Wealth funds feel heat of high budget spend and low oil price

A surge in public expenditure will combine with sliding oil export earnings to reverse years of steady growth in the assets of Gulf sovereign wealth funds (SWFs) in 2009, although they will remain awash with liquidity, analysts said.

After nearly seven years of massive surpluses, the current account and the budgets of the six-nation Gulf Cooperation Council (GCC) could either record a tiny surplus or a deficit this year because of a surge in expenditure and a sharp decline in crude prices and production, they said.

Most regional nations have endorsed record public spending for the 2009 fiscal year to mitigate the repercussions of the global financial turmoil despite an expected sharp fall in their income because of lower oil prices and production.

"A deficit or a small surplus in their account and budget mean there will be no extra funds to support foreign assets," said Ihsan bu Hlaigga, a Saudi economist. "Those assets could even shrink if the deficit largely widens because of big increases in actual spending, as some members usually resort to foreign assets to finance the deficit. I think we'll see no growth in those assets this year."

GCC foreign assets jumped in the first nine months of 2008 because of a steep rise in oil revenues before they suffered severe losses with the eruption of the global crisis.


Low surplus

The collapse in oil prices badly hit exports and this will combine with a cut of nearly two million barrels per day in crude output to depress the GCC countries' current account surplus to nearly $15 billion (Dh55bn) this year from a record $290bn in 2008, according to forecasts by the National Bank of Kuwait (NBK). It said budgets may record a deficit of nearly $20bn this year after posting a massive surplus of $220bn in 2008.

"Consequently, the rally in accumulation of foreign assets over recent years is not expected to continue in 2009," the bank said.

Saudi syndrome

Saudi Arabia, the largest Arab economy and the world's top oil exporter, has already seen a decline of nearly SR217bn (Dh214bn) from its foreign assets since the end of 2008 to fund its record 2009 budget.

The withdrawal represents a departure from the kingdom's policy of financing ?budget gas through domestic borrowing. But analysts explained that Riyadh had resorted to local borrowing before the 2002-2008 oil boom on grounds that its foreign assets were relatively low, not exceeding SR200bn.

The Government pursued such withdrawals despite the improvement in oil prices over the past three months, indicating it is largely overshooting spending.

"Oil prices have largely improved over the past two to three months and recently they surpassed $70 a barrel… yet we still see a ?decline in the foreign assets of the Saudi Arabian Monetary Agency (Sama), mainly deposits with banks abroad," said Mohammed Omran of the Saudi Economic Association.

"Perhaps this is because of a large increase in government expenditure… the Saudi economy has been strong but we want to see the effects of this increase in spending on the domestic economy… we hope to see that in the near future," Omran added.

According to the US Council on Foreign Relations (CFR), the surge in oil prices to record high levels in 2008 pumped at least $300bn into the Abu Dhabi Investment Authority (ADIA) and other Gulf SWFs and central banks, compared with nearly $230bn in 2007, when oil prices averaged $70.


Shrinking funds

Though oil filled the SWF coffers, other factors negated some of this gain. The analysts' report said about the 2008 oil price boom that this "inflow was more than offset by the mark-to-market losses on the equity portfolios of the large sovereign funds… All these funds now look likely to shrink in 2009, as the price of oil has fallen to the point where many Gulf economies will need to draw on their foreign assets to sustain their current level of imports."

The report showed that the total assets of the Gulf's SWFs and central banks peaked at over $1.4 trillion in the second quarter of 2008, including the foreign assets of Saudi pension funds managed by Sama. They have fallen to around $1.2trn, with the decline in the market value of the assets managed by the large sovereign funds accounting for the entire decline, according to CFR.

The report showed that Adia's losses because of the crisis stood at nearly $183bn in 2008 but there was a net flow of nearly $59bn as crude prices surged to a record high of $147 a barrel and the country's output rose nearly to its capacity of 2.6 million bpd (barrels per day), boosting its hydrocarbon earnings to a record $90bn.

The Kuwait Investment Authority lost around $94bn but received a net flow of $57bn while losses and net flow stood at $27bn and $28bn for the Qatari Investment Authority, CFR said.


Falling income

Forecasts by the London-based Centre for Global Studies (CGES) showed that the decline in oil prices and production could depress the GCC's income by nearly $251bn this year. From around $459bn in 2008, the GCC's combined earnings are projected to tumble to nearly $258bn in 2009, it said.

Figures by the government-controlled Emirates Industrial Bank (EIB) showed that the GCC countries could revert to a budget deficit this year for the first time in many years, but it also noted that the shortfall would be manageable given the massive ?assets these nations control.

EIB noted that GCC nations, which control over 45 per cent of the world's recoverable crude deposits, based their 2009 ?budgets on an oil price of $45-55 a barrel, adding that prices could average in that range this year.

"This means their [GCC] budgets could have deficits but they will not be large deficits as oil prices are expected to average at that level through most of 2009 before they could ?improve at the end of the year and in early 2010 with the recovery of the global economy," the bank said in its monthly economic bulletin.

"But this will not be a big problem as the GCC budgets recorded a massive surplus in 2008, which will allow them to easily cover that deficit… such developments, however, again raise the question of the GCC's heavy reliance on oil exports because of two main factors… they include a steady increase in expenditure when oil prices are high and the absence of a taxation system that could generate revenue for the budget."

Strong crude prices, which averaged a record $95 in 2008, allowed GCC countries to post their highest ever budget surplus of nearly $189bn, although they had forecast a surplus of only around $32bn. Saudi Arabia alone ?accounted for more than 80 per cent of this surplus.


Deficits

Experts said that most of the GCC budgets could record deficits because of weak oil prices, rising actual public spending and lower crude production as the group's four Opec members are slashing output in line with an Opec agreement.

Saudi Arabia is expected to bear the brunt of the cuts as it pumps just below a third of the the cartel's supplies. The kingdom's oil production could average around 8.1m bpd in 2009 compared 9.2m bpd in 2008.


UAE

Unlike Saudi Arabia, the United Arab Emirates has never resorted to issuing bonds or any other sort of borrowing to finance its budget shortfall, relying instead on its immense financial muscle abroad. Withdrawal from overseas assets seems to have stopped over the past three years because of a massive surplus in the country's consolidated financial account (CFA), which covers the federal budget and spending by each of the UAE's seven emirates.

But according to a recent study by the NBK, the UAE could revert to asset withdrawal this year because of a possible deficit. "Further strong government spending growth in the UAE this year is likely to result in a sharp turnaround in the budgetary position," the bank said.

Assuming an average oil price of $50 a barrel this year, NBK expects the CFA surplus to fall from 15 per cent of the GDP in 2008 to effectively zero in 2009. "Although a major reversal, this trend provides little meaningful threat to the medium-term integrity of the government's overall financial position. A small deficit would pale beside the near $100bn of budget surpluses accumulated by the UAE government over the past four years," said the bank.

The UAE has not yet published actual CFA estimates for 2008 but estimates by the ?London-based Economist Intelligence Unit showed it was in a record surplus of Dh127bn. However, the surplus had stood at a much higher Dh145bn in 2006-2007.

Forecasts by the Saudi American Bank (Samba) showed that the UAE's CFA could still record a tiny surplus on grounds that oil prices could average $57 a barrel.

"Despite the higher government spending, with oil prices now expected to average $57/b in 2009, the consolidated fiscal accounts for UAE are projected to remain broadly in balance, after years of large surpluses," Samba said.

"In addition, the current account is expected to remain in surplus – albeit considerably reduced at 1.4 per cent of the GDP compared with 22 per cent in 2008 – and official ?reserve levels should stabilise at around $30bn. In line with our $65/b oil price forecast, both the fiscal and current account balances are projected to return to surpluses of above 3 per cent of the GDP in 2010," the bank said.

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