The word bogeyman is said to have originated from “bugis”—pirates from southern Sulawesi in Indonesia who traumatized sailors of the East India Company and the Dutch East India Company (themselves pirates in a different sense, but never mind that part of history); the English sailors took home tales to frighten their children into good behaviour.
There’s a new bogeyman in the world of finance—the sovereign wealth funds (SWFs) that have been buying stakes in big names such as Citibank, UBS and Merill Lynch.
What are these SWFs? How did they get so powerful and why has there been a growing clamour from the US treasury, liberal think tanks such as the American Enterprise Institute and others for some sort of control over them?
SWFs are government-owned investment corporations that manage a country’s foreign currency assets. SWFs have a long history. The first one was set up in 1816 in France. But, in modern times, the rise of SWFs can be associated with two events. One is the oil boom of the 1970s, and again in recent years, which led to a build-up of foreign exchange reserves in oil-exporting countries. The second is the Asian crisis. It led to a quest in many countries to raise forex reserves as a cushion against an attack on their currency. And then there is China. As usual, it is a special case, which does not fit in either category, but whose SWF is estimated to be worth $200 billion.
According to the International Monetary Fund, in 1990, the combined worth of SWFs was probably around $500 billion. It has now grown to almost $3 trillion, as more than 20 countries have set up such institutions. This is more than hedge funds (an estimated $1.6 trillion) but much lower than global pension funds ($ 21.6 trillion).
While 16% of the assets of the 14 largest SWFs are in developed countries (US Alaska Permanent Reserve Fund, Australian Future Fund and Norway’s Government Pension Fund-Global), 77% of the assets are in Asia. In a speech at the Bank of International Settlements, Philip Hildebrand, vice-chairman of the governing board of Switzerland’s central bank, identified eight countries as potential candidates to set up SWFs, where excess reserves were more than $10 billion. India ranked third in this list, behind Japan and Taiwan, with $80 billion designated as excess over short-term foreign currency debt obligations. As India is a prospective entrant into the field, the events in this policy space need to be carefully monitored.
The growing size and influence of SWFs has drawn the ire of many in the West, especially since they have been on a buying spree, as financial turmoil has struck big Western firms. With government ownership, the motive behind SWF purchases is considered suspect. As economist Larry Summers pointed out last July in the Financial Times, these funds shake the logic of capitalism. For him, “the pursuit of objectives other than maximizing risk-adjusted returns and the ability to use government status to increase returns” are the most disquieting risks ahead of the growing influence of SWFs. But can politics and economics ever be separate? In the case of SWFs, the link is direct. But there are numerous examples, overt and covert, of governments influencing other nations for the benefit of their domestic companies.
The US and the European Union (EU) are pushing for more transparency in SWF operations, in line with the Norway model. Set up in 1996, the Norwegian fund publishes annual accounts, has invested in more than 3,000 companies worldwide, but does not own more than 1.5% of any single firm’s capital. Summers believes that if SWFs invest through intermediary asset funds, it will go a long way in ensuring the separation of the political and economic fields. The G-7 is working towards a code of conduct to bring in accountability, transparency, risk management, etc., in SWF operations.
Clearly, transparency is an imperative, but the central issue cannot be avoided—that is, the political aspect of cross-border transactions. Hildebrand is spot on when he raises questions of greater concern— what is meant by a “non-political investment mandate,” what rules would apply if an SWF fails to adhere to the code, how is the extent of political influence to be judged?
Such questions are not easily answered, and while the issues are being debated, the major risk of the rising influence of SWFs is that of financial protectionism. A Time magazine article points to Chinese barriers to foreign control of domestic companies and quotes a US congressional staffer as saying, “So we’re just supposed to roll over and let them buy whatever they want here? Why would we do that?” Tempers can run high when politics mixes with economics, and talks pushing for reciprocal access have naturally begun.
It will be interesting to watch how the balance plays out over the next few years. Will the suspicion against China and the Arab states ever go away? Because, let’s face it, that is the crux of the problem. As long as capital was flowing from the West to the developing world, such issues never surfaced.
Now the situation has changed. And though forex adviser Jamal Mecklai has an interesting hypothesis that money will drive sanity into politics, a new world order of peace is a long way off. The action on the battleground of cross-border transactions is set to intensify.
(Sumita Kale is chief economist at Indicus Analytics. Comments are welcome at firstname.lastname@example.org)