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Mideast upheaval signals sovereign fund rethink

Mideast upheaval signals sovereign fund rethink

World markets could be disrupted as the management of windfall oil wealth changes in the face of mass social unrest.

March 2, 2011 1:21 by



BALANCE SHEET IMPACT

Vast oil wealth is a key factor underpinning credit ratings in resource-rich but politically vulnerable countries which have high youth unemployment.

Libya, for example, is rated BBB by Fitch Ratings — higher than Egypt’s BB. Gulf countries are all rated A or above.

But the protests have already had fiscal consequences.

Fitch expects even before the latest steps, Bahrain’s already expansionary measures would more than double its gross debt to 38 percent of GDP by 2012 from 2008.

“The credit ratings for some of the hydro-carbon rich sovereigns in the region have long been held down due to concerns about social and political factors like high unemployment or the absence of voice and accountability,” said Purvi Harlalka, director at Fitch.

“From a purely balance-sheet point of view, they look strong. However, now that the social and political risks that were factored into the rating have manifested, they have real and visible economic costs that further impact creditworthiness.”

DUTCH DISEASE

For global capital markets, a sudden change in a country’s wealth management policy or the environment surrounding their investment could trigger a sell-off and volatility.

Moves by U.S., UK and European authorities to freeze Libya’s state assets and a sell-off in shares of Unicredit, 2.6 percent owned by the Libyan Investment Authority, illustrate this point.

The redirection of oil wealth to domestic industries may have other downsides.

Sovereign wealth funds in resource economies do not exist only to invest for future generations but also to diversify their economies and avoid so-called “Dutch disease”.

Rapid oil sector growth could make other industries less competitive and lead to lower growth than those with fewer natural resources — as seen in the 1960s Dutch economic crisis following the discovery of North Sea natural gas.

Home investment is often seen by sovereign funds as something of a taboo, except in a severe economic downturn, because the domestic recycling of the surplus risks fanning inflation and discouraging competitiveness.

For this reason, certain SWFs such as Norway and Azerbaijan are not allowed to invest domestically.

“If we see a boom in local investments for internal needs, you might see a rise in inflation. Many of the decisions will be influenced more by immediate political needs than long-term economic plans,” said Efraim Chalamish, an SWF expert and adjunct Professor at New York University.

(By Natsuko Waki. Editing by Mike Peacock)



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