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Analysis

GCC Sovereigns: A Little Better Off

By Rachel Ziemba

Timothy Geithner, the U.S. Treasury Secretary, travels to the GCC (Saudi Arabia and the UAE) in a few days to commune with some of the more significant creditors of the U.S. and possibly urge these savings-rich countries to contribute to the IMF, as several emerging market economies have pledged. As a result it seems an apt time to re-estimate how much these governments and their neighbors in Qatar and Kuwait have accumulated.

While the Gulf’s holdings of U.S. assets pale in comparison to China’s, the GCC possesses the largest trove of US stocks among foreign governments. With most of its assets managed by the central bank, Saudi Arabia likely holds the most US treasury bonds. The other GCC countries, most of whom entrusted their oil windfall (and gas in Qatar’s case) to an array of investment funds, tend to have a more diversified portfolio. However, the U.S. dollar still dominates the Gulf’s foreign asset position.

With the rise in the price of oil in Q2, some analysts have again been talking again about the global role of sovereign funds. While some, such as the China Investment Corporation (CIC), for one, seem to have become more active investors again, the Gulf funds still seem to be homeward looking. The latest –and forthcoming - RGE Monitor Global Outlook suggests that growth in the GCC will be flat in real terms, with a slight contraction. The significant assets of the region have allowed GCC countries to steer their economies to a softer, if still, harsh landing. Much of the region’s output, investment and sentiment remain linked to oil despite various attempts to diversify its economy. Steffen Hertog has a nice piece on the lessons learned from the 80s by Arab oil producers.

Many GCC sovereign funds have boosted their holdings in domestic banks and domestic equity markets. Their holdings have also been drawn on to meet fiscal deficits. Meanwhile, some of the few identifiable foreign investments in H1 2009 were made by hybrid funds like the UAE’s Mubadala, which tend to invest in sectors that could help domestic economic development or in sectors they already dominate (such as oil and petrochemicals).

The foreign assets of GCC central banks and sovereign funds are estimated to have fallen to just over $1.1 trillion at the end of June 2009 from about $1.2 trillion at the end of 2008.  This estimate draws on a methodology Brad Setser and I created last year, which estimates the inflows to the funds, and assumes similar performance to benchmark indices for each asset class. This estimate though, is somewhat lower than some other prevailing estimates. Recently released analysis by McKinsey Global Institutes suggests that Sovereign investors of the GCC, one of their ‘new power brokers’ managed closer to $2 trillion at the end of 2008.

The national breakdown suggests that Saudi Arabia accounts for over $400 billion of the assets (including the non-reserve assets of the Saudi Arabian monetary Agency and the foreign assets it manages for other parts of the government). The UAE, accounts for the next largest amount, around $350 billion, not including Mubadala and some Dubai funds. Kuwait’s fund managed just under $240 billion and Qatar, over $60 billion. The remainder is managed by the central banks of the region.

The slightly more fiscally-conservative (and richer) countries with more oil reserves per capita, like Abu Dhabi and Kuwait, or gas reserves (Qatar) and their more risk-tolerant funds should have seen the value of their assets reflate along with risky assets. Despite the increase in the oil price, the correction at the end of June 2009, limited the paper gains.

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These countries’ investment income seems to be correlated with their hydrocarbon income, though they may still not be feeling very flush given continued liquidity needs at home. Despite an increase in the value of existing holdings, and a slight increase in inflows, GCC foreign assets are still well off their highs. Assets likely peaked at around $1.4 trillion in June 2008.  They began to tumble on lower returns in equities, real estate and private equity in the fall.

Yet there are some shifts in relative values. Much of the decline in H1 2009 can be explained by one fund – the Saudi Arabian Monetary Agency (SAMA) - which manages the bulk of Saudi foreign assets. SAMA’s non-reserve foreign assets, which consist mostly of bonds and US dollars, have fallen from about $412 billion last fall to $365 billion in May 2009. The majority of the fall in SAMA’s asset has come from the drawdown of its deposit holdings, i.e. its most liquid assets. The holdings of foreign securities have fallen much less. These funds have likely been utilized to avoid having to borrow domestically to meet the governments 2009 fiscal spending needs.

SAMA data for June won’t be out for another month or so, but they are likely to either show no growth in foreign assets or another slight decline given spending needs.  SAMA tends to accumulate less in Q2 than in other quarters, possibly because of its fiscal cycle.

Abu Dhabi-based investment agencies like the Abu Dhabi Investment Authority (ADIA) and the Abu Dhabi Investment Council (ADIC) continue to rival Saudi Arabia’s. Saudi Arabia’s larger population and greater share of OPEC production cuts have led it to draw on some of its assets. The UAE’s fiscal spending needs have been somewhat lower and the recent reflation rally boosted the value of some assets.

Yet even Abu Dhabi’s asset allocation has shifted over the last year. Not only has Abu Dhabi needed to utilize its liquid assets to support its banks, but it is also believed to have provided the capital for the bonds issued by Dubai and purchased by the UAE central bank in February of this year. Such a purchase may just be reflected in a shifting from one USD denominated claim to another. The need to do so, however, underscored the importance of liquid assets.

There has been another shift – one that makes modeling these portfolios a little trickier, if more interesting. Beginning in 2008, an increasing share of the UAE’s savings has been allocated to investors like Mubadala and IPIC. Mubadala alone received about $26 billion in new capital from the government, roughly half of Abu Dhabi’s surplus.  ADIA clearly received a much smaller piece of the pie. In fact, some suggest that ADIA received almost no capital at all in 2008. The shift in funds to investors like Mubadala - which privileges concentrated stakes and includes domestic holdings - is but one way in which some of these funds seem to be looking inward using their savings to support their near-term and longer-term domestic economic goals.

So what does that all mean for the future? Lower asset accumulation, most likely. The growth of these funds all depends on the price of oil and how much is spent at home. With an oil price of $50 a barrel, inflows to sovereign funds and central banks would be practically negligible. Consequently, only the return on investment would lead to a slight increase in the assets under management in 2009.

But even at higher oil prices (see below), the savings might be more limited.  Given that oil exporters are spending a lot, savings going forward might be smaller even if the price of oil climbs again.

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Source: Author’s estimates, updated from Setser and Ziemba (2009)

Given the absorption of oil revenues at home through higher spending and investment (the latter intensifying in 2008), oil exporters contributed a bit more to rebalancing. This explains why few, if any, oil exporters will run a current account surplus this year even if the oil price averages $65 dollars a barrel. In fact, as shown below, even if oil averaged $75 a barrel, the amount saved in 2009 would be much lower than it was in 2006 or 2007 when oil averaged $67 a barrel and $71 a barrel, respectively.

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Lower oil production adds to the spending pressures. According to estimates of OPEC oil production, Kuwait, Qatar, the UAE and Saudi Arabia are now producing around 13.1 million barrels a day (mbd) of oil. (Saudi Arabia accounts for about 8mbd.) That is about 2.5mbd less than they were producing in the summer of 2008 (15.6mbd). If less oil is produced, a higher dollar per barrel price is needed to balance the growing budgets.  Note that the chart above assumes that oil production will start increasing in 2010 and will return back to early 2008 levels by the end of that year.

At current oil prices ($60 a barrel), most of these countries can balance their budgets, but barely. On average, GCC countries needed around $45-50 a barrel to balance their budgets in 2008. In 2009, with spending demands higher and oil production lower, the break-even price will be higher. That adds up to less savings, especially for countries like Saudi Arabia. Unlike Russia, where an import collapse triggered by a weaker ruble, rising unemployment and a lack of credit has contributed to a narrow current account surplus, most GCC countries are likely to not have much of a surplus this year if oil averages around $55 a barrel. This means that the GCC’s role in global asset markets may be more subdued even as their role in domestic asset markets and economies grows.  Ultimately, however, much depends on the price of oil. A sustained increase in the price of oil would lead to larger surpluses and more foreign investment.

A few final considerations.

The increased need for liquidity suggests that the dollar share of GCC investments may actually have risen in 2008 as Saudi Arabia’s accumulation dominated some of the other funds. Other countries, seeing a need for liquid assets, may also have boosted dollar shares, possibly even boosting their short-term dollar assets. However, with more being absorbed at home, these countries could slow their purchase of dollar assets.

Yet, as with monetary policy, asset allocation is constrained by currency pegs. The dollar’s dominance in the region’s monetary arrangements will limit the GCC’s ability to shift away from the US dollar, especially if the currency renews its trade-weighted downtrend. Dollar depreciation could again boost the cost of imports for GCC countries, which largely import from Europe and Asia. Yet with broader disinflationary trends and currency revaluation off the table, the pressures on the currency are likely to be muted.

The biggest factor that accounts for returns of institutional investors is asset allocation. In 2008, an equity and alternative-asset-heavy portfolio faced significant valuation losses. Thus the GCC sovereign funds, exposed to equities, could also have faced significant losses.

Note: The GCC funds may have shifted their asset allocation somewhat over the last year, although there is no clear evidence. Given the domestic liquidity shortages which pre-dated the global credit crunch, some may have begun boosting liquid assets. So when updating the estimates of the funds’ AUM for the end of June, I tweaked the model slightly in order to see how performance may have been affected by a change in the allocation of the inflows of capital. Putting almost all the inflows for Kuwait, the UAE and even Qatar into bonds does lead to somewhat higher headline figures.  To avoid the losses predicted by the model, older, larger funds like those of Kuwait and Abu Dhabi would have had to actually sell equities and other assets to have a more significant asset allocation shift.

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