Sovereign Wealth Funds: Furthering Development or Impeding It?

Article excerpt

OVERVIEW

While sovereign wealth funds have existed since the 1950s, their significance and importance in economic, political and policy terms have increased exponentially in the past decade or so. Generally speaking, a Sovereign Wealth Fund (SWF) is a state-owned investment fund composed of financial assets such as stocks, bonds, real estate, or other financial instruments funded by foreign exchange assets. These assets can include, for example, balance of payments surpluses from sales of commodities or other exports, official foreign currency operations, the proceeds of privatizations, or fiscal surpluses. SWFs are generally structured as a fund, pool, or corporation. (1)

Sovereign wealth funds are specifically defined by the U.S. Treasury as government-held investment funds that are in foreign currency (or, in other words, held in currencies other than the investing host government's own currency). (2) These reserves are managed separately from official currency reserves, and are often invested in foreign companies or enterprises for profit. When an excess of such foreign currency reserves (usually held in U.S. dollars, Euro or Japanese yen) are accumulated, a host country may decide to establish a sovereign wealth fund.

Although certain countries such as Korea, Thailand and Russia began accumulating large foreign exchange reserves in order to cushion their economies from future economic shocks, (3) there are other reasons to create SWFs, which may include, for example:

* Protecting and stabilizing the host country budget and economy from excess volatility in revenues/exports;

* Creating a diversified fund of holdings generated by non-renewable commodity exports;

* Earning greater returns than on foreign exchange reserves;

* Increasing savings for future generations;

* Funding social and economical development;

* Exercising increased political influence by making strategic foreign investments. (4)

   The IMF has identified fives types of SWFs based on their
   underlying objective: (1) stabilization funds designed to insulate
   the host government's budget and economy against commodity (e.g,
   oil) swings; (2) savings funds set up to convert nonrenewable
   resources such as oil or minerals into a more diversified portfolio
   of assets for use by future generations; (3) reserve investment
   corporations who are established to increase the returns (earnings)
   on reserves; (4) development funds which typically help fund
   socio-economic programs; and (5) contingent pension reserve funds
   which provide budgetary support for potential unfunded contingent
   pension liabilities. (5)

Not only has the influence of and interest in SWFs increased exponentially over the past decade, but their total size worldwide has as well. In 1990, sovereign wealth funds were estimated to hold approximately U.S. $500 billion; the 2008 total is estimated to be around U.S. $2-3 trillion, and is expected to climb to U.S. $10 trillion by 2012. Although over 20 countries have SWFs, the top five account for over 70% of the total assets in SWFs. (6) For example, Russia accumulated over U.S. $157 billion in its oil proceeds fund over the last five years, and currently has a total of over U.S. $2.5 trillion in a SWF. (7) Currently, Abu Dubai has an SWF estimated to be between U.S. $600-700 billion. (8)

DEVELOPMENT IMPLICATIONS OF SWFs

SWFs seem to indicate that global capital markets are working well as indicated by the net flow of capital from developing countries to advanced nations; however, there is a significant sea change underway. While a great deal of discussion has been generated by dependency theorists who argue that a net flow of capital from the developing world and emerging economies to industrialized powers is part of the equation causing "underdevelopment" in these places, the new trend of increased investment in SWFs indicates something else completely. …