The latest Global Competitiveness Report, released by the World Economic Forum on 31 October, ranks Kuwait 30th for its economy, just ahead of Qatar. It comes top overall for its macroeconomic position.
It is a rare vote of confidence for the state, which is often criticised for its slow decision-making and the rivalry between the government and National Assembly (parliament) that hampers its economy and causes major projects to be delayed or scrapped (Kuwait Special Report, pages 41-66).
The two key factors behind its ranking are the national savings rate and the government surplus, where it is ranked first and third in the world respectively. Both are directly linked to its oil revenues. In contrast, in terms of business competitiveness, it comes a low 49, behind Tunisia and five other countries in the Middle East (see tables, page 10).
The country has led the way among Gulf states in investing its oil revenues overseas. In 1984, it set up the first government investment agency in the region, the Kuwait Investment Authority (KIA), which has since been copied by almost all other major oil producers.
While Dubai and Qatar have hit the headlines for their aggressive approach to foreign acquisitions, the KIA has quietly gone about its business as normal. But that is changing and Kuwait is showing signs of following its Gulf rivals into more risky investments.
The evolution of its approach comes at a tricky time for the GCC’s sovereign wealth funds. Dubai has faced vociferous opposition to several of its attempted overseas acquisitions, most recently the failed bid for Auckland International Airport in New Zealand.
An even more high-profile bid by Qatar for UK supermarket group J Sainsbury collapsed in early November and it was forced into an embarrassing retraction of its bid. The £10,600 million ($22,132 million) deal was being carried out through its London-based investment vehicle, Delta Two, and relied on large levels of borrowings.
Delta Two cites the deterioration of global credit markets and the extra funding needed for the Sainsbury’s pension schemes as the reasons for the withdrawal of its bid on 5 November. These two factors made the deal too expensive. Paul Taylor, who heads up Delta Two, says it was no longer in the best interests of its stakeholders.
The failure of the bid is unlikely to affect the ambitions of sovereign wealth funds for long. However, it does cast them in an unfavourable light. The funds have grabbed the attention of governments worldwide. Concerns have been raised, not least at the IMF and World Bank, about the impact that these opaque funds have on the global financial system.
With conservative estimates putting GCC funds under management at $1.17 trillion, GCC investment authorities have come under particular scrutiny. “It is as if suddenly people realise that the Middle East is rich,” says Randa Azar Khoury, chief economist at the National Bank of Kuwait (NBK).
The Institute of International Finance (IIF), a global association of banks and other financial institutions, estimates that capital outflows from the Gulf totalled $540,000 million between 2002 and 2006. It estimates the GCC state’s foreign assets were $1.55 trillion in December 2006.
With $213,000 million under management and a remit to administer the General Reserve Fund and the assets of the Reserve Fund for Future Generations (RFFG), the KIA’s central function is to channel Kuwait’s enormous surpluses overseas. The authority also includes the Kuwait Investment Office, which has been managing the state’s overseas assets from London for more than 50 years.
The authority places some of its investments in local and regional companies, funds and debt through the General Reserve Fund. The KIA is subject to parliamentary scrutiny, but unlike other decisions on domestic spending, it is not held back by political fighting between the cabinet and the National Assembly. It is mainly regarded as an autonomous investment authority that helps to develop local investment talent.
However, most of its investments are made overseas, and for good reason. The domestic economy is unable to absorb all the proceeds of the ongoing oil boom. NBK forecasts that surpluses for fiscal year 2007/08 could be the largest ever, at KD 7,000 million ($25,193 million).
“No economy can support such significant investment,” says Khoury. “It is inflationary, and the government is already pumping enough money into Kuwait.”
Official estimates of Kuwait’s foreign assets do not include KIA investments, and so vastly underestimate its wealth stored overseas. According to the Central Bank of Kuwait, government entities including Kuwait Petroleum Corporation, the social security fund and Kuwait Airways held a total of KD 12,000 million ($43,189 million) in foreign assets in 2006, up from KD 6,900 million ($24,833 million) in 2005.
By including the investments made by the KIA, the figure rises rapidly. The IIF estimates that Kuwait has $400,000 million in foreign assets, the bulk of which are managed by the KIA. This puts the country’s total overseas investments just behind Saudi Arabia, at $450,000 million, and below the UAE’s $600,000 million.
The RFFG, which is specifically mandated to build up foreign assets, receives 10 per cent of all state revenues, which are soaring. NBK forecasts total revenues for the year could reach KD 17,417 million ($62,685 million), based on a top oil price of $67 a barrel.
This would mean RFFG coffers swell by KD 1,741 million ($6,266 million). However, with oil prices close to $100 a barrel, the actual figure is likely to be far higher. As the high oil price also means the rest of the government’s budget is in good health, there is no pressure for the KIA to return to the state any of the profits it makes from its investments.
“The fund is being built up over the long term for times when the oil revenue is not so high and spending obligations are more marked,” says Simon Williams, Gulf economist at HSBC. “There is no need for income to be repatriated with oil at $90 a barrel.”
In addition to its share of state revenues, the RFFG is caught in a virtuous circle of spiralling income from its existing investments, which it can reinvest in new, revenue-generating assets. If investment returns for the fund come in at a conservative 5 per cent of its $213,000 million disclosed total, the KIA will generate about $10,650 million in investment income in a single year.
“The fund does not directly contribute to growth in Kuwait because the vast majority of it is held offshore,” says Tristan Cooper, a Dubai-based analyst at Moody’s Investors Service. “The money is, however, stored there if they ever need it. It is essentially a long-term fiscal savings fund.”
The accumulation of overseas investments is expected to continue despite the recent volatility in the global equity markets brought on by the crisis in the US high-risk mortgage market. Even as other countries, such as Qatar, suffer from the credit crunch, Kuwait is unlikely to be affected.
“You do not see KIA doing major mergers and acquisitions activity like Dubai or Qatar,” says a regional analyst. “It might be that they are just low-profile or more happy to be traditional sovereign wealth fund managers.
“They are pretty cautious. If you put the old Gulf sovereign wealth funds against the new ones, you see distinct approaches. Dubai and Qatar are actively looking at private equity, while Abu Dhabi, Kuwait and Saudi Arabia seem to be much more traditional in approach.”
But as its assets grow, the KIA has had to modernise. In June 2005, as part of an overhaul that later resulted in a change in management structure and the introduction of performance benchmarks, the KIA board agreed to switch its investment strategy to include riskier investments.
It has reduced its exposure to traditional assets classes such as listed equities and bonds, and instead turned towards alternative investments such as private equity, hedge funds and real estate. Analysts also expect the continuing fall in the dollar to encourage the fund to shift out of dollar-denominated assets.
In addition to asset diversification, the KIA is diversifying in terms of the geographical location of its investments. It is moving away from traditional targets in the US, Europe and Japan and further into emerging markets.
The fund bought a $720 million stake in the Industrial & Commercial Bank of China in late 2006. It has also acquired a stake in Halkbank, Turkey’s privatised state bank. With this strategy, its stated goal is to double its assets under management in 10 years to build a firm cushion for when the oil windfall dwindles.
Meanwhile, its private equity strategy is expected to be finalised in early 2008. This could take it into difficult territory, but the problems faced by Qatar are a timely warning of what can go wrong. Just as it led the way by setting up an investment fund in 1984, the task now facing Kuwait is to find a way to be more assertive in its investments while avoiding those problems.