Academic journal article Asian Development Review

Developing Asia's Sovereign Wealth Funds and Outward Foreign Direct Investment

Academic journal article Asian Development Review

Developing Asia's Sovereign Wealth Funds and Outward Foreign Direct Investment

Article excerpt

Sovereign wealth funds (SWFs) have emerged in developing Asia as a policy response to an unprecedented accumulation of foreign exchange (FX) reserves since 2000. At the same time, developing countries have become an increasingly important source of outward foreign direct investment (FDI). The central objective of this paper is to evaluate the prospects for SWFs to serve as a major conduit for the regions outward FDI. In principle, FDI represents an attractive means of earning higher returns on FX reserves than traditional reserve assets. In practice, the limited institutional capacity and the political sensitivity of state-led FDI severely constrains the ability of developing Asia's SWFs to undertake FDI on a significant scale. Therefore, the potential for developing Asia's SWFs to become major sources of outward FDI is more apparent than real. This paper also explores the implications of the Santiago Principles and the global financial crisis on outward FDI by SWFs.

I. INTRODUCTION

One of the most significant developments in the global economic landscape since the Asian crisis of 1997-1998 has been the transformation of developing Asia from a net capital importer to a net capital exporter. This development was to a large extent driven by the large and persistent current account surpluses developing Asia has run since the Asian crisis. It is important to note that before the Asian crisis, the region as a whole ran a current account deficit. Therefore, current account surpluses are a relatively new phenomenon in the region. A significant consequence of those surpluses has been an unprecedented accumulation of foreign exchange (FX) reserves by the central banks of the region. The reserves have grown so fast that a consensus is growing that they now exceed all plausible estimates of the amounts required for traditional liquidity purposes. The emergence of surplus reserves, in turn, has prompted widespread calls for more active management of FX reserves with a view toward maximizing risk- adjusted returns rather than preparing for shortages of international liquidity.

Sovereign wealth funds (SWFs) provide a natural blueprint for the proposed shift of surplus FX reserves from passive liquidity management to active profitseeking investment. Unlike central banks, which traditionally manage reserves for liquidity purposes, SWFs are state-owned institutions that use reserves to pursue commercial profits. The predictable response of regional policymakers to the emergence of large and growing surplus reserves has been to set up SWFs as a means of using those resources more productively. Although SWFs have been largely under the radar until quite recently, they have been around for a long time. In fact, the commercial success of some well-established SWFs has been a major motivation behind the establishment of SWFs in developing Asia. In particular, due to their strong investment track records, Temasek Holdings and Government of Singapore Investment Corporation (GIC)- the two Singaporean SWFs- have attracted the attention of regional policymakers as a potential benchmark model. In short, Asian countries are setting up SWFs as a policy tool for coping with the relatively new phenomenon of surplus reserves.

One potential avenue for active profit-oriented foreign investment by SWFs is acquisition of ownership interests in foreign assets. To the extent that such acquisitions involve a long-term relationship and involvement in management, they are viewed as foreign direct investment (FDI). If they are devoid of such elements, they are seen as portfolio investment. The boundary between the two types of foreign investment is not always clear-cut. What is more relevant for this paper is not the distinction between FDI and portfolio investment but rather the use of reserves for profit rather than liquidity. Portfolio investment, or the purchase of corporate bonds or small equity stakes without any influence on management, is certainly one way to make money. …

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