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Sovereign wealth funds in Australia

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3 December 2007 11:02

Sovereign wealth funds (SWFs) are the topic-du-jour in financial circles (especially among the big finance houses that want to earn fees from managing them), and it seems that every self-respecting country needs to have one. Some people even want to include Australia’s Future Fund, although it has few of the required characteristics.

There is, nevertheless, an issue for Australia here. As financial markets gets more integrated and international capital flows get larger, we need to think again about our attitude to foreigners owning our assets, because there will be a lot more foreign investors queuing up. We should start from the presumption that capital flows are a good thing, but like all good things, it might be possible to have too much. The issue isn’t just about SWFs: we might have views about other forms of foreign government ownership. This is too big a topic to cover in a 900 word op-ed, but my tentative venturing into this area in the Australian Financial Review today (subscribers only; for the full text of the article, hit the 'more' button below)  is just an attempt to flag an issue in the hope of stirring up a substantive debate.

Sovereign Wealth Funds 

China and Russia have both announced that they will launch sovereign wealth funds. The term “sovereign wealth fund” (SWF) is a recent invention but high world oil prices and external surpluses in Asia have given vogue status to this nomenclature and revived interest in some old issues.  

SWFs are still relatively small but growing fast - currently a bit more than $2 trillion (compared with official foreign exchange reserves of well over $5 trillion) but are expected to reach $10 trillion by 2012. 

The catch-all term SWF covers disparate institutions with different origins, motivation and behaviour.  The US Treasury describes them as “a government investment vehicle which is funded by foreign exchange assets, and which manages those assets separately from official reserves”. But the lists in current circulation often include Australia’s Future Fund, even though its source of funds and main assets are domestic. Even leaving aside this sort of anomaly, however, the definition encompasses two very different types of fund.  

The first has its origins in resource-rich countries which can’t usefully absorb all their foreign exchange earnings immediately or which want to put some earnings aside for future generations. Essentially they are swapping wealth in the ground for wealth held in the form of financial assets. This covers the huge Middle East accumulations (where the Abu Dhabi fund has $600 billion, twice the next-biggest fund), through to the still-modest Timor oil fund. These are true “sovereign wealth”, owned by the governments in question. This type of fund has a long history: the ill-starred Nauru phosphate fund was an early example, close to home.  

Conceptually different are the funds built up from conventional balance of payments surpluses. Most countries have foreign exchange reserves as insurance against the normal vicissitudes of the international economy. Some, however, go on accumulating, even after they have a comfortable buffer. These excess reserves may be transferred to a separate fund: a SWF.  

While the income-smoothing motivation of resource-based SWFs is generally accepted as valid, those funds which comprise cumulated balance of payments surpluses are open to accusations that they reflect mercantilist policies: countries have built these through the promotion of exports and discouragement of imports – what one observer describes as “forced savings by exporters”. These countries are accused of keeping their exchange rates too low and their growth too slow, maintaining their strong external positions at the expense of their mutual obligations as good world citizens. Countries with such funds reply that the Asian crisis taught them that they had to rely on their own resources, and the old measures of reserve adequacy make no allowance for the risk of large-scale capital flight. Singapore, with its very substantial Temasek and GIC funds, might also argue that these provide a small globally-integrated country with portfolio diversification, with these assets balancing Singapore’s large foreign capital inflows. 

Some critics object to SWFs on principle, even including the resource-based funds. Ted Truman, former senior US Treasury official, says: “Large cross-border holdings in official hands are at sharp variance with today’s general conception of a market-based global economy and financial system in which decision making is largely in the hands of numerous private agents pursuing commercial objectives.”

There is another, wider, issue. The huge increase in international capital flows in recent years has revived old sensitivities about foreign ownership. Even countries with a powerful market culture are not immune, as demonstrated by America’s rejection of the Chinese CNOOC bid for the oil company Unocal, and Abu Dhabi’s bid for P & O Ports in the USA.

SWFs are now on the international agenda: the G7 has called on the International Monetary Fund, the World Bank and the Organisation for Co-operation and Development to study the issue. For our part in Australia, we should join this debate to keep it aligned with our national interest. We need to recognize that a globalised world means doing business with economies which are less private-market-based than our own. At the same time, some of these new arrivals will be looking to establish security of resource supply, just as Western countries have sought to do in various ways (e.g. with Middle East Oil) for decades.

Australia, like other countries, wants to retain influence over the way its resources are developed (this was the issue at stake in Shell’s bid for Woodside), while acknowledging the general presumption that capital flows, like trade, are in our interests. Does it make any difference whether the foreigners are private companies or governments, and if so, what difference? Does it make any difference if they are SWFs or government-owned companies (the latter are much larger international investors than SWFs)? There is also the question of reciprocity: if we’re not allowed to invest in certain countries, why should they be allowed to invest here? Most of these are issues of national rather than international policy-making, but finding a sensible balance could be helped by international best-practice guidelines, which might involve the encouragement of greater transparency and accountability (ensuring, for example, that we get a proper share of taxes), not just for SWFs but for all foreign investors, including the hedge funds whose behaviour in Australia in 1998 was so unhelpful. The debate needs to be wider than SWFs, or the true underlying issues may be obscured. 

Stephen Grenville is visiting fellow at the Lowy Institute for International Policy and former deputy governor at the Reserve Bank of Australia

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