After being seen as white knights for sick banks, SWFs are now even assisting in the acquisition of rival companies.
In a spectacular move, a Kuwaiti sovereign wealth fund and Warren Buffet’s Berkshire Hathaway have joined hands to assist Dow Chemical’s acquisition of rival chemicals maker Rohm and Haas for $15.29 Billion. Until now, sovereign wealth funds were regarded as white knights ready to bail out struggling banks and financial institutions. Now they are beginning to assume the role of assisting in acquisition of rival companies, contributing to industry consolidation and enhancing their presence in the frontiers of global trade and investment.
General Electric and Abu Dhabi-based sovereign fund Mubadala’s recent global partnership includes a commercial finance business, a research centre for clean energy and water and plans to expand GE’s aircraft engine service and repair in the Middle East. Billions of dollars of Arab sheikhs and the Chinese government are being used to bail out distressed financial majors such as Citigroup and Merrill Lynch. A Merrill Lynch report recently caused a bit of a stir when it reckoned the amount of assets these funds already control is around $2,000 billion and could $10,000 billion by 2011 — that’s around a tenth of the total global market capitalisation already. In many cases — Citigroup being an excellent example — sovereign funds snapped up prime US assets at near-term bargain prices. Kuwait Investment Authority (KIA) and Singapore’s Temasek have poured billions of dollars into Merrill Lynch when the investment bank raised capital in December 2007. Add to that, China — with its $1,300 billion in foreign exchange reserves — holds several hundred billion dollars of US government debt.
Some SWFs such as Norway’s behave as capitalists bent on making as much money as they can. Others may have “strategic goals” — to nurture national champions, say, or to galvanise regional development. Sovereign wealth funds are also a way to recycle emerging market surpluses. Countries such as China have successfully used SWFs to protect and augment strategic interests — to pick up stakes in companies in Africa to safeguard the country’s access to natural resources such as minerals.
The history of sovereign funds – going back to the first major oil price rises in the early 80s — showed Gulf investors are passive, long-term, ask few questions and sit tight when the company is in trouble. It is interesting to note that the price of Citibank, in which the Arab sheikhs had invested 25 years ago is still the same even today (if Arab SWFs had invested in India, their wealth would have multiplied 165 times over!). Not only do the Arab sheikhs remain with Citibank even today, they have even added to their positions.
While most governments that have set up such funds have enjoyed commodity export windfalls and sustained consistent current account and fiscal surpluses, India would be atypical in that it is a large oil importer and has sizeable current account and fiscal deficits. In the recent past, the RBI has warned that the country could once again find itself in a vulnerable balance of payments situation as witnessed in 1991 should capital inflows suddenly reverse. However, soon after the Prime Minister’s Council on Trade and Industry’s proposal to set up a $5 billion SWF, the RBI also has decided to support such a move.
Presumably, the falling return on US treasury bills and the comfortable forex reserves are the motivating factors behind the governmental adventure. By most rules, including the famed Greenspan-Guidotti rule, which provides a benchmark, India’s reserve strength is formidable. With over $9,000-10,000 billion ready to migrate from the west to the east over the next decade and the fact that India’s share of the pie is minuscule, the RBI’s coffers are likely to continue to swell, even without any mineral income. In any case, India’s IT exports are poised to double in another three years, to $80 billion, and substitute for mineral wealth incomes.
It is true that the fact that India’s large current account deficit makes it different from other large reserve holders like China whose reserves have been built up from large trade surpluses, but the current account deficit is manageable and if we were to include software and services income, the trade deficit reduces to $32 billion. Indeed, the RBI estimates that the ratio of volatile capital flows (cumulative portfolio investment and short-term debt) was only 38 per cent of the reserves as on March 2007.
I believe the time has come for India to start climbing the learning curve. A good role model could be Singapore which has done a commendable job in building an infrastructure to detect high-return opportunities and investing in them. This competence, of which Temasek (Singapore’s Sovereign Wealth Fund) is a prime example, took a long time to develop; Temasek was founded in 1975. The Singapore government’s ability to find attractive investment opportunities is what even China, by its own admission, seeks to replicate in its fund.
Given India’s susceptibility to what happens in global oil markets, it would be a good idea to spend part of the cash reserves investing in energy resources. Of course, not all SWFs have the same purpose. Brazil’s $200 billion SWF, for instance, is supposed to help weaken the Real by buying foreign currency and keeping the funds in an overseas account, where they can be used to provide finance to buyers of Brazilian exports and to finance overseas investment by Brazilian companies. Chile’s stabilisation fund has a similar purpose.
Motives for investing vary even more. The China Investment Corporation bought a 9.9 per cent stake in Morgan Stanley just as the bank announced a $5.8 billion loss in the fourth quarter of 2007. But the attraction is more than just bargain basement prices. When China Development Bank bought a 3.1 per cent stake in Barclays in July, the two lenders detailed the many ways they would be working together.
If an Indian Sovereign Wealth Fund had invested in an internationally-acclaimed investment bank at the time it was hunting for augmenting its capital reserves, it would have succeeded in tapping into the banks’ expertise in trade finance and financial systems—crucial areas for emerging economies such as India and China. India’s banks, apart from not having the capitalisation to be counted in the Top 10 in the world, lack sophisticated systems of internal trade and investment and the impressive global reach of the Anglo-Saxon banking model. The author is CEO, Sunil Kewalramani Global Capital Advisors and may be reached at sunilkew@gmail.com
