Kavaljit Singh
VoxEU.org
20 November 2008
French
President Nicholas Sarkozy has proposed that European
nations create sovereign wealth funds to protect national companies from
foreign “predators.” This column says that idea is protectionist and without
merit. Emerging economies establish sovereign wealth funds to invest foreign
reserves or commodity revenue – not to bail out domestic firms and stifle
global competition.
In a
hard-hitting speech to the European Parliament in
“I'm
asking that we think about the possibility of creating, each one of us,
sovereign funds and maybe these national sovereign funds could now and again
coordinate to give an industrial response to the crisis,” he told members of
the European Parliament.
On
October 23, while addressing business leaders in
Both
speeches were made at a time when the financial markets in
As of
now, the details of the new French sovereign wealth fund (such as asset size,
sources of fund, investment policies, etc.) are not publicly available. It is
also not clear how the new sovereign wealth fund would be different from the
existing one, Caisse des Dépots
et Consignations (CDC), that was established way back
in 1816. With €60 billion of funds, CDC undertakes investments in local
development projects, equity markets, real estate and private equity. It is
expected that the new sovereign wealth fund would be managed by CDC and become
operational by the end of 2008. The media reports suggest that the new
sovereign fund would actively invest mostly in strategically-important
industries of
The
concerns expressed by Mr. Sarkozy over non-European
sovereign wealth funds are not new. Across the Western world, politicians,
business leaders and commentators are bemoaning the rapid rise of sovereign
wealth funds, particularly from the Middle East and
With an
estimated $3 trillion in assets, sovereign wealth funds are large pools of
assets and investment funds owned and managed (directly or indirectly) by
governments. They may be funded by foreign exchange reserves, commodity
exports, the proceeds of privatisations and fiscal
surpluses. The sovereign wealth funds manage foreign exchange assets separately
from official reserves. To a large extent, sovereign wealth funds are set up to
diversify and improve the return on foreign exchange reserves or commodity
revenue, besides protecting the domestic economy from fluctuations in
international commodity prices.
Protectionist
responses
Much of
the controversy on sovereign wealth funds is centred
on political questions. Western policy makers fear that the operations of
sovereign wealth funds are largely influenced by strategic policy objectives
rather than commercial interests. They suspect that investments by sovereign
wealth funds are meant to secure control of strategically-important industries
(such as telecommunications, energy and banking) for political ends. In
particular, the paranoia is centred on the
multi-billion dollar investments in international banks by leading sovereign
wealth funds in the wake of credit crisis that began in mid-2007.
These
fears have sparked a heated debate within the developed world about the extent
to which sovereign wealth funds should be allowed to invest in national
markets. A protectionist backlash against sovereign wealth funds is fast
emerging in the developed world.
Countries
such as the
In early
2008, the Australian government introduced new guidelines to enhance the
screening of investments made by foreign state-owned entities. The guidelines
contain six principles by which investments by foreign state-owned entities
will be measured. One of these principles states that the country will consider
whether “an investor’s operations are independent from the relevant
government.”
European
sovereign wealth funds
Mr. Sarkozy’s proposal for creating European sovereign wealth
funds is flawed on many counts. The conditions for establishing sovereign
wealth funds are squarely missing in
Unlike
their Middle Eastern counterparts, most European countries (barring a few) do
not have any dominant exportable commodity (such as oil or gas) so as to
generate significant surpluses.
The main
policy rationale behind setting up sovereign wealth funds is not to support or
bailout domestic companies, as proposed by Mr. Sarkozy.
Rather, these funds are set up to diversify and improve the return on
foreign-exchange reserves or commodity revenue and insulate the domestic
economy from volatile international commodity prices. That is why the
overwhelming majority of sovereign wealth funds invest globally, not
domestically. Establishing sovereign wealth funds to protect domestic companies
is nothing but a non-commercial, political motive, which, hypocritically,
European countries such as
Double
standards
Much of
the paranoia in
Since
sovereign wealth funds have no explicit liabilities, they are patient investors
with long-term investment horizons. Nor are sovereign wealth funds prone to
withdrawals by investors that could force them to liquidate their market
positions quickly.
The
overwhelming majority of sovereign funds are passive investors. The bulk of
their money is invested in fixed-income instruments such as government and
agency bonds. The foreign direct investment component of their total
investments is not even 1% of assets in 2007.
In rare
cases where sovereign wealth funds undertake direct investments, they do not
seek controlling interests. Even the direct investments in the ailing US and
European banks during 2007-08 are minor in ownership with no special rights or
board representation. These direct investments were not hostile in nature and
involved convertible bonds which would be converted into equity stakes in the
future. Further, the investments were made in a transparent manner with the
approval of host country banking regulatory authorities.
It also
needs to be emphasised that the investments in
Western banks were made at time when they were facing a severe liquidity
crisis. The stakes in UBS, Citigroup, Merrill Lynch and Credit Suisse were
bought when their credit default swap (CDS) spreads were very high. The higher
the CDS spread, the higher the perceived risk. By injecting billions of dollars
into ailing banks, the sovereign wealth funds acted as counter-cyclical
investors and enabled banks to continue their business. By and large, most
sovereign wealth funds have suffered losses on their investments in the Western
banks. The value of stakes of most sovereign wealth funds have plummeted with
the spread of credit crisis.
Not long
ago, the EU gave a call for a “Global Europe” with much fanfare and avowed
commitment to an open economy. Why the double standards?
Source: Voxeu.eu