The rise and politics of Sovereign Wealth Funds

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By Gilbert Muponda

THE current shift of financial power from multi-national organisations such as the World Bank, I.F.C and others to Sovereign Wealth Funds presents developing nations such as Zimbabwe with a new source of foreign direct investment.

A sovereign wealth fund (SWF) is a state-owned fund composed of financial assets such as stocks, bonds, property or other financial instruments. Sovereign wealth funds have gained world-wide exposure by investing in several Wall Street financial firms. These firms needed a cash infusion due to losses resulting from the credit crunch caused by the mortgage meltdown which started in the USA.

These funds present an important source for capital for developing nations especially Africa since many of them are from other emerging countries who seem to understand the emerging markets more accurately due to similar background.

Many SWF are held solely by central banks, who accumulate the funds in the course of their monetary and fiscal management of a nation's financial system; this type of fund is usually of major economic and fiscal importance. Most of the newer sovereign wealth funds are simply the state savings which are invested by various entities for the purposes of investment return, and which may not have significant role in fiscal management.

However, due to their government control, size and potential to be used to effect none-financial outcomes, SWFs are attracting attention than before. A nation has to be more proactive to attract these funds as their global clout is on the rise.

The accumulated funds may have their origin in, or may represent foreign currency deposits, gold, SDRs and IMF reserve positions held by central banks and monetary authorities, along with other national assets such as pension investments, oil funds, or other industrial and financial holdings.

These are assets of the sovereign nations which are typically held in domestic and different reserve currencies such as the dollar, Euro and yen. Such investment management entities may be set up as official investment companies, state pension funds, or sovereign oil funds, among others.

A significant development arising from the current trend of record-high commodity prices is the increased investment clout of emerging markets and their governments. This is not news to anyone who has been monitoring the re-emergence of China, India and Russia as economic powerhouses. These states have amassed sizeable reserves derived from oil and gas revenues in the cases of Russia and the United Arab Emirates, while China has built up its reserves and holds large amounts of foreign debt, especially US T-bills.

The immensity of these foreign exchange reserves exceeds the typical buffer that a country requires, thereby enabling these states to make strategic foreign investments buying critical foreign assets. These massive reserves are looking for a stable destination which is why Zimbabwe and other African nations have to position them self as attractive destinations. A resource rich nation such as Zimbabwe is a ideal candidate of SWF most of which were built from resource generated wealth.

SWFs are typically created when governments have budgetary surpluses and have little or no international debt. This excess liquidity is not always possible or desirable to hold as money or to channel it into consumption immediately. This is especially the case when a nation depends on raw material exports like oil, copper or diamonds. To reduce the volatility of government revenues, counter the boom-bust cycles' adverse effect on government spending and the national economy or build up savings for future generations, SWFs may be created.

Fuelled by resource income, state sovereign wealth funds from China to Africa are reshaping the global economy and at their current growth rate will surpass current U.S. economic output by 2015. By 2016, analyst group Global Insight said the funds, which grew 24 percent a year in the last three years, would outstrip the current output of the European Union -- which has become the world's largest economy due to the recent decline in the value of the dollar. China, Russia and Kuwait were the owners of the largest funds, the report said -- but with others including African oil-rich countries once more associated with instability and conflict following rapidly behind.

Their growth may effectively reverse the trend in which rich western investors put money into emerging markets by making developed economies more dependent on emerging market cash. Even if growth slowed, they would likely eclipse the United States within a decade, the group said. This highlights how financial markets are becoming more integrated and rely on each other and this makes it imperative for Zimbabwe to return into the international community to benefit from such funds.

Increasingly, these states have been directing vast amounts of capital into sovereign wealth funds (SWFs). These investment funds, owned and managed by governments, are not a new investment Vehicle; they have been around for some decades. What is new is the rapid growth of SWFs thanks to Rising commodity prices and increases in net exports as a result of significantly increased production brought about by globalisation.

In the past 3 years, at least 12 new SWFs have been created. The current estimated level of assets under management in SWFs is between US$2 and 3 trillion, with research predicting that this will triple or quadruple in the next 5 to 7 years to US$10 to 12 trillion.

The activities of SWFs in developed markets such as the US, Canada and the EU have gained the attention of governments which have reacted to them with varying degrees of concern. This indicates the new power of SWF and why developing nations should tap into them because at this rate even developed nations will be relying on them.

Nigeria's sovereign wealth fund grew by 291 percent in the last five years, it said, followed by Oman at 256 percent and Kazakhstan at 162 percent, it said. Angola, still recovering from decades of civil war, saw its wealth fund grow 84 percent. Sovereign Wealth funds made $60 billion in mergers and acquisitions in 2007, the report said, accounting for 35 percent of worldwide mergers and acquisitions.

In January 2008, it estimated SWFs accounted for 28 percent of mergers and acquisitions in the United States -- exceeding activity from private equity buyouts, hit by the credit crunch. At the end of 2006, Asian central banks were accounting for $3,100bn of global SWF investments. That was more than double the total assets managed by hedge funds and quadruple those held by global private equity.

By their definition and operations, SWFs are not answerable to private shareholders. Because of their size, they are often used as instruments of the state, to invest in strategic industries, to gain relevant business or technological expertise, and to build up the presence of the country owning such funds in their target investment locations. China’s SWFs, for example, are set up for the following reasons:

(a) to look for higher returns for her huge foreign currency reserve; (b) to reduce her excessive domestic savings and liquidity; (c) to help redress the global financial imbalance; (d) to relieve international pressure on the RMB to appreciate too fast;
(e) to facilitate the globalization of China’s financial services; (f) to sharpen her international financial expertise; and (g) to gain international strategic leverage.
SWFs are sometimes regarded as investing in ‘risky assets’ but are generally run according to commercial principles.

As a source of huge and ready cash, SWFs are becoming increasingly welcome in a world reeling from a global credit crunch coupled with a host of financial and economic uncertainties. SWFs are increasingly being courted as white knights in shining gold armour for the rescue of Financial Institutions in distress. This is underpinned by a desire to forge closer links with some of the world’s most dynamic emerging markets.

The debate over SWFs and their impact on the domestic politics of developed countries is illustrative of the new-found economic influence of emerging markets. This presents an opportunity for the emerging markets, Africa and Zimbabwe included. As the developed nations seek ways to limit SWFs, Zimbabwe and Africa can present themselves as alternative investment destinations.

In the final assessment though, perhaps what this debate is revealing is the first real, concrete signs of a shift in geopolitical influence and long-standing power relationships – a shift that America and Europe are now confronting head on. Suspicion over SWFs and their financial and political impact is contributing to nervousness in Washington, Berlin, Paris and Brussels, and these governments are being challenged to think about their place in the world in a different light in terms of new order in control of financial resources.

Gilbert Muponda is a Zimbabwe-born entrepreneur. This article appears courtesy of GMRI Capital. More articles at www.gmricapital.com

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