BY PUNEET ANAND RISHIKA SINGHAL ANNU DANGIABHISHEK SOLANKI VASU
A sovereign wealth fund (SWF) is a state-owned investment fund composed of financial assets such as stocks, bonds, property, precious metals or other financial instruments. Pools of money derived from a countrys reserves, which are set aside for investment purposes that will benefit the countrys economy and citizens. Sovereign wealth funds are invested globally. Most SWF’s are funded by foreign exchange assets.
SWFs are state-owned funds SWFs are managed separately from official foreign exchange reserves SWFs have high foreign currency exposure Unlike pension funds, SWFs have no explicit liabilities SWFs have high-risk tolerance SWFs have long-term investment horizons
Kuwait Revenue Equalization Abu Dhabi Investment InvestmentAuthority-1953 Reserve Fund of Kiribati- 1956 Authority-1976 Singapore’s Norway’s Coined By Government GovernmentAndrew Rozanov Investment Pension Fund- in 2005 Corporation- 1990 1981
Sovereign wealth funds are essentially set up to manage surplus foreign exchange reserves and revenues. Some funds also invest indirectly in domestic industries. In addition, they tend to prefer returns over liquidity, thus they have a higher risk tolerance than traditional foreign exchange reserves. In 2012, there are more than 50 sovereign wealth funds, and according to the SWF Institute, has exceeding north of $5 trillion.
SWFs are typically created when governments have budgetary surpluses and have little or no international debt. The main reason for creating a SWF is because of the properties of resource revenue: high volatility of resource prices, unpredictability of extraction, and exhaustibility of resources. Other reasons for creating SWFs may be economical, or strategic like when a nation has excess money, it uses SWF as a way to funnel it into investments rather than simply keeping it in the central bank or channeling it back into the economy.
Generate high return on investment Ensure domestic economic stability Reduce the volatility in tax revenues and export income Diversify from natural resource exports Strengthen the regional development Accumulate savings for future generations
Current account surpluses Profits from sale of natural resources National assets
COMMODITY SWF NON-COMMODITY SWF Commodity SWF’s are Non-commodity funds are financed by exporting typically financed by an excess commodities. An SWF acts as of foreign currency a stabilizer to diversify the reserves from current countrys money by investing account surpluses. in other areas. Non-commodity SWF’s They have seen huge growth totaled $2 trillion in 2012, as oil and gas prices increased which is three times the total between 2000 and 2012. In three years earlier. 2012, commodity SWF’s totaled more than $2.5 trillion.
Transparency- Lack of transparency is a major concern for nations. SWFs are being criticized for inadequate disclosures regarding size and source of funds, investment objectives 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.
POSITIVE – Reduce volatility and Support function NEGATIVE – Currency movement and announcement effect Role similar to those of Hedge funds and Financial Institutions.
Our Reserves: What Do They Really Represent? • India currently faces the highest fiscal deficit it has recorded in the past decade and a half - a staggering 6.8%.Our reserves stands at over US $270 billion. Indias reserves do not represent its actual net savings. These reserves are either debts which need to be paid back, or funds which may flow out of India at a moments notice. • Even if the current reserves could be put aside for SWF investment, there is little confidence that the current growth rate of our surpluses can be maintained. • We do not have surpluses in our reserves which we can invest. A move to divert these funds from these reserves to form a SWF would be fraught with danger since it could prove to be disastrous in the event of a need to liquefy the reserves.
Risky Investments v/s Safe Bets: Assessing Indias Risk Appetite • The RBI is entrusted with the responsibility of handling Indias reserves. These reserves are invested in the US treasury bills, which result in relatively low yields but are safe investments. • SWFs are generally considered to have an affinity for risky and potentially high yielding investments. • Withdrawing vast sums of Indian investments from the US treasury paves the way for further volatility in the global economy. This would also translate into the reduction of Indias export competitiveness since the current reserves ensure that an appropriate level of currency prices is sustained.
India facing challenges despite market recovery • It has been said that the market situations have considerably improved over the recent months, India should look to take advantage of opportunity to set up a SWF and acquire assets at inexpensive rates. • Though it is true Indian companies have done very well over the past couple of quarters, bettering expectations. On the other hand, the current fiscal deficit of US $270 billion, surging oil prices and the spiking inflation levels are indicative of the real situation which, on the whole, is far from favorable. • Therefore, despite a promising market performance, SWFs may prove to be far less yielding than expected, or may have longer gestation period for maturity.
Domestic Needs v/s Overseas Projects: Quenching Whose Thirst First? • Setting up of SWFs is possible in countries which do not have challenging domestic needs. In other words, a poverty struck country like India setting up a SWF is, at best, unusual. • India faces various domestic challenges and would need to focus more on and give a higher priority to the problems of poverty, infrastructure development, fiscal deficits.
Post Recession Investment • With proper and scrutiny judicious investment India can make small investments to obtain otherwise expensive assets
Indias Current Financial Restraints • As per some analysts, figured in the list of countries with the most accumulated reserves • With a fractional fund earmarked for a SWF, India can start a relatively smaller SWF continue its knowledge gathering before making large investments • SWF investments over the next few years, India can move towards reducing its fiscal deficit
Strategic Investments - A Gain in Exchange • SWFs are also tools of mutual strategic relationship building for countries, India becoming a world-power should leverage on that • Investments through SWFs are often used to fulfill the objectives of a wider economic and/or political strategy of a country. • For instance, an investment made using a SWF can further economic relations between the host and the investor country, and can be translated into mutually beneficial terms of development. • For SWF a body like SEBI will be created which will monitor, manage and regulate
Domestic v/s Abroad • Since India’s economy is investment thirsty a nominal amount invested judiciously in SWF would prove beneficial than to have a blanket ban policy to restrict investment • Returns from these investments can be cycled back into aiding domestic development