Sovereign suspicion

Recently the Prime Minister8217;s Office asked the finance ministry to inquire into the operations of sovereign wealth funds in India. SWFs are at the centre of this year8217;s most contested financial debate. This pursuit of clarity on SWFs by the PMO is shared by many other governments. Primarily at the urging of the United States, the International Monetary Fund is engrossed in a much awaited study of these funds, and is expected to draft a code of best practices in a few months. Indeed, the debate in the US must be keenly watched, as it encapsulates the crux of the confusion over SWFs sweeping across the world, and it is a caution against hasty acceptance of a suggestion made this week by Reserve Bank of India Governor Y.V. Reddy that India consider setting up its own fund.

An SWF is a fund held by government in foreign currency derived from accumulation of foreign exchange reserves. At present, countries with SWFs include some oil-rich Gulf states, Norway and Russia, as well as China, Singapore and South Korea. There are at present more than 20 SWFs, and together they wield 3 trillion in capital. Depending on how you look at them, SWFs are either a fabulous fallout of global capitalism that provides a new source of capital for companies and banks 8212; or they are a threat to liberal capitalism as we know it. Among the votaries are beneficiaries of these funds8217; capital, including most recently banks like Merill Lynch and Citigroup. Among the most vocal critics of SWFs is former American Treasury Secretary Lawrence Summers, who engaged fund representatives in some of the most engaging debates at the World Economic Forum in Davos this January. Among his concerns was the fact that these funds are mostly held by governments with poor records in economic management and transparency. Also, when no matter what lines of separation may be drawn between SWFs and government 8212; as in Norway 8212; there is the possibility, and always the suspicion, that money may be invested with motives other than profit. And since it is sovereign wealth at stake, governments could use coercive diplomacy to guard their investment.

The RBI governor has a point when he asks whether it makes sense for India to invest its substantial reserves more than 300 billion at the last estimate in treasury bonds with low, but guaranteed, returns. But given the confusion surrounding SWFs, it would be prudent for India to wait for clarity on how it would receive the inflow of SWF capital before it took steps to start a fund of its own.