COMMENT: Middle East Money

By Dr. James Leontiades

Cyprus International Institute of Management

 

As the price of oil shoots toward the sky, so does the amount of money in the treasuries of the Middle East oil producers. It is desirable, both from the view of the oil consuming countries as well as the oil producing countries that these funds are recycled. Using them to buy goods or to invest in the oil consuming countries provides these countries with funds needed to buy more oil. Just sitting on them is not to anyone’s interest.

For the Middle East oil producers there is clearly an economic rational for investing some of their oil money in equities. The oil will one day presumably run out – what then will be the future for such countries? Their traditional investment has been in bonds. But clipping coupons is neither adequately rewarding nor does it hold much scope for developing the skills, technologies or industrial connections and knowledge which hold greater promise for their future.

Recycling is of course nothing new.  However, it has lately acquired several notable new characteristics. Firstly, Europe has become more than ever a prime destination for such investment. Since 9/11 the USA, the major investment recycling destination of the past, has lost much of its attractiveness. Financial restrictions and an adverse political climate linked to the fight against terrorism have turned away billions of dollars of Middle East investment. The abrupt rejection by congress of the attempt by Dubai Ports World to buy an interest in a company servicing American ports is but one example.

 

— State Investment Funds

 

The rapidly rising oil wealth has also given rise to a relatively new type of investment vehicle in the region, state sponsored investment funds. Even a relatively small oil producer, Qatar, has a government sponsored fund worth 60 billion dollars. This is expected to double in the next few years. The funds available to countries such as Saudi Arabia are of course much greater. The Morgan Stanley investment bank estimates that the total of state investment funds, including those of China, Russia and the oil exporting countries has reached 2,800 billion dollars. Other estimates place the total at three trillion dollars. Suffice it to say that the funds available here dwarf even the largest Western hedge funds.

The vast size of such funds and their relation to foreign governments has raised questions regarding their role in foreign equity markets. The managers of these funds declare that their investment decisions are made solely according to commercial criteria – but a number of analysts have observed that this is not always the case.

Abu Dhabi bought a 5% stake in Ferrari. This may have made good commercial sense but there was also the fact that Abu Dhabi wanted to hold a Formula One race on its territory.

Dubai Borse received backing from a Dubai investment fund in its purchase of 20% of New York’s Nasdaq stock exchange specializing in high tech companies as well as the purchase of Sweden‘s OMX exchange. It has also acquired 28% of the London Stock Exchange. Here again these deals are perhaps justifiable on their own merits but they also benefit the states goal of developing an international financial center on its territory.

 

— Market versus Political Objectives?

 

Global finance represents what is probably the modern world’s most successful attempt at a truly world market. The possibility of non-market objectives in relation to such state owned funds is causing concern in Europe and the USA. There is fear of a protectionist reaction against them. Angella Merkel, the German Chancellor, said that her government was “looking at mechanisms…both on a European and German level” to deal with their influence. The financial experts of the Group of Seven (G7) richest countries has called for greater transparency in the operation of these state owned funds and the identification of best practice. The US Treasury Secretary, Mr. Paulson suggested there should be a code of conduct for them. This would demonstrate to critics that such funds can make a positive contribution to the international financial system.

Small equity markets such as Cyprus are in a special situation. The power such funds are able to exert in small equity markets is undoubtedly much greater compared to what is possible in the larger markets. At the same time their contribution toward providing greater liquidity and depth to small equity markets where such qualities are badly needed is a decided plus.