GCC Investments: A Change of Fortune

In a long-hinted-at paper released today by the Council on Foreign Relations and available here and here, Brad Setser and I argue that sovereign wealth funds of the Gulf are likely to be somewhat slower growing and less aggressive investors than they were prior to about six months ago.

We put forth a new model of how the GCC’s assets might grow (or shrink) under a range of oil price scenarios – ranging from $25/b to $100/b.   At any point on the oil price spectrum , GCC funds – previously the most-risk taking of all sovereign investors - are likely to be more conservative in 2009 , especially as diversification hurt many of them last year.

Despite record inflows (we estimate $300 billion) stemming from an average oil price of $97 a barrel, our model suggests that GCC sovereign funds and central banks now manage less than they did a year ago. After peaking at about $1.4 trillion in mid-2008, GCC assets fell to about $1.2 trillion at the end of 2008.

The fall in oil revenues and the financial market stresses will boost the need for liquidity among GCC governments – as it has for many emerging and frontier market economies.  The need to support domestic economies and financial institutions will require a lot of capital, even as the revenue outlook (both oil and non-oil) seems precarious. Most of the GCC - Saudi Arabia, Oman, the UAE, Qatar all suggest that they plan to increase spending from last year, policies might help to offset the major hit to growth in the region even if it means that outward investment is much lower as funds are more than absorbed at home. It is uncertain if they plan spend more than they wanted to spend last year  or what they actually spent. Either way, it would be difficult for these countries to cut spending much, and doing so would be contractionary for them and the global economy. Further government capital injections and a larger role in the infrastructure projects partly funded by the private sector are likely. 

Dubai for one (which isn't blessed with much oil), plans to increase its spending even though the revenue outlook is particularly challenging. The EIU notes that most of its revenues come from the very sectors that are hardest hit in the global recession (trade, steel, aviation, aluminum, real estate) - so too does non-oil output throughout the region. Expect more borrowing from Abu Dhabi, either directly through bond issues or indirectly through UAE financial institutions. Abu Dhabi has yet to release its own spending plans, but presumably will be on the rise - especially if its ambitious Abu Dhabi 2030 plan continues on course. All of which means that ADIA and other UAE investors may be privileging liquid assets. The Gulf though, is much better off than some of its oil-rich counterparts like Russia, which will likely have a fiscal deficit equal to about half the holdings in its reserve and wealth funds in 2009.

GCC Funds thus will be needed for stabilization purposes. The forthcoming RGE Monitor Global outlook suggests that all GCC countries are likely to run fiscal deficits at current oil prices (or anything below about $50 a barrel).  As a group, GCC countries might see their growth slow to 2% or below, much lower than in recent years,with some of the larger, more oil dependent and rigid economies, like Saudi Arabia and Kuwait, finding it hard to grow more than 1%. That would be quite painful despite government support. With their homeward focus, GCC funds epitomize a broader trend, the transition to sovereign rescue funds. Sovereign funds may now have returned to their stabilization aims - which was in fact, the primary reason for saving such money in the first place.