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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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Emerging Markets

Regulators close ranks on crypto

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Regulators are continuing to step up their scrutiny of cryptocurrencies, with central banks and South Korea’s tax authorities demonstrating fresh concerns.

In a report published on Wednesday, the Bank for International Settlements, the global body for central banks, argues that digital tokens such as bitcoin have few redeeming features and “work against the public good”. It also dismissed stablecoins — a link between crypto and conventional assets — as an “appendage” to traditional money.

Perhaps unsurprisingly, the BIS did endorse the development of digital currencies backed by central banks, saying they could be a tool to achieve greater financial inclusion and lower the high costs of payments. “Central bank digital currencies . . . offer in digital form the unique advantages of central bank money: settlement finality, liquidity and integrity,” it said.

In contrast, bitcoin wasted energy and cryptocurrencies were “speculative assets rather than money, and in many cases are used to facilitate money laundering, ransomware attacks and other financial crimes”.

South Korea has acted against the financial crime of tax evasion, with more than Won53bn ($47m) of bitcoin, ethereum and other cryptoassets confiscated from 12,000 people. Officials said it was the largest “cryptocurrency seizure for back taxes in Korean history” and noted that local exchanges had allegedly been used to conceal assets because they did not collect the resident registration numbers of account holders. Many of South Korea’s 60 crypto exchanges are battling to meet regulatory conditions to operate beyond September.

This week’s #techAsia newsletter asks whether the death knell is being sounded for cryptocurrencies. That could be the case in China, where it is scaling up tests of its official digital renminbi, and appears serious about stamping out the crypto industry on its soil. Bitcoin fell below $30,000 on Tuesday following the latest regulatory crackdown, but it has recovered to be worth more than $34,000 today.

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China bolsters ties with Myanmar junta despite international condemnation

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Trade and diplomatic ties between Myanmar and China are normalising in the face of intense domestic opposition and international condemnation of the military junta that seized power in February.

Beijing has strengthened relations with Myanmar’s military leaders despite a series of violent attacks against Chinese business interests in the country after Aung San Suu Kyi’s government was toppled.

Yun Sun, an expert on Myanmar-China relations with the Stimson Center, a US think-tank, said Beijing had already made a “fundamental assessment” that Myanmar was moving into another prolonged period of military rule.

“I think the Chinese can see that this military coup is successful and is here to stay,” she added.

The resumption of state-level engagements and economic activity signals that Myanmar is reverting to its traditional economic reliance on China. The country has used its larger neighbour as a buffer against international sanctions and divestment by foreign investors, who have announced plans to quit the country or shelved projects.

Since the coup, 875 people have been killed by the junta and 6,242 arrested, according to the Assistance Association of Political Prisoners (Burma), a human rights group. The country’s economy and public services were severely disrupted by mass protests in the three months that followed the putsch, and have only partially recovered.

The resumption of bilateral trade will fuel the widespread suspicion among anti-coup resistance groups that China was prepared to support the new military regime.

The cumulative value of China’s imports from Myanmar for the first five months of the year was $3.38bn, up from $2.43bn in 2020 and $2.56bn in 2019, before the coronavirus pandemic, according to official Chinese customs data.

Exports to Myanmar for the same period have not recovered to the same extent, however. By the end of May, goods valued at $4.28bn had been shipped to Myanmar, compared with $4.56bn and $4.79bn in the two previous years.

In a further sign of strengthening diplomatic relations, Chen Hai, China’s ambassador to Myanmar, met coup leader and military commander-in-chief Min Aung Hlaing in Naypyidaw, the capital, in June. In a subsequent statement, Chen referred to Min Aung Hlaing as the leader of Myanmar.

China was among the countries that abstained in a UN general assembly vote last week calling on the international community to halt the flow of arms to Myanmar and release Aung San Suu Kyi and other political detainees. 

Beijing had good relations with the government of the deposed leader, who is in detention facing multiple criminal charges. However, it has refrained from criticising the military, fanning anger among the mass protest movement that sprang up after the coup. 

Beyond being Myanmar’s biggest trading partner, China also has strategic infrastructure investments in the country, including energy pipelines that give Beijing a critical link to the Indian Ocean.

James Char, a Myanmar expert at the S Rajaratnam School of International Studies in Singapore, said many people in Myanmar still blamed the Chinese government and business interests for complicity in supporting the military’s decades of rule before the transition to democracy.

“The Chinese, themselves, are very clear about [public sentiment in Myanmar],” Char said.

Attacks on China-linked businesses in the wake of the coup culminated in an explosion at a Chinese-backed textile factory west of Yangon on June 11, according to reports from local Myanmar media, as well as junta-controlled information services and Chinese state media.

Beijing’s wariness of inflaming Myanmar protesters would probably slow Chinese direct investments and the resumption of planned larger-scale developments that formed part of President Xi Jinping’s Belt and Road Initiative, analysts said.

Additional reporting by Sherry Fei Ju in Beijing



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Australia calls Great Barrier Reef warning politically motivated

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Australia has labelled a draft decision by the UN’s World Heritage Committee to include the Great Barrier Reef on its “in danger” list as politically motivated.

The committee, which is chaired by Tian Xuejun, China’s vice-minister for education, and selects Unesco World Heritage sites, proposed adding the world’s largest collection of coral reefs to the danger list because of the damaging impact of climate change and coastal development.

The designation could ultimately lead to the reef losing its World Heritage status, although officials said listing was intended to prompt emergency action to safeguard a living structure that stretches 2,300km along Australia’s eastern coast.

But Sussan Ley, Australia’s environment minister, said the government had been “blindsided” by the committee’s finding and alleged there was a lack of consultation and transparency. She added that Canberra would challenge the draft decision.

“When procedures are not followed, when the process is turned on its head five minutes before the draft decision is due to be published, when the assurances my officials received and indeed I did have been upended, what else can you conclude but that it is politics?” she said.

That the World Heritage Committee is chaired by a senior Chinese official has stoked suspicions in Canberra that it had been singled out over its diplomatic and trade clash with Beijing.

China-Australia relations have soured following Canberra’s call last year for an inquiry into the origins of Covid-19 and Beijing’s imposition of tariffs on Australian wine and barley imports.

Ley said she and Marise Payne, Australia’s foreign minister, had already spoken with Audrey Azoulay, Unesco director-general, to complain about the draft decision.

But scientists downplayed the suggestion that the “in danger” listing was politically motivated. Three mass bleaching events in five years demonstrated the need for the government to do more to tackle climate change, they said.

“I’m seeing some press coverage saying this is all a plot by China not to buy wine, lobsters and to screw the Barrier Reef. I think that’s pretty far-fetched given that the draft decision released overnight will be voted on by 21 countries,” said Terry Hughes, professor of marine biology at James Cook University.

The controversy will heap further international pressure on Canberra, which has been pressed by the US, UK and others to commit to a national target of net-zero emissions by 2050.

In a draft decision due to be voted on next month, the committee urged Canberra to “provide clear commitments to address threats from climate change, in conformity with the goals of the 2015 Paris Agreement, and allow to meet water quality targets faster”.

It noted the loss of almost one-third of shallow-water coral cover following a “bleaching” event in 2016 — a process linked to warmer than normal water that can lead to a mass die-off of coral.

The row over the “in danger” listing occurred at a difficult time for Australia’s conservative coalition, which is embroiled in internal squabbling over climate policies.

On Monday, Barnaby Joyce, a climate sceptic and supporter of coal mining, ousted Michael McCormack to become leader of the National party, the junior coalition partner to the Liberal party, and Australia’s deputy prime minister. Joyce is expected to oppose any move to commit to net zero by 2050.

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