Tracking GCC Savings and Borrowings...

Tracking GCC Savings and Borrowings...
Rachel Ziemba | Apr 27, 2008
With WTI Crude oil futures tipping over $120 billion on Friday, there's a lot of speculation about where the surplus revenues are going, especially those of the GCC.

A couple interesting data points
1) the IMF suggests that the aggregate current account surplus of the GCC may exceed $300 billion in 2008

2) UAE foreign debt, mostly of the private sector increased by a half in 2007.
3) UAE reserves increased by $25 billion in the month of November - more than the foreign asset growth of Saudi Arabia.

4) SAMA governor's warning that inflation might top 10% before falling.

5) Relatively few reported aquisitions by GCC sovereign funds in recent months - and no major role in recent bank recapitalizations.

All together these add up to illustrate some of the economic policy conundra, including some of the less than intended consequences of some policy responses.

With the oil price averaging over $100 a barrel so far this year - there's still a lot being saved (perhaps as much as $40-50 a barrel, for more on possible dynamics, check this post of mine from last month). Overall, with a constant oil price, even $90, domestic spending would likely catch up to new revenues in the medium term. As the economist notes in this week's cover story, most of the savings are still in government hands. And given the rate of growth of assets managed by UAE (likely over $50 billion) and Saudi central banks ($70 billion, stripping out valuation gains) in 2007, conservative, USD assets likely dominated the increase in foreign assets.
But more is staying in the region too. Some of this is being spent on capital projects to make up for decades of underinvestment - both in the energy sector and related. economic cities and attempts to diversify the economies away from oil or to higher value-added hydrocarbon products. As the IMF's John Lipsky noted this week, investment in the energy sector doesn't go as far as it used to. Despite nominal increases in spending, added capacity has been limited. But its not just government funds - the private sector is increasingly present in the megaprojects.

Other funds are being spent to maintain the standard of living of citizens in the face of rising inflation. The fiscal costs of subsidies to cushion inflationary pressures are rising too and furthering the inflationary pressures. this probably means Saudi Arabia won't hold to its pledge to rein in fiscal spending in the short term.

Yet oil @ or above $100 still means a lot of savings abroad.
So where have they been going?

- Shift to cash/safer assets. Like others they may be waiting on the sidelines. Brad Setser notes the rapid buildup of custodial holdings at the FRBNY, suggesting that central banks and sovereign funds have reverted to safe assets.

- They might have been among those investing in capital raising private equity funds. They may also have been investing in some small stakes in equity that aren't disclosed.

One trend we've seen is an increase in joint venture funds. QIA in particular has signed a number of such deals, including one in Vietnam. A local partner may open doors and help gain accss to some investments.

They might be wary of future losses. If funds were tracking the equity indices, funds could have sustained significant losses. Those countries more subject to public oversight might be wary of the fallout of investments - and are taking the opportunity for more due diligence.

Finally, they may also be worried about what Theodore Kassinger called the unpredictable, potentially volatile political environment in Congress. Together with the worries about the US economy, the decision to stay on the sidelines may be overdetermined.
If they've been wary, that doesn't mean people haven't been courting them. Frank Kane reports on the Dubai stop of the Freddie Mac roadshow in Dubai and suggests middle eastern
investors might be returning to Agency bonds. Yet Freddie Mac claims that recent investment from the Middle east has been in the 10s of billions of dollar range, with Saudi and the UAE accounting for most. nothing to sneeze at, but a small share of assets to place. This is hard to track though. The GCC didn't really participate in the EM shift to agencies of last year (at least as far as the US data story tells) and its purchases don't seem to have accelerated so far this year.

GCC foreign liabilities have been attracting more attention. On the one hand it seems a bit unusual to talk about the debt of the GCC. After all, all GCC countries are net creditors - the net CAS was well over $200 billion in 2007(IMF). The 2008 surplus will likely be much larger, about $330 billion if the IMF is right (oil price estimate $95). The investment funds and central banks added $215 billion in 2007 and are on track to add over $300 billion in 2008 (and maybe more). And that doesn't include private wealth.

But debt has been growing too. UBS notes that the UAE's foreign debt rose by 50% in 2007 to exceed $105 billion. These liabilities are dwarfed by savings, but its still an increased pace.
$13 billion is public sector borrowing, with the rest that of the private sector, especially the banks. Of course many of the banks are closely tied to the public sector and investors may assume that they won't be allowed to fail. After all, the GCC bank with the largest subprime related losses, Bahrain's Gulf international Bank is co-owned by many GCC governments and received a $1 billion capital injection after reporting a $757 million loss.

While some projects could be delayed, it seems unlikely big projects at home will fail. But credit costs may rise or delay financing. But new projects could be on hold, especially those outside. This week Emaar pulled out of a big project in Seattle in part because of financing - and perhaps questions about the health of the US property sector. In the property sector, even capital rich investors still care about debt costs, especially for multi-year projects.

Short-term cash flow may be a bigger concern. Yet, the GCC is protected from some of the refinancing issues faced by a country like Kazakhstan where challenges of rolling over foreign financing have made Kazakh banks ripe for foreign investors.

Global credit tightness could have the side benefit of deepening domestic capital markets. Markaz reports that GCC funds and state corporations are are increasing their stakes in GCC equity markets. Gulf news suggests that rather than seeking more expensive funds abroad, GCC banks may seek to raise more funds at home, issuing medium term notes to mitigate against existing maturity mismatches. This might have the side benefit of new listings for the Dubai Financial exchange. Mubadala, Abu Dhabi's economic development arm just bought almost a billion dollars of bonds issued by aldar, the abu dhabi property development arm. Mubadala has always had domestic investments - and invested abroad in joint ventures to support economic development at home - perhaps it is just a shift from equity to debt. This trend, matches that of increased domestic and international private sector involvement in the large capital projects.

Yet international trends may also limit economic policy autonomy and asset allocation choice. Speaking of the savings of the Emirates, I'm a bit delayed in noting the stunning rise of the UAE's reserves in the fourth quarter. Although the central bank has yet to officially report the data, the press quoted officials stating that the reserves reached $75 billion in November. a record $25 billion over October and almost trippling from January - November 2007. To put it in perspective the UAE added more in reserves in the month of November than Saudi Arabia's foreign asset growth ($17 billion). This increase is almost entirely the result of central bank intervention to neutralize inflows betting on a revaluation. After all, it was in November that 12m UAE dinar forwards surged and the UAE central bank governor seemed to endorse moving to a basket and away from the US dollar. No wonder Charles St-Arnaud of Morgan Stanley sees a continued fast pace of reserve accumulation and suggests that the GCC could join the ranks of the largest reserve stockpilers - without even including the over $300 billion in non-reserve assets of Saudi Arabia's Monetary Agency. He suggests GCC reserves might increase by a factor of 3-7 over the next 8 years.

But as he notes the pace of reserve growth is dependent on one major thing - the exchange rate regime and its credibility. For now at least, revaluation seems off the table - likely a fear of kicking the dollar when its down. Furthermore, the GCC monetary union seems back on the table. Yet current denials of a revaluation may be more credible and 12 month forwards have stopped rising in recent months. Yet it is another example of the way in which the dollar peg limits freedom of economic policy.

The biggest implication of this news though - is that GCC countries have yet to really diversify their currency holdings. Central banks of the GCC - including SAMA- likely added around $140 billion in assets, compared to just over $100 by sovereign wealth funds. Central banks tend to hold a much higher share of US dollars.

One data point to watch is the international banking data of the bank of international settlements released this week. It may give some indication of borrowings but also clues whether countries like Libya have increased the risk profile of their assets, as the creation of the Libyan Investment authority would indicate.