Sovereign wealth funds in the new era of oil

From Vox by Rabah Arezki, Adnan Mazarei, and Ananthakrishnan Prasad

As a result of the oil price plunge, the major oil-exporting countries are facing budget deficits for the first time in years. This column goes through the evidence, suggesting that the low price environment is likely to test the relationship between governments in oil-exporting countries and their sovereign wealth funds, at a time when spending is going up.

As a result of the oil price plunge, the major oil-exporting countries are facing budget deficits for the first time in years. The growth in the assets of their sovereign wealth funds, which were rising at a rapid rate until recently, is now slowing – and some have started drawing on their buffers.

Figure 1. Brent crude price, 2014-2015 (US dollars per barrel)

In the short run, this phenomenon is not cause for alarm. Most oil exporters have enough buffers to withstand a temporary drop in oil prices. But what will happen if low oil prices persist, and how will policymakers react? We explore here the fallout from low oil prices on sovereign wealth funds in oil-exporting countries and find that that they have important domestic implications. The impact on global asset prices will depend on the extent of unwinding of the sovereign wealth funds of oil exporters that will not be compensated by portfolio adjustment in other parts of the world that will in turn depend on their economic prospects.

Figure 2. World’s biggest sovereign wealth funds, 2015 estimates

The rise of sovereign wealth funds

In the early 2000s, high oil prices brought about a massive redistribution of income to oil exporters, resulting in current account surpluses and a rapid buildup of foreign assets. Governments established new sovereign wealth funds or increased the size of existing ones to help manage the larger pool of financial assets. The total assets of sovereign wealth funds are concentrated in a few countries. As of March 2015, it is estimated at $7.3 trillion, of which $4.2 trillion are oil and gas related. While there are large differences across sovereign wealth funds, available information on their asset allocation points to a significant share in equities and bonds.

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Posted by at 11:49 AM

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