A fistful of dollars

Sovereign wealth funds are coming under increased scrutiny in the West. Diana Milne reports on the backlash and asks whether it will slow their march.

Guilty until proven innocent, was how Muhammad Al-Jasser, vice governor of the Saudi Arabian Monetary Agency, summed up the attitude of Western governments towards sovereign wealth funds at the recent World Economic Forum.

His words echo the sentiments of leaders across the Arab world which has pumped billions of dollars into troubled Western economies only to have their investments greeted with suspicion and in some cases outright objection. And they are not impressed, especially with the US.

"It has a choice - accept the money and keep its companies afloat or don't accept the money and watch them sink. You have an alternative - that is to have jobless people, a company collapse, economic repercussions and stock market repercussions," says Mishal Kanoo, one of the world's richest Arabs, who is deputy chairman of the Kanoo Group, one of the largest independent family-owned companies in the Gulf.

The spark that lit the flame was the purchase of British company P&O by Dubai Ports World in March 2006.

It provoked uproar among US Republican politicians because P&O controlled six major US ports. DP World eventually transferred all interest in P&O's US port operations to an American company.

Two years on and investments by SWFs, whose assets are said to be worth around US$3 trillion worldwide, are continuing to cause controversy.

Last year's G7 summit called on the IMF and OECD to draw up a new code of conduct for SWFs which would include greater transparency as French president Nicolas Sarkozy launched an attack on the funds and their "unscrupulous attitudes".

In January, US president Bush gave the go-ahead for a law to be passed which will tighten controls over the flow of foreign direct investment into the country.

It comes as Middle East and Asian SWFs are queuing up to pump billions into the US economy. According to Citigroup, SWFs are projected to more than double over the next five years.

Gulf-based SWFs alone are said to be worth around US$1.5 trillion dollars.

To date SWFs have provided emergency cash injections of up to US$60bn to US banks reeling from the subprime mortgage crisis and a looming economic recession.

In January, the Kuwait Investment Authority (KIA) invested US$5bn into troubled US banks Citigroup and Merrill Lynch and Abu Dhabi Investment House, the world's largest SWF with assets totalling US$875bn has invested US$7.5bn in Citigroup.

According to economists - it is these investments by sovereign wealth funds - that are helping to prop up the US economy in the wake of a looming recession. Marios Maratheftis, regional head of research at Standard Chartered Bank says: "We should not underestimate the role that SWFs play in keeping the global economy afloat. The US has a trade deficit and it needs to have a capital account surplus to balance that out."

The motives of SWFs - whether purely financial or political, are a matter of hot debate among economists. Pierre Chaigneau, financial markets researcher at the London School of Economics, believes that for sovereign funds, financial returns are a secondary consideration when making investments.

Their priority, he says, is to invest in entities that will bring long-term benefits - such as additional resources and information. "They are investing public money and are typically accountable to their government."

The wise investments being made by SWFs are also geared towards ensuring financial security for its future generations by buoying up the US economy.

While the country's trade deficits have created a ripe opportunity for opportunistic Gulf-based investors - they also pose a serious threat to the region, should they generate a full-blown US recession.

This could result in the US cutting its oil imports from the Middle East - a situation that could have serious repercussions in the Gulf.

The investment by Gulf-based SWFs into Western economies is supported by mutual need - need on the part of the Gulf countries to diversify their financial interests, import industry expertise and buoy up the US economy - and need on the part of the recipients of these investments to fend off recession.