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Economics > Corporate >

Wealth of Nations: The Rise of the Sovereign Wealth Fund

Paper ID: 498 Last updated: 17/09/2014 03:15:01
Criteria: bullet Impact:  Likelihood:  Controversy:  Where: Global When: 0-2yrs How Fast: Days
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Keywords: bullet Sovereign wealth funds, business, regulation, government, natural resources, protectionism, developing countries, aid, trade

Summary bullet

Sovereign Wealth Funds (SWFs) are usually defined as government investment vehicles, funded by foreign exchange assets and managed separately from the official reserves of the monetary authorities. Until recently SWFs received little attention, but this has shifted following a rapid increase in their holdings and attempts to acquire stakes in large Western companies. The influence of SWFs is still uncertain, but the potential for a huge shift in power is present if they continue to grow at such a rapid rate. The possible implications of this include political instability, unsettled international relations, declining levels or withdrawal of foreign aid, and threats to the global economy.

Discussion bullet

The past few years have seen a steady rise in the number and size of Sovereign Wealth Funds (SWFs). SWFs are bodies that have been set up to manage national savings for the purposes of investment. The accumulated funds may have their origin in, or may represent foreign currency deposits, gold, Special Drawing Rights, and IMF reserve positions held by central banks and monetary authorities, along with other national assets such as pension investments, oil funds, or other industrial and financial holdings.

SWFs are typically formed when governments have budget surpluses and little or no international debt. This excess liquidity is not always possible or desirable to hold as money or to channel into consumption immediately, so SWFs may be created to reduce the volatility of government revenues, counter the economic cycle’s adverse effect on government spending and the national economy, or build up savings for future generations.

Previously SWFs have mainly been associated with natural resources (particularly oil and gas). But part of the dramatic rise in the size of SWFs can be put down to the increase in the number of them associated with sources of funding other than oil: manufacturing, shipping and even international aid have recently been contributing to the funding of SWFs.

The spotlight has fallen on SWFs following recent attempts to acquire high-profile Western companies, including the bid by Delta Two (a Qatari-backed wealth fund) for Sainsbury’s, and Temasek Holdings’ (the investment arm of the Singapore government) move to obtain a stake in Barclays.
Current estimates of the value of SWFs vary considerably. In 2005 State Street estimated that they were worth $895 billion, [1] while in 2007 Morgan Stanley put the figure at $2.5 trillion. [2] These reports and others suggest that they are likely to continue to increase in size at a dramatic rate. [3], [2], [1]Some analysts suggest that the value of SWFs will surpass that of oil reserves by 2011, and that by 2015 they could be worth anywhere from $9,000 billion [4] to $12 trillion, [2] reaching $27.2 trillion by 2022. [5]

The increasing size and number of SWFs suggests that recent acquisitions of Western companies are likely to continue: while some analysts have argued that this presents no cause for concern, provided that markets are well regulated and SWFs subject to scrutiny, the international response has been more cautious.

As noted above, SWFs tend to be associated with oil-producing countries, several of which have authoritarian regimes, which may be at odds with Western economic and political values and policies. Countries such as China, Kuwait and Russia (all of which have substantial SWFs) are believed by some [2] to pose a threat to established Western economic interests and therefore any increase in power is likely to be carefully monitored by their competitors and trade partners in the West.

In July 2007 the International Monetary Fund and the US government warned that the spread of Sovereign Wealth Funds could create new risks for the global financial system, while in the same month the German Chancellor Angela Merkel expressed support for a European equivalent of US procedures to vet their acquisitions. [6] The UK and Italian governments remain open to SWFs at least in principle: a speech by Alistair Darling confirmed that he was concerned about the rise of new protectionism. [7] However, recent comments from Sir John Gieve, deputy governor of the Bank of England, stated that the rising power and financial clout of state-owned funds in global asset markets will lead to political tension and calls for protectionism. [8] It is clear from the reaction of many Western governments that the rise of SWFs is a development that is likely to change the current political and economic situation over the next decade.

Implications bullet

For the invested country

As noted above, the nature of the country that owns the Fund is of great importance, given that SWFs tend to be associated with major economic powers with highly centralised and relatively authoritarian political systems. [9], [10] Assets within many of these countries tend to be held by a small elite, resulting in the potential for these groups to limit press freedoms, political opposition, civil society and other independent institutions in order to protect their interests. As such, there is the potential for SWFs to lead to worsening international relations, or even for them to be used as a “tool of asymmetric warfare” to undermine liberal democracy. [5] Fears about SWF investment in Western companies may be “overblown” and under the right conditions, in particular increasing transparency concerning investment and risk management, funds may become an increasingly important feature of the global financial landscape, allocating money where it is needed most. [11] Having said this, there is a possibility that the good behaviour of SWFs is a "Trojan-horse strategy which in time will give way to mercantilist interference." [9], [12]

Economically, analysts have expressed concern that increases in protectionism are the likely outcome for many Western countries, which in turn will undermine globalisation. [4], [2] The sheer size of the SWFs and their ability to affect asset prices may also lead to market volatility. There are also concerns about reciprocity; if an Asian or Middle Eastern fund is able to buy companies in the West and gain access to intellectual property, the reverse should – in theory – also be possible. [13]

For the global market

Important large companies acquired by SWFs may collapse if excessive control is exerted by the host nation and bad financial decisions are made. Furthermore, situations may arise where it is necessary or desirable for the home country of the company to appease investing nations. As such, they may introduce favourable financial terms and conditions for those companies that have been invested in. This will upset competition, and companies that were not invested in by foreign SWFs may suffer.

For the investing country

For the investing country, there are various possible outcomes. One is that a country investing money abroad may see to a backlash from those within the country demanding a focus on domestic investment. This becomes more likely if the value of investments plummets, for example with China and the Middle East losing more than £1bn bailing out British and American banks [14] or the decline in the value of private equity firm Blackstone's shares that reduced the value of a $3 billion investment by China Investment Corporation by $500m. [15]

Another (positive) scenario is that by investing revenues elsewhere, investing countries avoid “Dutch disease” [16] (whereby increased revenues from natural resources make manufacturing less competitive and "deindustrialise" a nation's economy, partly as a result of a raised exchange rate). Through investment abroad, the revenues are instead brought back into the country gradually, enabling the manufacturing sector to remain competitive. Investing money elsewhere could also result in the investing country having a more stable revenue system, with a clearer idea of how much income it will have from year to year, as well as ensuring that some of the money from its natural resources is kept back for future generations. [17]

For developing countries

It is possible that the rationale for giving aid to developing countries will be undermined if aid recipient countries channel aid into SWFs rather than rather than investing it in domestic infrastructure. Libya, a country with underdeveloped infrastructure, announced in December 2007 that it was to invest "more than $100 billion outside Libya, in different fields". [18] This could lead to losses for the developing country as a result of unsuccessful investments, and a decline in levels of aid. Alternatively, we could see the gap between the developed and developing world getting smaller as developing countries use aid to successfully invest through SWFs. Indeed, Robert Zoellick has suggested that SWFs could be used to help boost economic activity in Sub-Saharan Africa: "The World Bank Group can create the equity investment platforms and benchmarks to attract these investors, the allocation of even one percent of their assets would draw $30 billion to African growth, development, and opportunity." The suggestion is that, within a ten-year time frame, investment from SWFs and other investment vehicles could accelerate the growth of financial markets on the continent. [19] However, SWFs are not aid or charity vehicles and reliance on them to deliver development goals may be misguided. [23]

Early indicators bullet

• Abu Dhabi Investment Authority purchases News Corporation
• Kuwaiti Sovereign Wealth Fund acquires major Western arms producer
• United States forced to change foreign policy, following financial threats
• Bangladeshi Investment Authority reports record profits for the third year running

Drivers & Inhibitors bullet

Globalisation of capital, goods and services;
Real wealth boom, oil in particular;
High price for oil and natural gas leading to budget surpluses in resource-rich countries.

Economic nationalism;
Regulations in the UK market;
Protectionist policies and regulation.

Parallels & Precedents bullet

* Bank Negara Malaysia selling a large amount of British pound sterling in 1990 resulting in the pound being devalued
* Similarities with “Gnomes of Zurich” - Harold Wilson accusing Swiss bankers of pushing the value of the pound down through speculation
* 1956 Suez Crisis - Macmillan forced by the United States (through a UN resolution) to withdraw from Egypt, or face economic collapse. [7][20][4][21][8][3][2][5][6][13][1][22][17][18][19][16][15][14][11][9][12][10]

Social Bookmarking bullet

Comments bullet

There is probably more than a little consolation to be taken in the lack of evidence for overtly political acts by SWFs. If they have the ability to sustain economic development in just the way the paper argues, which is consonant with the reasons for their creation by countries rich in natural resources, then their potential to contribute to global instability should be limited.05/02/2012 12:13:12ipitchford

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Sources bullet

1OtherRozanov, Andrew, (2005), Who holds the wealth of nations?, State Street Global AdvisorsEcon
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14The GuardianConnon, Heather (2008, September 28) 'Sovereign funds lose £1bn in Western banks', The GuardianVisit siteEcon
15The EconomistThe Economist, (2008 18 September), 'The rise of state capitalism'Visit siteEcon
16OtherEbrahim-zadeh, Christine (March 2003, Volume 40, Number 1). Back to Basics; Dutch Disease: Too much wealth managed unwisely". Finance and Development, A quarterly magazine of the IMF."Econ
17OtherEbrahim-Zadeh, Christine (2003), Dutch Disease: Too much wealth managed unwisely, Finance and Development Journal (Volume 40, Number 1).Visit siteEcon
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20The EconomistThe Economist, (2007, July 26), Sovereign-wealth funds: Governments go shopping, The EconomistEcon
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22OtherCSC staff (2008) Chinese SWF: We Behave Better Than Hedge Funds, Visit siteEcon
The contents of this paper were provided by the Outsights-Ipsos MORI Partnership. Any views expressed are independent of government and do not constitute government policy.