By first quarter 2007, Saudi Arabia’s accumulated foreign reserves were around $235 billion. Other Gulf oil producers have also accumulated sizeable foreign asset reserves, boosted by higher oil prices over the past four years. Most of these reserves are held in US dollars, despite some indications from the UAE Central Bank, that they would diversify part of their reserves to hold around 10 percent in euros. The major question is how to manage and use these dollar reserves in the face of a depreciating dollar? China, which is holding over $1.07 trillion, and expected to reach $1.3 trillion by year end 2007, seems to be showing one way that could be a model for the Kingdom.
The Chinese, in common with most other countries holding sizeable dollar assets, are keen to downplay any impact of China’s plans to diversify away from the dollar, knowing the implication of such moves on global markets. All indications however, seem to point toward China implementing a “Singapore model” in using its accumulated reserves. Basically China is planning to create a new state investment agency that will manage a significant amount of the dollar reserves. This new state foreign exchange management agency — provisionally and rather cumbersomely named the “United FX Investment Management Corporation”, will begin formal operations in 2008. The new agency’s mandate is simple: to invest around 20 percent of China’s foreign exchange reserves in domestic Chinese state enterprises. If this proves successful, the agency’s mandate could increase to higher levels of national reserves, up to 30 percent. China will continue to invest in low-risk, liquid dollar instruments, but China’s more import objectives seems to pursue several strategic aims.
One such aim is to promote the development of Chinese state enterprise groups in seven key identified sectors. The aim is to turn them into world-class, super multinational corporations by financing their international expansion plans and helping to modernize their domestic operations. Another key objective is to ensure that China secures stable sources of key mineral resources. China’s appetite for mineral resources is well documented to feed the current phenomenal Chinese economic growth. It is no longer viable, on the long term, for the Chinese to simply purchase on the open market and accumulate stockpiles of minerals and metals. The new approach, under the FX management program, will more likely finance international acquisitions and exploration activity overseas by Chinese state-owned companies. The implication to the world’s trading pattern is significant, with new potentials for Middle East and African countries.
China currently directly controls some 160 large enterprise groups, some more efficient than others, especially in their international operations. Over the next decade, as Chinese industries modernize, and become more cost and energy efficient, these state enterprises could well merge to a smaller number, which could well become global giants. They will in essence compete against the biggest companies in the Western world and rank amongst the world’s top 500 largest companies in terms of revenue potential.
While China’s domestic economy is fast evolving and many sectors still need government subsidies and support, the proposed FX Agency will concentrate on some key priority industries. These include oil and petroleum, electrical networks and power, telecommunications, aviation, transportation — including shipbuilding, coal, and upgrading military industries. Secondary industries include automobiles, IT, equipment manufacturing, construction and steel.
What motivated China to plan for alternatives to holding US financial securities was the apparent success of Singapore’s government-controlled investment firm, “Temasek”. This agency devoted its resources to funding Singaporean state firms’ activities in Singapore and oversees, mostly in Asia. The Chinese would also start in the domestic market before moving more aggressively overseas. However, given global powers positioning for key natural resources, the Chinese could move faster overseas. China is already beginning to build a strategic mineral reserve system alongside the investment agency, and United FX will focus on assisting state-owned resource companies to invest abroad in exploration and development.
This will translate into Chinese partnering in prospecting activities in China’s Asian neighbors, Africa, Middle East, Australia and Latin America. Such strategic partnership could focus on oil and gas fields as well as strategic metal extraction. Chinese participation could encompass equity stakes in new joint-ventures, or by acquiring existing foreign companies and projects. The pace of such partnerships will be limited only by the extent of shortage in overseas Chinese management expertise, but the Chinese already seem to be doing extremely well in the most unlikely of places around the world, from Siberia to Sudan. In the end, given the pace of China’s accumulation of new foreign exchange reserves, the spending of some $200 billion in this new strategy is roughly equivalent to the pace of annual growth of Chinese reserves. The problem for China will be to identify enough projects and willing overseas partners.
The implication for Saudi Arabia and other Gulf oil producers is clear: Either continue to sit on semi-liquid, dollar reserves depreciating in value, or embark on a modest and strategic program like China and Singapore. We are not talking here about going on a spending spree for luxury hotels, supermarket chains or theme park investments, but focusing on strategic fits that are based on the regions’ own natural resources. Saudi Aramco has announced an increase in its planned investment with Sinopec in China. Some private sector companies are also doing this, such as Tasnee Group’s Cristal Company, which acquired Millennium Inorganic of the U.S.A. and propelled Cristal from being a 2 percent global producer, into the world’s second largest producer of titanium dioxide, with 16 percent global market share, second to DuPont. This is what being a strategic “super global player” is all about.
Saudi Arabia should seriously consider the establishment of an autonomous state investment agency to examine long term strategic investment opportunities. A certain percentage of the current foreign exchange reserves could be allocated to this new agency. Who knows — the Kingdom could see itself partnering China, and others, in more and more strategic projects around the world in the future?
(Dr. Mohamed A. Ramady is visiting associate professor, finance and economics at King Fahd University of Petroleum and Minerals, Dhahran.)