Wednesday, January 9, 2008

Will We Witness an Indian Sovereign Wealth Fund?

Sovereign Wealth Funds (SWFs) have become the flavour of the day. The business press regularly reports investments (usually running into several billions of dollars) by the sovereign wealth fund of one or the other country into companies of located in yet another country. Several US financial companies embattled by the subprime crisis have been the largest recipients of investments by SWFs.

For a brief background about SWFs and their role in the international markets, please see an earlier post of mine in the Law and Other Things blog titled The March of Sovereign Wealth Funds.

As far as India is concerned, there are two primary issues that Indian regulators ought to consider while dealing with SWFs. The first issue relates to how the Indian regulators should control investments by foreign SWFs into Indian companies (SWF Inflows), and what the risks associated with such investments are. I have dealt with these concerns in The March of Sovereign Wealth Funds (link provided above).

The second issue relates to whether India needs to set up an SWF itself so as to invest its reserves and surpluses into other countries (SWF Outflows) so as to reap profitable returns. Consistent with international developments, there have been several calls for the Indian Government, particularly the Reserve Bank of India (which is the custodian of India’s foreign exchange reserves under the Reserve Bank of India Act, 1934), to set up a sovereign wealth fund. Specifically, two articles that appears in the Business Standard argue for the establishment of an Indian sovereign wealth fund. An article by Suneet Weling states that India should start evaluating options to create a sovereign wealth fund given the large accumulated reserves and sub-optimal investment strategy. Noting that India is now one of the few countries with large foreign asset holdings that have not created an SWF, the author argues that it is time for the Indian government to evaluate options to get the best risk-adjusted return for this wealth which ultimately belongs to Indian citizens.

Another article by Ramkishen S Rajan that adopts a similar approach states that it may be time for India to reconsider its exchange management practices and increase its risk-taking appetite. While recognising that the establishment of an Indian SWF will not be free of complexities, the author observes:

“There are clearly a number of prickly issues surrounding the creation and operation of SWFs in India, including the degree of independence of the agency and its investment managers from the RBI and finance ministry (that is, governance), organisational structure, investment objectives and policies (for example, commercial versus strategic; diversified portfolio or concentrated bets), and the degree of transparency in the agency's holdings and policies.

These issues are admittedly much harder to resolve in a democratic and open society like India, but that is no reason to shy away from debating the issue seriously. India should at least actively participate in the ongoing -- though nascent -- international dialogue of establishing a code of best practices/ behavioural guidelines for the creation, management and operation of SWFs.”

However, the stance of the Indian central bank appears to be more cautious. In an address by the Governor of the Reserve Bank of India, Dr. Y. V. Reddy expressed the view that the time was not yet ripe for India to set up an SWF. He states:

“However, of late, there have been suggestions that India should consider setting up a wealth fund on the lines of either a Stabilization Fund or a SWF. As mentioned, the objectives of establishing Stabilization Funds are to mainly smoothen the revenue flows arising out of volatility in commodity export proceeds. India's export basket is diversified and does not have a dominant “exportable” natural resource, which might bring “windfall” gains. Further, India has experienced consistent current account deficits, barring a modest surplus for a few years. Hence, creating a Stabilisation Fund may not be justified on the basis of current situation. SWFs are generally created amidst current account surpluses when the foreign exchange reserves attain a level higher than what is perceived as “adequate”. If we follow this global experience, consideration of an SWF for India may ideally await “more comfortable current account” and “significantly improved fiscal” situations.”
It appears from this report therefore that India is unlikely to see its SWF set up in the near future. However, I do agree with the observations of the commentators that establishment of an Indian SWF involves considerable ground work, and it may be necessary for policy makers to commence thinking about issues well in advance of the actual establishment of such a fund. There is also wealth of global experience in terms of structures followed and issues faced by SWFs in other countries to learn from.

1 comment:

Rajkumar said...

Personally, I feel that India is not mature enough for a SWF. Considering our track record of fiscal profilgacy, I feel that an SWF may not help the taxpayer all that much.

Having said that the track record of other SWF's is not glowing either. A very critical study of Temasek,pointed out that the returns were less then 8% year on year.