Local or Global? The New Wave of Sovereign Funds
Several countries announced recently their respective plans to establish a sovereign fund to better manage their national wealth. This trend is quite strong in Latin America and Africa, where several nations face a new commodities boom. Even Israel announced a new sovereign fund based on its newly discovered off-shore natural gas.
These announcements immediately caused a political and media debate. Local politicians wonder whether the revenues should then be invested abroad in order to reduce government’s debt, locally to promote defense and education, or a mix of the two.
It is easy to oversimplify the debate. Most economists are afraid of the “Dutch Disease”, a rising inflation due to a commodity boom and a stronger currency. On the other hand, many politicians would like to see commodities revenues invested locally for a better equality and distribution of national resources. But, is it really the full picture?
A new sovereign fund can present a unique opportunity for nations to better integrate their capital market into global markets.
First, allowing a sovereign fund to invest abroad provides the government with the opportunity to tie strategic relations to economic relations. The recent deal between China’s enormous sovereign fund and Vietnam to build an energy plant in Vietnam should be understood as part of rising political relations between the two nations. Countries can and should invest in friendly states and, more importantly, use investment wisely to create new friends.
Second, investing in bond and equity markets abroad will improve local financial know-how and create jobs in this area. Financial investment abroad is still a relatively small piece of the financial markets in the respective economies and can be improved as part of their financial integration. Several leading Arab nations used to employ foreign talents to lead their sovereign funds, who, eventually trained a new local generation of financial experts who represent their government abroad.
Third, several studies show a linkage between the establishment of a fund and improving governance practices and fighting corruption. The reason for that is the fact that building a fund that invests in corporate and governmental equity and debt increases the government’s exposure and transparency.
Fourth, the government’s ability to directly invest abroad can introduce new business models in large projects. Thus, for example, investing in an engineering company abroad in return for advisory services and transfer of know-how will help to advance several infrastructure projects. Recent German participation in the Gulf is a case in point.
Finally, better returns on investment abroad will increase the ability to support local needs, such as defense and education, for the long-run. This is an economic marathon, not a race.
No doubt, tax revenues can be used for many immediate needs. Yet, it is precisely the reason why policy makers and business people should fight the populist view and promote many of these new opportunities. The risk of negligent investments abroad can be mitigated by a closer review process and periodical reports to the government or the parliament. Investing in the local economy can be achieved by creating a mechanism of withdrawals in times of a need.
It is exactly in times of global economic crises that states need to invest in their resources and prepare themselves for deeper integration into the global economy. Leaving a new sovereign fund solely to local investments will be a lost opportunity for years to come on many levels. It is about time to open the debate.
3 Responses to “Local or Global? The New Wave of Sovereign Funds”
ok because the global crisis.. is capitalisme i have to remind you how the capitalisme survive? K MARX have the answere …you anderstand what i mean..ofcours can have investiment if not will stop cycle money .. thank you
Definitely sovereign fund is the way to rebalance the world trade. חג שמח
This is an article, suggesting to create Chinese sovereign fund, i published in China on March 31, 2009 in the middle of the crisis following a meeting with an important Chinese economist.
Our major assumption is that due to the emergency situation, the world economic crisis has to be treated with very short term tools (expected result up to one year). Every day may be THE DAY of a new collapse of a major financial institution with catastrophic consequences. China is a major economic force nowadays. If it wants to defend its economic interests, China has to take global economic responsibility.
The World’s major economic problems are the consequence of USA trade deficit, whose accumulation started about 25 years ago, with an increased momentum in the last years.
The deficit was partly covered by China. It created about 2 trillion US$ federal reserves in China and approximately the same amount in other countries, mainly Japan. Chinese reserves are mainly in US government bonds and bonds of other major US companies, as their liabilities are partly guarantied by the US government. The accumulation of US trade deficit in continuous growing grade created a world financial system, which gave loans based on mortgaged assets. As it appears the assets have been unrealistically overvalued. These loans were later “packaged” and sold worldwide, (partly back to exporting countries).
The credit crunch started, when the trend of real estate prices changed its direction.
Within a year, since the first signs the crisis appeared, the assets values were reduced world wide by tenths of percents, while the liabilities of the borrowers remained on the same level. This phenomenon caused deficiency of mortgage coverage and subsequently problems of liquidity to the system. The crisis affects also China as a major creditor of the USA, and its investments are endangered. With the collapse of US and world economy, China and other export oriented economies have lost markets for their merchandises.
China can’t replace in the short term the US and European markets with domestic demand as supplement to lost markets. If China uses only economic tools (such as revaluation, interest rate reduction, taxation etc.), it cannot replace even partly the loss of US and European consumption demand. Economic measures alone will have no immediate impact on the economic behavior of the population (saving rates), unless it will be paralleled by social legislation. Social legislation has long term influence on the society. It has to be very cautiously judged and needs long political procedures. As a consequence of the economic crisis, the demand for US goods will be also reduced and the closing of its trade deficit will be a very long process. Even if the USA will reduce substantially its demand for imported goods, it will not be able to balance its “trade deficit” in the short term. The US policy of bailing out Banks and Financial institutions, purchasing toxic assets etc, will further increase the debts of US government. These steps will create on the long term a devaluation of the US$, and in parallel it can cause an outbreak of inflation. Since the banks’ main problem today is to increase their liquidity, the money that is poured into the financial institutions by the US and European governments is not transferred to the economy.
To help to restart the world economy, China has to pour back the reserves it is holding in US$ into the USA economy. Until now it has done it by purchasing bonds. The bonds are loosing value even if they are guarantied by US government. (Due to the risk of outbreak of inflation and/or devaluation of the US$.) We suggest an alternative policy of investing directly into US economy and purchasing assets; for example shares of major US and European companies, real estate, as well as strategic investments (when purchasing the majority share of a company).By doing so, liquidities will increase in the US and European economies. Since the price of the assets was reduced substantially by the crisis and they seem to have reached the bottom, China will most probably gain substantial profits by that policy. Due to its overwhelming weight in World’s economy, China will become a market maker. To reduce the danger of conflicting situation with US and Europe, when a strategic investment is done, China has to do it in tight coordination with the US, and respectively with European governments. To implement this policy, the Central bank of China has to create several investment funds, in which it will invest large part of China’s foreign currency reserves. To finance these purchases, China should avoid selling the Bonds it is holding in foreign currency reserves, because this will degrade their value. China should instead pledge the bonds to commercial banks and take loans against it. As a by product of the suggested policy, banks will intensify their loaning policy and this will restart the economy.
Expected consequence of the suggested policy; US and European economies will get back liquidities. By purchasing assets in today’s prices, China will profit or at least preserve the real value of its US$ reserves. The upward trend of financial markets and real estate prices will renew the activity of financial institutions. An increase in the value of World wide assets will enable the banks to re-evaluate the pledged assets of its creditors and allow them to increase lending.