Sovereign Wealth Funds: India's Stand on SWFs

India has realized that SWFs can play an important role in financing its growing economy and has started drawing attention of Oman, Kuwait and Qatar, countries holding largest SWF assets. India and Oman recently entered into MoU with $100 million of seed capital increasing to approximately $1.5 billion over the next two years. Core sectors like infrastructure, telecom, health, tourism and utility are expected to benefit from this funding. At present, large pool of foreign exchange reserves have been invested in low yielding OECD government securities bonds and other low yield deposits.

Indian Government had announced in its recent meeting with Gulf nations that it needs around $500 billion investment over the next decade to fund their growing infrastructure requirements. This also presents an opportunity for rich and wealthy Gulf nations that are hunting for better investment avenues beyond developed countries which are still under recession post Subprime mortgage crisis.

A section of industry experts however opine that since India’s reserves are not derived by commodity exports, unlike cash rich Gulf nations, establishing its own SWF is not a good idea. With its current account deficit still running around 2% of its GDP, it makes more sense to hold as much reserve as possible as against long term investing through SWFs. While reserves of Middle East countries come from oil and commodity exports, India’s reserves are derived from FDIs, External Commercial Borrowings and other term credits.

Opening up to Islamic banking will enable India in attracting huge amount of SWFs which are being diverted to China and other emerging Asian economies. Singapore is cultivating Islamic Banking so as to leverage its position as a leading financial centre.

Sovereign Wealth Funds: Concerns attached with SWFs

Several countries are keeping their economies away from SWFs due to the concern that some investments are being diverted for political objective to acquire control of strategically important assets. It has been observed that OPECs have been diverting large pool of funds in acquiring strategic assets and investing in important sectors like infrastructure, telecom, energy and media across developed countries. After much opposition from US Congress, Abu Dhabi's Investment Authority had to withdraw from its ADIA Dubai Port after 9/11 terror attacks.

China Investment Corporation’s $5 billion stake in Morgan Stanley and acquisition of Citigroup by Abu Dhabi Investment Authority for $7.5 billion was severely criticized after the recent subprime crisis.

Lack of transparency continues to be a major concern for nations that are experiencing increasing SWF funding in their economies. SWFs are being criticized for inadequate disclosures regarding size and source of funds, investment objectives and their holding in private equity funds. While in the U.S., these concerns are addressed by the Exon-Florio Amendment to the Omnibus Trade and Competitiveness Act of 1988, European Union preferred to avoid SWF funding. Some experts opine that such a fear is unwarranted if we compare the size of SWFs assets ($2 trillion) with the size of global investment funds assets ($20 trillion) and securities traded in dollars ($50 trillion).

IMG tried to address this concern of transparency and governance by issuing the Santiago Principles in 2007, a set of 24 voluntary principles to ensure transparency and sound governance by sovereign wealth funds (SWFs). However, very few SWFs have been following these principles seriously.

Sovereign Wealth Funds (SWFs)

Sovereign Wealth Funds (SWF) are owned and managed by governments or central banks of various countries around the world to invest their trade surplus globally, usually on a long term basis. They are funded by trade surplus of international trade, foreign currency deposit, International Monetary Fund reserves and other national funds like pension funds and oil funds. With subprime crisis haunting the global financial sectors, several SWFs are being criticized for investing heavily in Citigroup, Morgan Stanley and Merill Lynch which left them gasping for cash infusion. Nevertheless, from $500 million in 1990 to $3.8 trillion in assets today, SWFs have their presence now spread across 27 countries.

Around two-third of SWFs are held by the commodity and oil exporting and gulf countries like Qatar Investment Authority, primarily with the objective of diversifying their revenue streams and reduce oil-related risk and their dependence on oil export revenue.

Over the last decade, large current account surplus enabled Russia and China to build up their sovereign funds. They seemed to have realized (after Asian financial crisis of 1997-98) that it is better to build up their own reserves instead of depending on IMF to bail them out at the time of crisis. Russia and China now manage around $450 million and $1.44 trillion in SWF assets respectively.

Industry experts predict that assets under SWFs’ control could reach $12 trillion by the end of 2015.

The two main purposes of SWFs are short term foreign currency stabilization and liquidity management. The Global Financial Stability Report (2007) classified SMFs into five groups depending on investment objectives of their respective governments. They are:

(i) Stabilization Funds

(ii) Saving Funds for Future Generation

(iii) Reserve Investment Corporate

(iv) Development Funds; and

(v) Contingent Pension Reserve Fund.

During the period of rising oil prices, SWFs of oil exporting nations drastically due to increase in their foreign exchange reserves which are then used to make strategic acquisitions across the world. On the other hand, SWFs of emerging economies like China, Singapore, Malaysia and South Korea tend to grow steadily.

Another point of difference is the SWF to Foreign Reserve Exchange ratio which is used to determine the proportion of reserves which are invested using SWFs. It has been observed that OPEC have higher ratio compared to emerging economies. Last year, ratio for Qatar Investment Authority was 5.9 times compared to China Investment Corporation’s 0.12 times.