Middle Eastern Investments in the US Decreasing but Still Strong

According to the National Real Estate Investor magazine, “Global real estate investment by Arab investors will nearly double this year, to $22 billion, say analysts Jones Lang LaSalle. Arab investments in the U.S., however, may lag. Through May of this year, Middle East investment in the U.S. totaled $1.8 billion, far less than the $4.8 billion spent in the first five months of 2007 and $8.2 billion spent for the year, according to New York-based research firm Real Capital Analytics.”

One of the major factors responsible for the dwindling investments by Middle Eastern investors, mostly sovereign wealth funds, in the US is the fear of persistent economic downturn. The depreciating US Dollar is another factor contributing to reduced interest in US assets and real estate. Arab investors are finding more compelling opportunities in the emerging markets such as India and Eastern Europe. Arcapita, an investment firm managing capital of wealthy families in Bahrain, is an example of institutions active is such regions.

As for their US investments Arabs have had a policy shift, preferring to participate indirectly through private equity firms and other alternative vehicles. Despite the pessimism, however, capital has not stopped to flow into the US. GE, for example, recently announced that Mubadala Development Company is likely to become one of GE’s largest 10 institutional investors through the partnerships that the two are forming. Among other projects, the companies are working on initiatives in clean energy, finance, and aviation. The recent $800M purchase of a 75% interest in the Chrysler Building in New York by the Abu Dhabi Investment Council is another case in point.

These investments are taking place in an environment where most of the world’s largest sovereign wealth funds are scaling back their exposure to US Dollar. Middle Eastern sovereign funds have invested in several troubled US companies recently and have witnessed the value of their investments diminish. Moreover, they are not the only ones that are seeking alternative investment targets in the emerging markets and in Europe. The Chinese government fund is also in talks with European private equity firms in an effort to diversify and to reduce its exposure to the US Dollar. Furthermore, some private equity funds are instructed to increase their exposure to natural resources as a means of reducing their vulnerability to the US Dollar decline.

Some believe that the US Dollar is not very likely to decline much further against the Euro. That can be a part of why the Abu Dhabi Investment Authority has not yet taken any major steps away from the US Dollar. To others, however, it is only prudent to diversify away from US denominated assets to reduce the potential damage from “catching a falling knife.” While the US economy might be suffering from a credit crunch, falling real estate prices, weak currency, and inflation, it is still the largest economy in the world and that is not expected to change anytime soon. When the dust settles and the real estate and credit markets correct themselves, the US economy shall turn around to a healthy growth.

Global Financial Turmoil and Glimmer of Hope in the Middle East

In recent months global banks have increasingly shifted their resources and management to the Middle East in the face of financial turmoil elsewhere. Deutsche Bank was the latest to announce the move of senior banker, Christophe Laing, to the Dubai International Financial Center. Laing is head of Deutsche Bank’s equity capital markets for the Middle East and Africa as well as Eastern Europe.

Financial institutions around the world have written down around $400 billion as a result of the credit crunch and have raised $300 billion to repair their balance sheets. Shifting to the Middle East and committing to the oil-rich region is an obvious move to become closer to the riches of funds and governments in the area.

Others who have recently appointed senior management to the Middle East are Lehman Brothers, Citi, and Merrill Lynch. The major incentive is being close to sovereign wealth funds and their seemingly endless pool of capital. Estimates show that these funds shall grow to $15 trillion by 2016.

Emerging Markets and Global Inflation

Despite the rising “decoupling” discussion of the U.S. economy and the emerging markets, it is irrefutable that the sub-prime mortgage crisis and rising global inflation are due partly to large capital flows from Asian economies and oil-rich Middle Eastern sates to US assets. Such capital flows are designed to prevent the currencies of such Asian and Middle Eastern countries from rising and create demand for US bonds, regarded by those economies as a safe asset, increasing prices of those bonds and depressing the yields. Lower rates translate into cheap money and, with the Federal Reserve more concerned about recession than it is about inflation, the result is a loose monetary policy that is responsible for the melt down of the US credit markets. Cheap imports from China and other Asian countries have granted the central banks in rich countries the luxury to worry less about inflation while keeping rates low.

Now that the US economy has entered a downturn, the direction of these capital flows has reversed and those countries that have linked their currencies to the US Dollar are being subject to the loose monetary policy of the Federal Reserve, despite their overheating economies. This in-turn causes price rises in those economies due to low interest rates that might be suitable for the US economy at its current state but not for the overheating Asian and Middle Eastern economies. Add the high prices of oil and other commodities to the equation and the result is an inevitable global inflation that is poised to threaten growth globally.

The overvaluation of currencies has sparked talks in many Middle Eastern circles of re-valuation of local currencies. An alternative scenario would be changing their currency pegs from the US Dollar to Euro. While the latter is less likely, it cannot be ruled out entirely. Only time will tell how ultimately the capital flow to and from the emerging economies will affect global inflation. What’s known is that so far it has been partially, if not significantly, responsible for it.

Diversification, Diversification, and then again Diversification

In the previous post, I mentioned how GCC States have fueled their exponential growth with an immigrant labor force that is now demanding more compensation and is creating an imbalance in the labor markets where the private sector is less inclined to hire nationals.

One possible solution to the problem, is already being investigated and, in some cases, implemented in the region. The basic assumption is that by investing their huge oil wealth in other industries and by simultaneous investment in educating and training their younger generation, the GCC countries can create industries that can be competitive on a global scale and can be run by the skilled force of their nationals.

A bold initiative along these lines is the Masdar Institute of Science and Technology by the Government of Abu Dhabi. It involves substantial investments aimed at fostering clean technology ideas from research to commercialization. Projects like this are channels to divert the oil wealth to alternative industries in which the regional countries can emerge as global pioneers and leaders. If such high risk, high reward projects come to fruition we might see a future Gulf that is way more diversified than the one we know today. It can be more than just one of wealthiest areas in the world in terms of its petroleum income and act as a power center for development and deployment of intellectual capital and breakthrough technologies. Only time can show us what the outcome will be.

Cheap Immigrant Work Force and Imbalanced Labor Markets

Countries in the Gulf Cooperation Council (GCC) face a tricky situation. For years cheap imported labor from India, Bangladesh, Pakistan, and other countries has been providing a seemingly unlimited factor of production. That source, however, has recently realized its contribution to regional growth and has dared to ask for more compensation. Such claims have been supported by the government of the countries supplying labor to GCC countries as well.

Interestingly, some GCC countries have voluntarily engaged in practices to make immigrant labor more expensive in a bid to make the labor markets more competitive. Bahrain, for example, will be charging a visa fee and a per-head levy on foreign labor. GCC nationals like the lifestyle that they enjoy, which is mostly made possible by the work of migrant workers. What they don’t like is the competition it creates in the labor markets. Nationals are predominantly hired in artificial government positions and benefit from distribution of Petrodollars. This is while the private sector does not compete with the government to match salaries and instead hires immigrants for a fraction of the cost. The trick is to find the benefits that foreign labor brings and match them against the costs of unemployment (or employment in quazi positions) of local labor force.

The Wealth Effect: The Gulf’s Difficulty in Spending its Vast Revenues

The geographic span to the south of the Persian Gulf and to the west of the Indian Ocean is flushed with economic activity. The region is home to several landmarks including man-made islands and record breaking sky scrapers. The rapid social and economic growth that has affected the Gulf has transformed a vast region from small tribal economies to global financial and business players. Abu Dhabi, the capitol of the United Arab Emirates, for example, lacked even a paved road before 1961. Now, it is a wealthy community, with control over major petroleum reserves and multi-national firms are present in every corner.

Despite the rapid growth, regional economies are facing a major hurdle: Absorbing the petro-dollars the accumulation of which is beginning to clog their arteries. The six nations of the Gulf Cooperation Council (GCC) earned $381 billion in 2007 from exports of oil and $26 billion from gas according to Institute of International Finance. If oil remains at $100 a barrel they will reap a windfall of $9 trillion by 2020 according to McKinsey Global Institute. This is when in 2007 the combined GDP of the GCC was $800 billion in 2007. To avoid overheating a large part of this windfall is stored in foreign assets. Some goes to central banks and sovereign wealth funds while some end up with wealthy families. It all added up to $1.8 trillion by the end of 2007, by Institute of International Finance’s estimates.

In the 1990s low oil prices left petroleum producing countries with small revenues and the level of spending was subsequently adjusted to match such low revenues. As the oil prices rose higher revenues outpaced their ability to spend. Recently, however, the GCC states’ ambitions have grown to catch up with their greater means. According to the Middle Eastern Economic Digest, members of GCC have begun projects worth $1.9 trillion in 2007, 43% more than a year ago. It is remarkable how these countries are beginning to spend on themselves.

Dubai has the tiniest oil reserves of all the UAE emirates but has been very aggressive and effective in spending its wealth widely and building an infrastructure that has transformed the small emirate into the most luxurious place in the region. Dubai has made a point of exhibiting its wealth and in the process, attracting businesses and capital from around the world. This is in part due to its long term reliance on its guests. It is now more than just a municipality with oil revenues. It’s both a destination and a business hub simultaneously.