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Gulf states turn inward as they face diminishing resources

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In the early weeks of the coronavirus pandemic, Saudi Arabia’s ambitious sovereign wealth fund scented an opportunity.

As global markets plummeted, the Public Investment Fund went on a spending spree, buying stakes in a host of US and European blue-chip stocks in the first three months of the year, worth collectively at least $7.7bn

But Crown Prince Mohammed bin Salman, the kingdom’s de facto leader and the PIF’s chair, last month signalled a potential shift in focus as Saudi Arabia, like other Gulf countries, grapples with a rising fiscal deficit and an economy battered by the pandemic and the fall in oil prices.

In a November speech to the Shura Council, an advisory body, Prince Mohammed said the $347bn fund would pump about $40bn into the Saudi economy annually in 2021 and 2022, up from $15.5bn last year.

“This liquidity will be provided through monetisation and recycling of the fund’s investments to enter into new opportunities, [and] create a local economic cycle that enables the emergence of new sectors,” he said.

Saudi Crown Prince Mohammed bin Salman Al Saud
Fiscal stimulus: Saudi Crown Prince Mohammed bin Salman © Alamy

His comments were interpreted as an attempt to address concerns about the PIF spending money overseas at a time of recession at home, and an acknowledgment that the government needs to redirect funds if it is to push ahead with state-backed projects.

It also hints at a trend that economists and bankers expect to be hastened by the coronavirus: a more inward focus by the oil-rich Gulf states that have garnered reputations as exporters of capital through sovereign wealth funds (SWFs) and wealthy merchant families.

It is not just SWFs that are likely to be affected, as governments grapple with diminishing resources and the need to accelerate the reform of rentier economies. 

Even senior Gulf officials have acknowledged the coronavirus crisis has underscored the need for change. 

Chart showing emerging markets’ spending on Covid-19 response

“The region, like all regions of the world, will be financially and politically weaker and we would be wise to think about our development models,” Anwar Gargash, the United Arab Emirates’ state minister for foreign affairs, was quoted as saying by Abu Dhabi’s National newspaper, in May.

Days later, Saudi Arabia announced it would triple VAT to 15 per cent, just two years after it was first introduced, and suspend civil servant benefits as part of austerity measures. Governments across the region have been forced to delay or halt projects as they cut state spending.

Saudi retailers during the pandemic: economists say taxes are likely to rise © Alamy

The IMF forecasts that all the Gulf states, except Qatar, will run double-digit budget deficits this year. Even before the pandemic, the fund warned that at the current fiscal stance, the region’s financial wealth could be depleted by 2034.

But if the oil price was $20 a barrel, the Gulf states would endure “wealth exhaustion” in seven years — the point when governments’ financial wealth, including central bank reserves and sovereign wealth funds’ net assets is less than debt, it said in a February report.

That would turn the Gulf from a net creditor to a net borrower vis-à-vis the rest of the world.

Prices of Brent crude, the international benchmark, briefly fell below $20 a barrel in April and are currently trading around $40 a barrel, well beneath what most Gulf states need to balance budgets.

Chart showing oil prices and volatility

An executive at an international asset manager says he has not yet seen redemptions from the region, but he expects that to happen and predicts that “wealth exhaustion” will occur faster than the IMF predicts.

“There will have to be more focus internally,” he says. “These [SWFs] are rainy day funds and it’s pretty much pouring at the moment.” 

Prince Mohammed said that if the government had not increased non-oil revenues to about $96bn this year from about $27bn in 2015, Riyadh would have been forced to reduce public sector salaries by more than 30 per cent, “cancel allowances and bonuses completely” and halt capital spending.

The break-even oil price for Riyadh, Abu Dhabi and Kuwait last year ranged from $83 per barrel to $53, according to the IMF. Qatar, the world’s richest nation in per capita terms, had the lowest break-even price at $45. For Oman and Bahrain, it was $93 and $106 respectively. 

Gulf states were touting ambitious economic reform programmes prior to the coronavirus outbreak such as Prince Mohammed’s “Vision 2030”. 

But progress has been uneven across the region and attempts to diversify away from oil have mostly been slow.

All governments are now expected to have to raise non-oil revenue through taxes of some form, increase borrowing and trim wage bills in the public sector — the main source of employment for locals across the Gulf. 

In Saudi Arabia, public sector salaries account for about 45 per cent of expenditure; in Kuwait state wages and subsidies account for more than 70 per cent of outlays. 

John Sfakianakis, a Gulf expert at Cambridge university, said across the region there would “be a combination of more taxes, less spending and an awareness that the entitlement years are way behind us”.

“The social contract is in flux and the perception of global investors is one of uncertainty and concern,” he said. 

Experts say that while it is unlikely that any of the Gulf states would introduce income tax, corporate tax could become a reality. 

“These conversations have been happening for five to six years, but the willingness to make these decisions is higher now,” said an executive in the region.

The UAE, Qatar, Kuwait and Saudi Arabia all have large sovereign wealth funds — and Riyadh’s has foreign reserves of more than $430bn — to act as buffers.

A market in Qatar, the world’s richest nation in per capita terms © QATAR OUT/AFP via Getty Images

State investment vehicles are expected to continue seeking foreign opportunities, but not necessarily on the same scale as in the past. 

The PIF has a dual mandate to invest in foreign assets and develop the domestic economy. It has sold down about $3bn of its US stocks, while pumping a similar amount into stakes in units of India’s Reliance Industries this year. But Saudi Arabia and the Gulf’s other wealthier states all face their own pressures. 

Saudi Arabia has by far the Gulf’s largest population is blighted by record unemployment. It also needs to preserve its reserves to avoid speculation on its riyal-dollar peg. 

Abu Dhabi has to be ready to support poorer emirates in the UAE. Kuwait boasts the region’s second-largest sovereign wealth fund, with an estimated $600bn of assets, but it relies on petrodollars for almost 90 per cent of state revenues and is often criticised as being one of the slowest to drive reforms.

S&P Global Ratings downgraded Kuwait’s credit rating to AA- from AA in March and changed its outlook to negative in July as it estimated that Kuwait’s budget deficit would widen to 40 per cent of GDP this year. 

A senior banker, who at the beginning of the year was fielding calls from Gulf sovereign investment funds hunting opportunities, says: “I just don’t see them being active”. 

The exception, he added, was the Abu Dhabi Investment Authority, the region’s biggest fund, which has been “super-active” in private equity. 

More broadly, the banker says, “the phones aren’t ringing”. He believes Gulf funds “are more inward looking. They’ve definitely cooled off”.



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Pakistan’s finance minister ousted in surprise defeat for Imran Khan

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Pakistan’s prime minister Imran Khan suffered a major political setback on Wednesday, when his finance minister was defeated in a contest for a seat in the country’s senate.

Khan must now appoint a successor to the cabinet post by June 11 under Pakistani law. The surprise defeat of finance minister Abdul Hafeez Shaikh, a respected economist and former world bank official who led the country’s negotiations with the IMF for a $6bn loan, comes amid an escalating campaign by main opposition parties to have the prime minister removed from office.

Elected officials vote to fill vacated seats in the senate every three years. Following the result, the government announced it would “take a vote of confidence in parliament” to prove that the prime minister retained a majority of support.

Business leaders have warned that Shaikh’s departure creates uncertainty over the future of Pakistan’s fiscal policies as the country battles the pandemic’s fallout on the economy.

“Right now, it was essential to give a message of confidence to a range of stake holders within and outside Pakistan on the state of our economy. Now, people will be left asking questions,” the president of a private Pakistani bank told the Financial Times.

An 11-party opposition alliance, the Pakistan Democratic Movement (PDM), has accused Khan of using the powerful military to tip the 2018 election result in his favour — which leaders from the prime minister’s party have denied — and for failing to revive the moribund economy.

The PDM has announced a March 26 deadline for Khan to step down or face widespread opposition protests.

Though some opposition leaders have said they plan to follow up Wednesday’s defeat with a vote of no confidence against Khan, analysts said it was too early to predict his downfall ahead of the end of his five-year term in 2023.

“It’s a major upset for Imran Khan and his PTI (Pakistan Justice Party),” said Huma Baqai, a political commentator at the University of Karachi. “The government from hereon will face further pressure as the opposition continues to step up its campaign.”

The vote count suggested a break in Khan’s PTI party, with as many as 16 party members either voting for the finance minister’s opponent, former prime minister Yusuf Raza Gilani, or spoiling their ballots.

Shaikh’s defeat “will not automatically lead to the prime minister’s downfall. Some PTI members clearly changed sides [for this vote]. But it will be much harder for them to agree to removing the prime minister,” an opposition leader told the FT.

Faisal Javed, a PTI leader, claimed some representatives had been bribed by the opposition. “There has been a major corruption. There has been horse-trading. People have been sold,” he told the local ARY news channel on Wednesday. Opposition leaders have denied this.

The electoral college for the senate consists of members from legislatures of Pakistan’s four provinces as well as the lower house of parliament in Islamabad known as the national assembly.



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Australia’s treasurer warns global stimulus threatens financial stability

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Australia has warned that unprecedented global stimulus efforts during the coronavirus pandemic are creating financial stability risks that will only intensify when interest rates inevitably rise.

Canberra has also defended tough new foreign investment rules that have led to a collapse in Chinese investment, arguing the number of proposed deals motivated by strategic, rather than purely commercial gain, was increasing.

Josh Frydenberg, Australia’s treasurer, said the Pacific nation was in a strong economic position as its net debt to gross domestic product was about half that of other advanced economies, even as it begins unwinding fiscal stimulus.

“There is no doubt elevated debt levels will create challenges for many countries. While global interest rates are low those debt levels can be serviceable — but there will be a time when the monetary policy settings change,” he told the Financial Times.

Frydenberg’s comments on the risks posed by global stimulus followed a similar warning delivered last week by Peter Costello, a close political ally and former Australia treasurer.

Australia will be among the first advanced economies to taper off Covid-19 fiscal stimulus with the closure of its A$90bn (US$70bn) JobKeeper wage subsidy scheme this month.

Canberra has argued that the recovery is already under way, citing a fall in unemployment to 6.4 per cent in January and a 3.3 per cent economic expansion in the three months to September last year.

Frydenberg, who counts Margaret Thatcher and Ronald Reagan among his role models, said the government’s A$250bn stimulus was required to stabilise the economy during the pandemic. But he said JobKeeper, which supported 3.6m workers at its peak, was no longer needed as the recovery could be supported by tax cuts, which were announced last year.

Asked if he thought the economic policies of Thatcher and Reagan were still relevant, he said: “[Reagan and Thatcher] achieved a lot when they were in office and they were committed to lower taxes. They were committed to cutting regulation and that’s certainly what I’ve been committed to as well.”

But trade unions and businesses that are still suffering as a result of border closures and restrictions, particularly in the tourism and entertainment sectors, have warned that the scheme’s closure will dent the economy.

“JobKeeper should be extended for those businesses that are still affected by coronavirus. [Through] no fault of their own, they are suffering that downturn,” said Sally McManus, secretary of the Australian Council of Trade Unions, last week. “And we say that because that will save jobs.”

Josh Frydenberg, Australia’s treasurer, is a rising star in the country’s conservative government and is tipped as a future prime minister © AP

Frydenberg, who was the architect of foreign investment rules aimed at countering rising Chinese influence, said he made no apologies for putting “national interest” at the heart of Australia’s investment policies.

Chinese investment fell 61 per cent last year to A$1bn, down from A$2.6bn in 2019 and a peak in 2016 of A$16.5bn, data showed. Frydenberg was instrumental in blocking two potential deals: China Mengniu’s A$600m bid for Japan-owned Lion Dairy and China State Construction Engineering Corp’s A$300m bid for Probuild, a South Africa-owned construction company.

“We absolutely reserve the right to make decisions around foreign investment based on national interest and having put in place an explicit national security test allows us to do that,” he said.

“Increasingly we’ve seen foreign investment proposals that have been motivated not by purely commercial gains but more strategic ones. When those foreign investment proposals potentially compromise the national interest, then we reserve the right to say no.”

Frydenberg said Australia was not alone in tightening its rules, noting that other countries shared Canberra’s views on national sovereignty and foreign investment.

“Obviously we have had some challenges with China,” he said when asked about Beijing’s imposition of trade sanctions on a range of Australia’s exports following Canberra’s call last year for an inquiry into the origins of Covid-19 in Wuhan.

Frydenberg insisted that Australian ministers were prepared to sit down with their Chinese counterparts to discuss the bilateral relationship but only on a “no conditions attached” basis.

“It is a mutually beneficial trading relationship — we supply the bulk of their iron ore and that iron ore has helped underpin their economic growth,” he said.

Frydenberg is a rising star in Australia’s conservative government and is tipped as a future prime minister.

Last week, he shot to global attention following several days of negotiation with Facebook’s Mark Zuckerberg over the social media company’s decision to block news on its platforms in Australia in response to a law forcing it to pay news publishers.

On Friday, Facebook “refriended Australia” and returned news to its Australian platform following amendments that may make it easier for the company to avoid the toughest elements of the law.

“Trying to negotiate with these guys is a bit like playing chess against a chess master,” said Frydenberg, who joked that he spoke to Zuckerberg more than his own wife last week.

“The reality is they are massive companies with huge balance sheets and global reach. If this was easy other countries would have done it [made Big Tech pay for news] long ago.” 



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Ecuador’s exporters caught between US and China after debt deal

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Exporters in Ecuador are worried that their all-important trade with China will suffer as a result of a controversial agreement the US says is aimed at shutting China out of the South American country’s 5G telecoms network.

The agreement, signed by the US International Development Finance Corporation (DFC) and the Ecuadorean government just days before Donald Trump left office in January, envisages the US buying oil and infrastructure assets in Ecuador on the understanding Quito uses the proceeds to pay off its debt to China.

It also obliges Ecuador to sign up to what the Trump administration called the “Clean Network” — a state department initiative designed to ensure that nations exclude Chinese telecoms services and equipment providers as they build out their high-speed 5G mobile networks.

Adam Boehler, the recently departed chief executive of DFC, has described the deal as a “novel model” to eject China from the Latin American nation.

But it has caused unease in Ecuador, which has become increasingly reliant on exports to China.

“The announcement has generated a lot of inquiries and a lot of doubts,” said Gustavo Cáceres, head of the Ecuadorean-China Chamber of Commerce (CCECH). “We hope our authorities handle this in the best way possible so as not to give the impression that we’re turning our backs on China.”

One of the smallest countries in South America, Ecuador has traditionally exported primarily to the US and Europe, but China is fast catching up. Its share of Ecuador’s exports jumped from 3.9 per cent in 2015 to 15.8 per cent. In the same period, the US’s share fell from 39.4 per cent to 23.7 per cent.

The Chinese buy oil, shrimp, bananas, cut flowers, cacao and timber from Ecuador. Last year, despite the coronavirus pandemic, Ecuador’s exports to China grew more than 10 per cent and, for the first time, the country boasted a trade surplus with Beijing.

The shrimp industry has become particularly important. Since 2016, Ecuador’s shrimp exports worldwide have jumped 86 per cent. The nation of just 17.4m people is now the largest exporter of shrimp in the world, having overtaken India last year, when it exported 676,000 metric tonnes of the crustaceans in trade worth $3.6bn. After oil, shrimp were the country’s most lucrative export commodity.

Over half of that went to China, which, with its expanding middle class, is acquiring a taste for seafood once seen as a luxury.

“China will remain our main market,” forecast José Antonio Camposano, president of Ecuador’s National Chamber of Aquaculture (CNA), which oversees the industry. “We need a smart approach to China. A market of 1.4bn people with the acquisitive power that the Chinese have? I’m a businessman, how can I say no to that?”

The CNA was sufficiently worried by Ecuador’s agreement with the US that it sent a three-page letter to Ecuador’s president Lenin Moreno reminding him of China’s buying power.

While the letter did not mention the DFC deal directly, it urged Moreno — who in his four years in power has shifted Ecuador’s axis away from Beijing and towards Washington, reviving relations with the IMF and renegotiating the country’s debt to bondholders — “to reinforce with senior Chinese leaders the point that the excellent relationship between Ecuador and China remains intact”.

Freshly caught shrimp being packed into containers in Ecuador in 2011
Ecuador’s shrimp industry has fed a growing appetite among China’s expanding middle class © Bloomberg

China’s ambassador to Ecuador, Chen Guoyou, said he was unconcerned by the DFC deal and described media reports that it excluded Chinese companies from Ecuador’s telecoms network as “over-interpretation and gratuitous assumption”.

“China respects the sovereign and independent decision of the Ecuadorean government to develop pragmatic, balanced and diverse partnerships with other countries,” he told the Financial Times in an email.

Responding to his comments, one of the former Trump administration officials who negotiated the deal said it had been made explicitly clear in the text that the agreement was contingent on the country participating in the “Clean Network” — which would prevent it from including Huawei or any other Chinese company in its telecoms network.

The future of the deal, and indeed Ecuador’s future relations with China and the US, will depend in part on the outcome of the country’s presidential election on April 11. It pits leftwing economist Andrés Arauz against Guillermo Lasso, a conservative former banker. 

Arauz has the backing of Rafael Correa who took Ecuador out of the US’s orbit and pushed it towards China while serving as president from 2007 until 2017. He broke off relations with Washington’s financial institutions and signed a series of loans-for-oil deals with the Chinese. If Arauz wins the election he is likely to seek support from Beijing and might rip up the DFC agreement, particularly now Trump is no longer in office.

In contrast, Lasso told the FT previously the deal was “a pleasant surprise” and “good news” for Ecuador.

“It’s clear that the US is our principal ally and in my government I would look for an even closer alliance with the US,” he said.



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