An Indian Sovereign Wealth Fund?

Should India launch a Sovereign Wealth Fund?

India has foreign currency reserves topping $254 billion. Most of it is invested in “safe and liquid” US Treasury Bills. The returns on these investments are very small because the risks are low. All other BRIC countries are experimenting with different investment strategies. Many have set up Sovereign Wealth Funds (SWF) .SWFs are essentially government-owned pools of assets represented mostly by foreign portfolio investments.

SWFs are by no means tiny plays. The total funds invested in SWFs are estimated to be just under $4 trillion which is about 4 times India’s annual GDP. The Big 7 SWFs are really huge. The league table as of January 2009 reads like this (in billions of dollars): Abu Dhabi 895, China 758, Singapore 464, Saudi Arabia 433, Norway 301, Kuwait 264 and Russia 225. All other countries have funds that are below $100 billion

Should India launch its own SWF? Or should India continue to follow the “widow strategy” of keeping its entire reserves in safe and liquid assets? Some SEBI officers, in a recent study, have recommended that India should refrain from floating a SWF. The arguments underpinning this conclusion are: 1. India’s foreign currency reserves are built on capital account inflows. Hence we are exposed to the risk of such flows reversing 2. The Indian SWF may be mismanaged and there could be allegations of corruption and 3.The Indian SWF may be “misled to promote domestic political or foreign policy objectives”.

Firstly, nobody in his right mind would suggest that we invest our entire foreign currency reserve of $254 billion in a SWF. As to the second objection, it is difficult to concede that Brazil, Russia, China and the GCC countries are able to manage their funds and India, which produces some of the finest global fund managers, will .make a mess of it. The last objection centres around governance. I believe we should put our political system to a test of fire. The International Working Group of Sovereign Wealth Funds met in Santiago, Chile in October2008. They drafted 24 principles (known as The Santiago Principles) to enforce good governance and sound working of SWFs. Thus, the rules of the road are defined. Transparency in SWFs is measured by the Linaburg-Maduell index –Norway tops that index with a score of 10 and Singapore with 8. India should aspire to be on top of this chart.

There are other strong arguments against setting up a SWF. The Norwegian Government Pension Fund- a SWF which invests the liquidity emanating from its North Sea oil reserves has recently burnt its fingers. On May 20, the Fund announced that it had recorded a negative return of 4.8% in the first quarter of 2009 which translates to $ 14 billion. Most SWFs which invested in large tranches of equity in the US financial sector have all lost serious money.

It is also true that 5 out the top 7 SWFs (Abu Dhabi, Saudi Arabia, Norway, Kuwait and Russia) were created out of pools of financial liquidity created by oil and gas exports. The two others viz., China and Singapore created these funds out of trade surpluses.

The price of oil has plummeted, the international financial market is in doldrums and the West is in recession. Is it the right time for India to think about SWFs? Some would argue, the idea is right but the time is wrong. However, the window of opportunity to acquire assets inexpensively may close soon.

Let us examine the recent creation of new SWFs. China is about to launch a new SWF with an initial capital of $7.3 billion. Saudi Arabia which is already a major player in global capital markets is adding two new funds ( Sanabi-al Saudia. and Hassana Investments).

The French President Nicolas Sarkozy announced the creation of a fund in November 2008. This French fund is an interesting strategic play in defence. It will have an initial capitalization of $27 billion and will invest in strategic French companies in economic difficulty and at risk of being taken over. This SWF owes its existence to French fears about foreign SWFs investing in domestic companies. The new Brazilian Sovereign Fund called Fundo Soberano do Brasil will be drawn out of the country's foreign exchange reserves and treasury bond sales.

It is certainly time for India to begin playing the game. Warren Buffet is investing his personal funds in equity. He is not sitting on cash or low-yielding debt instruments or gold. He knows that over a reasonable period equity outperforms bonds. I believe India should start a modest SWF with an initial corpus of $10 billion .The fund should be owned by the government, managed by professional fund managers. We should embrace principles of good governance without being stifled by bureaucracy. Thereby we will not only gain experience, India will acquire clout.