Investing our foreign currency reserves smartly
(Views expressed are personal)
India’s foreign currency reserves reached $263 billion in November 2010. China, on the other hand, topped the league table with a reserve of $2.6 trillion, followed by Japan with $1.1 trillion. And just for context, the remaining two countries in the so-called BRIC configuration had Russia with $443 billion and Brazil with $ 288 billion.
However, the way these countries invested their reserves is worth studying. Most of them invested in US treasury securities. As of July 2010, more than $4 trillion was borrowed by the US government from China, Japan, India and the oil-exporting countries. Once again, China topped the list of “creditors” with $846 billion. Looked at from another angle, more than a fifth of US’s foreign-owned treasury security was from China.
But China was not just a passive lender . It has also actively set up a number of Sovereign Wealth Funds (SWF). It is a popular belief that the largest SWF on the planet is the Abu Dhabi Investment Authority . As a stand- alone entity, it is. But if one looked at the data published by the Sovereign Wealth Fund Institute, China as a country, tops the league table again by a long shot. It has actually four SWFs, one of them operating out of Hong Kong. If one added up the assets under management of SAFE Investments Co. ($347 billion), Hong Kong Monetary Authority Investment Portfolio ($259 billion), China Investment Corporation ($332 billion) and National Social Security Fund ($147 billion) then $1.09 trillion of assets under management are owned by four China-based SWF entities. Abu Dhabi trails behind with $627 billion, SAMA Foreign Holdings of Saudi Arabia has $439 billion, Singapore’s two SWFs combined have $381 billion and Kuwait has $203 billion.
Japan thus far had no SWF despite a foreign currency reserve in excess of $ 1 trillion. But winds of change are blowing there as well. According some watchers, Japan is all set to begin a sovereign wealth fund by stealth. Japan is contemplating formal legislation this year which will enable the Japan Bank for International Cooperation (JBIC) to fund transactions in the Western economies of North America and Europe. The enabling legislation is to implement the underpinning strategy of enabling Japanese companies to acquire companies abroad more aggressively and also to earn higher returns than what is currently provided by US treasuries.
The Japanese move is different from China’s or Singapore’s. JBIC itself will remain a bank and will not manage foreign assets directly. But by financing private Japanese companies to acquire companies and to invest abroad it will achieve a similar outcome. It will also address the unstated risk of the US currency depreciating as its public debt mounts.
As Asian economies grow stronger and accumulate large foreign currency reserves, bridging the fiscal deficit of the US will not remain the only outcome of their available menu of options. Historically, strong economies have traditionally exported capital and have dominated global investments in international business. In 1914 UK had about 50% share of global investments and in 1967 the US had around 50% share. In comparison China, which is already the second largest economy, has a mere 6% of the global investments. India’s global investments are probably less than 1 %. Both China and India are, at this time, punching far below their weights.
Strategic thinkers in both countries are worried about the risks of devaluation of the US currency and the possibility of defaults in the developed world. After problems witnessed in Iceland and the so-called PIGS (Portugal, Ireland, Greece and Spain) economies–the Chinese apprehension of possible defaults in the future cannot be dismissed as paranoia.
India is a democratic country with a relatively vibrant private sector. Therefore, transplanting Chinese models of state capitalism may not work here without some major tailoring. However, our needs are similar. To accelerate our growth, we , like China, need to access key raw materials, fortify our energy security, gain access to foreign markets and acquire technology, R&D facilities, Intellectual Property and global talent. Our shopping lists look very similar.
Chinese SWFs are often looked upon with fear and suspicion in the West because Chinese companies are state-owned and , therefore, considered as instruments of Chinese hegemony and geo-politics. India, on the other hand, has a democratic system of government, boasts a strong private sector with a large pool of entrepreneurs and professional managers. In India, sustainable returns and strategic intent, rather than geo-political ambitions drive acquisitions.
It is high time that India evaluated a twin-track approach of deploying a part of its foreign currency reserves strategically. The first track could be the creation of a bank which will assist and finance qualified private sector companies and PSUs (e.g. Maharatnas) to acquire companies and assets abroad-in priority sectors like energy and food. The second track of this strategy could be to start two SWFs perhaps with a corpus of $20 billion each . The first SWF could focus on investments in developed countries in North America, Europe and Australia. The second could specialize on investments and acquisitions emerging markets in Africa and Latin America. As the world opens up opportunities for our capital and managerial expertise, we must create an enabling financial infrastructure. Thus we will be able to grasp the nettle in seizing our rightful role in global business.