A number of countries have set aside budget and trade surpluses in reserve funds. For example, Russia, Norway and Saudi Arabia used the excess revenues from oil exports to install a buffer for rainy days in the future. This type of buffers are also called Sovereign Wealth Funds (SWF). However, the commodity rout had a severe impact on the fiscal budgets of these countries. Is it for SWFs now the time to reverse the flows?
Budget concerns One of the most severely hit countries by lower oil prices is Saudi Arabia. The International Monetary Fund (IMF) estimates that the government of this Arabic country needs an oil price of USD 106 a barrel to run break even. With oil prices running below USD 50, a neutral budget is unrealistic, even with harsh cuts. The IMF therefore expects the country will run a 19.5% deficit this year. Translated to money, this means USD 107bn. Although Saudi Arabia has very low government debt (1.6% of GDP as at end of 2014), it has to adapt to the new reality. Next to cutting subsidies and further reforms, it may have to use part of its reserves. The country is believed to have withdrawn USD 70 billion from asset managers. Its SWF, the Saudi Arabian Monetary Authority’s reserves dropped from USD 737 billion in August 2014 to USD 661 billion in July, according to Bloomberg. We have to wait for more recent numbers, but these are believed to be much lower. The country is currently battling a war in Jemen, together with low for longer prices for oil it has no other option than to use more of its SWF.
Also Norway is believed to use its Government Pension Fund Global (GPFG) battling the effects of low oil prices on its economy. With a size of USD 882 billion as at June (source: SWF Institute), this SWF is one of the largest investors in the world. Norway’s Government indicated it would consider to use the GPFG to meet its budget. Budget cuts which could harm the economy can be avoided. Another commodity-rich country which is severly hit by current low prices, is Russia. The Eurasian country used some part of its Reserve Fund and National Wealth Fund at the end of last year to support its currency, the Ruble. For now, the Central Bank of Russia (CBR) which manages the reserves, refrains from using the pool of money that amounts currently close to USD 370 billion. But with the Russian economy in difficult times, pressure is building and the question is how long the CBR can withstand calls from the government to use the funds. Russia is now facing the rainy days where the reserves are intended for.
Pressure on assets
The use of funds pooled in SWFs may well be justified by current conditions. However, the funds should be used combined with reforms. Some painful effects of reforms can be mitigated by use of SWFs. Or in line with Keynesian policies funds can be used to implement anticyclical measures to prevent a country from sliding into troubled times. For commodity exporting countries, it’s obvious that rainy days are here and we can’t hope for the better i.e. wait for higher prices to repair budgets. However, the use of SWFs and the accompanying withdrawal of serious amounts of money have a huge impact on financial markets. Deutsche Bank called the unwinding of reserves by the Peoples Bank of China to support its currency the Renminbi as a QE-offsetting force and even spoke about Quantitative Tightening. This force gets stronger and stronger if SWFs join the unwinding of assets.
When SWFs are selling their assets, short term candidates are bonds and shares of listed companies since these are the most liquid and can be converted to cash quickly. This adds to the pressure on stock markets, which might explain part of current heavy losses on the global stock exchanges. We don’t see rates increasing at the moment, so liquidity in the bond markets might be deep enough to cope with current withdrawals, if they are indeed occurring at the moment. But with the US Federal Reserve close to a decision for a rate-hike, heavy supply by SWFs could lead to a tightening effect. US bonds become less attractive if the interest rates are increased by the Fed, leading to supply. The question then is: who will buy these Treasuries if the traditional buyers, the SWFs, are selling as well?