unshackling Morgan Stanley’s world-class securities business from Dean Witter’s mediocre retail brokerage, its lacklustre mutual-fund line and its disappointing credit-card business, Discover, which has steadily lost market share.

Until the past weekend, Mr Purcell enjoyed the support of Morgan Stanley’s board. They rejected most of the group of eight’s proposals, though they did agree to sell off the credit-card business. Undeterred, the rebels took their battle public, buying full-page newspaper advertisements to convince shareholders that their plan could unlock hidden value in the bank’s shares, which have performed poorly in the past five years (see chart above). As institutional investors climbed aboard the bandwagon, pressure on the bank’s board increased, and the company’s stock price seemed to become directly correlated with the probability that Mr Purcell would leave his job.

Shareholder pressure may not be the only factor involved in Mr Purcell’s departure. On May 3rd, Morgan Stanley disclosed that it had found e-mails previously said to have been destroyed in the September 11th 2001 attacks on the World Trade Centre, where Morgan Stanley had offices. Many of its competitors have suffered harsh penalties over various financial scandals following the discovery of incriminating e-mails but no such damning evidence had come to light in Morgan Stanley's case. The sudden rediscovery of missing messages has proved embarrassing to Mr Purcell, who had previously gloated about his firm’s luck. It has also brought unwelcome attention from the Securities and Exchange Commission.

More pressingly, Morgan Stanley is haemorrhaging talent. Since the departure of the management-committee members, ever more investment bankers have joined the conga line flowing down Broadway to the bank’s competitors. On Friday, a nine-person team from the bank’s equity-derivatives group defected to Wachovia, an ambitious rival which is trying to build its stock business. Equity derivatives has recently been one of Morgan Stanley’s most successful businesses, and the loss of its team may well have been the final straw as regards the board’s support of Mr Purcell. The board will also have been dismayed at Morgan Stanley's weak financial performance: on Monday, the bank gave a warning that its second-quarter earnings will be as much as 20% below the equivalent figure for 2004, and well below what stockmarket analysts had expected.

The plain-speaking Mr Purcell has not tried to sugar-coat the reasons for his departure with talk about “spending more time with my family” or “seeking new opportunities”. The second sentence of his letter of resignation reads: “It has become clear that in light of the continuing personal attacks on me, and the unprecedented level of negative attention our Firm—and each of you—has had to endure, that this is the best thing I can do for you, our clients and our shareholders.” So far, the market seems to agree; Morgan Stanley’s shares opened on Monday morning at $51.76, up sharply from their $49.88 close on Friday. Stockmarket analysts, like the group of eight, seem to be hoping that his departure will mean the sale of Dean Witter’s assets and Morgan Stanley’s return to being run by its investment-banking aristocrats. It would not be the first time that a dictatorship of the proletariat proved to be short-lived.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.

A lively contest—but will it matter?

Jun 17th 2005
From The Economist Global Agenda

Mostafa Moin, a leading reformist, is putting up a strong challenge to Akbar Hashemi Rafsanjani, the conservative front-runner in Iran’s presidential election. But whoever wins, it is unclear if Friday’s vote will change the way the Islamic Republic is run

ALL the campaign razzamatazz in the final days of Iran’s presidential election campaign might lead a casual observer to conclude that the nation has become the sort of liberal and pluralist democracy that George Bush wants to see across the Middle East. Tehran’s streets thronged with supporters of the various candidates; cars blared out campaign songs; there were even roller-blading girls handing out leaflets. Television stations screened slick, Hollywoodised propaganda slots, while coverage on state-run broadcasters was reasonably even-handed. What is more, it was far from certain which of the contenders—ranging from hardliners to liberals—would win. On polling day, Friday June 17th, the authorities extended voting by several hours, saying this was due to “massive participation”. Some hours before the close, an official told the French News Agency that about 55% of voters had already turned out—though there was no independent confirmation of this.

Iran today is indeed a less stiflingly repressive place than it was in the early years following the 1979 Islamic Revolution, in which a pro-western monarchy was swept away by puritanical Shia Muslim clerics who despised America—“the Great Satan”. Young Iranians have rather more freedom in how they dress in public, in their contact with the opposite sex and in the music they enjoy.

However, it has seemed increasingly clear during the two terms in office of the current, moderately reformist president, Muhammad Khatami, that for all the outward signs of democracy, ultimate power continues to rest with the mullahs—in particular the Supreme Leader, Ayatollah Ali Khamenei. Time and again, President Khatami saw his liberalising laws passed by the elected parliament, only for them to be overruled by the unelected Council of Guardians, a hardline group of clerics and Islamic jurists.

So it is unclear how much will really change, whoever wins the presidency this time. Opinion polls suggest that the front-runner is Akbar Hashemi Rafsanjani, a conservative former president (1989-97) regarded as the second most powerful figure in the land after the Supreme Leader himself. Mr Rafsanjani has reinvented himself as a cautious reformer who would liberalise Iran’s economy and improve relations with America. But he may not gain the 50% of votes cast that he needs to avoid a run-off.

Of his six rival candidates, Mr Rafsanjani has faced strong challenges from two quite different characters: Muhammad Ghalibaf, a former police chief with strong support in the Revolutionary Guards—the regime’s main enforcers—who is nevertheless painting himself as a moderniser; and Mostafa Moin, a liberal who defended students’ rights during a spell as higher-education minister.
Curiously, the Council of Guardians tried to ban Mr Moin from standing, only for Ayatollah Khamenei to overrule them and reinstate him. Mr Moin and his campaigners have made much more of a splash than had been expected, while Mr Ghalibaf has cut a dash with lavish campaign commercials, showing him piloting a plane. Despite his hardline past, Mr Ghalibaf is seen as having reined in the excesses of the often brutal police force—in particular during pro-democracy protests in 2002-03.

As for the religious hardliners, they may now be regretting not uniting around one candidate, since none of the three remaining hardliners in the race has done well. The worst case for them would be a run-off between the liberal Mr Moin and the independent-minded Mr Rafsanjani, the candidate most able to challenge the ayatollahs. Some suspect that bombs in Tehran and elsewhere in the final days of the campaign, which killed several people, were the work of conservatives trying to scare voters from the polls; but the various attacks may in fact have unrelated causes.

In a country whose minimum voting age is 15 and where half of the 67m population is under 25, the main candidates have been keen to demonstrate that they understand young Iranians’ frustration at their lack of personal freedoms and gloomy job prospects. However, young voters’ enthusiasm for change is tempered by their scepticism that changing the president will really change the country. Many are expected to stay away from the polls.

The issue that most interests the outside world is Iran’s apparent attempts to learn the techniques for making nuclear bombs, and America’s determination to stop this. On Thursday an official of the International Atomic Energy Agency (IAEA) said Iran had admitted it continued trying to produce plutonium until 1998, having earlier claimed to have stopped doing so in 1993. (The Iranians later quibbled with this, saying they had not significantly changed their story.) Iran continues to resist the IAEA’s demands to let inspectors have full access to its nuclear installations. But none of the main presidential candidates has dared to antagonise the Supreme Leader by calling for an end to Iran’s nuclear defiance. Indeed, they barely mentioned the issue during the campaign, regarding it as too hot to handle.

Besides the nuclear issue, Iran’s international isolation is reinforced by its support for Islamist terror groups and its failure to back the Israeli-Palestinian peace process. Though it is unclear if Mr Rafsanjani would, overall, be as much of a reformist as he now claims to be, he has long argued for an improvement in relations with America—and many in the West see him as the only candidate with the clout to persuade the Supreme Leader to agree to such a rapprochement.

The next Turkey? Or Ukraine? Or maybe North Korea?

With growth faltering, unemployment officially at 11% (the true figure may be almost twice as high) and inflation at 14%, the economy is the issue that most concerns Iranians. Since the Islamic Revolution, statist Iran has been greatly overtaken by liberalising Turkey, its big rival to the north-west. Freeing Iranians’ entrepreneurial spirit and making it easier for foreign firms to invest in the country’s colossal oil reserves would do more to improve the lot of its citizens than building nuclear bombs. Mr Rafsanjani and Mr Ghalibaf have talked of privatising inefficient state firms but, once again, whoever wins the presidency would face fierce resistance from the clergy.

Some Iranians see signs of an unstoppable popular desire for liberty, and dream of a Ukrainian-style revolution to free their country from the mullahs’ grip. The more pessimistic fear a drift towards becoming the next North Korea—a regime that brandishes nuclear weapons at the outside world while its people slide into penury. For all the recent signs of liberalisation, the clerical regime is determined to hang on and can still crush its opponents with impunity. Even if the successful presidential candidate is sincere in his promises of reform, he may have no more success than the hapless Mr Khatami in wresting power from the theocrats.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.

An odd time to be rising

Buttonwood

Jun 14th 2005
From The Economist Global Agenda

Europe’s share prices are rising smartly even though Europe itself seems to be falling apart

DOES it strike anyone else as odd that European shares are jumping ahead these days? The future of the euro, perhaps even of Europe, looks more than a bit uncertain. Each new economic statistic is soggier than the last. Yet France’s CAC 40 has risen by 1.7% since its citizens voted against the proposed European constitution, and it touched a three-year high en route.

Frankfurt’s DAX has gone up by 3.5% and the pan-European FTSEurofirst 300 by 3.1%. America’s S&P 500, meanwhile, has risen by a mere 0.2% and the Dow Jones Industrial Average has slipped by 0.2%. Looking at total returns, which include dividends along with share-price movements, the pattern is the same. And so it has been since before the beginning of the year.

At first glance this looks like another conundrum. Economic growth in the euro area is likely to be just 1.4% this year, according to the European Central Bank, and most expect the forecast to be cut again before long. Of the zone’s biggest economies, Italy is in flat-out recession, while France and Germany are barely growing, with unemployment of around 10%. Britain, outside the euro area, has enjoyed good economic growth, but house prices are now trending down and consumer spending is slowing. Across the Atlantic, by contrast, the United States is growing at about 3.5% and unemployment is just over 5%. So, why are European shares doing so well?

The first answer is that they aren’t, exactly. As the chart below shows, translated into dollars, European shares have done roughly the same as American shares. The dollar has strengthened by over 12% this year against the euro, and is likely to strengthen further as the gap between American and European short-term rates increases.

This means that foreign investors in euro-area shares have seen some of their profits lost in translation. But the strong euro had been a millstone around the necks of Europe’s exporters: Italy, of all places, became a net importer of shoes last year. The weaker euro brings hope of export-led growth. Among the higher-flying European shares these days, points out James Barty, head of tactical asset allocation at Deutsche Bank in London, are those that are most sensitive to exchange-rate moves. These include Richemont, a luxury-goods maker, whose stock has risen by 13% over the past month, and capital-goods manufacturers such as SKF, which is up by 7.5%.

A recent shift in expectations about interest rates is another part of the answer. As recently as a couple of months ago, their likely direction seemed to be upwards in America and undecided in Europe. Investors now seem to reckon that the Fed will soon find lower growth a greater threat than higher inflation and stop hiking interest rates—though a rise looks virtually certain later this month. Ten-year Treasuries have recently flirted with yields below 4%. In Europe the ECB is being pressed to cut short rates, and most expect the Bank of England to lower rates.

When bond yields fall (ie, bond prices rise) and look likely to stay down, shares tend to look undervalued by comparison—and investors rush in. This is happening, to some degree, in both America and Europe. But there is a difference. Europe’s shares are relatively cheaper than American ones to start with, and its bonds are dearer. Yields on ten-year German Bunds, for example, are 93 basis points lower than the yield on ten-year Treasuries. Euro-area shares, meanwhile, are selling for 13 times forecast 2005 earnings, on figures from Deutsche Bank, while S&P 500 shares are trading at price-earnings (p/e) multiples of 16. So the comparison between dividend yields and bond yields favours shares even more in Europe than it does in America.

It is a bit misleading to compare share indices across boundaries, because their sectoral composition can be quite different. Europe, for example, is reckoned lighter in growth stocks than America, so some argue that it is logical for the index to reflect lower p/e multiples. Stripping out sectoral differences, however, Mislav Matejka, head of European equity strategy at J.P. Morgan Chase, finds that European shares (excluding health care) sell at a 15% discount to American shares.

Is that discount justified? Probably not. True, share prices are supposed to reflect expectations about future profits, and long-term trends favour America. Productivity is increasing faster there than in Europe and its working-age population is decreasing more slowly, so a growth gap of some magnitude is likely to continue. But Europe has the edge in two respects.

First, European firms are better placed to react to their common dilemma: competition from emerging countries with low wages and high investment rates, which is also pushing up commodity prices. With virtually full employment in America, companies cannot squeeze labour costs to compensate; in fact, unit labour costs are rising. In the euro area, where unemployment is high, companies can continue to lean on real wages. In addition, while companies on both sides of the Atlantic have healthy balance sheets after a couple of years of paying down debt, European firms deleveraged more, says Luca Silipo, an economist at IXIS CIB in Paris.
European profits should therefore be more robust, despite lacklustre economies, and so should shares. Indeed, they have been since mid-2004, reckon the team at IXIS CIB.

The second point is that, for all its deservedly bad press, Europe’s monetary union has done some of what it was supposed to do: make companies streamline and become more competitive. Germany is the main example of a country where some tough restructuring has taken place.
The current wave of mergers and acquisitions, which has boosted the share prices of European firms in recent days, is one sign that whatever the politicians think Europe has much to gain from consolidation. The €15.4 billion bid for German bank HVB by Italy’s UniCredit, agreed on Sunday, is Europe’s biggest cross-border banking takeover but it will not be the last one.

So should we all race out and buy Siemens shares? If you believe that the Fed is about to hang up its rate-hiking jersey, then yes, for a bit. But some of the cannier heads are not so sure. Rolf Elgeti of ABN AMRO warns that there is a “significant possibility” that the market is wrong, and that the Fed will keep raising rates on signs of continued inflationary pressure. If so, equities could see severe setbacks. And David Bowers of Merrill Lynch points out that if the euro is weak because markets sniff the end of restructuring in Europe, or equities look cheap because of lower interest rates that tell us deflation may be returning, these are hardly positive signs for an asset class that depends on growth.

At the end of the day, big companies are ever less anchored to the domestic economy in which they are domiciled anyway. Siemens sells more than half its products outside Germany; Nokia is a play not on Finland but on global demand for mobile phones. So Buttonwood’s answer is to look for long-term investment in anything that is yield-sensitive and selling at fair value (among utilities, oil and gas, telecoms, insurance), and for short-term investment among potential takeover candidates—and it doesn’t much matter whether you buy it in America or in Europe.

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Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.

OPEC’s symbolic move

Jun 20th 2005
From The Economist Global Agenda

In confirmation that OPEC's raising of its production quotas last week was largely symbolic, oil prices have raced towards $60 a barrel. With supplies tight, and new production and refining capacity slow to come online, prices are likely to stay high in the short term. But consumers aren’t cutting back on their spending as a result. Expensive oil may not be the harbinger of doom that economists once thought

FOR years now, pessimists have been proclaiming that oil prices were about to bring a dread reckoning on a world thirsting for energy. These days, there must be more than a few red faces at the Legion of Doom. Their predictions of devastating economic effects from high oil prices came to naught as the black stuff soared past $30, then $40, then $50 a barrel, and the world economy posted the best growth rates in a generation. Even more embarrassingly, the gluttonous United States has outperformed its oil-sipping peers.

Nonetheless, even members of the Organisation of the Petroleum Exporting Countries (OPEC), whose oil wells might as well be pumping out hundred dollar bills, are looking for ways to calm prices. They fear that a sustained period of expensive oil, such as the one in the 1970s, during the cartel’s formative years, will bring about a global economic downturn that slashes demand for their product—or worse, spur consuming nations to make their economies more oil-efficient.
In the latest OPEC meeting, held on Wednesday June 15th, fretful members like Nigeria overcame the resistance of hawks like Venezuela to secure an increase in official production levels. Members agreed to an immediate quota increase of 500,000 barrels per day (bpd), to 28m bpd, and said they would consider a further 500,000 bpd increase later in the year if prices stay too high.

Unfortunately for oil consumers, this is more of a symbolic effort than a real attempt to ease oil prices. Thanks to cheating by members on their quotas, OPEC is already pumping at least 28m bpd, and possibly as much as 30m. The quota increase merely legitimises activity that is already taking place. Worse, OPEC may not be twiddling its thumbs because it wants, despite the rhetoric, to keep prices high, but because its members lack the capacity to increase production.
OPEC members, particularly Saudi Arabia, the cartel’s swing producer, have historically maintained a buffer of spare production capacity which could be brought online if prices surged. In recent years, however, that buffer has been run down, in part due to soaring demand and in part thanks to the bitter memory of $10-a-barrel oil, which has made oil producers leery of ramping up production capacity too quickly.

Non-OPEC sources of oil are even tighter. Russia, which has been growing its production rapidly in recent years, has seen output stagnate over the past few months, largely thanks to government interference in the energy sector. Elsewhere, the big oilfields that were developed in the wake of the 1970s oil crises have begun to decline, and oil companies are having to look to undeveloped regions where big investments in technology are needed to get the oil out of the ground, and political and legal risks are often high. For these reasons, global spare capacity has dropped close to a 20-year low.

But this does not mean, as some alarmists are arguing, that world oil production is nearing its peak. There is room for OPEC’s members to increase the amount they pump; it is the memory of $10 oil, not physical limits, that is holding them back. And constantly improving technology is not only raising yields in oilfields everywhere, but also opening up new sources of oil. Companies are going after the stuff under deep water, or locked in unconventional sources, such as oil shale or Canada’s tar sands.

Refining their thinking

However, the fact that there are additional sources of oil to be exploited does not necessarily mean that oil will be cheap. Already, many—including OPEC—are warning that tight refining capacity is an even bigger problem than oil production. Any extra oil that OPEC produces right now will be heavy, high-sulphur crude, which requires high-tech refineries to make the end products meet western environmental standards. But that sort of refinery capacity is already stretched. OPEC ministers have essentially admitted that the current round of quota increases will have no effect on price, saying that until there is more refinery capacity, there is little they can do. The market seems to agree. The price of West Texas crude, the US benchmark grade, rose in the days following the OPEC meeting, and by Monday June 20th it was trading at a whisker below $60 a barrel, a new record—partly because of terrorism alerts at western consulates in Nigeria, the world's seventh-largest oil exporter.

But there remains fierce resistance to building new refineries in rich-world, oil-consuming nations. Moreover, in America subtle differences between the states’ oil-composition standards mean that refiners are forced to make large numbers of small production runs. This not only limits their efficiency but also sometimes causes price spikes as consumers are left stranded, unable to buy “foreign” petrol that does not meet their local standards. Technological advances have thus far enabled refiners to eke out more production from existing facilities. But the potential bottlenecks leave consumers vulnerable to price swings.

So far, however, consumers don’t seem to care. High oil prices have had little noticeable impact on world demand—even for oil itself—leaving analysts scrambling for an explanation. Some look to governments, which in the 1970s took vigorous action to improve the energy efficiency of their economies by enacting things like gas taxes and fuel-efficiency standards. There has been little such activity this time around.

Others think that price increases up to a certain point may have little effect, but that even moderate increases after that point (whatever it is) might produce sharp changes in consumers’ behaviour. And still others argue that consumer reaction has been muted because the latest round of price increases, unlike past rounds, has been driven by increasing demand, rather than a sudden contraction in supply. The economic growth driving the higher demand, they argue, may be offsetting the negative effects of high oil prices. Or it may simply be that demand-driven increases are more gradual than those following a supply shock, giving consumers, and economies, time to adjust gracefully.

But now that the world economy is bumping up against short-term supply limitations, that may change. Saudi Arabia seems to be in the process of rebuilding OPEC’s buffer, but this will take time. In the meantime, even if prices fall, they are likely to remain volatile, as even small shocks to supply (a few exploded refineries in Iraq, say) will be able to produce a sudden sharp mismatch between supply and demand. Until the world develops some spare capacity, the road ahead looks sure to be bumpy—particularly if you are driving an SUV.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.

Mbeki cleans up, Zuma faces charges

Jun 20th 2005
From The Economist Global Agenda

South African prosecutors are to bring corruption charges against Jacob Zuma, who was sacked as deputy president last week by Thabo Mbeki. The moves against Mr Zuma are the strongest signs yet that Africa’s leading nation is serious about fighting top-level corruption

SACKING his popular deputy was a tough decision, perhaps the toughest that President Thabo Mbeki has yet faced. But Mr Mbeki's bold action, last week, has at last encouraged South Africa's prosecutors to move against Jacob Zuma, who is accused of taking huge bribes from a businessman friend, Schabir Shaik. On Monday June 20th, the state prosecution authority said two criminal counts of corruption would be brought against Mr Zuma. Mr Shaik was sentenced to 15 years' jail earlier this month.

Sacking Mr Zuma was hard for Mr Mbeki because his deputy is a charismatic figure who remains highly popular in the ruling African National Congress (ANC) and among the country’s powerful trade unions. Mr Zuma’s supporters admire him for his modest beginnings and his role in the struggle against the former white-supremacist apartheid regime—and many of them dismiss the corruption allegations as a conspiracy. The appointment in 1999 of Mr Zuma, a Zulu, helped to end years of violent clashes between the ANC and a rival for votes among the country’s black majority, the mainly Zulu Inkatha Freedom Party. But in the end, the president told parliament last Tuesday, he had concluded that it was in the best interests of Mr Zuma himself, the government and “our young democratic system” to relieve him of his responsibilities.

The ANC—which has governed South Africa since democratic majority rule was introduced in 1994—has recently had its reputation tarnished by a number of scandals. It has fought back by promising to take a tough stand against corruption in public life. The case of Mr Zuma and his links to Mr Shaik has been the ANC’s biggest embarrassment and thus the biggest test of its determination to clean up.

Mr Shaik received his jail sentence for paying Mr Zuma 1.3m rand ($189,000) in return for advancing his business interests and for soliciting a bribe on Mr Zuma’s behalf from a French arms firm. Though the Scorpions, South Africa’s equivalent of the FBI, had said there appeared to be a case against Mr Zuma, prosecutors took their time in deciding to press formal charges against him. Protesting his innocence, Mr Zuma had resisted pressure to resign of his own accord, complaining of having to undergo “trial by media”. However, the judge in Mr Shaik’s case concluded that the relationship between the two men was “generally corrupt”.

The verdict against Mr Shaik was in itself a victory for those trying to root out top-level corruption in South Africa. But Mr Mbeki’s decision to kick out his number two, and the bringing of charges, are the most encouraging signals yet from sub-Saharan Africa’s leading nation that it is serious about combating graft. At a time when the rich world’s leaders are discussing a big rise in aid to poor African countries and forgiving their crippling debts, Mr Mbeki’s action was a timely response to those sceptics who argue that boosting aid is pointless because so much of it is embezzled by corrupt political elites. Had he not acted now to remove his deputy, he would have faced an awkward meeting with the rich donor countries’ leaders at next month’s Group of Eight summit in Scotland—and he would have had to leave a seriously tarnished Mr Zuma running the country in his absence.

The sacking of Mr Zuma came shortly after the ANC gave a warning to its parliamentarians that any of them found guilty of fraud in another scandal, concerning travel expenses, will also be fired. Earlier this year, Transparency International, a corruption-monitoring body, praised the South African government’s efforts to curb graft. Transparency International’s league table of corruption perceptions already rates South Africa as the least corrupt country in sub-Saharan Africa bar Botswana. But the country’s size, and the prominent role it takes in regional institutions such as the African Union, mean that its drive against graft will set a positive example to neighbouring countries with weaker governments.

Nonetheless, there is still plenty of scope for greater openness in South African politics. Worryingly, last month a court barred the Mail and Guardian, a leading weekly, from publishing an update on what is being called “Oilgate”. The newspaper alleges that public funds from a state-owned oil company ended up in ANC coffers via a private company, just before last year’s general election. Also last month, a court refused to let the Institute for Democracy in South Africa, an independent outfit, force the country’s four biggest political parties to disclose who their private donors were.

Though Mr Mbeki and the ANC easily won last year’s election, the recent rash of corruption allegations has come amid signs of public dissatisfaction at the government’s failure to deliver on its promises. Last month, there were riots over housing and poor local services. In a sign of strains within the ruling party, the premier of Western Cape province, appointed by Mr Mbeki, has just been defeated in elections for the ANC’s provincial leadership. Later this year or early next year, the party will have to defend its record in local elections.

Thus it will be important for the president and his party to put the bribery scandal quickly behind them. One of the most important issues now will be whom Mr Mbeki chooses to replace Mr Zuma as deputy president, and who the ANC eventually chooses as its second in command, a job Mr Zuma keeps, for now at least.

In his parliamentary speech last Tuesday, Mr Mbeki only said that a successor would be announced in due course. Among the leading contenders are the defence minister, Mosiuoa Lekota, and the foreign minister, Nkosazana Dlamini-Zuma (who is the sacked Mr Zuma’s former wife). Another possibility is the minerals and energy minister, Phumzile Mlambo-Ngcuka, whose husband, then a public prosecutor, said two years ago that there was prima facie evidence of corruption by Mr Zuma but not enough to guarantee a conviction. Now that Mr Zuma seems to have been ruled out of succeeding to the leadership, the choice of his replacement will be watched carefully for signs of which direction South Africa, and the region as a whole, will take in future.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.

Europe’s painful summit

Jun 17th 2005
From The Economist Global Agenda

At a summit in Brussels, leaders have agreed to put the European Union’s proposed constitution on hold, but a deal on the EU's budget looks unlikely. Nor is much progress expected on the long-term challenges of economic reform and enlargement

THE European Union has faced crisis before. The 1970s are widely considered a lost decade for European integration. In the 1990s, Danish voters rejected the Maastricht treaty. And Irish voters did the same with the Nice treaty in 2001. So while French and Dutch voters have recently delivered a stinging slap in the face for “ever closer union” between the EU’s 25 members, by voting to reject the Union’s proposed constitution, the show will go on. On Thursday and Friday of this week, the leaders of the EU’s member states are meeting in Brussels to try to determine exactly how.

The first thing the summit has had to determine is what to do about the constitution. It would have made some (mostly sensible) reforms to the EU’s voting system and created a longer-term presidency. It would have also given Brussels power over more areas of formerly domestic policy (such as some bits of justice and home affairs). But the French and the Dutch associated the document with a whole host of mostly unrelated things, such as EU enlargement, and blew it an almighty raspberry in referendums on May 29th and June 1st respectively.

Immediately after the votes, Jean-Claude Juncker, Luxembourg’s prime minister, who holds the six-month presidency of the EU, said that other members planning to hold referendums should go ahead with them despite the Dutch and French noes. Jacques Chirac, France’s president, who had thrown his weight behind the yes campaign and was left humiliated by the result, agreed. But Britain, scheduled to hold a referendum next year, announced that it was suspending plans to do so. Tony Blair, the prime minister, feared losing it in any case, and is happy to put it on the shelf.

Though many European leaders were, unlike Mr Blair, extremely reluctant to put the constitution formally on hold, on Thursday evening they bowed to the inevitable and did just that. Mr Juncker announced that the original ratification deadline of November 2006 no longer applied. Immediately, several countries, including Sweden and the Czech Republic, said they would delay ratification until the future of the constitution was clear. This in effect leaves the document, in its current form, dead.

The issue on the agenda for Friday, the EU’s budget, will be thornier. The member states’ leaders must agree a framework for spending for 2007-13. But a row has developed between the countries that pay the most in and those that get the most out. A group of the biggest paymaster countries wants to cap the budget at 1% of the EU’s GDP. The European Commission, the EU’s Brussels-based executive, would like 1.14%, and the budget’s biggest net recipients tend to agree that the pie should be bigger. The Luxembourg presidency has offered a compromise leaning towards the smaller budget.

But an even more divisive question than the size of the budget is that of who gets what. In the spotlight is Britain, which for two decades has received a special annual rebate. When Margaret Thatcher secured the “abatement” (in Eurospeak) in 1984, Britain was both a big net contributor and one of the EU’s poorer members. Since then, Britain has prospered (while on the continent France, Germany and Italy have stagnated in relative terms) and is now one of the richest members. When the ten countries that joined the EU last year—most relatively poor ex-communist lands—start paying their full share of the budget, they will be contributing to Britain’s rebate. All of them see this as deeply unfair, as do France, Germany and most other older members of the Union.

But Mr Blair has found an answer for them: the biggest item in the budget, the common agricultural policy (CAP), is egregious too. It consumes a great deal of money—close to half of the total budget (see chart)—on the 4% of the EU’s population that still works the land, drives up food prices in Europe and hurts farmers in the poor world. With his new-found zeal on reducing poverty, especially in Africa, Mr Blair says he will only negotiate on Britain’s rebate in the context of an overall reform of the budget. Since the CAP is the main reason for Britain’s budget imbalance (it has relatively fewer farmers than other members do), trading the rebate for CAP reform seems to make sense.

To Mr Blair. For Jacques Chirac, France’s president, it is out of the question. Mr Chirac is a former farm minister who cut his political teeth in rural France. And though farmers nowadays make up a small percentage of the population, even in France, they are a crucial part of Mr Chirac’s Gaullist party’s support base. They are also adept at direct action, sometimes even blocking the streets by dumping tons of produce or manure. There are other countries that do well out of the CAP—Spain’s farms are big beneficiaries, and Poland’s will be—but it always seems to be France that prevents reform. In 2002, Mr Chirac and Gerhard Schröder, the German chancellor, stitched up a deal to keep farm spending from being cut before 2013, which other leaders later ratified. Mr Schröder says Germany honours its deals, which means he will stand with Mr Chirac.

On this issue, too, Mr Juncker has tried to find a compromise, suggesting that the rebate debate be linked to farm-subsidy reforms, and that Britain’s rebate be frozen in nominal terms for several years. That, of course, would mean it would shrink, both in inflation-adjusted terms and as a percentage of the (growing) EU budget. Mr Blair met Mr Juncker on Tuesday, ahead of the summit, and then later Mr Chirac. But the British leader’s office has said that freezing the rebate would cost Britain €25 billion-30 billion over the 2007-13 budget cycle, and Mr Blair said after his “immensely amicable” meeting with Mr Chirac that they had failed to reach a deal. Nor is one likely at the summit.

What won’t be said

The constitution and the budget will take up most of the time at the summit. This is unfortunate, as Europe needs to talk about reforming its economy, and when and how to enlarge again. The “Lisbon agenda”, which is meant to make Europe’s economies more competitive and technology-driven (through the sharing of “best practice” and the naming and shaming of laggards), is moribund. Big European states, especially France, Germany and Italy, have constipated labour markets. But since many Frenchmen rejected the constitution precisely because it didn’t create enough of a “social Europe” (ie, job protection and the like), a call for economic liberalisation is unlikely to appear in strong form in the summit’s final communiqué.

Nor will another word appear: Turkey. The EU promised in December that it would begin membership negotiations with the big, poor Muslim country in October 2005. But the leaders will include only an oblique reference to enlargement in their final statement, mindful that this is a delicate time for a Europe struggling to define itself. It seems the Turks, who desperately want EU membership, and not the second-class status some would like to give them, face a very long wait.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.

A big, and rare, European bank merger

Jun 15th 2005
From The Economist Global Agenda

Does the €15 billion bid by Italy’s UniCredit for Germany’s HVB mean that the long-awaited wave of consolidations among European banks has begun? If so, bank customers would benefit. But such cross-border mergers still face daunting obstacles, not least protectionist attitudes by national regulators

FOR all the constant rumours of bids and mergers between European retail banks, there has been disappointingly little progress towards the creation of a single, continent-wide market in financial services analogous with the single market in goods that the European Union has enjoyed for the past 13 years. So far, most of the mooted cross-border banking tie-ups have faltered in their early stages. However, on Sunday June 12th, Italy’s UniCredit announced that it was going ahead with its heavily trailed bid for HVB, Germany’s second-largest banking group, which if completed will be Europe’s biggest cross-border bank merger to date.

UniCredit (known until recently as UniCredito) is offering €15.4 billion ($18.6 billion) for HVB, plus several billions more to buy out minority shareholders in two of the German bank’s subsidiaries in Austria and Poland. Until now, the only significant cross-border retail-banking deal in Europe was last year’s takeover of Britain’s Abbey by Spain’s Banco Santander Central Hispano (SCH). When seeking growth opportunities, Europe’s big banks have tended to look either at home or further afield outside Europe. The lack of consolidation means that retail banks’ costs continue to vary hugely from one European country to the next. Were banks able to compete more freely across borders, many consumers might benefit from lower prices.

Several reasons are often given for the reluctance of European banks to engage in cross-border liaisons. Cultural differences are often mentioned first. There is a belief that differing consumer habits and expectations of banking services have discouraged banks from looking elsewhere in Europe for partners. At the same time, much is made of the local relationships and knowledge that drive a successful bank. Undoubtedly there might be some difficulties for a bank moving into new territory but these are surely overstated. For example, SCH and its big Spanish rival Banco Bilbao Vizcaya Argentaria (BBVA) have made a number of big and largely successful acquisitions across Latin America in recent years. Some 70% of the earnings of HSBC, Britain’s biggest retail bank, come from abroad.

A far greater deterrent to Europe-wide integration is that the two arms of a merged bank would have to operate under different regulatory regimes while lacking a centralised payments mechanism. Dealing with a jumble of rules means that any truly pan-European bank would find it hard to offer comparable products to customers in all the countries in which it operated. Often it is regulations, rather than the demands of customers for differing levels of service, that account for price variations. And even if it were possible to offer homogeneous products across the continent, payments originating from a bank in another country could take many days to process, thereby giving domestic banks a competitive advantage over ones run from another European country.

In spite of such obstacles, UniCredit is aiming in the long term to create cross-border “product factories” throughout the combined banking group. This will be quite a challenge, since it will also involve making all the group’s computing systems compatible across all the countries where it has retail bank branches.

The EU’s leaders have been talking for years about what they can do to help banks overcome the obstacles and foster the creation of an integrated market in financial services. But the EU’s financial services action plan, launched in 1999, has made slow progress and is proving unpopular among the banks themselves. They complain that the welter of new regulations proposed in the plan will in fact hamper progress and add to costs.

It is ironic that an Italian bank is leading the biggest attempt yet at pan-EU banking, given the efforts that Italy’s regulators have made to frustrate attempts at consolidation. Antonio Fazio, the governor of Italy’s central bank, who has resisted foreign banks’ efforts to buy domestic ones, is currently facing two such challenges. BBVA is mulling a bid for Banca Nazionale del Lavoro; while ABN AMRO of the Netherlands is after Banca Antoniana Popolare Veneta (Antonveneta) and, on June 10th, raised its offer for the 80% or so that it doesn’t own, to value Antonveneta at €7.6 billion. Five days later, Banca Popolare di Lodi, a rival domestic bidder favoured by Mr Fazio, upped its own offer for Antonveneta to trump ABN AMRO's latest bid. If pressure from both the European Commission, and domestic critics that want Italy’s highly fragmented market to become more competitive, force Mr Fazio to wave through the foreign bids, other Italian banks could become targets.

Economic nationalism of this sort, standing in the way of consolidation, is in evidence elsewhere in Europe. On June 13th, Handelsblatt, Germany’s biggest financial newspaper, echoed national sentiment with a call for more “ambition and patriotism” to stop Germany’s other big retail banks from falling into foreign hands in the wake of HVB’s takeover. And the paper’s desire for “global champions in the financial sector” (meaning national champions) is shared across much of Europe.

The German paper also urged mergers among Germany’s poorly performing banks to deflect foreign predators. This reflects another factor holding back bank consolidation across borders—the fragmented nature of banking in countries such as Italy, Germany, Spain and France. Here a simpler route to growth for ambitious banks is consolidation at home where big gains are still on offer. Rather than pay the higher prices needed to secure banks in other countries banks prefer the rewards of domestic consolidation.

A further obstacle to consolidation is that cross-border mergers in Europe are difficult to pull off. Gaining regulatory approval is often onerous. Deals often take a long time to come to fruition and do not always offer the potential for job cuts and cost savings that might accompany a domestic merger. Even so, UniCredit executives said on Monday that once the merger with HVB goes through they would seek to cut around 9,000 jobs, or about 7% of the current workforce, over the next three years.

Yet another factor inhibiting pan-European banking mergers is the justifiable scepticism over the benefits of such deals. One of Europe’s few truly cross-border banks, a Danish-Finnish-Norwegian-Swedish combination called Nordea, is widely considered to have fared poorly. A study by A.T. Kearney, a consultancy, of the Abbey-SCH takeover concluded that it did not create value. It is unsurprising therefore that banks’ shareholders are unenthusiastic about them entering into deals that are expensive and difficult to complete and which may not yield the promised results.

Given all the difficulties, do not expect UniCredit’s bid for HVB to trigger a flurry of pan-European bank deals, even if it ultimately succeeds. What it might do is set off a wave of domestic consolidation in Germany and perhaps other EU countries with fragmented financial systems. At least this will be something.

Copyright © 2005 The Economist Newspaper and The Economist Group. All rights reserved.

Economist.com Cities Guide: Dubai Briefing - June 2005

News this month

Human resources

An American report has attacked the United Arab Emirates for its record on human trafficking and its failure to tackle the trade in prostitutes, labourers and child camel-jockeys. The State Department singled out four Gulf states—the UAE, Saudi Arabia, Qatar and Kuwait—and threatened sanctions if they failed to improve. Sheikh Saif bin Zayed Al Nahyan, the UAE's minister of the interior, said the country would use the report as a platform for reform.

Most labourers powering the UAE’s construction boom are from Asia and work for as little as $250 a month while living in cramped camps. Prostitutes from Eastern Europe and China are the mainstays of the country’s sex trade, and a number of hotels are well-known pick-up joints. In May the country pledged, yet again, to crack down on the illegal use of camel jockeys aged under 15, a practice that continues despite a series of attempts to end it.

Financial watchdogs bite

Financial watchdogs in the UAE have shut down a rogue investment house, SMI Private Equity, as part of their continuing drive to clean up the country’s financial image. Police, the central bank and regulators from the new Dubai Financial Services Authority (DFSA) all joined forces on the case. Officials said the company, already blacklisted in Britain, was selling dubious investment funds from an address in Sharjah emirate.

Strictly speaking, the company fell outside the remit of the DFSA. But Dubai is paranoid about suggestions of financial impropriety, especially after some funding for the September 11th attacks was traced to the banking system here. So DFSA staff, many of whom were regulators in London and Sydney, used contacts in Britain to glean information about SMI, which they then passed to the police.

The emperor’s new clothes

Naser Nabulsi, one of the leading figures in Dubai banking, has swapped his suit for the dish-dasha robe as he seeks to build a local financial empire. A Palestinian by birth, Mr Nabulsi wants to make the most of the current oil boom by launching Al Mal Capital, an investment bank and private equity house that aims to raise $325m in a stockmarket listing in July.

Stockmarkets are in overdrive across the Arab world, and the Dubai Financial Market index has more than doubled this year. Mr Nabulsi is well-placed to take advantage of this. He is close to the Dubai government, having left Merrill Lynch to run Crown Prince Sheikh Mohammed’s investment portfolio in 2000. And two years later he was appointed chief executive of Dubai International Financial Centre, the government’s new financial free zone. Last year Mr Nabulsi was granted UAE citizenship, and with it the social obligation to wear the dish-dasha on home turf. His challenge is now to disprove sceptics who warn that Al Mal's launch comes just as the current boom turns to bust.

Hot stuff

Dubai suffered a city-wide power failure on June 9th, losing air-conditioning for several hours during the sweltering day-time heat. Officials at the state-run Dubai Electricity and Water Authority blamed a technical flaw. The weekend had already started for half of Dubai’s workforce, who work Saturday to Wednesday, but the Thursday failure still caused widespread disruption.

Power was restored after about five hours, and key facilities such as Dubai International Airport switched to independent generators, so economists said the short-term impact was limited. But some Western managers said the incident could cast doubt over Dubai’s role as a regional trade hub. As one senior manager remarked: “They don’t tell you they’ve got dodgy wiring when they’re giving you the sales patter to move your regional head office and 300 staff here.”

Scary movie

Those who tire of Hollywood plot-lines may enjoy an exciting diversion in Dubai's cinema houses. A four-foot python attacked a film-goer at a recent screening of “Mr & Mrs Smith”. She escaped unharmed owing to the quick wit and compassion of a fellow theatre-goer named Sherana Alansudhir. According to reports in 7 Days, a newspaper, Ms Alansudhir was watching the film when she heard a lady nearby scream. With the light in her mobile phone, she noticed that the snake was wrapping itself around the woman’s leg. Ms Alansudhir calmly unwrapped the offending reptile, took it out of the theatre—which by this time had stopped the film—and called the police, who took the python away. “I don't know why I did what I did but I believe that nothing is more important than helping people”, she explained.

Catch if you can

July 2005

Dubai Summer Surprises

June 22nd-September 2nd 2005

This two-month carnival is geared for children and, unsurprisingly for Dubai, centred on the city’s shopping malls. The aim, when the government launched it seven years ago, was to prevent the traditional summer exodus of locals and expatriates, and to lure tourists from neighbouring Gulf states. It has worked: organisers say it pulled in 1.5m visitors last year, an almost three-fold increase on its debut in 1998. Expect plenty of face-painting and Disney-style live concerts for children, endless car raffles and gold giveaways for parents, and malls teeming with Saudis and Kuwaitis.

Held at locations across Dubai. Tel: +971 60 054 5555. Visit the event's website.

More from the Dubai cultural calendar

Economist.com Cities Guide: Hong Kong Briefing - June 2005

News this month

Victory assured

Donald Tsang Yam-kuen, Hong Kong’s acting chief executive, has effectively secured the territory's highest post. He says he has 710 of the 800 electoral committee nominations; a rival would need 100 such nominations to run, so Mr Tsang will automatically assume the top job. According to recent polls, he is supported by 70% of Hong Kongers. His appointment still awaits formal ratification by the government in Beijing, but there is no doubt that he will be sworn in.

Mr Tsang, a recipient of a British knighthood, served for three decades under colonial rule. He worked closely with Chris Patten, Hong Kong's last British governor and a strident critic of Chinese policy toward the territory. He became the temporary head of Hong Kong in March, after the Beijing-friendly Tung Chee-hwa resigned two years before the end of his second term (the first began after the 1997 handover). Beijing recently overruled Hong Kong's Basic Law—which stipulates a five-year period in office for the chief executive—by announcing that the winner of the poll would merely see out Mr Tung’s term.

Joining the cause

Hong Kong's business leaders have joined a chorus of critics against a new land-reclamation project in Victoria Harbour. In June, around 100 of the city's biggest firms joined local residents to protest against plans for a road bypass that would reclaim a further 23 hectares around the Star Ferry pier in Central. Calling itself the Harbour Business forum, the protest group, which includes HSBC, Jardine Matheson and Standard Chartered, insists the harbour is too vital a part of Hong Kong's heritage to diminish. It plans to publish reports on planning around the harbour, and examine how other cities manage waterfront development.

Recent public outcries have centred on the shrinking harbour and the inland air pollution resulting from buildings walling off the waterfront. In the past 50 years, parts of the harbour shoreline have been stretched by hundreds of metres, and half the original harbour has been filled in, shrinking it to 3,200 hectares. Last year saw mass demonstrations against these developments, with activists successfully campaigning against one 26-hectare project.

When Greens attack

A plan by Disney to serve shark-fin soup at its forthcoming amusement park in Hong Kong drew protests from conservation groups this month. Activists, who claim that the shark-fin trade threatens the fish with extinction, said they would picket the theme park's opening, unless the menu item was withdrawn. After meeting with Greenpeace and the World Wildlife Fund, Disney offered to remove the soup from the main menu and serve it by special request only, accompanied by an educational pamphlet on cruel fishing practices. The soup, a traditional Chinese delicacy, is usually served at banquets and special occasions.

When to hold, when to fold?

Though it seems that Hong Kongers are becoming millionaires at a heady pace, the good times might be hampered by a slowing economy. The Ninth Annual Merrill Lynch/Capgemini World Wealth Report found that 67,500 Hong Kongers had US$1m in assets (excluding primary homes) in 2004—18.8% more than in 2003. But their number is expected to taper off. That coincides with an expected fall in Hong Kong's GDP growth, to 5.3% this year after growing 8.1% in 2004. The report’s stance on the Hong Kong stockmarket was fairly mixed and ultimately neutral.

Rising interest rates are expected to batter residential property prices—perhaps causing a drop of 25% in the next 18 months. From May 23rd, HSBC, Bank of China and Hang Seng Bank increased their prime lending rate by 50 basis points to 5.75%. Standard Chartered lifted its prime lending rate to 6% from 5.5%.

Telecommunications

Hong Kong’s largest fixed-line phone operator, PCCW, returned to the cellular business by buying a 60% stake in Sunday Communications, the city’s smallest mobile-phone company. Richard Li Tzar-kai, the chairman of PCCW, announced on June 13th that his company would pay HK$1.16 billion (US$149m) in cash to two shareholders for the shares. Sunday is one of four Hong Kong mobile operators with a 3G licence.

PCCW left the cellular business in 2002, when it sold CSL, a mobile subsidiary, to Australia’s Telstra for US$2.29 billion. Mobile use in Hong Kong is widespread (some figures put it at 100%, as some people have several phones), and the number of cell-phone users on the mainland has grown to 354m. While Sunday’s sales have fallen for four consecutive years, it is scheduled to kick off its 3G service in June.

Catch if you can

July 2005

Secret Codes: The Art of Hon Chi-fun

Until July 31st 2005

The 60 paintings by Hon Chi-fun at the Hong Museum of Art confirm the 81-year-old as one of China's most important living painters. He is credited as the first painter to meld traditional Chinese calligraphy with modern techniques, such as pouring, screen-printing and collage. He has also written calligraphy with oil and airbrush, instead of ink.

While Hong Kong is famous as a meeting point for the Orient and Occident, artists only combined the two cultures in the 1960s. Largely self-taught, Mr Hon's exposure to the west began during a year studying in New York. He later befriended Mark Rothko and Henry Moore. Although a western aesthetic has shaped his work, Chinese traditions clearly loom large.

Hong Kong Museum of Art, Special Exhibition Gallery 1, 2nd floor, 10 Salisbury Rd, Tsim Sha Tsui. Open: daily 10am-6pm (closed Thurs). Tel: (852) 2721 0116. See the museum's website.

More from the Hong Kong cultural calendar

Economist.com Cities Guide: Zurich Briefing - June 2005

News this month

Swiss edge towards EU

Swiss voters have endorsed plans to join the European Union’s Schengen passport-free travel zone by a 55%-45% majority. In a nationwide referendum on June 5th, the notoriously Eurosceptic Swiss also voted to join the Dublin agreement on handling asylum-seekers. But a further referendum on September 25th could nullify the decision unless voters agree to open Switzerland’s domestic labour markets to workers from ten new EU member states.

In Zurich, opponents of the accords erected an eight-metre Trojan Horse near a major road and protestors jumped out dressed as Osama bin Laden and Mohammed Atta. But most voters warmed to the optimistic message of the accord’s proponents, who promised that easing visa restrictions would boost tourism, among other things.

Gay marriage

Zurich is no longer Switzerland’s only canton to allow gay marriages. In another nationwide referendum on June 5th, 58% of Swiss voters agreed to allow civil unions between homosexuals. Although married gay couples will still be forbidden to adopt children or receive fertility treatments, they will be able to obtain residence permits, widow’s pensions and favourable inheritance-tax rates. Like married couples whose incomes are combined, civil-union couples may face higher taxes and, in the event of break-ups, will have to deal with the equivalent of divorce and alimony.

The referendum appears to signal a surprising level of progressiveness in this supposedly old-fashioned nation. But word is that many “yes” voters, particularly in less urban areas, agreed mainly because of the ban on adoption.

No more home lunches

Zurchers have approved a new law to keep state-educated children at school all day. Many Swiss cantons send schoolchildren home at noon, although some provide the option of school-based block schedules and lunch programmes. The new law will help working women in Zurich, since variable school hours have been cited as a reason why mothers in Switzerland still struggle to find careers.

Fiery Zurich: 25 years on

It has been 25 years since the Opera House protests, a rare outbreak of civil unrest and youthful violence in the typically quiet city. On May 30th 1980, a group of young people gathered outside the city’s Opera House to protest against its SFr62m ($49m) restoration grant. The demonstrators complained that public funds were only reinforcing elitist institutions, and neglecting the cultural needs of the young. The city ultimately gave the protesters a youth centre, but unrest continued, particularly after police found a cache of drugs and weapons in the centre. In 1982, protestors set their clubrooms on fire, prompting the city to tear down parts of the building and precipitating one last wave of protest. Some 120 policemen were injured as they arrested 3,800 people.

Anyone who feels nostalgia for Zurich's brief flurry of excitement has been keeping mum. No public ceremonies have marked the anniversary, and the restored Opera House has emerged scar-free. Perhaps the only evidence that the outbreak took place is an old documentary, “Züri brännt” (“Zurich is Burning”), which was recently re-released on DVD.

Ursine invasion

Some 630 life-size plastic bears are filling Zurich’s city centre. They are the latest in a parade of zoological sculptures that began with plastic lions in 1986 and resumed with plastic cows in 1998. But today’s bears have a cuddly humour the lions and cows lacked. Some are Teddy Bears; some are made of real chocolate or liquorice; some are out in public in their underwear or lederhosen. Whatever tourists may think, locals have their doubts about the ursine invasion. Demonstrators draped black rubbish bags over a few bears’ heads, protesting that the bear programme treats citizens like children.

Catch if you can

July 2005

Lang Lang at the Zurich Festival

June 16th-July 10th 2005

The ninth annual Zurcher Festspiele (Zurich Festival) fills the Swiss summer with ballet, opera, plays and concerts. Among this year’s highlights will be a concert by Lang Lang, a Chinese pianist (June 26th at the Tonhalle), and a performance of the Bruckner Cycle (all ten Bruckner symphonies, from June 17th to July 10th, also at the Tonhalle).

Mr Lang is a prodigiously talented 22-year-old who cemented his reputation four years ago by standing in for André Watts with the Chicago Symphony at Chicago’s Ravinia Festival. Having earned a standing ovation for his concert in Zurich last February, he returns with a programme of Schubert and Mozart, accompanied by the Zurich Opera House Orchestra.

The Bruckner Cycle will be performed by four orchestras: the Tonhalle-Orchestra Zurich, the Zurich Opera House Orchestra, the Gewandhausorchester Leipzig and the Orchestre des Champs-Elysées.

For details on all events visit the festival's website. See Mr Lang's website.

More from the Zurich cultural calendar

Economist.com Cities Guide: Singapore Briefing - June 2005

News this month

Getting tough

Singaporean authorities have charged five executives from China Aviation Oil (CAO), China’s leading supplier of jet fuel, with insider trading and other crimes. This follows the financial scandal of 2004—the biggest in the city-state since the collapse of Barings Bank in the mid-1990s—when the locally listed Chinese company admitted to losing millions of dollars in ill-placed derivatives bets.

Chen Jiulin, CAO’s suspended chief executive, was charged on June 9th with 15 counts of forgery, insider trading and failure to disclose losses. Four other executives were also charged, including Peter Lim, the firm’s finance director. The charges followed the release on June 3rd of a scathing report by PricewaterhouseCoopers on CAO’s implosion, which found failure at every level, but concluded that Mr Chen should bear the responsibility. The day before Mr Chen and the others were charged, CAO’s creditors voted to accept an offer to recover 54% of the company’s $550m debts. The deal, which must now be approved by CAO shareholders, could allow for new investment in the group.

Slowing down

Further evidence emerged this month of a slowdown in the growth of Singapore’s trade-driven economy. On June 3rd the central bank, the Monetary Authority of Singapore (MAS), said its latest survey revealed that private-sector analysts had reduced their forecasts for GDP growth by half a percentage point to 3.8%. The revised consensus—which tallied responses from 20 analysts, mostly at global investment banks—contrasts with a survey last December, when forecasters were predicting an expansion of 4.3%. The MAS said the main reasons for the subdued outlook were high oil prices, waning demand for information technology, and an expected drop in American growth rates.

Down, but not out

In recent years, Singapore has been at the forefront of official efforts in South-East Asia to counter extremist Islamic groups, especially Jemaah Islamiah (JI), a movement linked to al-Qaeda, which has been blamed for the Bali bombings of 2002 and other Indonesian attacks. However, this month the prime minister, Lee Hsien Loong, warned that although these efforts had weakened JI, the group remained dangerous.

Addressing the fourth annual Asia Security Conference (also known as the Shangri-La Dialogue), an annual gathering of defence ministers, security experts and military officials, on June 3rd, he said, “The JI is morphing into a loose web of dispersed individuals and small groups, highly resistant to penetration and detection.” He compared the group to a hydra, whose many heads make it difficult to kill, and warned that it was especially active in Indonesia, the world’s most populous Muslim state. Mr Lee concentrated on the threat terrorism poses to the Malacca Straits, which ships use to carry 30% of the world’s trade and 50% of the world’s oil every year. A disruption would have far-reaching economic consequences.

I spy...

A correspondent for the Straits Times, Singapore’s main English-language newspaper, has been accused by Chinese authorities of espionage on the mainland. Ching Cheong, the paper’s chief China correspondent (based in Hong Kong), has been under arrest since April 22nd. On May 31st Beijing said Mr Ching, who is a permanent resident of Singapore with a British National (Overseas) passport, was a spy—but did not say for whom he allegedly was working. Singapore authorities denied that the journalist was on their payroll, stating that his arrest was “not related” to the city-state's government.

The controversy may be over Mr Ching's access to confidential speeches by China’s leaders, secured through contacts at the Chinese Academy of Social Sciences in Beijing. It may also be because of his efforts to acquire the manuscript of a book about Zhao Ziyang, the late, former Communist Party chief, who opposed the 1989 crackdown in Tiananmen Square. Straits Times lawyers are seeking access to the journalist.

Not so gay

Though Singapore's ministers clamour for more tourists, it seems that this may not extend to gay visitors. Police have banned one of the region’s largest gay gatherings, the annual August beach party called “The Nation”, due in Singapore for a fifth year. A police statement explained that the event was expected to be a big gay party, which is “contrary to public interest”.

The decision to end this annual tradition comes three months after Balaji Sadasivan, the junior health minister, argued that such events could generate a rise in local HIV-infection rates. Stuart Koe, the organiser of The Nation, accused the government of discriminating against gays. The festival will now take place in Phuket, the Thai resort island.

Catch if you can

July 2005

Singapore Food Festival

July 1st-31st 2005

Singaporeans love their food, which draws its inspiration from the country’s Chinese, Malay and Indian communities. The annual Singapore Food Festival that takes place in July is a gut-busting series of events, now in its 12th year. Among the highlights is a weekend offering for vegetarians at Parco Bugis, a downtown mall (July 22nd-24th). Sanjeev Kapoor, a local television celebrity chef, will offer Indian dishes, while Häagen-Dazs, an international ice-cream chain, will pitch in with a few specially prepared desserts.

For more details, visit the festival's website or phone +65 6780 4681.

More from the Singapore cultural calendar

Economist.com Cities Guide: Berlin Briefing - June 2005

News this month

Welcoming guests

Berlin may be economically depressed, but tourism is on the rise. Germany's capital has edged out Rome to become the third most-visited city in Europe, with 13m visitors per year, according to the city's official tourist office. London, with its 60m visitors, is the top tourist destination, followed by Paris with 30m visitors. But third place does not seem good enough for the city-state's government, which is pushing a raft of measures to make the city more tourist-friendly.

Moves include creating more parking places at the new main rail station and near popular attractions. The city also plans to take better advantage of Berlin's numerous waterways, though there must first be more boat-refuelling stations. Local officials are encouraging owners of hotels and restaurants to train their staff in foreign languages and city history. From August, the government will offer a three-year course to teach young people how to deal with tourist groups and to work at tourist attractions.

Tightening up

Berlin's elegant Schloss Bellevue, the official workplace and home of Germany's figurehead federal president, is getting a makeover. But aesthetics is not the motivation: the castle, first built in 1785, will soon have bullet-proof glass, 24-hour video surveillance and automated blinds. Such measures may be commonplace for most world leaders, but Germany has long had a relaxed approach to security. Some see the changes as belated recognition that no official (even a largely ceremonial one) is free from the risk of terrorism.

Safety aside, the €19m ($23m) renovation, due to be completed in December, is much needed. Like much of the city, Schloss Bellevue was in tatters at the end of the second world war. Despite moderate renovations in the 1950s and 1980s, and a gorgeous exterior, it was a laughing-stock in official circles, thanks to the frequency of burst pipes, power blackouts and stuck lifts during state visits. Few presidents have deigned to live there. Horst Köhler, the outspoken incumbent, is no exception—he recently had the living quarters transformed into office space for his wife and her staff.

On schedule

Berlin's new main railway station is nearly finished. The modernist and completely transparent terminus, which sits on the Spree alongside Berlin's new government quarter, will officially open next May, but already trains are zipping through its glass terminals. City leaders hope the five-level station, designed by Meinhard von Gerkan and Volkin Marg, two Hamburg-based architects, will be fully operational in time for the World Cup football tournament, which Germany is hosting in June and July 2006. It is destined to become Europe's biggest-ever rail hub, with 300,000 travellers and 1,600 trains passing through daily. By 2010, planners expect 50m long-distance- and 85m regional passengers a year.

Most Berliners welcome the new development, but its name has become somewhat controversial. The new station sits atop the old “Lehrter Bahnhof”, which worked from 1871 to 1952 before it was left to rot alongside Berlin's cold-war dividing line. Nostalgic types want to keep the old name, but Klaus Wowereit, Berlin's mayor, prefers a more simple handle: “Berlin Hauptbahnhof” (main railway station). Anything else would simply be confusing, he insists.

Flying high

Air wars have begun in Berlin. On June 5th Germanwings, a discount airline, baptised its new fleet of “Berlin Bearbus” planes—four Airbus A319 painted yellow with a smiley bear face and a long red tongue—at Schönefeld airport. The planes not only travel to major German cities, but also offer cheap flights to Oslo, Stockholm, Moscow, Zagreb, Split, Istanbul and Ankara. More destinations are planned for winter.

Klaus Wowereit, Berlin's mayor, has praised the company for helping open Berlin to a Europe-wide audience. Naturally, Germanwings’ competitors, such as easyJet, based in Britain, and Air Berlin, are not sitting still. EasyJet has announced plans to add inter-Germany flights to its schedule in early 2006 and John Kohlsaat, who runs the company’s German division, said the company intends to up its German fleet by eight planes. Air Berlin will also increase its flights to and from the German capital.

A time to score

At least 40,000 prostitutes are expected to descend on Germany when it hosts the 2006 World Cup football matches, scheduled for June and July. As the capital, Berlin will be one of the biggest draws for sex traders, and city health officials are already planning a slew of safe-sex campaigns, including the free distribution of 100,000 condoms. Intriguingly, the city also plans to have a woman dressed as a condom stand outside Olympic Stadium, where the matches will take place, and pass out leaflets offering ten “rules of conduct” with a prostitute. They include: be polite and respectful; maintain a high standard of hygiene; always use a condom; and clearly state your desires.

Other German cities, notably Cologne and Dusseldorf, are planning to set up special wooden street-cabins—dubbed “bird houses” or “sex sheds”—to make it easier for men to find prostitutes and to prevent the women from turning their tricks too publicly. “The World Cup naturally offers fantastic opportunities to earn money,” explained Katharina Cetin, of Berlin's prostitution lobby group, Hyrdra. But there are limits to such entrepreneurialism: individual prostitution is legal in Germany, but organised rings are prohibited.

Catch if you can

July 2005

“Die Brücke” and Berlin: 100 years of Expressionism

Until August 28th 2005

On June 7th 1905, four architecture students—Fritz Bleyl, Ernst Ludwig Kirchner, Erich Heckel and Karl Schmidt-Rottluff—met in Dresden to form the “Brücke” (bridge) artistic movement, later hailed as the true beginning of Expressionism. The movement, which was short-lived but hugely influential, has long been associated with Berlin, where most of the artists lived. This 450-piece display draws heavily on the Brücke Museum's permanent collection, as well as on the Neue Nationalgalerie's vaults and other museums' collections.

“Die Strasse” (The Street) by Kirchner (pictured), from the Museum of Modern Art in New York, is a particular highlight. The popularity of the Brücke artists was underlined at an auction in Berlin in early June, when oil paintings by Kirchner and Emil Nolde were sold for record prices in Germany.

Neue Nationalgalerie, Kulturforum, Potsdamer Strasse 50, Berlin-Tiergarten. Tel: +49 (30) 266 29 87. See the exhibition's website.

More from the Berlin cultural calendar