Tuesday, July 31, 2007

Sovereign wealth funds

Governments may have retreated from running businesses everywhere through privatization but they are not getting into businesses as investors. Developing countries are sitting on huge hoards of foreign currency on which they would like better returns than they get on US bonds. So, many countries are now investing in equity. They do this through their own funds, called sovereign wealth funds (SWFs). The amounts these funds command is enormous- $ 2.5 trillion according to Morgan Stanley.

Is this a good thing or a bad thing? We have two contrasting views from former US Treasury Secretary Larry Summers and the Economist.

In an article in Business Standard today, Summers argues that the issues are not only transparency, reciprocity (industrial countries must have the same freedom to invest in developing countries) and investment in strategic sectors or sectors that impinge on national security.

Summers says that there is fundamental difference between private investment funds and SWFs. The former focus only on profit maximization. The latter might have other objectives: getting technology for domestic firms from firms in which they had made investment or managing their investment in such as way as to help national champions. It would be a different matter if foreign governments routed their investments through mutual funds, not their own SWFs. So, policy on SWFs must emerge after a careful review of how governments have behaved as investors.

The Economist takes a more benign view. No problem if the Qatar government acquires Sainsbury's, Britian's oldest supermarket or Russia's Gazprom controls energy utilities in Europe. As long as competition and regulation are ensured, there's no cause for worry.

The only problem, according to the Economist, is lack of tranparency. Because SWFs control huge amounts of funds, their actions can be potentially destabilising.

There is one other issue I would flag. Government-owned funds may not add value by of improving management or governance they way private equity or mutual funds do. The funds they acquire are the government's monopoly, it is not that SWFs have to garner funds from the public. So SWFs may contribute less to improved governance and performance than private funds. The pressure to deliver returns in less intense.

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