India needs lots of things, but not a sovereign wealth fund (SWF). The country is reportedly toying with the idea of ploughing some of its $285 billion (Rs11.23 trillion) foreign exchange reserves into a state-owned investment vehicle. That would put the country in the new developing world elite —along with cash-rich countries as China, Abu Dhabi, Qatar, Kuwait and Singapore.
SWFs have quickly become fashionable government play-things. In the last month, Japan, Saudi Arabia and Libya have all signalled interest in redeploying their reserves to seek higher long-term returns. Of the largest 20 sovereign funds— holding $2.5 trillion assets worldwide, nine have been established since the turn of the millennium.
India looks to have enough money to join play, if only in the second league. At $285 billion, its total foreign reserves have grown $00 billion in the last year, and are up from a mere $1.5 billion in 1991.
But the cash doesn’t really represent sovereign wealth. Unlike established SWF rivals, India’s reserves are not a result of high commodity prices or excess savings. The country runs a current account deficit of 2% of gross domestic product (GDP). It needs to keep a fair amount of cash on hand just to ensure that trade keeps flowing.
More important, India is still very poor and crying out for investments. Investment accounts for 33% of GDP in India, far below China’s 43%.
The government recognizes the problem. Its latest Five-year Plan includes $492 billion of infrastructure spending, but it expects the private sector to come up with two-thirds of the cash. It would make sense to use any extra unneeded foreign currency to increase the government’s share.
In the long term, the returns on even modestly well thought out domestic investments will surpass those earned by a sovereign wealth fund. If indirect social benefits are included in the calculation, the balance tips even further towards an India-first government investment policy.
SWFs are in fashion. India need not become a fashion victim.