Growing importance of Sovereign Wealth Funds (SWFs)

Surplus wealth of many oil rich countries is managed by SWFs

Sovereign Wealth Fund (SWF) is state owned pool of money invested in various financial assets.  This investment fund is established by current or capital balance of payment surplus and budget surplus. Sovereign wealth funds can be distinguished from foreign exchange reserves. Sovereign wealth funds aim to maximize long-term returns while foreign exchange reserves promote short term currency stability. Recent years has seen a rapid rise in number of sovereign wealth funds. Rise in oil and gas prices led this rapid surge.

The primary purpose of SWF is to diversify economy and generate wealth for future generations.

Sovereign wealth funds invest in various financial assets

SWFs can be categorized in two types depending upon their financing.

1.       Commodity

2.       Non commodity

Commodity funds are those financed by commodity exports, the most common of which is oil export. This type of fund is usually set up by those economies that are dependent on single commodity exports. When the price of commodity in international market rises the exporting nation will see greater surplus. Conversely when export driven economy sees the fall in commodity price it faces a huge current account deficit. Therefore a sovereign wealth fund is established to stabilize the economy by diversifying the country’s wealth in other industries.

Non commodity funds are those financed through surplus foreign currency reserves.

Political motives

Sovereign wealth fund may have political/strategic motives like gaining control of strategic industries for political reasons. Many politicians criticized the investment by SWFs as security risk. On January 15th, 2008 Hillary Clinton said: “We need to have a lot more control over what they [sovereign-wealth funds] do and how they do it.” The huge size of these funds can make an impact on global economy. Some experts claim that all these funds combined to hold 5 trillion dollars in assets in 2012.

Extension of state

These funds can be thought of as extension of state therefore they are not necessarily driven by profit and loss. Hence these funds can act as a tool of Government policy.

As Arab countries faced the problem of food inflation their Governments started to negotiate for land lease through these sovereign wealth funds. This land will be used to produce food which then will be exported back to the investing country. This investment is in fact resource seeking instead of market seeking. Land grabbing by these institutional investors in Africa and Asia has occurred often to the prejudice of local population. Investing in agribusiness helps investors take control of not only producing but also of distributing the produce.