TREASURY U/S QUARLES VISIT TO UAE

C O N F I D E N T I A L SECTION 01 OF 04 ABU DHABI 001472

SIPDIS

SIPDIS

STATE FOR NEA/ARPI, EB/IFD/OMA
STATE PLS PASS TO USTR FOR SDONNELY, DBELL, KCLAYMAN
TREASURY FOR U/S QUARLES, RAMANATHAN

E.O. 12958: DECL: 04/15/2016
TAGS: EFIN EINV ETRD ECON AE
SUBJECT: TREASURY U/S QUARLES VISIT TO UAE

Classified By: Ambassador Michele J. Sison for reasons 1.4 (b) and (d).


1. (C) Summary. During Treasury Under Secretary Quarles'
March 22 meetings, his interlocutors stressed their belief
that the U.S. - UAE relationship was strong and that
government investors in the UAE would continue to invest in
U.S. assets, despite DP World. Over ninety-eight percent of
the Central Bank's $23 billion in foreign exchange reserves
are in dollar denominated assets, and the Governor has no
plans to change that allocation in the near term. ADIA
currently holds $3.7 billion in inflation indexed bonds and
about $4 billion in nominal bonds, and is plowing about 50%
of its oil revenues into dollar assets. UAE investors do
have concerns about the impact of the Patriot Act of the
security of their investments in the U.S. and are likely to
re-examine some potential direct investments in light of DP
World to ensure that they "go smoothly." While he is willing
to consider DP World an anomaly, Dubai Holdings CEO Gergawi
is looking at the response to a pending purchase of
Doncasters Ltd. as an indication of how open the U.S. really
is to foreign investment. End summary.


2. (C) On March 22, Treasury Under Secretary for Domestic
Finance Randal Quarles, Treasury financial economist Karthik
Ramanathan, and Abu Dhabi Econchief met with Central Bank
Governor Sultan Nasser Al-Suwaidi, MinState Finance Dr.
Mohammed Khalfan bin Kharbash, Abu Dhabi Investment Authority
(ADIA) Deputy Managing Director Khalifa Al-Kindi, MinState
Cabinet Affairs (and Dubai Holdings CEO) Mohamed Al-Gergawi,
and Dubai Investment Group CEO Saud Ba'alawy. Ambassador
accompanied on meeting with Governor Al-Suwaidi and CG
accompanied on meeting with MinState Gergawi. U/S Quarles
explained that he was visiting the region in order to reach
out to investors in the U.S. especially holders of U.S.
treasury securities. His interlocutors all stressed the
close relationship between the U.S. and the UAE and the UAE's
continued interest in investing in the U.S. despite the
recent problems with DP World.

U.S. Investments Still Attractive
--------------


3. (C) All of U/S Quarles' interlocutors stressed that the
size and liquidity of the U.S. market ensured that it would
remain the investment destination of choice for the
foreseeable future. In contrast to his earlier public
comments that the Central Bank would consider transferring up
to 10% of its $23 billion in reserves to Euros, Governor
Al-Suwaidi stated that the Bank would keep its reserves in
dollars. He explained that the UAE dirham was pegged to the
dollar, and that he measured the sustainability of the peg in
three ways: investment currency for the UAE, currency for its
international trade, and cash requirements of tourists. By
this measure, the dollar led two to one on the Euro. Only
the UAE's tourists suffered when they visited Europe, but the
bank could weather those complaints. He noted wryly, "if we
buy the euro, what do we do, lend to Italy? How liquid are
they?"


4. (C) Governor Al-Suwaidi also stated that the GCC would
likely maintain its dollar peg if it entered into a monetary
union in 2010. In his view, it made no sense to change the
peg after monetary union, since he envisioned that the common
currency would move to a free float after a transition
period. In a subsequent meeting, Dr. Kharbash explained that
when the GCC laid its blueprint for the unified economic
agreement in the late 1980s early 1990s, it had given some
thought to pegging to the IMF's Special Drawing Rights. The
decision had been, however, to peg to the dollar and, given
the risk-averse nature of bureaucrats, he didn't see that
changing.

But There Are Concerns
--------------


5. (C) Despite their stated support for U.S. investments, all
of the interlocutors raised concerns about investing. One of
the major topics of conversation was DP World. All expressed
their sharp disappointment with the outcome, but stressed
their appreciation for the administration's support for DP
World, and their belief that the U.S. - UAE relationship
would not be harmed. Al-Suwaidi noted, for example, that the
result had been beyond the administration's control and was a
result of mixing politics with commerce. A common theme was
that, while the UAEG appreciated the USG's support, the "man
on the street" was more angry and hurt and was less able to
understand the political nuances behind the problems.

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Gergawi said that the UAE pulled out of P&O's U.S. assets
since the relationship was more important than a business
transaction. He added however, that "people don't like to be
insulted." DP World raised issues for Arab investors such
as "are we welcome or not" that needed to be addressed. He
noted that the UAE business community had put pressure on the
UAEG for negotiating an FTA with the U.S. arguing "what's in
it for us." DP World gave the business community more
ammunition.


6. (C) MinState Gergawi said that Dubai Holdings' real estate
and hotel investments in the U.S. would continue, but that it
might need to re-think investments in certain industries, to
be sure that everything went smoothly. He noted that Dubai
Holdings was trying to buy another UK company with assets in
the U.S. (Doncasters Group Ltd). This purchase was also
undergoing CFIUS review and he viewed it as a test of whether
the U.S. really was open to foreign investment. He said he
had a good feel about Doncasters. One of the plants was in
Georgia. He had raised the deal with Senator Chambliss, who
had visited on March 12, and obtained his support. At the
end of the day, he said, he was trying to grow his business
and not put it to a "political spin." U/S Quarles stressed
that successive U.S. administrations had seen the value in
foreign investment in the U.S., encouraged it as a matter of
policy and were unlikely to change that policy in the future.
He admitted that there would be "periods of noise," but
expressed his hope that DP World would remain an anomaly.


7. (C) In separate meetings Al-Suwaidi and MinState Kharbash
noted that the Patriot Act posed a concern for Arab
investors. Al-Suwaidi opined that the end result might be to
make a safer financial sector, but that he feared that it
would "catch innocent people" and might make the U.S. payment
system less attractive. U/S Quarles stressed that the
provisions of the Patriot Act were necessary, but that
Treasury did monitor the impact to ensure that it would not
place undue impact on the payments system.


8. (C) Several interlocutors raised questions about the
continued foreign appetite for U.S. assets (in particular
from the Chinese and GCC states). They also raised questions
about the sustainability of the current account deficit.
Al-Suwaidi asked what the impact of the U.S. efforts to have
China move to a more flexible exchange rate would be on U.S.
interest rates. U/S Quarles replied that he thought the
impact on the U.S. ability to finance its deficit would be
minimal, since historically as one investor stepped out
another stepped in. He said that he believed the U.S. could
sustain a current account deficit for a longer period and at
a higher level than most other countries for a number of
reasons: even after an extended period of running a current
account deficit, net foreign claims on the U.S. were still
relatively low at 25 percent of GDP; the U.S. had significant
foreign investments of its own, as the dollar declined, the
value of these investments increased, meaning that the net
foreign investment position was not changing as quickly as
the current account deficit would imply; finally the dollar
was still the world's reserve currency. Although an
adjustment would need to occur, as long as it was gradual,
there was no expectation that it would have serious impacts
on the economy. The U.S. economy had gone through a number
of shocks over the last few years, but none had caused
investors to suddenly decide to pull out of the market.


8. (SBU) MinState Kharbash, explaining that "things do add
up" in creating a positive or a negative investment climate,
raised the UAE's interest in negotiating a double taxation
treaty (DTA) with the U.S. He said that he had been charged
with trying to negotiate a DTA with the U.S. on behalf of the
whole GCC, but that the Treasury department had turned him
down, since the GCC didn't "have taxes." He added that the
UAE had DTAs with France and a number of other European
countries, which certainly provided an added incentive for
UAE investors to look to Europe. U/S Quarles noted that he
had heard similar concerns in Kuwait. He explained that the
tax negotiators had to set priorities, but said he would
raise the issue at Treasury.

ADIA's portfolio
--------------


9. (C) Al-Kindi stated that ADIA currently holds $3.7 billion
in TIPs (inflation linked bonds) and about $4 billion in
nominal bonds. He added that ADIA was investing about half
of the current oil windfall into dollar denominated
instruments. (Note: The Emirate of Abu Dhabi turns oil

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revenues in excess of expenditures over to ADIA to invest.)
He said that ADIA had a long term perspective on investing
and -- unlike the Central Bank -- had a preference for
longer-term maturities. Senior Investment Advisor Jean Paul
Villain noted that bonds played a role in ADIA's portfolio
both as a source of return and as insurance against low
probability, but highly damaging events. ADIA, he noted was
attracted by inflation indexed bonds, since they were
essentially no risk assets. As U.S. inflation linked bonds
became more liquid, ADIA's appetite increased. He added that
ADIA tended to try to keep a fairly constant flow into
various asset classes and not make large sudden movements.
Villain stated that ADIA's appetite for bonds extended across
the yield curve.


10. (C) ADIA Executive director Salem Al-Mazroui raised the
fact that some of the current GCC's current petrodollar
surplus was not being recycled back to U.S. Treasury Bonds.
Al-Kindi stated that Abu Dhabi still tended to look for
external investments, whereas the Saudis were paying down
their government debt. As long as oil is over $30 per
barrel, he noted, ADIA is not likely to undertake any major
shifts. He noted, however that ADIA was diversifying into
new asset classes (including small cap stocks, emerging
markets, and mortgages and agencies as asset classes separate
from government bonds).


11. (C) Villain gave some insight into ADIA's portfolio
allocations, noting that ADIA had recently reduced its weight
in Japanese bonds, believing that the JP Morgan index was
over weighted toward Japanese bonds. As a result, ADIA
changed its benchmark. He explained that ADIA had
restructured its emerging market debt portfolio to reflect
the major shift away from dollar denominated debt to local
currency debt. Villain, who manages a Middle East Fund,
explained that the Middle East was "starting to be a real
place to invest." Regional economies were growing rapidly,
not just because of high oil prices, but from increased
economic openness. It was possible to make large returns
investing in the Middle East as the demand for capital
outstripped local supply. Regional markets had boomed over
the last two years, but recently had corrected to a more
normal 15-20 price/earnings ratio. Al-Kindi noted that the
Ministry of Economy, in an effort to control the massive drop
in market capitalization following on recent IPOs had stopped
banks from increasing capital and financing IPOs.

Central Bank's Portfolio
--------------


12. (C) Governor Al-Suwaidi explained that since the UAE
dirham was pegged to the dollar, dollar interest rates were
central to the UAE's monetary policy. Over 98 percent of the
Cntral Bank's reserves were in dollar denominated assets.
The question of whether or not to take Treasuries or
corporate bonds was more of a question of returns, he noted.
Saef Al-Shamsi, the Central Bank's Executive Director for
Treasuries explained that preservation of capital and
liquidity were higher priorities than rates of return, but
acknowledged that the Central Bank's board set benchmarks
based on the Bank's yearly budget. The Central Bank invests
largely in short and medium term debt instruments, by mandate
it is limited to securities with maturities of seven years or
less. The current focus is on agency bonds for interest rate
protection. Currently, it is investing in shorter term
securities since returns are higher and risks are lower. The
Central Bank does not invest in inflation indexed bonds

Dubai Holding and Dubai Investment Group
--------------


13. (C) Saud Ba'alawy CEO of Dubai Holdings subsidiary Dubai
Investment Group briefed on Dubai Holding's investment
portfolio. Real estate makes up about 20-25 percent of its
assets (with the majority of investments in the U.S.) The
remainder of the company's portfolio was in equities.
Ba'alawi explained that the U.S. had gotten pricy in term of
real estate and that Dubai Investment Group was selling down
its U.S. real estate in favor of Europe.


14. (C) On the portfolio side, the company was about half
U.S., 10 percent Europe, and the rest in the Middle East and
South East Asia. Ba'alawy did not see that allocation
shifting over the next five years. He noted that the company
would never get into the U.S. banking system, since the
regulations were too onerous. Dubai Investment Group started
with relatively straightforward real estate investment, but

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would likely diversify over the next five years.


15. (C) Ba'alawy said that his company was also looking at
the Islamic financial market and would be converting Dubai
Bank into an Islamic financial institution. He argued that
Islamic investments represented the only true alternatives to
conventional investment and that the growth potential was
very strong. He preferred Islamic investments for his
personal portfolio, although he noted that as a company Dubai
Investment Group would invest where the returns were.
Islamic finance was still immature and had a long way to go
in developing professionalism and investment products.


16. (C) Comment: All of the UAE federal and emirate level
officials were "on message" that the relationship was more
important than a commercial deal. It was fairly clear that
at least some had coordinated their message. MinState
Kharbash openly admitted that he had called Governor
Al-Suwaidi both before Al-Suwaidi's meeting with U/S Quarles
and after that meeting ended. The tone of the meetings was
uniformly positive; with all of the officials stressing that
the anger over DP World reflected that of "the man on the
street." Although there were references to the ongoing FTA
negotiations, most interlocutors did not dwell on them. End
Comment.
SISON