Sovereign Wealth Fund [SWF] is an investment fund owned and managed by a sovereign entity. It is often the policy of a sovereign entity to create the fund when the economy experiences hefty balance of payments surpluses, an increased remittance flow and in a few cases fiscal surpluses.
The purpose is to maximise the return through investment in a range of financial assets such stocks and bonds or in precious metals. The funds in many cases work as a buffer to mitigate the impending danger due to the fall in the prices of a major exportable such as oil in the case of Saudi Arabia or may work as a cushion in the case of sudden outflow of fund related to foreign portfolio investment. Indeed, one of the main reasons of the Asian Financial Crisis in 1998 was the sudden spurt on the drain of fund related to portfolio investment in Indonesia and Thailand. Broadly, there are two types of funds; one related to commodity and the other is non-commodity. An example of non-commodity fund is the pension fund or the national stabilisation fund. The example of commodity fund relates to oil, copper or diamond. Almost 60 per cent of the SWF constitutes commodity and 40 per cent constitutes non-commodity.
Sovereign wealth fund is now a common concept in financial markets. The first such fund worth of $250 billion was created by the Kuwait Investment Authority in 1953. The collective assets as of September 2017 are over $7.4 billion. This reflects a 100 per cent increase from the level of $3.4 trillion a decade back. Though there are over 79 SWFs, the assets are concentrated only to a few units, the top 10 comprised over 77 per cent of assets. The asset value ranges from gigantic $875 billion to a paltry $100 million. The creation of the fund signal the state of performance of the global economy since the avalanche is generally observed when the global economy bounce back or individual country experience export boom. The SWFs of the major oil exporting countries were during the sharp rise of oil prices during 1970 and 1980. The SWFs of China was due to surging foreign currency reserve. The SWFs of the United States is meagre in comparison to the size of the economy. Huge trade and current account deficit may be one of the reasons but that is being compensated by the huge private investment of the corporate sector in many countries of the world.
Bangladesh is on the way to enter the ambit of SWF. Earlier this year the cabinet approved $10 billion worth of SWFs. The buoyancy in foreign exchange reserve [over $30 billion] mainly from increased flow of remittances provides the elbow room for this prestigious venture. The rationale of SWF as it figures today is pragmatic. The persistent growth of the economy for the last two decades deserves a massive overhaul of the physical infrastructure to cope up with the growth momentum. Indeed, investment in physical infrastructure is an essential prerequisite to sustain the growth process. It transpires that the fund would be created through this way may find a productive outlet in the development of physical infrastructure. This may be a profitable drive given the interest rate in the financial market very close to zero per cent and the interest on the commercial borrowing is positive.
There are certain preconditions for effective use of funds. Here, the governance issue is very important. A separate management structure comprising professionals on investment strategies and insights to deal with risk management is a binding requirement for day to day activities encapsulated through a legal framework with explicit directions on fund use. Again, projects implementation and monitoring is crucial for timely completion of the projects. An advisory council with professionals in financial management may be an important adjunct. They would recommend to the board on the effectiveness of the fund utilisation. It is important that transparency is also maintained through weekly or monthly update and annual publication of audited report for public dissemination. Weak disclosure ranks poor investment strategy and governance. The Sovereign Wealth Fund Institute [SWF Institute] prioritise fund on the basis of certain criteria and it is important that transparency in fund use is crucial for good ranking. Another is the Santiago Principles known as Generally Accepted Principles and Practices through which members maintain transparency through reporting. This is a self-assessment programme but conjoin local traditions, “particularly in terms of legal and governance.”
When foreign exchange reserve is above the safe limit [more than the import payments of four months] the excess reserve may result in the overvaluation of currency. Indeed, Bangladeshi Taka is overvalued in reference to currencies of many countries of the world including USD and GBP. One way to stabilise the value of the currency is sterilisation that may often be costly for the central bank. The other option is to invest abroad or use the reserve to buy precious metal such as gold. The idea of SWF and the cabinet approval is timely. However, one of the concerns is to earn better return than what it currently earns. It is obvious that the GOB will buy the foreign currency from the Bangladesh Bank [BB] through certain mechanism. One of the mechanisms is the sale of Treasury Bonds by the BB. This binds the government in strict budgetary discipline. On the other hand, when financial institutions buy the treasury bonds that crowd out investment in the private sector may result in higher interest rate. When the fund is invested in mega projects, there are several areas where discipline is critical not only on the modus operandi of cost recovery but also on the issue of cost overrun and time overrun that reduces the utility of projects.
The writer is a Professor of Economics, United International University