May 05, 2008	Monday	Rabi-us-Sani 28, 1429

THE rise of sovereign wealth funds on the global financial horizon and their recent acquisitions of major stakes in the West’s prestigious enterprises has apparently created a strong feeling of being left behind among India’s policy-makers and business elite. Although the country has a strong and highly developed private sector with an impressive international outreach, it has no SWF which, many believe, is a symbol of new economic power and represents a reverse wave of globalisation.

Currently, sovereign wealth funds represent a pool of investment resources provided by their governments and estimated to be in trillions of dollars globally. Often, either it is oil or high level of other vital exports that build up such a pool. Some of the large global funds are from the UAE, China, Singapore, Kuwait, Australia, Saudi Arabia, Brunei, Russia, Qatar, Malaysia and Kazakhstan.

So, in a bid to catch up with the new corporate phenomenon which is incidentally a state-led investment activity, the Indian government is seriously thinking to launch a SWF of its own with an initial corpus of $5 billion.

But a final decision is still far off because of some hiccups. A major impediment is lack of consensus. The finance bureaucracy in New Delhi is divided over whether to go for an SWF or not, keeping in view the fact that a ‘yes’ decision is not without critical risks. But it looks the thinking in support of launching a fund has gained strength after the country’s next-door neighbour China floated a $200-billion SWF in September. India considers China its rival and competitor and if running an SWF is a thing of the future and a matter of status for emerging economies, it cannot afford to lag behind.

But those arguing against are not without powerful rebuttal. They say China is building its corpus from current account surpluses while India remains a current account deficit country. Normally, countries with large balance of payments surpluses transfer excess foreign exchange reserves to sovereign wealth funds.

The Wall Street Journal recently observed: “Sovereign-wealth funds may be blossoming elsewhere in Asia, but India’s plans to create its own investment fund aren’t likely to become a reality soon. Commanding Asia’s third-largest foreign-currency war chest and the world’s second-fastest-growing major economy, India could be an ideal candidate for such a fund. But plans so far to take advantage of the credit crunch in the West and soaring foreign-exchange reserves at home could be bogged down by political disputes and volatility in the country’s foreign capital inflows”.

Other countries eager to join this race are Japan and Brazil. Japan intends to set up its fund in 2009 but it may be run by wealth managers from the private sector. There is a realisation in Japan that public funds should not be managed by bureaucrats. Initially, a fund of $98 billion may be created. In fact, the loss in foreign exchange reserves due to continuous fall in the dollar’s value has created an urgent need for establishing an SWF so that the reserves may escape declining dollar’s impact and be profitably invested elsewhere.

Brazil plans to create a sovereign wealth fund but with a different aim. It wants a fund that would intervene in foreign exchange markets to counter the appreciation of Brazil’s currency. The Fund will have the function of reducing the offer of dollars in the market and helping the real to appreciate less. The plan has been revised several times in recent months. The uncertainty has caused concern among investors and officials at the country’s central bank. What makes India so uneasy about the SWFs phenomenon is difficult to understand. It is already a fast-growing corporate power, much ahead than Abu Dhabi, Kuwait, UAE and Qatar in terms of economic clout. Only last year, Indian businesses were seen buying several of reputed British brands such as Tetley, White & Mackay whisky and Corus, the remaining fragment of British Steel, acquired by Tata, for $12billion. Twenty years ago, none would have visualised that Indians could become the second biggest investors in London –– something like a post-colonial revenge.

Yet, a passion for having a sovereign wealth fund looks irresistible. That is why Governor, Reserve Bank of India, Dr Yaga Venugopal Reddy, in one of his recent speeches, advocated a cautious approach on this matter though accepting the idea that higher returns are possible by deploying foreign exchange reserves in diversified assets across the world. He thinks the pressure on India to do this will increase if the rate at which reserves are growing — over $100 billion in 2007-08 — continues over the next few years. The RBI will then be forced to curtail its losses arising from investing the bulk of its reserves in US treasury bills but paying a much higher interest rate on domestic bonds released into the market to suck excess liquidity. Dollars accumulated on account of net FII investment, external debt, etc., are returnable. So India has to be far more cautious. But the idea is worth exploring.

Meanwhile, the central bank is closely watching the IMF project of creating global codes of conduct and practices for sovereign wealth funds following America’s clamour that these funds lacked transparency. Only when things are clear, Reddy says, India could decide whether to set up its own fund or not and also which kind of policy it should adopt about their activities in India.

Of late, the SWFs have been quite active in India. The 2007 data about private equity and venture capital deals shows that sovereign wealth funds’ investment in India accounted for as much as one-fifth of the total deal value. Temasek, a sovereign wealth fund based in Singapore, was the largest investor.

India’s large foreign exchange reserves reflect an inability of the economy to fully absorb capital inflows, whereas most countries that had set up sovereign wealth funds had built reserves through persistent current account surpluses or revenue gains from commodity exports. India’s foreign exchange reserves, the third-largest holdings in Asia, rose to a record $311.89 billion on April 4 this year.

Indian finance ministry intends to set up a committee to examine the pros and cons of the matter. In case it decides to have an SWF, it will opt to create a special purpose vehicle (SPV) type fund, now being set up in London, which will borrow funds from Reserve Bank of India in the form of long-term securities in foreign currency and lend the same to Indian companies at lower rates. Thus, RBI and the government will be able to earn more on forex reserves, which currently fetch average returns of 3.5 to 4 per cent only.

An SWF essentially helps governments get better returns on the excess foreign exchange reserves ,they accumulate. Singapore, for instance, earns over 20 per cent annually by deploying its SWFs in diversified assets abroad. India earns less than five per cent by investing its forex reserves in US treasury bills. In times of excess capital flows, the return becomes negative as it pays higher than five per cent interest rate in sterilising excess dollar flows.