The globalisation of finance has produced a structural and ideological transformation in the financial system since the beginning of the 1970s. The globalization of the financial system in turn has accelerated the process of globalisation in other sectors, ever since states first made the decision to enter into the financial markets.  Such involvement has enabled some countries to assume prominent positions in the global financial system. This is clearly noticeable in the case of the Gulf Cooperation Council (GCC) countries – Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates (UAE).

These countries have achieved economic prosperity due to the accumulation of wealth generated from oil and gas revenues. However, the Gulf has struggled with regional troubles for the last few weeks. Although a regional diplomatic crisis has plagued the Gulf in the past, the recent crisis has gone beyond a diplomatic one with the imposition of tangible sanctions on Qatar. Although Qatar is a small country in terms of its population and land area, it is an example of the “small States, big politics” trend experts describe in literature about the region. Under these circumstances, the impact of the Qatar crisis on current politics and economics will be not only regional but also global, as can be understood from the official reaction by world leaders.

According to the IMF, Qatar had the highest GDP per capita in the world –  $128,000 GDP per capita (at purchasing power parity) in 2016. Beside this, Qatar, which holds the world’s 9th largest Sovereign Wealth Fund (SWF) worth some $350 billion, has invested in real estate, banking, automotive and technology sectors. This already means Qatar has a significant role in the global financial system. Furthermore, Qatar is one of the biggest financial supporters of professional sports – its SWF owns the French Paris Saint Germain football team, and sponsors the Barcelona Football Team through Qatar Airways. Qatar will host the 2022 World Cup, and is buying beIN Sport, one of the biggest sport channels in the world.

The Qatar crisis has had a negative impact on many markets, and Qatar’s stock market experienced a severe fall. The Qatar stock exchange underwent its largest price drop in 18 months, nearly 8 percent, after the diplomatic rift on Monday. According to Wednesday market data, Although the Qatar Stock Exchange became the world’s worst performer with 8,965.01 point since January, 2016, Qatar Stock Exchange reached the high of 9,237.86 point since Monday, when was started the sanctions against Qatar. Some companies, moreover, were uptrend on Wednesday and Thursday by contrast with Monday, when all companies were down. In addition to Qatar Stock Exchange, the investments of Qatar through SWF, which are, mainly, invested in abroad such as European and Asian countries, could be affected by Gulf crisis in the long term.

http://thenewturkey.org/what-is-behind-the-crisis-in-the-gulf/

In addition to the stock market, the crisis will lead to trade problems in the region, and will have an impact on Qatar’s import-dependent food sector. Food imports from Saudi Arabia account for about 90% of Qatar’s daily food consumption. According to 2016 data, Qatar’s trade volume was around $11 billion with the other GCC countries. However, Qatar’s trade volume with Saudi Arabia, the United Arab Emirates, and Bahrain, which cut diplomatic ties with Qatar, were around 85% of the total GCC trade volume of Qatar in 2016. This data shows that Qatar will be faced with a daily food scarcity in the short term, and a lack of food products in long-run if they don’t find alternative daily food suppliers from friendly countries.

Another impact of the crisis on Qatar’s economy is the changing air route of Qatar Airways, which will decrease customers because of the longer distance and cost-plus pricing the airline will have to follow. Lastly, the businessman who are visiting Dubai and Abu Dhabi, which are financial and business hubs for the region, will not prefer to visit Doha after their UAE visits due to travel difficulties to Qatar from the UAE. After mentioning the potential worst scenario of the Gulf crisis on Qatar’s economy, it is important to emphasise that this crisis will not affect the country’s gas production and its transportation to customers abroad, mainly Asian countries. Qatar may also have a shortage of cash to pay for imports, and the fact that its border with Saudi Arabia is sealed will further exacerbate this problem, but one solution is to find a trade partner the country can import from, in exchange for providing energy and raw materials for construction.

President Recep Tayyip Erdoğan has clarified that Turkey stands with Qatar, and is focused on mediating between the sides to calm the tension. Turkey’s parliament also approved draft bill allowing troop deployment to a new military base in Qatar on Wednesday. After these political and military steps, it is important to evaluate the impact of the crisis on the economic relationship between Qatar and Turkey, which has historically not been as promising as the political relationship.

In 2016, Turkey’s export to Qatar were around $440 million, mainly comprised of ships, yachts, appliances, furniture, and electronic products. In the same year, Qatar’s exports to Turkey were worth around $271 million, and were chiefly aluminium products, plastics, fertilisers, fossil fuels, and mineral oils.  Turkey has an advantage over Qatar because its products cover a wider range, and Turkey has an overall trade surplus. From this perspective, Turkey has positioned itself as a major supplier to Qatar in the new conjuncture. Turkey, thus, will find an opportunity to increase its exports in the near future. Furthermore, new products, which have not been sold to Qatar before, might be brought into line for export. The increase in Turkey’s exports to Qatar, therefore, would relax Qatar’s shortage of food supplies in the long-run. This trade partnership will initially bring extra cost for Qatar, mainly due to higher transportation overhead, but in the long term, if a viable system of trade is found and new channels opened, Qatar will meet its needs.

There seems to be no universally applicable definition of a sovereign wealth fund (SWF), and the SWF industry is made up of a heterogeneous class of funds, often shaped by the individual needs and conditions of the originating countries. However, against the background of the existing funds that are widely classified as SWFs, a sovereign wealth fund can be defined as an investment fund where:

1. The asset owner is a sovereign government,
2. It is managed professionally (either in-house or out-sourced) and independently of other government institutions,
3. Its governance structure is well defined and partially transparent in that it reports either to the finance ministry or directly to the prime ministry,
4. It has no or very few direct financial liabilities such as pension obligations,
5. It invests in a wide range of financial and real assets for long-term financial return.

The source of capital for a SWF is typically one or more of the following national assets:

1. Commodity revenues such as oil and gas exports
2. Excess foreign exchange reserves and budget contributions
3. State-owned or state-controlled real and financial assets

Historically, SWFs may have been founded for diverse purposes but the current SWF landscape seems to cover the following as purposes of SWFs: 1) “Stabilization” and reserve management (that include fiscal stabilization by managing investments of budget and trade surpluses, financial price stabilization through market-making against disruptive cross-border money flows and excess volatility in financial markets, and management of excess reserves at central banks, where excess means beyond the amount needed for monetary policy and stabilization), 2) growth of equity capital and markets through management of “savings” for inter-generational wealth transfer, 3) and finally economic “development” through investment in strategic sectors and assets.

Among many, the IMF’s definition of SWFs is closest to the above definition. According to the IMF, there are five categories of SWFs: 1) stabilization fund; 2) savings fund; 3) development fund; 4) pension reserve fund, and 5) reserve investment company. However, these categories need not be mutually exclusive.

History and Market Size

While SWFs have existed since 1970s, the SWF industry has grown considerably only after early 2000s. During the period, total assets under management (AUM) by SWFs have grown from less than $1 trillion before 2000 to about $7.4 trillion in 2015 and about two-thirds of the 78 SWFs today have been established since 2000. As such, the growing importance of SWFs is a relatively new phenomenon. Today, the current value of AUM can be estimated at around $7.8 trillion and it is expected to grow considerably in the foreseeable future. More than 80% of total AUM are held by the biggest 10 SWFs, most of which originate from emerging markets. The biggest SWFs (AUM, country of origin, source of capital, purpose) are shown in the following table:

Despite the fast growth, SWFs make up only about 7-8% of total AUM by institutional investors. As of 2015, the value of AUM globally is roughly estimated as $117 trillion with $100 trillion in conventional funds (39 in pension, 30 in insurance, and 30 in mutual funds)  and $16 trillion in alternative funds (7.4 in SWF, 4 in private equity, 2.4 in hedge funds, 2.6 in ETFs, and others). These figures exclude privately managed private wealth. AUM under SWFs is more than the sum of private equity and hedge funds but still make up a small portion of the total fund industry. For reasons to be mentioned below, the share of SWFs is expected to increase in the future.

It is to be noted that SWFs are not the only type of sovereign investment instruments. In addition to the $7.4 trillion in SWFs, there is also about $10.2 trillion in other sovereign investment vehicles such as development funds, commodity savings funds, reserve investment funds, pension reserve funds and government – owned companies. (This does not include about $11 trillion in official foreign exchange reserves outside of the SWFs.) There are huge public funds in the US and Europe that very much resemble the SWF format but yet not classified as such. It will not be surprising to observe these funds being re-structured as SWFs in the near future, possibly reaching a total AUM value of about $20 trillion. SWFs constitute a big financial market with significant potential impact on the allocation of investments globally.

It is estimated that around 55% of SWFs’ assets ($4.3 trillion) at the end of 2016 were from commodity revenues. The remaining $3.1 trillion were from non-commodity sources. Non-commodity funds have however grown at a faster rate since 2000 and this trend is likely to continue. As a case in point, the newly established Turkish National Wealth Fund falls in the latter group.

As of 2016, AUM by SWFs are 50% in public equities, 30% in cash and fixed income, and the remaining 20% in alternative asset classes such as private equity, hedge funds, and real estate. In recent years, the share of fixed income has been decreasing, and the shares of equity and real estate has been increasing. This trend may be explained by the increasing focus on long-term performance by SFWs and also by the low/zero interest rate environment in developed markets since 2009.

Issues and Opportunities

Although SWFs have become major players in global markets and their relevance is likely to increase further, the current state of the world and the “new difficulty” in predicting the future of politics imply three major issues facing governments and SWFs:

1. While most of the SWFs are from emerging countries, most of their investments are in developed markets. The new financial environment after 2009, changing trade imbalances, and the new political paradigm globally will easily prompt policy makers to question this phenomenon and possibly revise SWF mandates.
2. It is often claimed that SWFs may invest not only on the basis of purely financial considerations but also on (biased) strategic and political considerations. Thus,  recipient countries may be concerned about both corporate governance and also “national interests.”
3. Most importantly, private conversations with managers of SWFs reveal the limitations they are facing in where they can invest! Many complain that, largely due to regulatory and statutory reasons, they cannot invest in growth and start-up companies either in their domestic markets or in foreign markets. This is part of the larger and deeper problem of the broken link between financial institutions and the real economy.

These issues can evolve into problems but they can also be turned into opportunities. Both for existing and new SFWs such as the Turkish SWF, the following recommendations are appropriate:

1. SWFs should pursue all mentioned purposes (stabilization, savings, development) simultaneously and allocate their investments accordingly. They should not limit their capabilities by choosing a subset of these three purposes. This will result in an acceptable balance between international and domestic allocations, and it will also limit any possible negative impact (or, perception) of political considerations.
2. Depending on the investment type, a SWF should be able to co-invest with other national and international partners (other SWFs, pension funds, hedge funds, etc.) to strengthen its equity base and for better risk management. For example, it is of utmost importance that SWFs are able to invest in both small start-up companies and also big infrastructure projects. These may call for different co-investors.
3. Due to their ownership, SWFs can powerfully fulfill the social responsibility of educating financial markets and institutions to better serve the real economy. All they have to do is to set good examples for other investors by: (1) Focusing on long-term rewards and never being short-termed; (2) Supplying equity capital at the maximum and avoiding debt as much as possible; (3) Implementing good corporate governance; (4) Properly considering environmental and social issues; and (3) Involving “wise business people” in the decision-making process and not giving all the power to finance professionals.

The newly established Turkish SWF seems to have a historical chance to become a good example not only for other SWFs but also for the whole finance industry. The same goes for other similar SWFs to be started hereafter.

Sovereign Wealth Funds (SWF), which are referred to some cases as National Funds, are the savings of countries outside their official reserves. Historically, central banks in many countries that hold foreign exchange reserves in their hands for urgent needs have started to set up various funds to use their savings profitably, and therefore SWFs have emerged. Especially since the 1950s, the swift increase in oil revenues and SWFs, which manifested themselves in the practices of the Gulf countries, have also been adopted by Asian countries that have achieved a budget surplus over time.

Today, the 15 largest national SWFs in the world have nearly $11 trillion in assets. Looking at the world average, revenues from oil and gas sales constitute 56.60% of these funds, while income from other sources is 43.40% of the funds. In the beginning of the 1990s, SWFs collectively were worth for $500 billion, and by 2015, they were worth $12 trillion. It is expected that the total size of SWFs, which are continuing to be invested in all over the world, will reach close to $15 trillion within a few years.

National Asset Funds are funds under the ownership and management of the state that aim to increase their income by investing in various financial assets, and the revenue of these funds is usually composed of budget surplus. Countries that transfer the budget surplus to these funds generate income by purchasing local and/or global financial assets through these funds, with the goal of passing on this wealth to future generations. However, having a budget surplus does not constitute a necessity for the countries in the process of establishing the asset fund. Asset funds have been successfully established in countries with many high performing, income generating institutions and facilities such as Turkey.

SWFs are an important source of financing for the public, as well as a shield against speculative waves in economies in the long-term. SWFs, which also consider community welfare, can attract state savings to more sheltered ports and allow a safer investment path. About 80 countries have SWFs today, meant to ensure the sustainability of important public investments such as education, health, and infrastructure.

In Turkey, a bill called the Asset Fund law was enacted on 20 August 2016. With the Law No. 6741, the Turkish Wealth Fund (TWF) is meant to contribute to overcoming the structural problems of the economy and help Turkey have more influence in the international arena. By law, the fund will be managed by a corporation, TWF Joint Stock Company. The initial capital of this company was 50 million TL, provided by the Privatization Fund. As of February 2017, the current amount of funds in TWF has exceeded 31.3 billion TL, together with 14 companies transferred to its control, 46 fixed land assets exceeding 2.2 million square meters, as well as 3 billion TL obtained from the Defence Industry for three months.

In the short term, this fund size is estimated to be 200 billion dollars. The Prime Minister will appoint the Board of Directors, Chairman and members of the TWF. Other companies and sub-funds to be established by TWF will be subject to independent auditing. Consequently, the Court of Auditors will not monitor them. This is mainly based on the principle that this company will provide financing for major infrastructure projects. TWF’s activities are carried out within the framework of the principle of accountability, which requires a structure in which responsibilities are clearly defined and areas of authority and governance are drawn with certain lines.

Accordingly, TWF under the Prime Ministry is subject to independent external auditing. This structure is therefore strengthened by internal systems and control mechanisms in the form of policies, procedures and guidelines in the areas of risk management and investment approvals, corporate values and ethical standards. It also provides information required by the law and relevant authorities and ideas raised in various platforms to internal and external stakeholders. The organization structure of TWF is an institutional identity strictly connected to performance criteria, including all the above-mentioned processes.

As a vision, TWF is committed to creating sustainable growth of the country’s economy by adopting a pioneering, efficient, innovative, transparent corporate culture based on corporate governance principles. By contributing to the sustainable growth of the country’s economy and making strategically important investments, it aims to play an important role in socio-cultural development, economic capital and human capital development as well as to transfer economic wealth to future generations.

Together with TWF, incentives, customs exemptions, corporate tax reductions, and insurance premium exemptions will be offered to attract potential investors to the country and provide convenience for current investors. The companies that will obtain credits under the asset fund will be included in the scope of strategic investments and the debt will not be increased because the funds will be provided with appropriate terms. Furthermore, the funds will not be obtained from the Treasury. Since these transactions will be carried out from another fund, the functioning of the SWF will have worked with this mechanism.

TWF is expected be able to make capital market transactions such as foreign, public, private sector and public debt instruments, issuer shares, time deposits, participation accounts, all allocated Treasury real estate and deposit certificates, gold and other precious metals and capital market instruments based on mines. In addition, funds participations, repo and reverse repo, lease certificates, real estate certificates, warrants and certificates, money market transactions of the settlement and custody bank, cash guarantees and premiums of derivative instruments, specially designed foreign investment instruments, loan participation certificates, national investments and investments made by foreign companies and other states in the international arena and issuance of other investment instruments make up the other transactions of TWF. Without prejudice to the Turkish Commercial Code, the articles of association, liquidation, transfer, merger, dissolution, organs, committees, their formation, duties and responsibilities, accounts and distribution of profits shall be directly registered and announced.

TWF is a fund that holds and manages selected commercial assets of the state and its main duty is to undertake strategic investments on behalf of the nation. TWF primarily plays a key role in maintaining various strategic industries and national initiatives and in helping to improve Turkey’s long-term economic interests. TWF is an organization capable of providing direct or indirect investment both in domestic and overseas sectors in a broad perspective from the growth targets of financial markets to the infrastructural projects of Turkey. TWF supports the economy by providing opportunities for innovations such as Islamic finance and considering developments like the growth in the scale of financial markets, the level of transactions and financial deepening.

In addition to these, TWF is of great importance in terms of creating additional jobs in all sectors, developing the defence industry, supporting projects in areas of strategic importance for Turkey, especially energy, information and software technologies, and ensuring gains that will create a competitive advantage. Financing will be provided for large-scale projects such as Canal Istanbul, the third airport in Istanbul, the three-storey high Istanbul tunnel, high-speed train projects, a nuclear power plant, and new employment areas will be created.

Turkey, which wants to decrease its external dependency on energy, attaches a great deal of importance to TWF. The fund will also support strategic investment projects such as oil, natural gas, and renewable energy and nuclear power plants. It will open a front for domestic companies to operate, especially in industries such as defence, aviation, software and medicine. TWF is expected to reach a size of $200 billion in the near future. TWF is expected to contribute an annual average of 1.5 percent to the nation’s economy over the next 10 years.

Before 2002, Turkey had mostly focused on building trade relations with EU countries, but since the Justice and Development Party came to power, Turkey has been trying to diversify its trade partners by seeking more economic relations with the Middle East, Africa, Asia and Latin America. Economic relations between Turkey and Qatar gained momentum during this time period, especially after the Arab Spring. A strong political will from the two countries’ leaders created an impulse to improve trade relations further. The current Turkey-Qatar trade volume is about 750 million USD and it is expected to increase to 1 billion USD soon. But this trade volume is still below the potential of both countries.Qatar mainly imports iron and steel products, electrical equipment, motor vehicles, home textile products, food and furniture from Turkey. On the other hand, Turkey imports natural gas, plastic products, aluminium, and chemical derivatives from Qatar. Considering the trade balance between the two countries and the composition of goods being exchanged, it can easily be said that economic relations between Turkey and Qatar are not based on a zero-sum game, but on a win-win game. That is to say, Turkey and Qatar are not competing to become exporters of the same products. This makes it easier to develop economic relations further. While the short-term target will be to increase total trade volume to 2 billion USD, the long-term target will be to increase it to 4-5 billion USD.

Qatar’s economy is highly dependent on hydrocarbons. Due to the fall in energy prices, Qatar has been seeking to diversify its economic base. The opportunity cost of making structural reforms becomes relatively low for hydrocarbon economies during low energy prices. Therefore, this is the right time to work more on the diversification of economic activities. Qatar and other Gulf countries have been taking this issue more seriously since 2015, when global hydrocarbon prices fell dramatically. If they don’t, their economic prosperity will be under threat.

On the other hand, due to its heavy dependence on foreign energy resources subject to unpredictable geopolitical winds, Turkey has been seeking to diversify its imported energy resources. Turkey and Qatar can cooperate to meet these diversification targets.

Turkey and Qatar should work more on long-term liquefied natural gas agreements. Both countries can make joint investments in underground natural gas storage plants. On the one hand, these investments will help Turkey to get more reliable access to natural gas. On the other hand, they will provide an opportunity for Qatar to sell its natural gas to other potential markets more easily.

The defence industry is another area where both countries can work together. Private companies in Turkey have aggressively invested in the defence industry for the last few years. The public side is also giving full support to these companies. In recent years, Turkey has begun to produce its own weapons, tanks, armed helicopters, drones and military vehicles. Future joint investments of these two countries will not only be crucial for security issues, but also pave the way for new R&D activities and innovations.

Qatar is highly dependent on imported agricultural products. Although agriculture is a crucial sector for Turkish economy, Turkey has been unable to exploit its full capacity in this sector, mostly due to a lack of technological investment. Qatar can invest in promising agriculture areas and companies in Turkey. These investments will be beneficial for both sides. While these investments will enable Qatar to reach agricultural products at a lower price, they will increase Turkey’s agricultural production and export.

Another sector of cooperation is the health care system, which Qatar wants to reform in order to improve its quality. According to the results of one survey, 43 percent of Qataris would prefer to go abroad for the treatment of serious health problems. These results show that Qataris do not trust their health system too much. Turkey has improved its health system since 2003 and it has become one of the top destinations in health tourism. Turkey can share its know-how on the health system with Qatar. Turkish hospitals and healthcare groups can also make investments in Qatar.

At a more macro level, Turkey has established a sovereign wealth fund (SWF) to generate long-term and low-cost finance for strategic and large-scale investments. Turkey is taking baby steps on the SWF now. But Qatar is a mature country regarding the SWF. The Qatar Investment Authority has good experience in this area. Therefore, Qatar can share its experiences with Turkey.

Another lucrative sector is Islamic finance, which Turkey and Qatar both aim to develop within their current financial systems, and to become global players in this field. The two countries can forge strategic partnerships in Islamic finance. Strengthening the capital structure of existing Islamic banks and establishing new ones will move both countries to the upper class of this sector.

With all of these opportunities available, mutual foreign direct investment (FDI) in the defence industry, agriculture, health and banking sectors between Turkey and Qatar will be expected, if both countries build their investment cooperation based on technology and the transfer of experience. Both countries have attracted a significant amount of FDIs since 2000s. But, Western multinational companies are not so eager to share know-how and technology with domestic companies in the host countries. Therefore, Turkey and Qatar cannot reap the fruits of FDIs fully. Mutual investments in strategic sectors between Turkey and Qatar will bring not only static but also dynamic gains to both countries.

To strengthen economic relations, first, Turkey and Qatar should finalize the ongoing free trade agreement negotiations. This free trade agreement will significantly expand bilateral trade between two countries. Secondly, the Central Bank of the Republic of Turkey and Qatar Central Bank can also make an agreement that will enable the use of local currencies as the medium of exchange in bilateral trade. Last but not least, investment agencies from both countries should work together to channel Turkish and Qatari investors towards these and other promising sectors