LONDON Popular revolts across the resource-rich Middle East and North Africa may transform the management of windfall oil wealth, potentially denting national balance sheets, boosting inflation and disturbing world markets.
The region's state-owned funds, managing almost $1 trillion of assets -- equivalent to nearly two-thirds of the entire hedge fund industry -- have been a key driver in financial markets, making wide-ranging investments including stakes in blue chips such as UniCredit and luxury department store Harrods.
But political turmoil is rapidly changing the landscape for oil wealth management, prompting governments to spend more at home to appease angry protestors than invest overseas. Using oil windfall revenues for potentially inflationary pump-priming or even wealth redistribution may slow or even halt the accumulation of resource wealth in the long run.
This could hit national balance sheets and removes a key support factor for credit ratings. It may also disrupt world financial markets, whose strong recovery since the crisis was partly underpinned by petrodollar demand for risky assets.
Last week, Saudi Arabia unveiled benefits worth some $37 billion, in an apparent bid to insulate the world's top oil exporter from an Arab protest wave.
Bahrain, Libya, Oman and Kuwait have also increased domestic spending or handed outright cash to its citizens in packages totaling as much as 4 percent of gross domestic product.
"In the long term, we will probably see a meaningful shift in the balance between hydrocarbon revenues that are saved and invested overseas and those that are deployed at home," said Andrew Rozanov, head of sovereign advisory at Permal.
"Recent events in the region are refocusing people's minds rather urgently on new spending on domestic investment and welfare needs to maintain peace and social cohesion."
Among these countries which increased domestic spending, Saudi Arabia's is by far the biggest. Its spending plan, financed by its foreign exchange reserves, includes pay rises, unemployment benefits and affordable family housing.
"If oil prices stay sufficiently high to finance it, this will simply slow the growth of sovereign portfolios in the future. If, on the other hand, oil prices come down significantly, then certain funds may be required to make some adjustments to accommodate increased spending," Rozanov said.
BALANCE SHEET IMPACT
Vast oil wealth is a key factor underpinning credit ratings in resource-rich but politically vulnerable countries which have high youth unemployment.
Libya, for example, is rated BBB by Fitch Ratings -- higher than Egypt's BB. Gulf countries are all rated A or above.
But the protests have already had fiscal consequences.
Fitch expects even before the latest steps, Bahrain's already expansionary measures would more than double its gross debt to 38 percent of GDP by 2012 from 2008.
"The credit ratings for some of the hydro-carbon rich sovereigns in the region have long been held down due to concerns about social and political factors like high unemployment or the absence of voice and accountability," said Purvi Harlalka, director at Fitch.
"From a purely balance-sheet point of view, they look strong. However, now that the social and political risks that were factored into the rating have manifested, they have real and visible economic costs that further impact creditworthiness."
For global capital markets, a sudden change in a country's wealth management policy or the environment surrounding their investment could trigger a sell-off and volatility.
Moves by U.S., UK and European authorities to freeze Libya's state assets and a sell-off in shares of Unicredit, 2.6 percent owned by the Libyan Investment Authority, illustrate this point.
The redirection of oil wealth to domestic industries may have other downsides.
Sovereign wealth funds in resource economies do not exist only to invest for future generations but also to diversify their economies and avoid so-called "Dutch disease."
Rapid oil sector growth could make other industries less competitive and lead to lower growth than those with fewer natural resources -- as seen in the 1960s Dutch economic crisis following the discovery of North Sea natural gas.
Home investment is often seen by sovereign funds as something of a taboo, except in a severe economic downturn, because the domestic recycling of the surplus risks fanning inflation and discouraging competitiveness.
For this reason, certain SWFs such as Norway and Azerbaijan are not allowed to invest domestically.
"If we see a boom in local investments for internal needs, you might see a rise in inflation. Many of the decisions will be influenced more by immediate political needs than long-term economic plans," said Efraim Chalamish, an SWF expert and adjunct Professor at New York University.
(Editing by Mike Peacock)