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Gulf states turn inward as they face diminishing resources

In the early weeks of the coronavirus pandemic, Saudi Arabia’s ambitious sovereign wealth fund scented an opportunity.

As global markets plummeted, the Public Investment Fund went on a spending spree, buying stakes in a host of US and European blue-chip stocks in the first three months of the year, worth collectively at least $7.7bn. 

But Crown Prince Mohammed bin Salman, the kingdom’s de facto leader and the PIF’s chair, last month signalled a potential shift in focus as Saudi Arabia, like other Gulf countries, grapples with a rising fiscal deficit and an economy battered by the pandemic and the fall in oil prices.

In a November speech to the Shura Council, an advisory body, Prince Mohammed said the $347bn fund would pump about $40bn into the Saudi economy annually in 2021 and 2022, up from $15.5bn last year.

“This liquidity will be provided through monetisation and recycling of the fund’s investments to enter into new opportunities, [and] create a local economic cycle that enables the emergence of new sectors,” he said.

Fiscal stimulus: Saudi Crown Prince Mohammed bin Salman © Alamy

His comments were interpreted as an attempt to address concerns about the PIF spending money overseas at a time of recession at home, and an acknowledgment that the government needs to redirect funds if it is to push ahead with state-backed projects.

It also hints at a trend that economists and bankers expect to be hastened by the coronavirus: a more inward focus by the oil-rich Gulf states that have garnered reputations as exporters of capital through sovereign wealth funds (SWFs) and wealthy merchant families.

It is not just SWFs that are likely to be affected, as governments grapple with diminishing resources and the need to accelerate the reform of rentier economies. 

Even senior Gulf officials have acknowledged the coronavirus crisis has underscored the need for change. 

“The region, like all regions of the world, will be financially and politically weaker and we would be wise to think about our development models,” Anwar Gargash, the United Arab Emirates’ state minister for foreign affairs, was quoted as saying by Abu Dhabi’s National newspaper, in May.

Days later, Saudi Arabia announced it would triple VAT to 15 per cent, just two years after it was first introduced, and suspend civil servant benefits as part of austerity measures. Governments across the region have been forced to delay or halt projects as they cut state spending.

Saudi retailers during the pandemic: economists say taxes are likely to rise © Alamy

The IMF forecasts that all the Gulf states, except Qatar, will run double-digit budget deficits this year. Even before the pandemic, the fund warned that at the current fiscal stance, the region’s financial wealth could be depleted by 2034.

But if the oil price was $20 a barrel, the Gulf states would endure “wealth exhaustion” in seven years — the point when governments’ financial wealth, including central bank reserves and sovereign wealth funds’ net assets is less than debt, it said in a February report.

That would turn the Gulf from a net creditor to a net borrower vis-à-vis the rest of the world.

Prices of Brent crude, the international benchmark, briefly fell below $20 a barrel in April and are currently trading around $40 a barrel, well beneath what most Gulf states need to balance budgets.

An executive at an international asset manager says he has not yet seen redemptions from the region, but he expects that to happen and predicts that “wealth exhaustion” will occur faster than the IMF predicts.

“There will have to be more focus internally,” he says. “These [SWFs] are rainy day funds and it’s pretty much pouring at the moment.” 

Prince Mohammed said that if the government had not increased non-oil revenues to about $96bn this year from about $27bn in 2015, Riyadh would have been forced to reduce public sector salaries by more than 30 per cent, “cancel allowances and bonuses completely” and halt capital spending.

The break-even oil price for Riyadh, Abu Dhabi and Kuwait last year ranged from $83 per barrel to $53, according to the IMF. Qatar, the world’s richest nation in per capita terms, had the lowest break-even price at $45. For Oman and Bahrain, it was $93 and $106 respectively. 

Gulf states were touting ambitious economic reform programmes prior to the coronavirus outbreak such as Prince Mohammed’s “Vision 2030”. 

But progress has been uneven across the region and attempts to diversify away from oil have mostly been slow.

All governments are now expected to have to raise non-oil revenue through taxes of some form, increase borrowing and trim wage bills in the public sector — the main source of employment for locals across the Gulf. 

In Saudi Arabia, public sector salaries account for about 45 per cent of expenditure; in Kuwait state wages and subsidies account for more than 70 per cent of outlays. 

John Sfakianakis, a Gulf expert at Cambridge university, said across the region there would “be a combination of more taxes, less spending and an awareness that the entitlement years are way behind us”.

“The social contract is in flux and the perception of global investors is one of uncertainty and concern,” he said. 

Experts say that while it is unlikely that any of the Gulf states would introduce income tax, corporate tax could become a reality. 

“These conversations have been happening for five to six years, but the willingness to make these decisions is higher now,” said an executive in the region.

The UAE, Qatar, Kuwait and Saudi Arabia all have large sovereign wealth funds — and Riyadh’s has foreign reserves of more than $430bn — to act as buffers.

A market in Qatar, the world’s richest nation in per capita terms © QATAR OUT/AFP via Getty Images

State investment vehicles are expected to continue seeking foreign opportunities, but not necessarily on the same scale as in the past. 

The PIF has a dual mandate to invest in foreign assets and develop the domestic economy. It has sold down about $3bn of its US stocks, while pumping a similar amount into stakes in units of India’s Reliance Industries this year. But Saudi Arabia and the Gulf’s other wealthier states all face their own pressures. 

Saudi Arabia has by far the Gulf’s largest population is blighted by record unemployment. It also needs to preserve its reserves to avoid speculation on its riyal-dollar peg. 

Abu Dhabi has to be ready to support poorer emirates in the UAE. Kuwait boasts the region’s second-largest sovereign wealth fund, with an estimated $600bn of assets, but it relies on petrodollars for almost 90 per cent of state revenues and is often criticised as being one of the slowest to drive reforms.

S&P Global Ratings downgraded Kuwait’s credit rating to AA- from AA in March and changed its outlook to negative in July as it estimated that Kuwait’s budget deficit would widen to 40 per cent of GDP this year. 

A senior banker, who at the beginning of the year was fielding calls from Gulf sovereign investment funds hunting opportunities, says: “I just don’t see them being active”. 

The exception, he added, was the Abu Dhabi Investment Authority, the region’s biggest fund, which has been “super-active” in private equity. 

More broadly, the banker says, “the phones aren’t ringing”. He believes Gulf funds “are more inward looking. They’ve definitely cooled off”.


Source: Economy - ft.com

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