The debate on whether India should have its own sovereign wealth fund (SWF) was revived on Tuesday when Dr. Kaushik Basu, the chief economic advisor to the Prime Minister, said that its time India decides on the sovereign wealth fund issue. From a level of forex reserves of about $5 billion in early nineties, India currently had a reserve position of $300 billion and was the seventh largest holder of forex reserves, he noted. Let us see what a sovereign wealth fund is and how it can be beneficial to a country.
What Does Sovereign Wealth Fund - SWF Mean?
A SWF is a special purpose investment vehicle created by a Government with surplus foreign exchange to invest overseas. Pools of money derived from a country's reserves, which are set aside for investment purposes that will benefit the country's economy and citizens. The funding for a sovereign wealth fund (SWF) comes from central bank reserves that accumulate as a result of budget and trade surpluses, and even from revenue generated from the exports of natural resources. The types of acceptable investments included in each SWF vary from country to country; countries with liquidity concerns limit investments to only very liquid public debt instruments. A few years ago, India had considered setting up a SWF, but the proposal was not pursued.
Top 5 SWF’s
| Country | Fund Name | Assets ($billions) | Inception |
| UAE – Abu Dhabi | Abu Dhabi Investment Authority | $ 627 | 1976 |
| Norway | Government pension Fund | $556.8 | 1990 |
| Saudi Arabia | SAMA Foreign Holdings | $439.1 | NA |
| China | SAFE Investment Company | $347.1 | 1997 |
| China | China Investment Corporation | $332.4 | 2007 |
What is the purpose of setting up an SWF?
SWFs are typically created when governments have budgetary surpluses and have little or no international debt. This excess liquidity is not always possible or desirable to hold as money or to channel into immediate consumption. This is especially the case when a nation depends on raw material exports like oil, copper or diamonds. In such countries the main reason for creating a SWF is because of the properties of resource revenue: high volatility of resource prices, unpredictability of extraction and exhaustibility of resources.
There are two types of funds: saving funds and stabilization funds. Stabilization SWFs are created to reduce the volatility of government revenues, to counter the boom-bust cycles' adverse effect on government spending and the national economy. Savings SWFs build up savings for future generations. One such fund is the Government Pension Fund of Norway. It is believed that SWFs in resource rich countries can help avoid resource curse, but the literature on this question is controversial.
Other reasons for creating SWFs may be economical, or strategic, such as war chests for uncertain times. For example, the Kuwait Investment Authority during the Gulf war managed excess reserves above the level needed for currency reserves (although many central banks do that now). The Government of Singapore Investment Corporation and Temasek Holdings are partially the expression of a desire to bolster Singapore's standing as an international financial centre.
What is the opinion of the Indian Industry?
India Inc has favored the idea of setting up sovereign wealth fund. According to it the wealth fund size could be around US $50 billion. The way the country is growing has made it essential to secure future energy sources and the fund will play a significant role in this regard, said some corporate heads. India Inc feels that the fund will invest in sectors like energy especially oil and coal as well as infrastructure.
According to a survey by industry body Assocham, most corporates opine that the fund structure should be based on a public-private-partnership model.
Apparently India is the only BRIC nation without a sovereign wealth fund. Countries like China, Singapore, Saudi Arabia, Norway, Kuwait and Russia all have sovereign funds to invest in assets abroad.
Does India really need one?
The general argument behind the creation of a sovereign wealth fund is that it will help India to invest in energy assets abroad in order to safeguard its future energy needs. Countries like Kuwait, Saudi Arabia and Norway derive majority of their revenues from oil exports thus it is no surprise that their SWF’s invest in non oil assets in order to reduce their dependence on oil prices and to mitigate the associated financial risk. India, on the other hand does not depend on revenue from oil export. India is faced with a risk due to fluctuations in oil prices as oil accounts for more than a quarter of India’s imports. Based on this fact it may be a good idea to set up a fund that invests in energy assets so as to mitigate the risk of fluctuating oil prices. However one must understand that oil forms only a quarter of our imports, whereas hedging motive for countries like Kuwait and Norway is the fact that oil forms a much more significant part of their exports.
Another important issue is that the assets that India seeks are all abroad, in sovereign countries. Does one expect the governments of these countries to sit back and do nothing as we mop up strategic assets in their own backyard? There is a major political risk involved in securing such assets as many of the intended assets lie in countries that are not democratic. Will such nations honour the deals they make.
Do we have the appetite to take the risk?
Oil and other energy investments are a high risk and high return bet. How much risk will a government controlled fund be willing to take? Many of the deepwater bets taken by the smartest oil companies in the world have proved to be wrong, sinking millions of dollars. Will an Indian sovereign fund, where every decision has to be cleared by an empowered committee, be able to take these risks? The other problem is the speed of decision making. Government-owned oil companies like ONGC and BPCL already face red-tape and delays in getting clearance, often resulting in the opportunity being lost. Will it be any different for the sovereign fund? The fund will have to be answerable for its returns.
It is evident that at present the idea of a sovereign wealth fund seems very attractive. India should not merely try to ape other countries and be in a hurry to set up one. But it is also a fact that as we prolong this decision others are already securing energy assets globally. Chinese companies spent about $32 billion last year buying oil, coal and metals assets abroad, while ONGC invested $2.1 billion to buy Imperial Energy. Also given the perennially increasing current account deficit our forex reserves might not be as formidable as they seem. The government needs to decide on this issue soon.
