Presidents, ministers and major business leaders spent the past few days at the Davos forum discussing the fate of the world economy.
While the credit crunch, global warming and a possible recession were discussed, most of the participants had the growing global role of the extremely liquid sovereign wealth funds (SWFs) on their minds.
McKinsey recently published a research report showcasing the rapid increase in the assets controlled by SWFs, predicting that this growth will naturally give them more power in the world economy.
Oil prices broke the $100-barrier early in the year and are predicted to continue to rise, or at least remain above $80 a barrel this year.
This increase in energy prices is permitting investors outside Europe and the United States to shape trends in financial markets.
Petrodollar investors have newfound influence with the tripling of oil prices since 2002, and “a majority of these revenues have been recycled into global financial markets, making petrodollar investors powerful players”, the report said.
Based on three benchmark price points and research on global energy demand by McKinsey Global Institute, the report predicted the size of petrodollar foreign investments in the next four years.
If oil is at $50 a barrel the annual net capital outflows of the petrodollar countries would amount to $387 billion (Dh1,420bn) a year through 2012, corresponding to an infusion of capital into global financial markets at a rate of more than $1bn per day. At $70 a barrel petrodollar flows would reach $628bn annually by 2012, or $2bn a day. By 2012 the total stock of petrodollar foreign assets would grow to $6.9 trillion.
With such huge sums, investors from oil-exporting countries and China would undoubtedly shift economic power from the West, a dynamic that is raising concerns among Western political and business leaders.
US President George W Bush signed an executive order on Wednesday to tighten controls over the inflow of foreign direct investment. Over the past two months, following the massive write-downs at some of the world’s largest financial institutions, SWFs from the Middle East, China and Singapore pumped $60bn to shore up the sector.
The order was signed just a day before Bader Al Sa’ad, head of the Kuwait Investment Authority, and Muhammad Al Jasser, vice-governor of Saudi Arabia’s Central Bank, gave presentations at the Davos forum, in a session dedicated to SWFs. The US and Europe have been criticising SWFs for the past six months, mainly charging that the funds are not transparent.
Finance professionals at Davos argued that protectionist fears about the influence of SWFs have been unjustified and they should not be over-controlled.
“I would make an argument today that the greatest single benefit to the longevity of the US and UK financial structure is investment made by sovereign wealth funds into financial institutions,” said Michael Klein, Chairman and Co-Chief Executive of Citigroup’s markets and banking department.
Relatively young SWFs, hugely liquid but lacking experience, also offer lucrative opportunities to the investment community. Morgan Stanley predicts SWFs in the aggregate may outsource around 20 per cent of their assets to external investors, placing as much as $200bn in the next five years. The firm expects SWF assets to reach $12trn by 2015, almost 10 per cent of all financial assets in the world.
In an effort to explain the opaque funds controlled by oil-producing states, and where the rest of the petrodollars are going, McKinsey Global Institute Director Diana Farrell and consultant Susan Lund recently published a report. Following are some excerpts:
THE ASSETS
McKinsey estimates investors from oil-exporting nations owned $3.4trn to $3.8trn in foreign financial assets, which was invested in a number of ways, at the end of 2006.
CENTRAL BANKS
Some funds end up as resources held by central banks, which invest in foreign assets to stabilise currencies against balance-of-payment fluctuations. Among oil exporters, Saudi Arabia has the largest central bank funds, with an estimated $250bn in 2006.
SOVEREIGN WEALTH FUNDS
Unlike the reserves of central banks, these funds hold diversified portfolios that range across equities, fixed-income vehicles, real estate, bank deposits and alternative investments. The largest SWF among oil exporters, the Abu Dhabi Investment Authority, reportedly has total assets of up to $875bn.
INVESTMENT CORPORATIONS
Oil exporters channel some of their wealth into smaller, more targeted funds, such as Dubai International Capital and Istithmar. These entities invest directly in domestic and foreign corporate assets, shunning the portfolio approach of the wealth funds. And many operate like private equity firms, actively buying and managing firms.
Liquidity
The McKinsey report also examined the role of petrodollars in increasing liquidity. Since 2002, as oil prices have tripled, much of the incremental increase has ended up in the investment funds and private portfolios of investors in oil-exporting countries. This money is being recycled on global financial markets, whose liquidity is therefore rising.
In fixed-income markets, this added liquidity has significantly lowered interest rates. The total foreign net purchases of US bonds have brought down long-term rates by about 130 basis points.
Petrodollars have added liquidity to international equity markets as well. Taking into account the allocations of GCC investors, it is estimated that each year equity markets receive $200bn in petrodollars, accounting for about four per cent of their capitalisation.
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