BackTrouble from sovereign wealth funds
The end of the commodity supercycle will have complex effects on India
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All those who believe that the collapse in international commodity prices will be an untrammelled advantage for India would do well to look at what has been happening in the major commodity exporting countries. The sharp decline in revenues has put public finances in these countries under pressure. One logical response has been to pull money out of sovereign wealth funds to maintain public spending. India could be hit to the extent that these sovereign wealth funds sell emerging market equities in general and Indian equities in particular.
The process could already have begun. Norway has said this week that it will dip into its sovereign wealth fund to plug a growing budget hole thanks to the steep decline in global crude oil prices. The size of the Saudi Arabian sovereign wealth fund has been shrinking for seven months in a row for similar reasons. The Financial Times reported on 28 September that Saudi Arabia has “withdrawn tens of billions of dollars from global asset managers" to deal with its growing budgetary stress. Russia has also drawn money from its sovereign wealth fund. Even the International Monetary Fund has argued in favour of a strategy of using sovereign wealth funds to smoothen public spending.
In its new fiscal monitor released on Thursday, the multilateral lender has said that countries heavily dependent on volatile commodity earnings should build fiscal buffers to insulate their budgets from the vagaries of the commodity cycle. These countries should design fiscal policies across the commodity cycle as well as see sovereign wealth funds as instruments to stabilize savings over the long term. In short, this means that commodity exporters should save windfalls during a price boom but then liquidate investments when commodity prices collapse.
What does this mean for India beyond the most immediate impact on its equity markets? The end of the commodity supercycle will most probably alter the dynamics of current accounts across the world. The latest global data shows that current account surpluses are shrinking in commodity-exporting economies even as they are growing in the advanced economies. And since current account surpluses are the sources of excess saving, this also means that the commodity-exporting countries will decline in importance as sources of global capital, while the advanced economies will grow in relative importance (and China is a completely different third category in the evolving issues).
Several analysts have pointed out that the shift in the source of surplus global savings will throw up some interesting policy challenges in countries such as India. The reason is as follows. Capital exported by commodity exporters such as Saudi Arabia, through sovereign wealth funds, tends to get invested in equities. The situation is quite different when capital is exported by the advanced economies. Here, a lot of the money is allocated through pension and insurance companies, and finds its way into bonds that offer fixed incomes to an ageing population.
In effect, what this means is that countries such as India that need foreign capital to fund their current account deficits may have to take the bond markets more seriously, as ageing advanced economies have more capital to send out relative to most commodity-exporting countries. Of course, there is also the parallel concern about the risks to macroeconomic stability when money flows into the debt market rather than the equity market, as Indian policy makers have for long recognized. Foreign holdings of Indian bonds is still minuscule, but yet it is also important to remember that it was the big bond sell-off by foreign investors in July 2013 that almost tipped India into an external crisis.
The end of the commodity supercycle is in effect a massive tax cut for the Indian economy, and hence a big advantage. But nothing in the world of finance is straightforward. The resultant change in global current account dynamics—and hence capital flows—can have important effects on India.
Will the end of the commodity supercycle affect capital flows? Tell us at views@livemint.com
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