sovereign dilemmas: saudi arabia and sovereign wealth funds

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Sovereign Dilemmas: Saudi Arabia andSovereign Wealth FundsKristin Smith Diwan aa School of International Service, American University , Washington,DC, USAPublished online: 29 Apr 2009.

To cite this article: Kristin Smith Diwan (2009) Sovereign Dilemmas: Saudi Arabia and SovereignWealth Funds, Geopolitics, 14:2, 345-359, DOI: 10.1080/14650040902827831

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Geopolitics, 14:345–359, 2009Copyright © Taylor & Francis Group, LLCISSN: 1465-0045 print / 1557-3028 onlineDOI: 10.1080/14650040902827831

FGEO1465-00451557-3028Geopolitics, Vol. 14, No. 2, Mar 2009: pp. 0–0Geopolitics

Sovereign Dilemmas: Saudi Arabia and Sovereign Wealth Funds

Saudi Arabia and Sovereign Wealth FundsKristin Smith Diwan

KRISTIN SMITH DIWANSchool of International Service, American University, Washington, DC, USA

While the countries of the Gulf Cooperation Council (GCC) canclaim over half of SWF assets globally, the largest and most strate-gically important state, the Kingdom of Saudi Arabia, has hereto-fore lacked a dedicated investment fund. This paper challengessome of the conventional wisdom on SWFs in explaining the Saudigovernment’s reticence to launch an SWF and its recent decisionto cautiously move in this direction. First, while Washington policymakers raise fears of enemies using SWFs against US interests,Saudi foreign assets have been used in support of its continuingalliance with the United States. And second, while critics decry thelack of transparency of SWFs, the Saudi launch of a new SWFcould represent a move toward greater transparency, by workingto separate “private” sovereign funds from “public” ones. Indeed,the launch of a SWF fits into a broad pattern of reforms rationalis-ing Saudi governing institutions as King Abdullah has moved tocontrol spendthrift princes, to streamline decision making, and toattract more foreign investment.

The past several years of unprecedented high oil prices have announced thearrival of the Arab Gulf region as a serious player in global finance.1 The sixmember states of the GCC – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia,and the United Arab Emirates (UAE) – have been using the oil windfall toremake their domestic economies and to reconfigure their position in theglobal economy. A key component of this effort has been the creation ofsovereign wealth funds (SWFs). Indeed, the investment funds of the GCCgrew to represent over half of sovereign wealth fund assets globally in

Address correspondence to Kristin Smith Diwan, School of International Service, AmericanUniversity, 4400 Massachusetts Ave NW, Washington, DC 20016-8071, USA. E-mail: [email protected]

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346 Kristin Smith Diwan

2007,2 with the Abu Dhabi Investment Authority (ADIA) becoming the sin-gle largest SWF in the world.

Gulf sovereign funds have made their mark not only by their size butalso by their composition. Gulf funds have been noticeably more aggressivein their appetite for risk, holding higher percentages of equities and invest-ing with greater frequency in emerging markets than other SWFs.3 More-over, funds such as Mubadala in Abu Dhabi, Istithmar and DIC in Dubai,and the Qatar Investment Authority in Qatar act more as government-owned investment firms than sovereign savings funds. Their mandate todiversify and develop their domestic economies has led them to form part-nerships and to take direct equity stakes in firms which offer technology orexpertise needed in certain strategic industries. They have not shied awayfrom high profile projects, as exemplified by the controversial acquisition bythe government-owned company Dubai Ports World of the British companyP&O which was responsible for managing many US ports and which led toa political firestorm in the United States.

Yet while some of the smaller Gulf states have grabbed headlines withtheir bold investment, the largest and most strategically important of theGulf states, the Kingdom of Saudi Arabia, has seemingly played it safe. Untilthe announcement in April 2008 that Saudi Arabia will be launching a sover-eign wealth fund, no dedicated oil investment fund existed in the Kingdom.Instead its foreign assets have been managed by the Saudi central bank –the Saudi Arabian Monetary Agency (SAMA) – which has taken a conserva-tive approach to investing the nearly $300 billion in Saudi non-reserveforeign holdings. While neighbouring funds moved into private equities,SAMA remained predominantly invested in low yielding bonds. And whileneighbouring countries sent more of their holdings further afield, SAMAremained overwhelmingly dollar denominated, continuing to be heavilyinvested in US Treasury bills.

A study of the shifts in Saudi budgetary balances and economic priori-ties can explain these differences in part, by making clear some of thedomestic constraints that distinguish the Kingdom from its smaller, morehigh-flying neighbours. However, I will argue in this paper that this varia-tion also reveals a distinctive political logic. Pursuing this distinction bringsto light some incongruities with the conventional thinking on SWFs, andhighlights two ironies of the Saudi case.

While much of the public policy writing and emerging IR literatureconcentrates on concerns that SWFs will be used for political purposes, itappears that concerns about just such perceptions have discouraged theSaudis from launching an SWF.4 Moreover, while pundits raise fears of ene-mies using SWFs as tools of foreign policy, it can be argued that the Saudiforeign assets, overwhelmingly denominated in US dollars, have indeedbeen used as tools of foreign policy – in support of the Kingdom’s continu-ing alliance with the United States. Rather ironically then, this study finds

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Saudi Arabia and Sovereign Wealth Funds 347

that Saudi foreign investments have indeed been shaped by political consid-erations: to more fully support the United States and to avoid any politicalcriticism or financial backlash.

Another dominant theme of the emerging SWF literature relates to theirgovernance and transparency.5 There is concern that government managedfunds may be prone to large-scale corruption to the detriment of their owncitizens, or that the lack of transparency displayed by many of these sover-eign investment vehicles may create uncertainty and contribute to marketturmoil in host countries. I propose, again ironically, that the Saudi creationof a new SWF was spurred in part by a desire for greater transparency andaccountability: to further separate “private” sovereign funds from “public”ones. Indeed, the launch of a SWF fits into a broad pattern of the rationali-sation of Saudi governing institutions as King Abdullah has moved to con-trol spendthrift princes, to streamline decision-making, to diversify the Saudieconomy, and to attract more foreign investment.

To understand the distinctiveness of the Saudi case, it must first beplaced in its regional context. I will therefore begin by taking a look at theeconomic situation of the broader Gulf, examining the development andinvestment strategies of the GCC states as a whole. This will allow me torelate the contemporary dynamics of political economy in the Gulf, and tolay a basis for comparison with Saudi Arabia. I will then turn to the Saudiinvestment strategy and its newly proposed sovereign wealth fund, makinga political case for its incongruous development.

SOVEREIGN WEALTH FUNDS IN THE GCC

The member states of the GCC have nearly half of the world’s proven oilreserves. Revenues from the export of oil accrue directly to the government,financing petrowelfare states that provide extensive services to citizens andsustain the ruling monarchies. The past six years of unprecedented oilprices have certainly contributed to state coffers. According to the Institutefor International Finance (IIF), the GCC countries earned an astounding twotrillion dollars for their petroleum over that time period.6 At the height ofthe recent oil boom, the combined GDP of the six countries which make upthe Gulf Cooperation Council (GCC) was estimated to top $1 trillion USD,effectively making the GCC the thirteenth largest economy in the world, onpar with emerging economic powerhouses such as Russia and India.

The Arab Gulf states have been actively using the oil windfall both toremake their domestic economies as well as to reconfigure their role in theglobal marketplace.7 The amount of investment inside the Gulf region isstaggering. The countries of the GCC have embarked on an aggressive strat-egy of economic diversification through infrastructure development, indus-trialisation, and improving conditions for foreign investment and private

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capital. While the world has watched Dubai burst on the scene as a globalcity and hub for tourism, services and finance, the other Gulf States havebeen remaking themselves as well. Qatar has imported top Western univer-sities and Washington think tanks in its bid to become an education andconference centre. Bahrain has been working to consolidate its hold on theburgeoning Islamic finance industry. And Saudi Arabia is constructing neweconomic cities that are planned to have three times the population ofDubai, a GDP equivalent to that of Singapore, and an area four times thesize of Hong Kong. This construction boom is attracting top financial talent;HSBC reports that as much as one third of all project finance globallyinvolves Middle Eastern projects, making the Gulf the new epicentre for pri-vate equity deals.8 The economic statistics for the past five years reveal thatthis concerted push for economic diversification is bearing some fruit, asnon-oil sector growth has topped 10 percent in a number of states.9

Yet even with this new focus on domestic investment and economicdiversification, the oil exporting states of the GCC accumulated substantialforeign assets. Up until 2008 GCC foreign assets grew rapidly; in 2007 GCCforeign assets were in excess of US$1.2 trillion, more than 150 percent ofGDP.10 The growth of sovereign funds follows this upward trajectory offoreign assets. While in 2000 GCC funds managed under $300 billion,mostly in US assets, by 2007 they were managing much more diversifiedportfolios expanded to $1 trillion by oil revenues, investment returns, andthe availability of leverage.11

The nature of these funds vary considerably. The Gulf sports the fullrange of SWF strategies from stabilisation funds (Oman); to classic invest-ment funds (Abu Dhabi and Kuwait); to newer, smaller investment compa-nies prioritising concentrated stakes in public and private equity (QatarInvestment Authority, Dubai International Capital, Istithmar, Mubadala). Inaddition GCC central banks, including SAMA, manage non-reserve assets ina more conservative manner.

Despite this diversity, the clear trend among Gulf SWFs has been in thedirection of greater exposure to public and private equity. Rachel Ziemba ofRGE Monitor estimates that GCC funds in aggregate allocate 15–20 percentto fixed income assets, 50–60 percent in equity, and 15–20 percent in alter-native investment vehicles such as private equity and hedge funds.12 Bycomparison, American institutional investors are considerably less aggres-sive in seeking risk with average portfolios holding distributions of 55 percentfixed assets, 42 percent equity, and a mere 3 percent in other, presumablyless conservative, alternative investments.13 Ziemba also finds that all GCCfunds became more activist in 2007, making larger purchases and investingdirectly rather than through asset managers.14 This has brought Gulf SWFsincreasingly into competition with private equity, and runs counter to thecommon perception that SWFs are passive and unwilling to take strategicstakes in companies.

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This shift in the GCC toward public and private equity investment –which cuts against the grain of allocations favoured by other major oilproducers – has also been picked up by the Institute of InternationalFinance (IIF) tracking of capital outflows from the GCC from 2002 to 2006.The change in asset distribution from December 2001 to December 2006shows a marked decrease in bank deposits in favour of FDI holdings andUS debt and equities.15

The data, then, charts a move in the GCC towards equity investing; butwhich sectors are favoured by Gulf investors? Gulf SWFs are known forinvesting strategically, taking stakes in sectors that they are trying topromote domestically in the economic diversification schemes describedearlier. One key goal is clearly financial market development. Ziemba ofRGE Monitor reports that in 2007 the financial sector accounted for overhalf of total reported stakes as Gulf SWFs “invested in distressed financialinstitutions, built upon existing relationships with asset managers, andsought acquisitions to support domestic financial sector developmentgoals.”16 Interest in Islamic Finance has also been on the rise, with manyGulf countries now seeing this as a strategic industry and Gulf SWFstaking positions as both investors and consumers of Islamic finance.17

Their support is likely contributing to the growth in the market for Islamicbonds (sukuk).18 Other sectors of interest to Gulf sovereigns includeautomotive/aerospace, mineral/mining, and services such as healthcareand retail which are consistent with the development goals of sponsoringgovernments.19

As for geographical distribution, while GCC SWFs maintain a majoritypresence in the US and UK, their investment in emerging markets is on therise.20 There has been a pronounced growth in direct investment in thebroader Middle East, as well as in Asia where Gulf SWFs hope to capitaliseon rising consumer demand in the fast-growing region. In this area, GulfSWFs have shown a much greater tolerance for emerging market risk thantheir Western counterparts; for example, while US pension funds placedless than 5 percent of their portfolio in emerging markets, the Abu DhabiInvestment Authority placed an estimated 14 percent of its portfolio there.21

This shift in investment is beginning to affect the currency composition ofGulf SWFs which remain dollar denominated, but not overwhelmingly so:Ziemba estimates the currency distribution to be 45 percent in US dollars,40 percent in Euros and British Pounds, and 15 percent in Asian and EmergingMarket currencies.22

To sum up, Gulf funds through 2008 showed a greater appetite forequity, with private equity stakes on the rise. Although the majority ofinvestments still reside in the US and Europe, there has been a shift towardgreater investment in emerging markets. As a consequence, the dollardenomination of Gulf SWFs is also declining as funds seek broader diver-sity, in asset class, sector, and geographic distribution.

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So how does the Saudi experience shape up against the trend in Gulfsovereign funds? First and most obviously, Saudi Arabia is remarkable for itsabsence as the Kingdom has not had a dedicated sovereign wealth fund.Instead, Saudi Arabia has managed its surplus foreign assets – an estimated$290 billion at the end of 2007 – through the Saudi central bank, the SaudiArabian Monetary Agency (SAMA). SAMA also invests another $55 billion onbehalf of other government agencies, most likely Saudi pension funds.23

Perhaps as a consequence of its status as Central Bank, SAMA’s invest-ments have been much more conservative than Gulf SWFs. Ziemba esti-mates SAMA’s holdings as 20 percent in cash/deposits, 55 percent in fixedincome, and 25 percent in equity.24 It is thought that SAMA uses externalportfolio managers for its equity investments.25 It is notable that this 75 percentcash/bonds, 25 percent equity split is almost an exact reversal of the 20 per-cent cash/bonds; 80 percent equity/alternate investments found in aggre-gate Gulf SWFs. To further differentiate the Kingdom from the rest of theGulf, SAMA has taken no private equity stakes and it is unlikely to havemuch exposure to emerging markets.26 SAMA’s dollar share is also by farthe largest of the GCC funds; most analysts estimate that up to 85 percent ofSaudi foreign exchange reserves are invested in dollar denominated fixed-income securities. How does one account for this strikingly different foreigninvestment position? And why have the Saudis, the world’s leading oilexporters, been so slow to move toward SWFs?

ECONOMIC CONSTRAINTS: THE IMPERATIVE OF SAUDI INTERNAL REFORM

To understand the Saudi’s contrarian and cautious investment strategy,one must appreciate the different economic and political landscape theyface. While Saudi Arabia is the largest oil exporter, it is also the mostpopulous state in the Gulf by a wide margin. It is also emerging from anextremely trying period following the first Gulf War, which turned SaudiArabia from a surplus to a debtor nation. In 1998 when King Abdullaheffectively came to power, the state’s tenuous finances were set in a tail-spin by a steep decline in oil prices. With domestic borrowing already atover 100 percent of GDP, the state faced an inability to make payroll;incredibly, it was saved from bankruptcy only by an emergency loan fromAbu Dhabi’s ruler Sheikh Zayed. It was not until the recent oil price resur-gence that Saudi Arabia was able to pull itself out of deficit spending.27

Indeed, Saudi Arabia’s spending priority in the first years of the boomshow a disciplined effort to hold down spending accompanied by anaggressive campaign to pay down government debt; statistics show a 9percent reduction in debt in 2004 and a whopping 29 percent reduction in2005.28 The government has been paying down debt so rapidly that local

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banks have complained of the difficulty of getting government bonds touse for liquidity management and hedging.29

Tellingly, it was not until this debt was adequately retired, that theSaudis ramped up their expenditures and turned – like much of the rest ofthe Gulf – to domestic infrastructure expansion; the growth in Saudi foreignassets closely tracked oil revenues until late 2006 when the Kingdom begana steep increase in domestic spending. Thus while capital expenditure wasonly 10 percent of GDP in 2000; it rose sharply to 32 percent of GDP in2006.30

This sharp increase represents only a first installment for an ambitiousindustrialisation programme that is meant to address the structural deficien-cies in the Saudi rentier model revealed under the strain of lower oil prices.Over the course of the mid-1980s and 1990s, the benefits of the petrowel-fare state and public sector employment were unable to keep up with oneof the most rapidly growing populations in the world. Rising unemploy-ment, estimated at 15 percent or higher, and a steeply declining GDP percapita – which is, incredibly, only a third of what it was at its height in theearly 1980s and less than half that of the United States31 – formed theeconomic backdrop for the multiple reformist and jihadist movementschallenging the Saudi state over the past decade.

The twin imperatives of economic diversification and job creation havedriven the reformist King Abdullah to explore new means of mobilising thecapital of the Saudi private sector and engaging the managerial capacity ofits Western educated elite. This has been met by expanding foreign marketopportunities through the signing of the WTO treaty in 2005; opening upnew sectors, most notably petrochemicals, to the Saudi private sector; andempowering the Saudi Arabian General Investment Authority (SAGIA) tocreate a positive climate for foreign investment in the Kingdom.32 Thecentrepiece of King Abdullah’s reforms has been the creation of six entirelynew industrial cities meant to increase the absorptive capacity of the Saudieconomy and create jobs for its burgeoning population, 50 percent of whichis under the age of 16.33 The scale of the investment – SAGIA has over $600billion of investment projects in the pipeline in five different sectors overthe next twenty years – will certainly cut into the Kingdom’s sizeable currentaccount surplus.34

There is no question that some of the difference in the foreigninvestment strategies of Saudi Arabia and the Arab Gulf city states isexplained by the Kingdom’s larger population and the greater demands– and capacity35 – of its domestic economy. Simply put, there can be nosovereign wealth fund without sovereign wealth, and Saudi Arabia spentmuch of the past decade in a debtor’s position. Once emerging fromdebt ambitious projects for economic diversification have demanded alarger share of the Saudi revenues and have drawn the governmentfocus inward. However, there are likewise international political

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barriers which keep the Saudis from more fully seizing global investmentopportunities.

POLITICAL CONSTRAINTS: POST 9–11 FEARS AND ENDURING ALLIANCES

The popular framing of the literature on SWFs, informed by the state vsmarket dichotomy, presents global financial markets as being at risk of cor-ruption by the interjection of politics in the form of SWFs. However, theArab Gulf states have always seen the political valence of global financialmarkets, and have navigated them accordingly. Especially since September11th, in which 15 of the 19 hijackers were Saudi citizens, the Arab states ofthe Gulf have been affected by US political intervention in markets as partof the financial war on terror. In the years following the attacks many pri-vate Saudi investors had their accounts in the United States frozen, oftendue to mistaken identity compounded by confusion over Arab names.36

Indeed, this negative experience and the fear of future capricious seizureshave contributed to the partial repatriation of Saudi capital as well as thesearch for promising emerging markets by Saudi private investors.37

A similar fear constrains Saudi government investments. Anti-Saudi sen-timent has risen alongside oil prices in the US, and there is little appetite inRiyadh for taking investment positions that will draw attention to SaudiArabia’s accumulating capital reserves which are largely predicated on USoil demand.38 The Dubai ports scandal, in which public outrage forced thegovernment-owned Dubai Ports World to sell off its control of US portsmanagement, served as a clear cautionary tale of the danger of elicitingCongress’s wrath.39 Such fears factor into the Saudi reluctance to start a sov-ereign wealth fund, especially as unease over SWFs – surreptitiouslyreferred to as “Sino-Wahhabi funds” by the Washington chattering class –grips the US capital.

When viewed through this lens, the differing Saudi investment positionreflects Saudi’s distinct political positioning – especially vis-a-vis the UnitedStates. There is also a proactive reason for keeping foreign investment inSAMA’s conservative hands, and that is the enduring US-Saudi political alli-ance. Many scholars have argued that US allies may hold US debt as a wayof signalling their political support.40 It was previously noted that SaudiArabia maintains by far the highest percentage of dollar denominated assets:85 percent at a time when other Gulf countries are diversifying their hold-ings. Although Gulf US Treasury holdings tend to be underestimated, it isclear that Saudi Arabia’s reliance on US bonds makes it one of the largestsupporters of the dollar after China and Japan. Because the Saudi riyal ispegged to the dollar, there is of course a need to maintain enough reservesto defend the currency. And similar to the Chinese, the very act of holding

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US assets, not to mention oil revenues being priced in dollars, gives theSaudi’s a financial incentive to avoid destabilising the US currency.41

Still, the cost to the Saudis of maintaining the “dollar alliance” withWashington, expressed both in the holding of US debt and the riyal peg tothe dollar as negotiated in the aftermath of the oil crisis of 1973 to assurepetrodollar recycling, is substantial.42 One banker estimated the cost to theSaudi economy of keeping a US-based economy – due in large part to infla-tion and higher import prices – to be a whopping 30 percent a year.43 Andthe danger of rising political resentment is real. In 2007 in the heart of theoil boom, the religious establishment fired a shot across the bow, bypublishing an online statement signed by 24 Saudi clerics asking the gov-ernment to act against inflation by depegging from the dollar.44

There is an irony in this situation. Just as predicted by many analysts ofSWFs Saudi government foreign investments have been shaped by politicalconsiderations, but not in the way predicted. The Saudis have indeed man-aged their foreign surplus through SAMA for a political purpose: to maintaintheir strategic commitment to the United States and to avoid any politicalcriticism or financial backlash from the Western governments andbusinesses.

“SOVEREIGN’S WEALTH” AND INSTITUTIONAL REFORM: THE LAUNCH OF THE FIRST SAUDI SWF

If the decision to maintain sovereign investment predominantly dollardenominated and within the protective confines of SAMA are a demonstra-tion of the Saudi strategic commitment to the US, does the recent decisionto launch the Kingdom’s first SWF reflect a lessening of that commitment?45

To work through that question requires looking at yet another distinctivecharacteristic of Saudi foreign investment: the preponderance of Saudiprivate foreign wealth. A recent McKinsey Global Institute study on the roleof petrodollars in global capital flows estimates that governments hold59 percent of petrodollar foreign investments while private individuals hold41 percent.46 The percentage of government foreign investment in the GCCis higher, on average, with government holding 67 percent of foreign assetsand private wealth 33 percent. Saudi Arabia reverses this trend, however,and has the very low government holding at 38 percent while the foreignwealth held by private individuals is 62 percent. Indeed Saudi Arabia on itsown accounts for the majority of GCC private foreign assets.

Who are these high net worth individuals? Some insights may begleaned by looking to the largest single foreign investor in the US, the SaudiPrince Walid bin Talal. His Kingdom Holding Corporation has stakes in pub-lic and private companies all over the world estimated to be worth $50 billion.Yet some Middle East financial analysts believe that he “punches above his

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financial weight,” and many suspect that he invests on behalf of members ofthe royal family.47 Regardless of whether he invests on his own behalf or onthe behalf of others, there is no question that Saudi royals make up a largeprivate investing pool. As a rentier state and absolute monarchy, Saudiroyals take a portion from the oil revenues up front outside of the officialbudgeting process, and this money is then invested privately.48 Thus whileroyals in other Gulf city states like Dubai and Abu Dhabi invest substantiallyfrom within formal investment vehicles, royals in Saudi Arabia are investingfrom outside formal channels.

One could argue that this distinctive arrangement – namely the veryhigh percentage of private wealth in Saudi foreign investment – reflectsSaudi Arabia’s position within the structure of international political econ-omy. While SAMA maintains a high percentage of investment in T-bondssupportive of the US currency, the private investment of Saudi royals ismuch more diversified. Indeed, once the private investment of Saudi royalsis taken into account, the composition of Saudi “sovereign” wealth does notlook so different from the other Gulf states. One could argue that thisarrangement of public and private “sovereign” wealth allows the Saudis toexpress their support for the US implicitly through their substantial positionin US Treasury bonds, while taking advantage of a diverse risk portfoliothrough “sovereign” private investment. Indeed, this is a plausible explana-tion for the lack of urgency in creating a dedicated sovereign wealthvehicle.

Nonetheless, the separation between sovereign wealth and “the sover-eign’s” wealth is not fully worked out by this pre-budget royal stipend, ascan be seen through the actual dispersion of foreign investment within theSaudi government. While SAMA is seen as the official channel for the invest-ment of official Saudi foreign assets, it is acknowledged that there existsome 50–60 government agencies participating in foreign investment, eachwith their own strategies and policies. Many ministries have their ownforeign investment vehicles, and moreover many ministers have their owninvestment funds that fall within the overall structure of the ministry.49 It iswithin these investment funds that private interest and public interest aremost deeply intertwined, and not always for the public good.

This blurry line between government and ruling family ownershipreflects the political nature of many Saudi ministries that is an historic legacyof Saudi state formation. In the critical years of administrative growth in the1950s, as oil revenues began to fill government coffers, ministries becameresources in the struggle for power within the ruling family. Steffen Hertoghas examined this period and has skillfully analysed how the early person-alisation of institutional design resulted in the creation of “states within thestate” as competing ruling family members built bureaucratic fiefdomswhich they used as conduits of patronage.50 These pitched political battlesleft some ministries in the hands of technocratic commoners, and others in

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the hands of royals, resulting in bureaucratic islands of efficiency amongst asea of uncontrolled petrodollar-fueled bureaucratic expansion based onpatronage.51 However, once all the stakes were parcelled out, the fluidity ofthese early days gave way to fiercely defended personal fiefdoms, resultingin a rigid segmentation of the Saudi state that hinders coordination andstymies efforts at economic reform to this day. The permeation of govern-ment and ruling family money within segmented bureaucratic fiefdoms,many of them managing their own foreign assets, makes it virtually impossibleto have a coherent investment strategy as a state.

SWFS AS VEHICLES FOR TRANSPARENCY?

So what is one to make of the recent announcement of a new Saudi sover-eign wealth fund? If the Saudi stance of investing excess foreign reservesthrough the Central Bank reflects its commitment to the US, does thelaunching of a new SWF reflect a lessening of that commitment? I argue thatthis new move is not driven by foreign policy concerns, but rather by issuesof domestic reform. Taking a closer look at this internal dynamic will revealyet another incongruity between the Saudi experience and the conventionalwisdom on SWFs.

Host countries policy makers often worry about the lack of disclosureby these immense SWFs and their potential to destabilise transparentmarkets. However, from the periphery SWFs can appear to offer the possi-bility of better delineating public from private. Indeed, there are hopesthat the international financial institutions, in addressing core countryconcerns about SWF transparency, will encourage improved governanceand accountability through guidelines on best practices and disclosurerequirements.52

Could the newly announced Saudi SWF, Sanabil al-Saudia or Sanabel,play such a role? Some Saudi watchers believe so.53 Indeed, given the stateof ministerial investment bodies described earlier, it is possible that the newSWF may provide a vehicle for institutional reform by consolidating thefragmented investment bodies under one public investment vehicle.

Such a strategy of consolidation and rationalisation does fit within thebroad pattern of reforms enacted under King Abdullah. His reign has beenmarked by efforts to rationalise economic policy through the creation ofnumerous institutions to facilitate consultation from the private sector, andto streamline decision making. Early in his reign he created the SupremePetroleum Council and the Supreme Economic Council which clearlydefined decision makers and brought experts and key ruling figurestogether in one body. Under his rule, the regional Chambers of Commercehave been brought into more corporatist arrangements with the state andthe Majlis Al-Shura or Advisory Council has been expanded to include

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more experts and technocrats to increase the capacity of the state.54 KingAbdullah has also undertaken the reform of key ministries, sometimes tak-ing spendthrift princes to task, and working to put in place uniform proce-dures for the distribution of funds. It is consistent with these reforms toview the SWF as serving a disciplining function and bringing a similar effortof consolidation and rationalisation to the realm of foreign investment.

CONCLUSION

The Saudi experience with foreign investment has been a unique onewithin the GCC. From the outside the oil-exporting states of the GCC mayappear uniform in their spectacular wealth, but closer inspection revealsthat the liberties of that oil wealth are not uniform. Saudi Arabia, as thelargest and most strategically important state in the Gulf, faces specialconstraints, both domestic and foreign. Indeed, this paper has argued thatSaudi Arabia’s international structural position has impacted the institutionalorganisation and composition of its foreign investments.

Saudi Arabia has not been that wealthy. Emerging from years of low oilprices in the 1980s and the devastating economic effects of the Gulf War in1990, Saudi Arabia faced more than a decade of debt from which it has onlyrecently recovered. Once its balance sheets improved, it still faced theimperative of domestic economic reform to promote job creation for itsgrowing population and to stem the tide of Islamic radicalism. Theseinternal economic imperatives made the creation of a sovereign wealth funda much more difficult proposition for Saudi Arabia than for its smallerneighbours.

Saudi Arabia also faced external constraints due to its strategic positionas a key swing producer of oil and an unwavering ally of the United States.This commitment to the US influenced the composition of its foreign assets,as Saudi Arabia has maintained a much larger percentage of its foreignassets in US Treasury bills than Qatar and the UAE. Given the difficultdomestic political environment in the 1990s and early part of this decade, inwhich the alliance with the US came under much greater criticism by arising political opposition, holding this investment position alongside for-eign reserves, rather than in a more high profile dedicated wealth fund,made political sense. And the composition of Saudi foreign investment –with much higher percentages in the hands of private wealth – indicate thatSaudi “sovereigns” were still able to diversify their holdings through theirprivate portfolios.

Given the foregoing argument, one might surmise that the reversal ofthe Saudi position and its stated intent to finally join its neighbours in creat-ing a dedicated SWF marks a shift in its strategic commitment to the US.However, for the moment the purpose of the new Saudi SWF remains

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unclear. The approval of the new fund, Sanabel al-Saudia, by the Council ofMinisters was announced in July but there have been conflicting reportsabout its nature. In an interview, the head of the Public Investment Fund(PIF) where the SWF is to be housed, characterised it as a classic portfolioinvestor in mold of GIC, seeking to diversify investments and maximiselong-term rates of return while providing professional development forSaudi’s nascent financial sector.55 However a statement from the Minister ofFinance, the ministry that houses PIF and presumably the new SWF, sug-gested that Sanabel will not be a SWF at all, but rather will be an investmentcompany that will initially focus on “fields that could attract technology tothe Kingdom in alliance with global companies.”56 He also said that theinvestment firm may be open to private partners at a later date. Thus thereappears to be a debate among higher echelons of power as to its purpose.

Given the deepening international financial crisis, and the sustainedpush for domestic economic reform, it seems likely that the latter purposewill prevail, and that Sanabel al-Saudia will be used strategically to furtherentice Saudi private investors into Saudi reform schemes and to strengthenthe push for economic diversification at home. In keeping with this reforminitiative, I have argued that it may also allow for more efficient use of pub-lic investments by better consolidating ministry foreign investment portfo-lios, and lessening the “sovereign’s” dilemma of public wealth used forprivate purposes. In doing so, it may just represent a modest move towardgreater transparency and accountability within the Saudi context.

NOTES

1. McKinsey reports that oil exporting nations as a group have now surpassed Asia as the largestsource of net global capital flows in the world. McKinsey Global Institute, ‘The New Power Brokers:How Oil, Asia, Hedge Funds, and Private Equity are Shaping Global Capital Markets’ (Oct. 2007) p. 45.

2. J. P. Morgan estimates in 2007 have Gulf sovereign wealth funds accounting for $1.7 trillion ofthe $3–3.7 trillion held by sovereign wealth funds. J. P. Morgan Research, ‘Sovereign Wealth Funds:A Bottom-Up Primer’, May 22, 2008.

3. For a sceptical view about the risk profile of Gulf SWFs, see Jean Francois Seznec, ‘The GulfSovereign Wealth Funds: Myth and Reality’, Middle East Policy 15/2 (Summer 2008) pp. 97–110.

4. See for instance Benjamin Cohen, ‘Sovereign Wealth Funds and National Security: The GreatTradeoff’, Working Paper (Santa Barbara: UCSB Dept. of Political Science 20 Aug. 2008).

5. Robert Kimmitt, ‘Public Footprints in Private Markets’, Foreign Affairs 87 (Jan./Feb. 2008);Edwin Truman, ‘Sovereign Wealth Funds: The Need for Greater Transparency and Accountability’, Peter-son Institute for International Economics Policy Brief 08.6 (Aug. 2007).

6. Institute of International Finance, Economic Report: Gulf Cooperation Council Countries(Jan. 16 2008). Also cited in Afshin Molavi, ‘Rising Gulf,’ Newsweek International Web Exclusive, August 6,2007.

7. For more on this transformation see Rawi Abdelal, Ayesha Khan, Tarun Khanna, ‘Where Oil-Rich Nations are Placing their Global Bets’, Harvard Business Review (Sep. 2008).

8. Bill Spindle, ‘Boom in Investment Powers Mideast Growth’, The Wall Street Journal, 19 July 2007.9. Source: Institute for International Finance; Jadwa Investments; Brad Bourland, ‘Industrializa-

tion in the GCC: Context, Facts and Implications’, presentation to Georgetown conference on Industrial-ization in the Gulf, 27 March 2008.

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10. Institute of International Finance, Economic Report: Gulf Cooperation Council Countries(Jan. 2008).

11. Ibid., p. 1.12. Rachel Ziemba, ‘What are GCC Funds Buying’, RGE Monitor (June 2008).13. McKinsey Global Institute (note 1) p. 53.14. Ibid., p. 3.15. Reproduced from: Institute of International Finance (IIF), ‘Economic Report, Gulf Cooperation

Council Countries’ (16 Jan. 2008) p. 9.16. Ziemba, ‘What are GCC Funds Buying’ (note 12) p. 4.17. Rachel Ziemba, ‘GCC Sovereign Wealth and Islamic Finance’, RGE Monitor (Aug. 2008).18. McKinsey Global Institute (note 1) pp. 65–66.19. Ziemba, ‘What are GCC Funds Buying’ (note 12) pp. 4–6.20. Ibid., p. 7.21. Ibid., p. 8.22. Ibid., p. 2.23. Estimates drawn from: Brad Setser and Rachel Ziemba, ‘Understanding the new Financial

Superpower-The Management of GCC Official Foreign Assets’, RGE Monitor (Dec. 2007).24. Ziemba, ‘What are GCC Funds Buying’ (note 12) p. 19.25. Sources in the banking industry also indicate that SAMA is fairly transparent in terms of defin-

ing benchmarks and sharing them with Western banks that come calling. They also mention that SAMAis much more technocratic than the other Gulf SWFs which are beset by patronage relationships.

26. When looking at foreign holdings, it may also be worth considering the role of state-ownedenterprises (SOEs), such as Saudi Basic Industries (SABIC), which take strategic stakes in foreign compa-nies. Notably in 2007, SABIC and China’s Sinopec Corporation agreed to invest more than $1 billion in apetrochemicals plant in northern China.

27. Source: Amadan International Consulting.28. Rachel Ziemba, ‘Petrodollars: How to Spend It’, RGE Monitor (20 March 2008).29. Economist Intelligence Unit Country Briefing, ‘Saudi Arabia economy: Boom budget’, The

Economist (18 Dec. 2007).30. Ibid., p. 4.31. Ahmed Saeed, ‘The New Rules of the Game: Gulf Wealth and the Global Economy’, CSIS Gulf

Roundtable Series (31 Jan. 2008).32. See Jean Francois Seznec, ‘Industrialization in Saudi Arabia: A New Paradigm’, available at

<www.bitterlemons.org> (21 Sep. 2006).33. Philip Winder, ‘Musings on Sovereign Wealth Funds and Saudi Investment Policy’, Comments

made at the Euromoney Saudi Arabia conference, 7 May 2008.34. Middle East Economic Digest (Sep. 2008).35. It is notable that Saudi domestic equity market capitalisation makes up roughly half of total

GCC market cap. McKinsey estimates these at GCC 732 billion; Saudi Arabia 326 billion.36. For a full account of the conspiratorial climate see Ibrahim Warde, The Price of Fear: The Truth

Behind the Financial War on Terror (Berkeley: University of California Press 2007) ch. 7.37. Seznec (note 32) p. 2.38. Andrew England, ‘Saudi Arabia Approves Setting Up New Fund’, Financial Times (15 July 2008).39. Interestingly, a Time article from the era of the first oil boom notes SAMA’s “terror of American

politicians standing on the floor of the Senate and accusing them of buying up America.” CharlesAlexander, ‘Squirreling Away $100 billion’, Time, 13 July 1981.

40. See David Spiro, The Hidden Hand of American Hegemony (Ithaca: Cornell University Press1999); Eric Helleiner, ‘Political Determinants of International Currencies: What Future for the US Dollar?’,Review of International Political Economy 5/1 (2008) pp. 92–121.

41. For an exhaustive listing of the economic reasons for keeping the dollar peg see JohnSfakianakis, ‘Why Saudi Arabia is Right not to Revalue’, Financial Times (10 Oct. 2007).

42. Adam Robinson and Ed Morse, ‘Insight: Saudi Arabia Holds Key to Oil and Dollar Link’,Financial Times (24 Oct. 2007)

43. Personal interview conducted November 2007. See also Shawkat Hammoudeh and RamazanSari, ‘Do GCC Countries Finance US Current Account Deficit?’, Researcher’s Review, ZawyaCommunity Blogs (posted 3 Dec. 2007) available at <http://blogs.zawya.com/print/shawkat.hammoudeh/071203064331/>.

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44. Economic Intelligence Unit Country Briefing, ‘Saudi Arabia Economy: Boom Budget’, TheEconomist (18 Dec. 2007).

45. Many international relations theorists working on the Gulf have noted a shift to more multilat-eral policies in security. See Gerd Nonneman, ‘Determinants and Patterns of Saudi Foreign Policy:‘Omnibalancing’ and ‘Relative Autonomy’ in Multiple Environments’, in Aarts and Nonneman (eds.),Saudi Arabia in the Balance (New York: NYU Press 2006) pp. 315–352.

46. McKinsey Global Institute (note 1) p. 51.47. Interview with Financial Analyst, Lehman Brothers (Aug. 2008).48. Nimrod Raphaeli and Bianca Gersten, ‘Sovereign Wealth Funds: Investment Vehicles for the

Persian Gulf Countries’, Middle East Quarterly (Spring 2008) pp. 45–53.49. Interview with portfolio manager working with Saudi Arabia.50. Steffen Hertog, ‘Shaping the Saudi State: Human Agency’s Shifting Role in Rentier-State Forma-

tion’, International Journal of Middle East Studies 39/4 (2007) pp. 539–563.51. For a very compelling argument about how this division of ministries has left SAMA in techno-

cratic, non-royal hands, and how this technocratic divide affects Saudi reform efforts see Jean FrancoisSeznec, ‘Stirrings in Saudi Arabia’, Journal of Democracy 13/4 (Oct. 2002) pp. 33–40.

52. Roula Khalaf, ‘Transparency is in Everyone’s Interest’, Financial Times, 19 May 2008.53. Hossein Askari, ‘Sovereign Wealth Funds: Prosperity and Harmony – Or Just Greed’, Asia

Times 23 (May 2008).54. Steffen Hertog, ‘Building the Body Politic: Emerging Corporatism in Saudi Arabia’, Chroniques

du Yémen et de la Péninsule Arabe 12/1 (2005).55. ‘Interview Transcript: Mansour al-Maiman’, Financial Times, 28 April 2008.56. Souhail Karam, ‘Saudi Plans $5.3 Billion Investment Firm, Tech Focus’, Reuters, 6 May 2008.

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sovereign dilemmas: saudi arabia and sovereign wealth funds

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