Change of course for the Gulf States’ Sovereign Wealth Funds

Their sovereign funds are multi-faceted bodies which invest the Gulf states’ budget surpluses on the world’s stock exchanges. But the volatility of oil prices, the increasing debt ratios and the effects of the Covid-19 crisis on the economies of the region should by rights redirect these investments towards local corporations.

Dubai Financial Market.

Thanks to the development of some of the world’s largest gas and oil deposits, the countries of the Arab Peninsulas have salted away in just a few decades 2,000 billion dollars (1,575 billion pounds sterling) in capital assets, invested via their sovereign funds, especially in Europe and the United States. These State bodies manage their “combat funds” in such a way as to mitigate the fluctuations in the price per barrel of oil and make their economies less dependent on the hydrocarbon windfall. “The purpose of these funds is to transform a limited natural resource into a renewable financial resource for the peoples of the Gulf” says Victoria Barbary, in charge of strategy and communications for the International Forum of Sovereign Wealth Funds.

When US stock market indices fell by over 30 % at the beginning of 2020 as a result of the destabilising effects of Covid-19 and the shutdown of the world economy, the Saudi sovereign fund saw an opportunity to diversify its portfolio. In just a few weeks, its Public Investment Fund (PIF) deployed 8 billion dollars (6.3 billion pounds) on North American stock exchanges, acquiring shares in such multinational corporations as Boeing, Facebook, Disney, Marriott, Starbucks, Bank of America and Pfizer.

The fund, endowed with a capital of 360 billion dollars (285 billion pounds), examines “every possibility” says its governor, Yassir Al-Rumayyan. “They buy very cheaply into companies which are solidly established in areas which are themselves very solid,” is the evaluation of an expert on Saudi Arabia with the Research Institute for European and American Studies (Rieas), Quentin Pimodan. This strategy takes its cue from Qatar’s sovereign-wealth fund, the Qatari Investment Authority, which took advantage of the 2008-2009 financial crisis to invest in Crédit Suisse, Barclays, Volkswagen, Porsche and other companies. During the present crisis, this fund is focusing on its international activities, according to an announcement made by Qatar’s finance minister.

Yet some investments seem problematic. At a time when Saudi Arabia has promised to diminish its dependency on oil revenues, its sovereign fund is investing in the big oil companies. Quentin Pimodan objects that diversifying the local economy is not necessarily incompatible with opportunistic stock exchange gambits. “It would be foolish to dismiss out of hand their expertise on the oil markets.”

Critics also have a good laugh at the acquisition of 8 % of the capital of the world’s largest cruise ship operator, Carnival, a company for which the consumption of liquor, banned in the Saudi Kingdom, is an integral part of its economic model. In spite of the hypocrisy involved, this investment is meant to draw the cruise line’s attention to Saudi Arabia as a leisure destination, at a time when the Kingdom is trying to develop the tourist trade. In order to avoid too much media attention, the PIF could make its capital available to other investors, becoming a fund of funds, Quentin de Pimodan suggests. “It’s more conservative, but it may be a more suitable role for a sovereign fund,” the expert opines.

Deploying capitals locally

On a local scale, the idea of exposing the country’s wealth to stock exchange volatility sounds like a provocation to the ears of a Saudi population still reeling from the threefold value added tax increase enacted to help finance a budget deficit thought to have tripled since 2010. A distrust fuelled by the PIF’s disastrous investment in the Japanese Softbank’s Vision Fund. As the manager of a regional investment fund said to us: “It may be hard to justify investing in foreign companies when previously thriving local firms are short of cash, when the economy is shrinking and when job losses are on the rise.”

What with the coronavirus pandemic and the wave of panic affecting the oil markets, the Saudi economy is moribund. The country’s gross domestic product (GNP) is heading for the biggest contraction it has known for the last two decades and Oxford Economics estimates the number of job losses by the end of the year at 1.7 million.

While the Gulf States’ sovereign wealth funds function according to a relatively stable economic model, that on which the States which own them is based has been tottering ever since the rapid oil price decline began in 2014. So now the question is how to transform these tools for financial investment into vectors of economic growth. The sovereign funds “could become instruments of [economic] diversification for the governments of the region,” Nasser Saidi, former finance minister of Lebanon, observed during an online conference organised by the Washington based Arab Gulf States Institute. He suggested that these capitals be injected into local economies with an eye to sustaining and financing innovation, industry, new technologies and improving societies’ digital conversion in order to prepare for the “post-oil era”.

The International Monetary Fund (IMF) recommends the same approach. Interviewed for Orient XXI, the former director of the Oman Investment Fund did not explain the lack of economic diversification as the consequence of a dearth of capitals. “Diversification is not a cash problem, it’s a problem of the economic environment,” Fabio Scacciavillani asserts. He advocates in-depth reform of the labour market, better protection for property rights, a simplified bureaucracy and a revamping of the educational system to encourage research and innovation, thus attracting foreign investors in high value-added sectors.

Targeting diversified investments

Victoria Barbary sees many advantages in local investments but points out that the yields are not necessarily as high as those obtained from foreign placings. “The know-how, the competencies, the governance structures required to invest in international markets are very different from those needed to invest in the Gulf economies,” she adds, reminding us that most of these institutions were set up at a time when the region was not equipped to absorb such large capital flows – the PIF was created in 1971.

But the situation changed after the year 2000. Boosted by the soaring price of oil, the Gulf economies grew to a point where their collective GNP amounted to 1,600 billion dollars (1,250 billion pounds). “Consequently, new funds were set up in order to diversify the national economies with targeted investments” said the manager of an investment fund questioned by Orient XXI in connection with Mumtalakat in Bahrain and Mubadala in the United Arab Emirates. “We have not only achieved substantial financial results, but we have also continued to step up our participation in many categories of assets, sectors and markets with an eye to diversifying Abu Dhabi’s economy,” Khaldoon Al-Moubarak, head of Mubadala exclaimed, announcing the 2019 performances of his fund, which has invested 250 million dollars (196 million pounds) in start-up technologies throughout the Middle East.

But can local investments make up for the decline of the oil industry? The answer is far from obvious. “They were all struck by the poor performances of local economies even before the pandemic and are aware of their obligation to invest in ways that are reasonable and profitable” the manager of an investment fund admits. But with the advent of an historic crisis, likely to wipe out years of investments, he advises the Gulf countries’ sovereign wealth funds to intervene by making loans to viable businesses. In Dubai, 70 % of all companies expect to go bankrupt in the next six months. “Such programs are not a matter of charity, they represent an efficient and profitable response to help lubricate the economy, maintain activity and avert the wasteful deflationary spiral which appears increasingly in the offing.”

Budgetary support and public assets management

Besides investing the budgetary surpluses accumulated during the halcyon days, the Gulf’s sovereign wealth funds have essentially been treasury reserves that can be called upon when the oil market collapses and governments are in the red. While this strategy has worked until now, it is stretched to the limit when the world starts looking forward to a post-oil era, while oil continues to be the chief source of revenue for the Gulf states: without the financial support of other countries, the credit-rating agency Fitch predicts that the Omani sovereign fund could well be “exhausted by 2021” because of having to finance the country’s deficit.

Destabilised by the fall of oil prices, the Arab peninsula countries have already delved into their sovereign funds for over 600 billion dollars (470 billion pounds) since 2014, and the 2020 crisis has only made matters worse: their assets might well fall by another 300 billion dollars (260 billion pounds) by the end of the year. IMF economists think that the region’s “war treasure”, which for many years has been fiscally profitable, could easily be used up entirely between now and 2034. “Our government understands that we cannot count on oil forever” says Mohamed Al-Salimi, financial analyst with the central bank of Oman.

Along with these inroads on their available capital, the region finances its deficits by going into debt, since interest rates are often lower than the returns on sovereign fund investments. Since 2014 the debt ratio of the Omani Sultanate has increased twelve-fold. At a time of recourse to external financing, the capital resources held by the sovereign funds act as implicit guarantees for international lenders and “if these funds should shrink, this might have future implications as to the Gulf countries’ capacity to borrow at low interest rates,” Victoria Barbary reminds us.

In order to consolidate its assets and strengthen its position, Oman recently announced the merger of its two sovereign wealth funds and all its government-owned companies - with the exception of Petroleum Development Oman - into a single body, the Oman Investment Authority. According to experts consulted by us, a reinforced sovereign wealth fund will provide the Sultanate with a strong hand when it comes to negotiating loans or loan collateral.

Aware of the uncertainties that lie ahead, the Gulf countries have no other long-term choice than to reshape their local economies, and their sovereign funds are destined to play a strategic role in this reconfiguration. In Saudi Arabia, the crown prince Mohamed Ben Salman intends to pilot the Kingdom’s economic transformation via the PIF with its assets multiplied by five. With one foot in the world as it was and the other in the world of tomorrow, the Gulf States are faced with a major challenge: reinvent themselves before their budget deficits get the best of their sovereign wealth funds.