NOT for the first time, sovereign wealth funds have sprung a leak. The decline in the oil price has caused producers’ budgets to sink into deficit and their current accounts to slide.

Ostensibly the purpose of these official funds is to facilitate intergenerational transfers to help manage natural resource windfalls. At the same time they seek higher returns than those on foreign-exchange reserves, which are more defensively managed. Yet when the going gets tough, sovereign funds are vulnerable to raids by governments anxious to prop up those ailing budgets.

The impact on global asset markets is potentially significant, especially when combined with the rundown of forex reserves taking place in Asia — maybe even as significant as the future actions of the US Federal Reserve and the European Central Bank that so obsess the markets.

But the development that really matters is the decline in China’s official reserves, which fell by a chunky $87bn in November. So far this year they have dropped to $3.43tn from a peak of nearly $4tn.

Part of this is a valuation adjustment reflecting declines in the value of holdings of other currencies such as the euro and sterling against the dollar. But it is also driven by investors selling renminbi assets to protect themselves against depreciation, and by the People’s Bank of China selling dollars as it props up the currency. Falling interest rates in China and the likelihood that the Fed will raise rates this month have been further factors propelling outflows.

The clout of the oil and gas producers’ sovereign wealth funds is considerable. Economists at the IMF estimate that in March their total assets stood at $4.2tr, well over half the total pool of $7.3tr

The clout of the oil and gas producers’ sovereign wealth funds is considerable. Economists at the International Monetary Fund estimate that in March their total assets stood at $4.2tn, well over half the total pool of $7.3tn. For comparison, the value of outstanding US Treasuries at that time was $12.6tn.

Much hinges on how long the price of oil remains depressed. The IMF says that before the decline countries of the Gulf Co-operation Council alone had a combined fiscal surplus of about $100bn in 2015 and about $200bn between 2015 and 2020. It expects that to turn into a combined deficit of $125bn in 2015 and $450bn in 2015-20.

The fall in prices shifts wealth from energy producers to high-saving Asian countries, but also to large, low-saving advanced economies. That points to lower global saving and higher interest rates in bond markets.

While sovereign wealth funds have significant holdings of illiquid assets such as property, infrastructure and private equity, it is in the more liquid investments such as equities and government bonds that the selling pressure will be felt if budgets remain under pressure for a sustained period.

Fed economists showed in 2012 that a reduction in emerging market current account surpluses and a damping in the pace of reserve accumulation would inevitably slow foreign official purchases of US Treasuries. Such foreign holdings were valued at $3tn in mid-2010. On the economists’ estimate, if foreign official inflows into US Treasuries were to fall in a given month by $100bn, five-year Treasury rates would rise about 40 to 60 basis points in the short run.

But once foreign private investors react to this yield change, the longer-run effect would be about 20bp. Whether the drop in market-making capacity in the system might lead to bigger yield rises is moot.

If this change in the direction of capital flows reduces upward pressure on the dollar, a benign impact might be to reduce protectionist sentiment in the US during an election year.

Could this also be a turning point in terms of reducing excess savings and the global imbalances that have persisted since the financial crisis? Just possibly, if China really is shifting its economic model away from investment and exports towards consumption. Yet it seems equally plausible that Chinese households will continue to save, in a country that lacks a state pension or healthcare system.

In a world suffering from a shortage of safe assets, a reduction in excess reserve accumulation is welcome. But it is not, as yet, a game changer.

john.plender@ft.com

Published in Dawn, Business & Finance weekly, December 14th, 2015