Recent reports suggest the Union government has given an “in-principle” approval for creating a sovereign wealth fund (SWF) to buy natural resources such as coal, oil and gas, and other minerals. It has been suggested that an initial amount of $10 billion be devoted to get the fund going. For further requirements, the government could either tap into the country’s $350 billion pile of foreign exchange reserves and/or rely on budgetary allocations.
Both options are unworkable. In 2010-11, India’s current account deficit stood at 2.6% of the gross domestic product (GDP). Much of this is being bridged by short-term inflows that now account for nearly 22% of the country’s forex reserves. The ratio of these reserves to external debt in June was 99%. It is hardly prudent for any country that runs a current account deficit to dip into its pot of foreign exchange to buy assets abroad, let alone one with the figures that India has. An SWF is in the nature of buying long-term assets by using funds that have been borrowed in the short run. This is an inherently risky situation.
It is equally unfeasible to turn to the budget to fund an SWF. In 2011-12, India’s fiscal deficit has been targeted at 4.6% of GDP, a figure that looks increasingly shaky. It is not clear what budgetary resources can be spared unless, of course, the government raises taxes, and even that may not be enough.
That is not all. Most of the available, uncommitted natural resources exist in politically-volatile countries in Africa and elsewhere. In “normally” functioning spot markets for these resources, an SWF does not pose immediate risks. These are, however, exhaustible natural resources whose value will go up disproportionately as their availability and reserves decline. When coupled with the high political risks in these countries, the danger that investments made by India’s SWF can sink is very real. To keep its investments safe, India will have to craft a politico-military strategy along with an investment strategy as well. If China is able to do that, it is probably in part due to its having thought these issues through. Realistically, India is not capable of doing that.
Finally, the size of India’s fund can only evoke amusement. It is an open question as to what $10 billion can buy in this market. When China set up a similar fund in 2007— the China Investment Corporation—its initial fund size was $200 billion. India does not have deep pockets required to buy such assets. It needs to rethink the very idea of an SWF, if not abandon it altogether.
Can India afford an SWF? Tell us at firstname.lastname@example.org