Governments ‘defund’ assets in hostile macro environment

Published in Gulf States News, 22 October 2015

The squeeze on government revenues in a low oil price environment is forcing GCC states to sell off some overseas assets and fuelling speculation about privatisations at home, but it remains uncertain just how far governments will take radical measures to confront their fiscal problems.

Fiscal pressures resulting from low oil prices are starting to hit home, with the International Monetary Fund estimating the six Gulf Co-operation Council (GCC) states will run a combined budget deficit of 13.2% this year, and some countries – including architect of the Organisation of the Petroleum Exporting Countries policy Saudi Arabia – likely to be even further in the red. A policy response is unavoidable, but governments’ willingness to deal with the issue comprehensively remains uncertain, with only a few options authorities can realistically consider: cutting spending, raising more debt, drawing on savings and/or selling assets.

A mix of these policies has been adopted around the region to date. The UAE has cut fuel subsidies; Saudi Arabia has been scaling back on projects and drawing down foreign currency reserves. Oman and Saudi Arabia have issued bonds (an attempt by neighbouring Iraq failed for lack of investor interest), and Kuwait is expected to follow their lead.

The approach to selling state-owned assets has been more circumspect. There is growing evidence of sovereign wealth funds (SWFs) liquidating their assets overseas, in a still rather piecemeal process. “There has been several months of defunding activity by sovereign wealth funds,” said Riyadh-based investment manager Ashmore Group’s Middle East director John Sfakianakis. “This is what they are used for. When there is a fiscal deficit, the SWFs will come in and support the state.”

But there may still be as much buying as selling going on. “SWFs acquire and divest very frequently. I don’t think it’s a case of raising capital for sovereign balance sheets. It’s not a case that this year they’ve had more divestments than before,” a senior investment banker in the region told GSN.

Examples of continued deal-making include the activities of Abu Dhabi powerhouse Mubadala Development Company (MDC), which in September sold its Mubadala GE Capital joint venture with US conglomerate GE to MidCap Financial. A few weeks later, MDC formed a new joint venture with commodities trader Trafigura to invest in base metals. Qatar Investment Authority has sold stakes in European construction firms Hochtief and Vinci in recent weeks, but is reportedly also opening an office in the US to make new investments.

Whether or not there have been large net disposals, there is an assumption that the pace of asset sales will pick up as budgetary pressures increase. Some sales will be made quietly and without fanfare. Just over half of the Abu Dhabi Investment Authority portfolio is held in equities, so there is plenty of scope to reduce its shareholdings in the open market. Other SWFs hold most of their assets overseas, so such actions would not affect the local economies.

Some bankers expect governments to consider privatising more local state-owned enterprises. There are some precedents: the Saudi government has been gradually selling parts of the Saudia airline group, whose Saudi Ground Services Company was the latest to float on the Tadawul market in June. Others flagged up as potential privatisation candidates include Saudi Electricity Company. The Kuwaiti government has been trying to sell Kuwait Airways for many years; political inertia has so far prevented this but recent media reports suggest the government is about to embark on a renewed push.

But how many more privatisation candidates will emerge? Investment bankers, who would help to arrange the sell-offs, have mixed expectations. Some expect more deals to emerge in 2016. “We’re looking at a time when we may see more privatisations in the region – the UAE and Saudi Arabia clearly can offer a significant pipeline of deals,” a Dubai-based banker said. “I would expect that to start happening late next year.”

Privatisations could allow governments to relieve some fiscal pressure, but to date most have preferred other options. “They are using their SWFs and doing some asset swaps, and exiting some of their positions and using that as a way of helping the budget deficits,” said another investment banker. “That is much easier and faster than a big privatisation process.”

All governments say they are keen on privatisation, which could promote more private sector activity. It could also help to inject efficiencies into lumbering state-owned corporations. But there are potential downsides: now is a bad time to be floating on a stock market, as bourses around the world have been struggling, including in the Gulf. Despite initiatives such as opening up the Tadawul, the number of regional initial public offerings (IPOs) has been drying up – there have been none so far in H2 2015.

Such things are cyclical and market conditions will eventually improve. Other reasons for governments’ reluctance are more fundamental. Traditionally, privatisations in the Gulf have been a method of wealth redistribution, with shares being sold at artificially low levels to locals, who usually make handsome profits once the stocks are traded. This is an inefficient way of redistributing wealth that excludes the poorest, and is not much help in raising money for government. However, any attempt to sell assets at more realistic prices could meet resistance from a public used to easy profits. And governments may also fear losing face, lest they appear to be acting out of weakness.