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Middle Eastern SWFs

By: Carson Ezell

How do economies diversify when they are dependent on a small subset of resources? Policymakers around the world debate this issue, including within the oil-dependent economies of the Middle East. The COVID-19 pandemic exposed the vulnerabilities of oil producers to short-term volatility and foreshadowed their long-term financial instability amidst a shift away from nonrenewable energy. In 2020, the net income of Saudi Aramco—Saudi Arabia’s state-run oil firm—fell by 44 percent.

Foreseeing the threat to their stability, governments of oil dependent nations have stockpiled annual surpluses away in sovereign wealth funds (SWFs) for years. SWFs are large sums of state-owned capital that can be invested in various sources, from bonds to private corporations. They are less common in privatized economies like the U.S. because they involve significant government investments and ownership of industry, but they are integral to many economies globally, including the Middle East.

While SWFs have historically satisfied a variety of funding needs, they have increasingly been invested in the development of new industries and diversification of revenue streams for national economies. The continued use of SWFs to shift Middle Eastern economies away from oil is essential to their long-term success. This article will analyze the Middle East’s attempts to use SWFs to promote economic stability and diversification through strategic development initiatives.

SWFs can be used by governments for several purposes: responding to government deficits, making foreign investments, or developing domestic industry are some of their applications. They are held by governments throughout the world, with the largest SWF being the Government Pension Fund of Norway, used to divest Norway’s own oil revenues. SWFs are particularly popular in the Middle East, however, because of the oil wealth that has accumulated. The Kuwait Investment Authority was the first SWF ever established in 1953, and many Middle Eastern governments now maintain several SWFs which utilize different investment strategies with various appetites for risk. The largest SWFs in the Middle East include the Abu Dhabi Investment Authority (726 billion dollars), Kuwait Investment Authority (559 billion dollars), Saudi Arabia’s Public Investment Fund (360 billion dollars) and the Qatar Investment Authority (345 billion dollars). By comparison, Norway’s pension fund has a valuation of about $1.1 trillion.

With the need to diversify away from oil growing, Strategic Development Sovereign Wealth Funds (SDSWFs) are growing in popularity. These differ from other SWFs by focusing on investments to boost or diversify the economy, as opposed to other SWFs which may make low-risk investments and serve to stabilize budgets during economic downturns. This marks a move away from investments in safer assets like real estate and bonds. SWFs now focus more on technology, infrastructure, education and healthcare. COVID-19 further precipitated this trend, with SWF investments in property decreasing from 38 percent to 29 percent of all SWF investments, replaced by the aforementioned sectors.

SWFs have increasingly taken stakes in corporations as well. Saudi Arabia’s Public Investment Fund took a 45 billion dollar stake in the SoftBank Vision Fund 1—a technology-focused venture capital fund—and a 20 billion dollar stake in the Blackstone Infrastructure Fund.

Middle Eastern governments have also made significant investments in promoting tourism to supplement falling oil revenues. Tourism forms a large proportion of revenue in many developing economies that lack strong manufacturing and service sectors, especially when they have ecological or cultural attractions. In Saudi Arabia, religious tourism is strong because of the annual hajj pilgrimage to Mecca. In 2017, an estimated 8 million tourists brought 4 billion dollars of revenue to the kingdom, forming around 25 to 30 percent of private sector income in the region surrounding Mecca and Medina—the destination of hajj pilgrims. Beyond religious tourism, culture and sports have become new strategies for Middle Eastern economies to develop tourism revenue. In 2022, Qatar will draw international attention for hosting the FIFA world cup. In Abu Dhabi, SWFs are supporting the construction of new art museums, including the Louvre Abu Dhabi and Guggenheim Abu Dhabi.

Another priority of Middle Eastern SWFs has been developing high-tech sectors, especially in Saudi Arabia. The Public Investment Fund is responsible for developing a planned city known as NEOM, a sustainable and futuristic city incorporating smart technology. It is a continuity of the modern urbanization of the region which has previously built futuristic-looking cities like Dubai and Doha. In the Gulf countries, urbanization rates significantly overshadow the rest of the world. Eighty-six percent of the United Arab Emirates’ population lives in urban areas, exceeded by Bahrain (89 percent), Jordan (91 percent), Qatar (99 percent) and Kuwait (100 percent). By comparison, the urbanization rate of the United States lies just below 83 percent. A lack of arable land and overall area combined with population growth and the desire to develop stronger economies are main causes of the urban transformation.

Despite the past successes of SWFs, their rapid growth in popularity has created regulatory issues which need to be addressed. In order to organize their assets by investment strategy, governments such as that of Abu Dhabi have created several unique funds: the Abu Dhabi Investment Authority has only foreign holdings, Abu Dhabi Developmental Holding Company makes domestic investments, and Mubadala invests both domestically and internationally. The allocation of funds to different administrators not only risks creating a confusing web of bureaucracy, but it can place government funds in direct competition with one another. A better model may be Saudi Arabia’s Public Investment Fund, which is organized into six different capital pools within the same leadership structure. The pools are divided by categories of investments, including domestic and international. One of the four domestic funds includes the giga projects fund, which is responsible for building NEOM among other major works in progress.

Diversification is still a long way from complete in the Middle East. Ninety percent of export revenues in Saudi Arabia still come from the petroleum sector, accounting for a significant portion of GDP. The vulnerability to oil prices led to a budget deficit of about 79 billion dollars for the kingdom in 2020. Government revenues in privatized economies like the United States are not as vulnerable to commodities because they are more diversified and collect revenue primarily through taxation, not state-owned enterprises.

Building a portfolio with less exposure to oil will mean more than having steady revenue streams from SWFs. Investments in industries such as technology, healthcare and education are necessary to build a workforce that can generate high-value exports. Middle Eastern economies also must capitalize on higher incomes for domestic workers that increased accessibility to education brings. As of 2021, Saudi Arabia only projects to bring in 30 percent of its revenue from taxes. This marks an improvement from previous years, but it is far away from where it needs to be for an economy with a flourishing private sector. If Middle Eastern governments can deploy their cash stockpiles from oil revenues towards productive development while creating regulatory and tax policies that adapt with the changing nature of their economies, the decline of oil will not mark the end of their futuristic desires.



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