May 26 2009 2238 hrs IST
It is about time India begins playing the game. I believe India should start a modest SWF with an initial corpus of $10 billion, which should be owned by the government and managed by professional fund managers
By Roopen Roy
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 (Brazil, Russia, China) countries are experimenting with different investment strategies. Many have set up sovereign wealth funds (SWF), which 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 them are estimated at just under $4 trillion, which is about four times India’s annual gross domestic product. The Big 7 SWFs are really huge. The league table, as of January 2009, reads like this: Abu Dhabi $895 billion, China $758 billion, Singapore $464 billion, Saudi Arabia $433 billion, Norway $301 billion, Kuwait $264 billion and Russia $225 billion. All other players have funds below $100 billion.
Should India launch its own SWF? Or should we continue to follow the “widow strategy” of keeping our entire reserves in safe and liquid assets? Some Securities and Exchange Board of India (Sebi) officials, in a recent study, have recommended that India should refrain from floating a SWF. Their arguments are: One, India’s foreign currency reserves are built on capital account inflows. Hence, we are exposed to the risk of such flows reversing. Two, the Indian SWF may be mismanaged and there could be allegations of corruption and three, the Indian SWF may be “misled to promote domestic political or foreign policy objectives”.
First, nobody in his right mind would suggest that we invest our entire foreign currency reserves in a SWF. As to the second objection, it is difficult to concede that Brazil, Russia, China and the Gulf Cooperation Council 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 subject ourselves to this test of fire. The International Working Group of Sovereign Wealth Funds met in Santiago, Chile in October 2008. 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 chart with a score of 10 and Singapore is second 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 that 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 per cent in the first quarter of 2009, which translates to $14 billion. Most SWFs that invested in large tranches of equity in the US financial sector have lost serious money.
It is also true that five 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, namely, 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).
French President Nicolas Sarkozy announced the creation of a fund in November 2008. This fund is an interesting strategic play in defence. It will have an initial capitalisation 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. A new Brazilian sovereign fund, called Fundo Soberano do Brasil, will be drawn out of the country’s forex reserves and treasury bond sales.
It is about time India begins playing the game. Warren Buffet is investing his personal funds in equity. He is not sitting on cash or investing in 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, which should be owned by the government and managed by professional fund managers. We should embrace principles of good governance without being stifled by bureaucracy. Thereby India will not only gain experience, but will also acquire clout.