Reflections on the Sovereign Wealth Funds
A Sovereign Wealth Fund (SWF) is an investment fund owned by a sovereign State/nation with the mandate to invest in financial assets such as stocks, bonds, precious metals, property and other financial instruments. The basis of investments is for financial and economic benefit. The Risk-Return profile of each investment proposal is to serve as the key determinant in any investment situation. The economic transformation agenda of the present administration requires that Nigeria not only saves for the future fixes her infrastructure and diversifies her economy but also stabilizes the economy.
Sovereign Wealth Fund (SWF) is a state–owned investment fund composed of financial assets such as stocks, property, bonds, precious metals or other financial instruments. Sovereign Wealth Funds invest globally, and most SWFs are funded by foreign assets. Some Sovereign Wealth Funds may be held by a central bank, which accumulates the funds in the course of its management of a country's banking system. This type of fund is usually of major economic and fiscal implications. Other Sovereign Wealth Funds are simply the state savings that are invested by various entities for the purposes of investment return, and that may not have a significant role in fiscal management.
Since the year 2000, there have been about 50 sovereign wealth funds in operation around the world today. They have contributed substantially to the economic stability of the various nations. For Nigeria, whose economy depends over 90 percent on crude oil exports, the income from oil can be saved for the rainy day. For instance, Nigeria suffers from acute shortage of housing and experts suggest that financing for these high-ticket social projects could come from sovereign wealth funds. Analysts say there is intense competition among nations with or who desire SWFs for the best investment opportunities, managers, staff and “reputational capital” for the success of their investment programs and their country's international profile.
Meanwhile, the accumulated funds may have their origin in, or may represent foreign currency deposits, gold, Special Drawing Rights (SDRs) and International Monetary Fund (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 that are typically held in domestic and different reserve currencies such as the dollars, euro and ven. Such investment management entities may be set up as official investment companies, state pension funds, or sovereign oil funds, among others.
The establishment SWF is predicated on the need to save for the future, investment in strategic infrastructure and building a buffer against shocks such as the current global financial meltdown, or recession, or burst which has damaged numerous economics of nations across the globe, and all these are merely the core objectives. Though Sovereign Wealth Funds are typically created when governments have budgetary surpluses and have little or no international debt, it is only proper to know that economic well-being of any nation in the long run depends very significantly on how wisely or foolishly she invest.
The SWF is therefore an Investment Avenue through which funds would be utilized in generating wealth. It has been discovered that countries like Sandi Arabia, Kuwait, US, Brazil, Libya, China, Norway, Singapore, Canada and over twenty-six other national, have set up similar funds some years back and they are already reaping their investments bountifully. The SWF operations are estimated to account for one-eighth of global investment so far. Core reasons for creating SWFs may be economical, or strategic, such as war chests for uncertain times. For example, the Kuwait Investment Authority during the Gulf war managed excess reserves above the level needed for currency reserves (although many central banks do that now). The Government of Singapore Investment Corporation and Temasek Holdings are partially the expression of a desire to bolster Singapore's standing as an international financial centre. The Korea Investment Corporation has been similarly managed.
Currently, assets under management of SWFs increased to $4.7trillion in July 2011, increase of &700 billion from one year ago. There was an additional $6.8 trillion held in other Sovereign investment vehicles, such as pension reserve funds, development funds and state-owned corporations' funds and $7.7 trillion in other official foreign exchange reserves.
Countries with SWFs funded by commodities' exports, primarily oil and gas exports, totaled $2.7 trillion at the end of 2010. Non-commodity SWFs totaled $1.5trillion. Non-commodity SWFs are typically funded by transfer of assets from official foreign exchange reserves, and in some cases from government budget surpluses and privatization revenue. Asian Countries account for the bulk of such funds.
It is important that the SWF-to-Foreign Reserve Exchange Ratio which shows the proportion a government has invested in investments relative to currency reserves. According to the SWF institute, most oil-producing countries in the gulf have a higher SWF-to-Foreign Exchange Ratio-for example, the Qatar Investment Authority (5.89x) compared to the China Investment corporation (12x) reflecting a more aggressive stance to seek higher returns.
While countries like United Arab Emirates, and Kuwait China started this investment in 1976, 1953 and 1997 with total asset of 627 billion, 296 billion and 567.9 billion Pounds respectively, Nigeria, through the wisdom of the Jonathan administration has just joined the league of these nations last year with a total seed money of and N1 billion credited to the Fund's account, which was deducted from the Excess Crude Account. Though this idea may have been insulated to have been inspired by the IMF or World Bank, it must be appreciated that this project is purely the brain child of President Jonathan's administration.
Scholars are of the opinion that apart from applying the nation's external reserves for balance of payments in external trade transactions, further investments in the international capital market can be accommodated from the reserves in an effort to diversity Nigeria's sources of income. Quantitatively, decisions on what financial assets acquire and what financial assets to issue are also influenced by the size of the country and capital. Larger countries with a huge chunk of reserves can take advantage of diversification in their resources and uses of funds. This means that the overall risk of a portfolio or basket of investment of financial assets can be reduced acquiring or venturing into financial assets from many different borrowers or investment avenues. Similarly, a nation like Nigeria can contact a broader range of savers and achieve greater stability in her incoming flows of incomes or funds.
The SWF comprises three basic components namely: Future Generations Fund, Nigerian Infrastructure Fund and Stabilization Fund. The Future Generations Fund reflects the desire “to ensure that the resources of today are not all consumed – rather, that part will be saved, increased financially and shared as a legacy for unborn Nigerians and the development of the economy over the decades to come.” The Nigeria Infrastructure Fund will make investments specifically related to and with the objective of assisting the development of critical infrastructure in Nigeria and the diversification of the economy. The Stabilization Fund would also allow the nation to more effectively conduct a sound and responsible fiscal policy, while reducing the effects of the “boom and bust” commodity cycle of oil on Nigeria. So far, the Jonathan administration has taken deliberate steps to ensure that the Nigerian Sovereign Investment Authority is established on a safe, sound and robust legal framework.
Verily, the SWF is in line with the transformation of Nigeria's economy. No time is more appropriate than now for Nigeria to chart a new path of fiscal prudence and discipline in the management of scarce resources. This has even become more imperative because of the risks associated with the crude oil mono-culture baring all unforeseen circumstances that the Amnesty Program will continue to be sustained. The SWF will also provide measures to reduce the risk level inherent in our volatile economy. As has been made evident by the Governor of the Central Bank of Nigeria, the SWF intends to strengthen monetary tightening while the fiscal authorities plan to implement a budget that is not expansionary.
The SWF will certainly place the Nigerian Economy on the fast lane of global competitiveness. This will become more attractive for Foreign Direct Investments (FDI), which by implication would promote Nigeria's compliance to global standards of transparency and accountability in the management of natural resources.
Most investors wooing Nigeria as an investment destination are not comfortable with the accountability profile of the nation. Due to the inappropriate nature in the management of Nigeria's Excess Crude Account, it became obvious that the issue of transparency and accountability is at the heart of the debate for the establishment of the Nigerian Sovereign Wealth Fund.
The existence of the SWF would also curtail the culture of unrestricted spending of unanticipated income, which may flow from excess crude oil windfall and other sources. It is expected that the principles of the SWF would encourage based on sound, clear and beneficial economic parameters.
What perhaps made the SWF most attractive is the availability of a Pool of Savings or Back-up Funds for future generations for financing budget deficits or the provision of Infrastructure Fund to provide intervention in critical areas of the Nigerian economy. Arguments about promoting long-term investments and industrialization cannot be feasible without correcting the infrastructure deficit of Nigeria, which is a major challenge that vitiates economic growth.
Sovereign Wealth Funds would be beneficial investment funds and provide financing for Nigeria's badly needed infrastructure development – housing, health, education, roads, bridges, and railways. Development analysts believe that Nigeria needs N32 trillion to fund and arrive at the much trumpeted Vision 20: 2020. Viewed against this background, the SWF would also provide stabilization fund to defend the country against crude oil price shocks; enhance the development of critical infrastructure (education, health, transport) and provide a solid foundation for sustainable economic and social growth and economic diversification across all regions. This is in addition to providing a stable last-resort source of financing for commodity-price induced budget.
Nigeria is a peripheral capitalism and cannot allow a free reign of the market forces to determine the freedom for capital, goods and services, where the market is self-regulating allowing the “trickle down” notion of wealth distribution. Again, there is need for Nigerians to trust the present administration which is doggedly determined to enhance economic justice through the responsible stewardship of natural resources for present and future generations. Government has also promised to enhance critical infrastructure by deliberately sequenced reforms, such as incrementally achieving reliable and adequate electricity supply; as aptly stated, 'No Power, No Future' in terms of economic growth and development. It is against this background that government is poised to accelerate the implementation of key reforms including the Power Reform Roadmap, Ports Reforms, the Agriculture Transformation Action Plan, Downstream Deregulation, Land Use Act reform, and the passage of the Petroleum Industry Bill into law. For these reforms to be effectively implemented, the establishment of the SWF is a sine qua non.
From a critical analysis, it seems there could be a political gain or motive in the establishment of the SWF which to all intents and purposes is a state enterprise. Having established the SWF and depending on the private sector, generally regarded as the engine room of growth, to undertake external investment drives that will serve useful purpose in promoting and protecting Nigeria's economic interest and enhance economic growth.
There have been attempts to distinguish funds held by sovereign entities from foreign exchange reserves held by central banks. Sovereign wealth funds can be characterized as maximizing long term return, with foreign exchange reserves serving short term currency stabilization and liquidity management. Many central banks in recent years possess reserves massively in excess of needs for liquidity or foreign exchange management. Moreover, it is widely believed most have diversified hugely into assets other than short term, highly liquid monetary ones, though almost no data is publicly available to back up this assertion. Some Central Banks have even begun buying equities, or derivatives of differing kinds.
Considering the merits of the SWF, there is need for well meaning Nigerians to applaud the Jonathan administration for floating the SWF account. In fact critics of the SWF should have a re-think and examine the merits of the policy and embrace it. It should be considered as part of the nation's long-term investment with robust economic benefits to secure the future of the nation. With this SWF account, Mr. President's economic transformation agenda is given renewed impetus to translate policy statements in to practical reality. The policy initiative will feed off powerful values guarantee financial freedom and propel the state on the path of accelerated development. President Jonathan and his Economic Team have taken a positive step in bringing the future to the present so that the future will not be left to the vagaries and vicissitudes of speculations and uncertainties.
Idumange John, is Fellow Institute of Public Management, Nigeria