HOUSE_OVERSIGHT_016117.jpg

Public Investment Fund to gain prominence
The restructuring of the Public Investment Fund (PIF) is likely to allow greater focus on achieving a diversified foreign asset base which could support in turn the build-up of non-oil revenues. According to Deputy Crown Prince Mohammed bin Salman, government ownership of Saudi Aramco would be transferred to the PIF, which will be transformed into a SWF that will look to increase its overseas assets (from 5% of total to 50% of total by 2020) following its recapitalization and the proceeds of Aramco IPO. The PIF would hold on-paper a vast amount of wealth post-IPO (US$2trn, according to the Deputy Crown Prince, the bulk of which would be Saudi Aramco) as ownership of Saudi Aramco is transferred to the PIF, but it would only be able to deploy the cash proceeds of the monetized Aramco stake in the near-term, in our view. We think the PIF's transformation is still at a relatively early stage for now.

Room to grow PIF stature and budget contribution
The restructuring of the PIF is likely to allow further diversification of foreign assets, which will in turn increase the share of investment income in the budget over time. We estimate that in 2015 investment income transferred to the budget stood at US$9.9bn (1.5% of GDP), which entails transfers of US$4bn from the PIF and US$5bn from SAMA. These transfers pale in comparison to the estimated budgetary contributions among main GCC peers. We estimate that the rate of return (investment income) on foreign assets of SAMA, government entities and the private sector averaged c2% over the past 8 years, which already suggests some exposure to riskier asset classes, in our view. As the PIF gains importance, it will become more prominent in the examination of the breakdown of the Saudi Net International Investment Position.

Transitioning to an Abu Dhabi model
It will be interesting to see how the restructuring of the PIF into an SWF works out in practice. We hypothesise that it may be that, on top of the monetization of Aramco's stake sale, PIF could get a portion of the assets of SAMA. In this scenario, we would effectively transition to the Abu Dhabi and Kuwait model where the central bank holds little reserves and non-transparent SWFs are what matters both in terms of flow and stock. Foreign assets purchases of the PIF would also have to be managed within the overall Balance of Payments (BoP) framework as they could lead to drains on SAMA reserves in the near term. Over time, Saudi Arabia could decide to emulate the Norway model, which would entail a more prudent use and conduct of fiscal policy, in our view.

Chart 1: PIF budget contributions small versus GCC SWF contributions
[Bar chart showing US$bn, % of GDP, and % of total revenues for Qatar, Abu Dhabi, Kuwait, Saudi Arabia, Dubai]
Source: Haver, IMF, Saudi Ministry of Finance, BofA Merrill Lynch Global Research. 2015 data, Investment income and transfer of profits of public entities for Kuwait. Investment income from public enterprises (incudes Qatar Petroleum's net income) for Qatar.

Chart 2: High rate of return suggests foreign assets well diversified
[Line chart showing Implied rate of return with respect to IIP assets (%), Implied rate of return with respect to SAMA reserve assets (%), Net income balance (% of GDP, rhs) from 2001 to 2015]
Source: Haver, BofA Merrill Lynch Global Research. Implied rate of return on SAMA reserve assets simplistically assumes all investment income is earned by SAMA (instead of being earned by SAMA, government entities and the private sector).

Merrill Lynch
GEMs Paper #26 | 30 June 2016 7
HOUSE_OVERSIGHT_016117