sovereign wealth

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Sovereign wealth funds (SWF) are one of the most potent financial forces of the modern era, and having carefully studied SWFs through the prism of public value, I have come to see considerable merits in creating such institutions, but only in specific contexts. SWFs are uniquely situated in the relationship between the state and the market, and act as a sovereign (national) actor in financial markets under an investment management mandate. Some very well known SWFs include that of Norway, Singapore, China, and the UAE, who are so large (with roughly a trillion dollars each) as to be able to influence global financial markets with their investment decisions, and whose managers therefore wield extraordinary financial power. These SWFs are targeted towards growing a national financial endowment, and they are seen as significant national vehicles for societies as stakeholders in financial markets. Now that Pakistan is building an SWF with a capitalization of $8 billion, it is worth considering those merits, which will indicate that an SWF is ill-suited for our current context.

The first consideration is that sovereign wealth funds are ideal for countries with small populations and surplus capital, and not for large populations in deficit. For the surplus countries, the SWF becomes a concentrated vehicle for deploying excess capital in the national financial interest, when their own economy cannot or should not absorb (for inflationary reasons) the excess capital. For example, many energy-rich countries such as Norway and Kuwait have major SWFs, because their populations are too small to absorb or consume the revenues from oil and gas exports, and so their excess wealth is invested for future generations. Another category is for countries such as China, which have run significant trade surpluses for so long that they have to park the export earnings in a more optimal manner. A third category is small financial hubs (Hong Kong and Singapore), who become magnets of capital too large relative to their size. Is Pakistan an energy-exporting nation with a small population like Norway or Kuwait? Sadly, it is a very large net importer of oil, and its population is large and growing by the minute. Does Pakistan run significant trade surpluses that need to be parked somewhere as China does? Sadly, it runs consistent trade deficits and must borrow to fill the gaps. Is Pakistan a major hub of financial capital relative to its population size? If anything, capital has fled the country due to the serial mismanagement of the economy, particularly over the past 18 months.

The second consideration is that an SWF is an emblem of a long-term orientation towards society. By building an SWF, a society is making a commitment towards intergenerational financial transfers, as future generations can enjoy the returns on capital invested today. But if there is one signature trait of Pakistani elites over the past 50 years, it is that they simply do not have a long-term orientation. The general public also does not have a long-term orientation, and this is evidenced in multiple ways, including a chronically low national savings rate (especially for an Asian country), and an explosive birth rate that pays no heed to rationality. The elites of this country cannot inculcate a long-term orientation onto the public, since they do not have it themselves. They also have considerable assets abroad, with little in terms of their own appetite for investing locally. If such people are establishing an SWF, it is already in serious trouble. A strong system for an SWF would include comprehensive financial reporting, publicly available audit reports, rigorous reporting on investment decisions, and shariah-compliant (if applicable) investment strategies. Such a system would require significant long-term planning to institute, and would not be done in the haste that the SWF is being established. It is horrifying that the bill creating the SWF here was part of the 54 bills that were passed in what can only be described as an epileptic seizure of legislative activity. This is not how intergenerational investment institutions are made.

This is also closely linked to a third consideration, which is the absolute need for transparency and accountability in SWFs. The Norwegian SWF is a good example of robust accountability, and this helps to explain its broad success since inception, and even it has faced some hiccups. As another example, the Malaysian SWF (1MDB) had a major corruption scandal that led to a political crisis. Ironically, I was to visit a few parliamentarians in Kuala Lumpur to discuss budget oversight mechanisms, when the 1MDB scandal broke out in 2015 and my visit was canceled. Now, in the present circumstances, is Pakistan ready for robust transparency and accountability in the design, execution, and maintenance of its SWF? There is no indication whatsoever that it is, which means that it will become a magnet for corrupt practices, and thus hemorrhage the invested capital on which it is being built. In addition, the SWF would itself need to be answerable to significant losses experienced by the fund. For example, a Chinese SWF investment in Blackstone, an investment manager, generated considerable losses, which then had to be accounted for. Only in an environment where mistakes are understood to be sincere would such things be tolerated, whereas any economic decision here can be cross-questioned on bad faith grounds. 

A fourth consideration is that of the state-owned enterprises (SOEs) that are being divested to raise the capital for diversion to the SWF. The government is divesting stakes in several SOEs for the SWFs, but although SOEs have become an intolerable burden on the national exchequer and their privatization is necessary, the means by which it is done is important. It is much more efficient and sensible to fully privatize the SOEs through a transparent bidding process, rather than divest the government stakes for the purposes of an SWF. SOEs are an area of my research interest, and I am compelled to argue that an SWF would be a suboptimal approach vis-a-vis SOE divestment. Why not privatize these institutions outright through transparent bidding instead?

 A fifth consideration is that of foreign investment, both inbound and outbound, through the SWF. On inbound investment, it is important to note that SWFs can become indirect conduits for foreign-controlling investment. This is a national security issue, and one that countries such as the United States have seen as grounds for rejecting the sovereign wealth fund model. After all, there is no “American sovereign fund” for a reason (although there is also an ideological basis in the US for rejecting SWFs too). On outbound investment, it is useful to note that most SWFs are intended to deploy capital abroad because local requirements are too small, and because local inflation can be outdone by investment denominated in foreign currency. But our local requirements are very large, and we would benefit much less from an SWF targeted at foreign investment. We are a country that needs local investment. 

A sixth and final consideration, and perhaps the most important one, is to ask: who will the ultimate beneficiary of the SWF be? SWFs are intended as a vehicle for the people’s benefit. Scarcely are things done here for the “people’s” benefit, and so the ultimate aim of the SWF may not be appropriate, further bolstering the argument for not building one. The weakness of our economy is in large part because it is not an economy that works by the people nor for the people. Because we have not been able to protect our economic sovereignty, we are mortgaging our entire sovereignty. A “sovereign” wealth fund is least likely, given the contextual factors mentioned above, to solve our economic sovereignty or economic security issues. As with the many lacerations that we are leaving for future generations, an ill-conceived SWF is but one more laceration for them to endure. 

Dr. Usman W. Chohan is Advisor (Economic Affairs and National Development) at the Centre for Aerospace & Security Studies, Islamabad, Pakistan. He can be reached at cass.thinkers@casstt.com.  

Note: CASS has done theoretical work on SWFs and SOEs. published as chapters in what has become the most authoritative book on the subject internationally.

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