Money makes the world go around. Funds, as economists love to call them, are at the heart of growth. Funds become dearer in times of economic turbulence. When coronavirus battered the world economy last year, some Gulf countries turned to sovereign wealth funds (SWFs) to bail out their economies. SWFs are insurance policy or savings for a rainy day. The day came a lot earlier than expected, thanks to COVID-19.
The third of the four-part series on GCC economies looks at how SWFs helped absorb the shocks from the global pandemic’s fallout.
Read Part 1 here: Why GCC economic recovery will be slow until 2023
Read Part 2 here: How Gulf countries are recovering from economic slump
Read Part 4 here: How GCC currencies are riding out the economic storm
How SWFs take care of government funding
The sovereign wealth funds (SWFs) of Abu Dhabi, Kuwait and Qatar have underpinned the ability of GCC economies to surmount the hurdles of lower oil prices and the coronavirus fallout, according to economists.
These SWF assets are likely to have grown last year due to supportive market returns and oil price recovery in the fourth quarter, despite some governments using foreign assets and other deposits to cover government fund requirements.
According to rating agency Fitch, estimated sovereign external assets of the SWFs of the UAE (Abu Dhabi), Kuwait and Qatar are sufficient to cover five to eight years of government spending and six to eight years of non-oil deficits at the current level of oil prices and government spending.
“We estimate that SWF assets in Kuwait, Abu Dhabi and Qatar would remain sizeable in the medium term even under adverse oil market scenarios. All three countries stand to substantially deplete their SWF assets in the long term without some combination of a recovery in oil prices, growth in production, fiscal adjustment and supportive financial market returns,” said Krisjanis Krustins, an analyst at Fitch.
According to Moody’s, SWF drawdowns [A drawdown refers to how much an account is down from the peak before its recovery] will help meet the rise in funding needs for most GCC sovereigns. Out of the six GCC members, only Bahrain does not have access to liquid government assets, which could be used for deficit funding.
“Oman and Saudi Arabia are likely to face most of the material impact on fiscal strength from a decline in SWF assets. Conversely, Abu Dhabi and Qatar will be relatively insulated due to their larger stock of assets and smaller financing requirements. In Kuwait, the depleting General Reserve Fund has increased liquidity risks despite SWF assets/debt coverage remaining very strong,” said Thaddeus Best, an analyst at Moody’s.
■ It’s derived from a country’s surplus reserves.’ State-owned natural resource revenues (oil revenue in the Gulf), trade surpluses and bank reserves are among the popular sources of surplus revenue.
■ It generally acts as an investment fund, allowing the SWF to grow.
■ The fund benefits a country’s economy and its citizens.
■ Kuwait Investment Authority’s (KIA) foreign assets under management (AUM) is estimated at more than $560 billion in 2019.
■ Abu Dhabi Investment Authority (ADIA)’s estimated foreign AUM is $580 billion.
■ Qatar Investment Authority (QIA) has an estimated foreign AUM of $250 billion).
■ Saudi Arabia’s Public Investment Fund, which is also considered an SWF, possesses an estimated AUM of $400 billion.
■ The Oman Investment Authority (OIA) and Petroleum Reserve Fund (PRF) are the two SWFs of the Sultanate. The State General Reserve Fund with assets of around $14 billion and Oman Investment Fund ($3.4 billion) merged to form OIA. The PRF is worth $2.9 billion, according to 2019 data.
How public institutional funds help in economic growth
The region is also home to several public institutional funds, including non-external reserve held by some central banks. Foreign assets of the Saudi Central Bank (SAMA) or Kuwait’s Public Institution for Social Security (PIFSS) come under this category. Unlike SWFs, public institutional funds are relatively less focused on external financial assets.
The assets of these holding entities with mandates include local development. Saudi Arabia’s Public Investment Fund (PIF), Abu Dhabi’s Mubadala Investment Company or Bahrain’s Mumtalakat Holding Company fall in this category and act as cushions for domestic sovereign balance sheets and external accounts.
“We expect the Saudi government to use the PIF to support economic growth and partly offset the impact of budgetary austerity through its domestic investments,” Cedric Julien Berry, an analyst at Fitch.
■ ABU DHABI: The Mubadala Investment Company holds a portfolio of strategic domestic and foreign assets, including in petrochemicals, mining, aerospace and semiconductor manufacturing. It reported AUM of Dh853 billion at 2019-end (around $230 billion or 90 per cent of GDP). About 72 per cent of it was reported to be outside the UAE.
■ DUBAI: The Investment Corporation of Dubai (ICD) holds a portfolio of mostly domestic assets on behalf of the Dubai government, including Dubai’s flagship bank, airline and property developer. ICD’s book value of equity was Dh250 billion at 2019-end (65 per cent of Dubai GDP), of which identifiable local equity holdings were about Dh70 billion.
■ BAHRAIN: The Mumtalakat, which mostly consists of large domestic entities such as Aluminium Bahrain and the National Bank of Bahrain, but it also has some international holdings such as McLaren. At 2019-end, Mumtalakat’s total assets were BHD7.1 billion (around $17 billion or 49 per cent of GDP).
What high fiscal deficits mean for GCC economies
The fall in oil revenue has eroded the financial power of Gulf countries and stifled economic recovery. This has placed their sovereign credit strengths under strain. Most GCC states have initiated fiscal consolidation efforts with revenue augmentation and spending cuts.
Oman and Saudi Arabia stand out with ambitious fiscal consolidation plans. Oman’s case reflects a weak starting position and funding pressures. Its medium-term reform plan includes VAT introduction in 2021, subsidy reform and the region’s first personal income tax. Saudi Arabia tripled VAT in 2020 and plans an 8 per cent spending cut next year.
The UAE and Qatar have greater fiscal strength than their GCC peers, thanks to their sizeable sovereign wealth fund (SWF) buffers.
■ The goal is to improve financial stability by creating a more viable financial position.
■ It can be achieved by reducing spending, increasing taxes, or both together.
The rating agency Moody’s expects subdued oil revenue to hamper government spending this year. Analysts said GCC states’ capacity to reduce expenditure after the drop in oil prices is strongly linked to institutional strength.
“We estimate that the UAE and Qatar — which have the strongest institutions and governance scores in the region — made the largest cuts to expenditure in 2020. We expect that this discipline will persist throughout 2021, with spending remaining significantly below pre-pandemic levels, despite a year-on-year increase in the UAE,” said Thaddeus Best, an analyst at Moody’s.
In Saudi Arabia, the government is likely to push through spending cuts this year after coronavirus-related costs delayed a planned tightening of expenditure last year.
Limited market access will keep Oman’s expenditure low. The government’s fiscal consolidation measures are likely to continue this year. These include a 10 per cent cut in non-interest spending — double of what it committed in March 2020 — and government wage bill reforms. It will also introduce VAT in April 2021.
Spending is forecast to stay above pre-pandemic levels in Kuwait and Bahrain, primarily driven by public sector wage bills in Kuwait and the 2020 budget spending in Bahrain.
Fiscal deficit to remain elevated with rising debt burdens
Moody’s expects GCC fiscal deficits to narrow only modestly this year.
“We forecast the median fiscal deficit to remain wide at 6 per cent of GDP in 2021, driving a further deterioration in fiscal strength, which will be most acute in Bahrain, Oman and Saudi Arabia,” said Alexander Perjessy, an analyst at Moody’s.
An increase in debt burdens for GCC states will be among the largest globally. “We forecast that debt will rise on average by around 21 percentage points of GDP over 2019-21 across the GCC, compared with an average of 12 percentage points for emerging markets and 14 percentage points for advanced economies,” said Perjessy.
■ It occurs when government spending exceeds revenue.
■ A fiscal deficit is calculated as a percentage of gross domestic product (GDP) or the money spent more than its income.
■ Total debt accumulated over years of deficit spending is called fiscal debt.
GCC governments with relatively high fiscal breakeven oil prices [the minimum price of oil per barrel required to balance the government revenue with expenditure], including Bahrain and Kuwait, will see the largest increases of 33.8 percentage points and 37.5 percentage points respectively in their debt burdens. The debt burdens of those with lower breakevens, such as Qatar and the UAE, will rise by only four percentage points and 11 percentage points, respectively.
The government debt burdens of Saudi Arabia and Oman exceed the SWF asset stock, and Moody’s expects the net asset positions to fall to negative balances of 18 per cent and 65 per cent of GDP this year.
■ It is usually measured as a percentage of gross domestic product (debt-to-GDP ratio).
■ National debt results from government borrowing in the form of financial securities issued or loans from international organisations.
■ Since the borrowing is at a national level, it is called national debt.
Moody’s forecasts that GCC government debt burdens will rise on average by around 21 percentage points of GDP over 2019-21, compared with 14 percentage points on average for advanced economies. However, sovereign wealth fund buffers will cushion the impact of higher gross debt burdens for most GCC countries.
Despite a significant easing in market conditions, Moody’s expects that borrowing costs to remain above pre-coronavirus levels for less creditworthy GCC states.