Raiding The Sovereign Rainy Day Fund

Note: A fuller version of the following note is available in pdf form here, including clearer versions of the chart. Norway is the latest country to plan a fiscal stimulus to be rolled out in early next year. It is also the latest government with a sovereign wealth fund that plans to ramp up domestic spending. It will likely turn to its sovereign fund, the government pension fund –global to finance this additional spending.  Norway’s euro and pound heavy fund has taken a beating in recent months – as the dollar rallied and global equities slumped (along with a range of global investors). The latest data suggests Norway manages about $308b at the end of November.

Norway’s stance was already expansionary. Its fiscal rule allows it to spend up to 4% of the GPF’s assets (the assumed return on investment in most years) to meet its non-oil deficit. Depending on the size of its stimulus, and the reduction of other tax revenues from slowing growth, Norway could have to draw on its principal not just on the income on its investments. But it must be remembered, a global economic crisis is a good time to have savings to deploy. The motivation for saving funds in times of boom is to have them available when times get tougher. And like other sovereign savings, the stabilization goal of Norway’s fund might now be getting the upper hand – as more liquidity is needed.

Norway of course is not alone in investing some of its funds at home. The escalation of the financial crisis and collapse of commodity prices likely only accelerated the trend in which sovereign funds or the governments that sponsor them are increasing their spending at home.

Many other funds have also announced support of their financial sector or fiscal stimulus to support growth. Some SWFs have themselves been vehicles of recapitalization, taking stakes in state banks, setting up equity stabilization funds. These demands come as SWFs are already receiving less capital as surpluses erode and competition for domestic resources rise. In an environment where growth is slowing and classic investment funds have sustained losses, investment vehicles privileging economic development may be most attractive. This dynamic might be more pronounced in oil exporting funds, but it also is the case in countries like China. Despite the rate of growth of China’s reserves, the CIC has not received new capital, perhaps in part because it has kept most of its existing funds in cash or frozen US money market funds. However, the public losses on Morgan Stanley and Blackstone might also make it more difficult to receive new funds.

The following table summarizes selected assets available to key sovereigns and the ways in which SWFs, other pools of sovereign capital and sponsoring government have or plan to invest to support domestic corporate or financials. It also includes broader fiscal stimuli planned. Note: I have not included the investments of central banks aside from the investment portfolio of Hong Kong and the non-reserve assets of Saudi Arabia as well as the Russian funds which are managed with its reserves.  Many of these estimates draw on a forthcoming paper with Brad Setser of the Council on Foreign Relations.  (a clearer version of these charts are available here)

Even if some of the planned stimulus packages do not come from the SWFs themselves, the diversion of capital from other government sources to offset the withdrawal of private capital at home or abroad will reduce funds available to the SWF. The combination of losses on existing portfolios by the more diversified funds along with greater demands for domestic investment either to support current spending or to assume the debts of the private sector, should continue to boost demand for liquidity and the safest assets.

For the oil funds, income from sovereign funds may allow countries to continue expansionary fiscal policy that began significantly in 2006-8 as countries became accustomed to higher oil prices.  Although countries may not have expected to tap their funds so soon, these are rainy day funds to smooth consumption and their availability may help support domestic consumption, lessening if not erasing the likelihood of domestic unrest. It may also avoid exacerbating the global demand contraction. Oil exporters may be more successful at holding up demand than Asian export-led economies particularly as their growth was already consumption led.  Countries with non-commodity funds, though may also be able to fund spending from income on the fund rather than re-investing it.  Yet, they might have to take out debt to fund spending as China and Taiwan are likely to do.

In 2007 and 2008, government and private expenditure grew at a fast pace and on average oil exporters now require over $50/b to balance their budget.

The following table summarizes oil price breakeven points. Note these are estimates, particularly as many countries are not transparent about the size of the budget or revenues, and much of current and capital spending may be funded by different pools of capital, including public sector companies. They do not yet include some of the fiscal measures mentioned above.

So which projects might be pulled back? The political costs of reducing current spending eg on wages, seem too high to allow cuts.  Some GCC countries are already losing jobs, even if these mostly affect non-nationals and easing inflation may limit wage expenditure raises, thus keeping spending at 2008 levels may be possible.  But some capital expenditure might be deferred or spread out if revenues continue to be weak particularly that being implemented by SOEs.

One area that might see a pullback in the near term is the energy sector, particularly as labor and production costs have yet to collapse along with inflation meaning that companies face still high prices for imputs and lower demand. The increasing demand for funds domestically may limit those available to national oil companies, some of which were just scaling up spending in recent years after a slow pace of expansion in the recent commodity boom. Many of these plans may be on hold given the outlook for lower demand and price over the next 12-18 months. Domestic refinery expansion may be particularly at risk as are larger more complicated projects.

The need to continue to pay government dividends from oil may limit the funds available to some national oil companies. Others, who relied on fund raising abroad to fund capital expenditure (Russia, Venezuela etc) may also have less funds available. Either way the lower demand for petroleum (and petrochemical) products, lower prices and lack of credit will freeze some projects and keep some on the drawing board. Yet once the global expansion finally comes under way (late in 2009 or early in 2010) all of the supply destruction could lead to longer-term higher prices and a need from oil exporters to be more efficient. Watch for a more detailed analysis on energy supply following the OPEC meeting.

And with more funds being invested at home or abroad in sectors of benefit to domestic economic development goals, sovereign investors are clearly already more discerning about investments abroad. One result: any concerns about sovereign investment will shift from sovereign wealth funds to state owned enterprises.  Of course, more of those state owned enterprises now emanate from developed not developing countries than they did a year ago.