Sovereign funds feel the pressure

US Treasury data released in May painted a dismal scene for Middle Eastern economies. In March, it showed, sovereigns drew down heavily on their foreign holdings as they sought to prop up flagging economies and bolster their mainly dollar-pegged currencies. In a sign of the scale of crisis, the UAE sold 25 per cent of its total US Treasury holdings, while Saudi Arabia sold 14 per cent, Oman 13 per cent and Kuwait 8 per cent.

Such large withdrawals underscore the seismic challenge that the Covid-19 crisis poses for oil-based economies. The IMF forecasts that oil exporters in the Middle East and North Africa (Mena) region will see a yearly decline in oil export receipts this year of $226bn. That has put additional pressure on fiscal positions, forcing governments in some cases to look for additional support in their sovereign wealth funds (SWFs).

In tandem with the repatriation of overseas holdings, which in Saudi Arabia’s case dropped by a record $24bn in March, regional governments view their own sovereign funds as a means of providing liquidity for shell-shocked economies.

The coronavirus outbreak could provide greater scope for SWFs to play a constructive role in giving a boost to domestic economies starved of liquidity.

Reserve drawdowns

One reason that SWFs are increasingly in the frame is that there are strict limits on how much further governments can tap into their foreign exchange holdings. Riyadh-based Jadwa Investment says it does not expect reserve drawdowns going ahead similar to the $24bn month-on-month decline in March. Finance Minister Mohammed al-Jadaan has set a limit on drawdowns to a maximum of $32bn this year.

Fitch Ratings expects about $140bn in drawdowns from fiscal reserves and SWFs by GCC countries in 2020, compared with just $10bn in 2019. Much of the heavy lifting will be done by the SWFs. The Washington-based Institute of International Finance (IIF) estimates that the funds of oil-rich governments could see their assets decline by a significant $296bn by year-end 2020. The UAE, Kuwait and Qatar will account for the bulk of the declines this year, with the assets of each set to drop by about $100bn, forecasts the IIF.

While most SWFs are still comfortably positioned to absorb such losses, having built up asset hauls of more than $2tn as part of their remit to invest the oil surplus for future generations, regional governments’ urgent need for liquidity will challenge their investment strategies. The situation is made more difficult as they face negative financial returns in the current market downturn that could put further pressure on their assets, although Fitch says asset prices have recovered from their lows in mid-March, which had erased gains registered in 2019.

Opportunities ahead

Some funds sense opportunity amid the crisis. Saudi Arabia’s Public Investment Fund (PIF) and the UAE’s Mubadala are picking up competitively priced assets after their valuations were eroded by the pandemic. PIF governor Yasir al-Rumayyan has said the $320bn fund is actively looking for buying opportunities given the crisis’s impact in forcing global asset prices down. Following a buying spree in early 2020, the PIF now holds about $10bn in US public equities, a rise of about $8bn on the start of the year.

Despite pressure, some SWFs are wary of liquidating assets in the face of a crisis, for fear that this could undermine investor confidence and erode the value of their equity holdings. Abu Dhabi Investment Authority’s recent decision to delay the sale of $2bn in private equity fund stakes followed speculation that it could not secure consensus over valuations of stakes in the turbulent climate.

There is still substantial scope for further drawdowns from sovereign funds this year.

According to Fitch, the reserve drawdown is likely to be led by Kuwait, Saudi Arabia and Abu Dhabi. Kuwait’s situation is complicated by the fact that accessing the bulk of SWF assets will require parliamentary approval – never a smooth process in the country.

Regional outlook

Kuwait looks particularly vulnerable, given its fiscal deficit could be around 40 per cent of GDP this year (compared to just 9 per cent last year) notes NBK Research. Financing the deficit could deplete most of the estimated KD16bn ($51.8bn) held in the General Reserve Fund. The government has significant financial resources in the longer-term Future Generations Fund, but these cannot be easily accessed under current laws.

In Doha, Qatar Investment Authority is reported to have sought to help replenish Qatari cash reserves by committing some of its biggest capital investments in Europe to a $7.6bn loan.

Oman, more vulnerable than its neighbours, is also dipping into its sovereign fund. Fitch Ratings said that Oman could deplete the State General Reserve Fund by more than $5bn to finance budget deficits. The fund has also already seen its holdings decrease by about a third to $14.3bn this year, according to the Sovereign Wealth Fund Institute.

With some of the largest Mena sovereign funds still in the process of high-profile asset hauls, the sector faces a difficult tightrope walk this year, balancing mandates to protect wealth for future generations with a need to help shore up economies that are being battered by the drop in oil income and a smothering of economic activity. Most will be aware that governments will be looking to have them on a tighter leash as the economic headwinds hammer economies that were still in recovery mode.