Sovereign forays

As a lengthening list of major global financial institutions discloses the impact that the sub-prime problem has had on their performance, a somewhat unexpected source of rescue and relief has emerged. These are the sovereign wealth funds (SWFs), pools of investment resources created by a range of countries, which have accumulated huge foreign exchange reserves by virtue of persistent balance of payments surpluses and, more recently, the high price of oil. The China Investment Corporation made the headlines for its acquisition of a stake in Blackstone, a large private equity investor. More recently, it has put money into Barclays and Morgan Stanley. The Abu Dhabi Investment Agency, one of the largest in the game with a portfolio estimated at close to $ 900 billion, has taken a stake in Citigroup, which has seen a change in its leadership in the wake of sub-prime related losses. Temasek, from Singapore, has invested in Merrill Lynch, while the other Singapore fund, the Government Investment Company, has invested in UBS. While the amounts invested and the equity stakes obtained are still relatively small, the resources that the SWFs command are vast, and reflect a transfer of first trading power and now financial power.

The SWFs' increasing inclination to invest in global corporations rather than in safe government securities has raised concerns of the kind that, in an earlier age, used to be expressed by people in poor countries about the mixing of finance and politics by rich western investors. In today's context, the debate is about the role that the SWFs intend to play in managing the companies in which they have invested. With particular reference to financial institutions, people worry that their intermediation and portfolio management activities may be used to serve the broader political agenda of the sovereign owners, which may threaten the stability of their home economies. As a consequence of these concerns, the demand has been voiced for the imposition of controls on the activities of the SWFs "" echoing old calls from the poor countries for controls on foreign investment. However, policymakers in the target countries will have to think their way very carefully through both the implications of this trend and their responses to it.

Globalisation, as an instrument of broad-based economic development, has been advocated most strongly by the developed countries, which have often used their economic leverage to bring reluctant trading partners into line. It is, therefore, rather hypocritical for them to be talking of limits and restrictions on outward investments by other countries, particularly when there are no overt strategic issues at stake. However, the countries running SWFs also have a responsibility to behave like ordinary shareholders in any corporation would, i.e. act to protect and advance their financial interests.

The increasing significance of SWFs highlights both the benefits and the dangers of globalisation; good governance, rather than restrictions and controls, is what will maximise the benefits, while mitigating the dangers. An attempt is being made by the World Bank group and the International Monetary Fund to template some best practices. Transparency, with respect to both investments and overall strategy, will be a critical component. Arms-length behaviour, as practised by the Norwegian fund, for example, will also need to be reflected in a compilation of best practices. Ultimately, while SWFs are funded by government resources, the welcome they get in other countries will depend on them behaving like private shareholders.