Course: CES

Instructor: Anubha Dhasmana

Government-controlled pools
of assets used for portfolio
investment.

A Sovereign Wealth Fund (SWF) is a state-owned
investment fund composed of financial assets such as
stocks, bonds, real estate, or other financial
instruments funded by foreign exchange assets. These
assets can include: balance of payments surpluses,
official foreign currency operations, the proceeds of
privatizations, fiscal surpluses, and/or receipts
resulting from commodity exports. The definition of
sovereign wealth fund exclude, among other things,
foreign currency reserve assets held by monetary
authorities for the traditional balance of payments or
monetary policy purposes, state-owned enterprises
(SOEs) in the traditional sense, government-employee
pension funds, or assets managed for the benefit of
individuals.

Stabilization Funds

Savings Funds

Reserve Investment Corporations

Development Funds

Contingent Pension Funds



Global Funds Flowing Across National
Boundaries With Little Oversight Or
Accountability.

Not Subject To The Regulatory Laws Of
Host Country.

Do Not Have A Global Regulator Yet.

Makes Them Potentially Risky Like
Other Shadow Banking Institutions.

Generally Accepted Principles and Practices –
Santiago Principles.

I.M.F Best Practices.

OECD Principles of Corporate Governance.


GAPP 1. Principle
The legal framework for the SWF should be sound and support its
effective operation and the achievement of its stated objective(s).

GAPP 4. Principle

The policy purpose of the SWF should be clearly defined and
publicly disclosed.

GAPP 3. Principle
Where the SWF's activities have significant direct domestic
macroeconomic implications, those activities should be closely
coordinated with the domestic fiscal and monetary authorities, so
as to ensure consistency with the overall macroeconomic policies.

GAPP 4. Principle
There should be clear and publicly disclosed policies, rules,
procedures, or arrangements in relation to the SWF's general
approach to funding, withdrawal, and spending operations.

GAPP 15. Principle
SWF operations and activities in host countries should be
conducted in compliance with all applicable regulatory and
disclosure requirements of the countries in which they operate.

GAPP 17. Principle
Relevant financial information regarding the SWF should be
publicly disclosed to demonstrate its economic and financial
orientation, so as to contribute to stability in international financial
markets and enhance trust in recipient countries.

GAPP 20. Principle
The SWF should not seek or take advantage of privileged
information or inappropriate influence by the broader
government in competing with private entities.

GAPP 23. Principle
The assets and investment performance (absolute and relative to
benchmarks, if any) of the SWF should be measured and reported
to the owner according to clearly defined principles or standards.

Global Imbalances

International Financial Stability


Long Term Investors With Little Leverage
– Likely to Sit Out Down Turns.

Likely to Avoid Sharp Adjustments in
Portfolios To Avoid Adverse Price
Changes.

Enhance Depth and Breadth of The
Markets Thus Reducing Volatility.

Contribute to Greater Market Efficiency By
Diversifying The Global Investor Base.

Having large, and often unclear, positions in
financial markets, SWFs—like other large
institutional investors—have the potential to
cause market disturbance.

Particularly True When The Markets in The
Host Country Are Shallow.

May Complicate The Crisis Management And
Coordination Efforts of a Central Bank in The
Face of Financial Turmoil.

May Start Using Risky Investment Strategies
in Search For Higher Returns.

The Case of CITI – Kuwait Investment
Authority, ADIA, GIC (Singapore)

China Investment Corporation and Blackstone

Quatar and Barclays

More Recently SWF Seem to Be Benefitting

From Bailing Out Ailing Banks, But….

Resources Are Limited As Are Opportunities
(Particularly in Developed World)

Domestic Financial Needs And Cost of Crisis First

Priorities

Un-winding of Global Imbalances

But Greater Willingness to Accept The Role of

Government in Managing Economy.

CIC Back In Business After Smarting From Initial

Losses.

SWF are here to stay and grow in future

The environment in which they operate would
change though

More investments domestically and in Emerging
Markets where opportunities would be greater.

As GAPP are applied more widely transparency
and efficiency of investments by SWF would
increase implying greater confidence and
acceptance in recipient countries.

Can Promote Market Efficiency and Growth if
Properly Handled
 Course: CES
Instructor: Anubha Dhasmana

I.M.F (Balance of Payments Manual, and Guidelines on Foreign
Exchange Reserve Management, 2001): External assets
that are readily available to and controlled by
monetary authorities for direct financing of
external payments imbalances, for indirectly
regulating the magnitudes of such imbalances
through intervention in exchange markets to
affect the currency exchange rate, and/or for
other purposes.

Foreign Banknotes

Bank Deposits

Treasury Bills

Short- and Long-Term Government Securities

Other Claims Usable in The Event of Balance of
Payments Needs.
 Foreign Reserves in Billions of USD
2500

2000

1500

1000

500

0
China Japan Russia Taiwan India South Brazil Hong Singapore Germany
Korea Kong

Tiding Over Balance of Payment Shocks

Maintain Confidence in The Domestic
Currency in The Event of a ‘Sudden Stop’

Buffer During the Times of
Financial/Economic Crisis

Assist The Government in Meeting Its Foreign
Exchange Needs And External Debt
Obligations

Intervene in Forex Market to Support The
Value of Domestic Currency

Ratio of M2

Months of Imports

Ratio of Short Term External Debt

Ratio of Total Debt

Liquidity At Risk

Opportunity Cost of Investing Domestically

Difference Between The Cost of External
Borrowing and Return on Liquid Reserve
Assets

Difference Between The Cost of Borrowing
Domestically Versus Return On Reserves

Direct Cost Due to Fluctuations in Exchange
Rate

Cost of Sterilization
Balance Sheet Of The Central Bank Of Dragon
Land

Assets Liabilities
Securities Held C
Net Foreign Currency R C+R=H
Assets (N.F.A)
Other Net Domestic Other Liabilities (O.L)
Assets (O.D.A)
 H = N.F.A + Securities + ODA – O.L.

» N.F.A ↑ = H ↑

Case 1. Central Bank Does Nothing: Domestic

Money Supply Goes Up Causing Inflation

Case 2. Central Bank Intervenes To ‘Sterilize’ The

Increase In Foreign Reserves
↑ N.F.A → ↑ H → ↑ Money Supply → ↑Price Level
↓
↑ R.E.E.R.
↓
∆H=0 ← ↓ N.F.A ← ↓ N.X.
Effectively The Central Bank Uses ‘Open Market
Operations’ To ‘Mop Up’ The Excess Liquidity
Generated In the Economy i.e.

∆ Securities = ─∆ N.F.A
So That
∆H = 0
Reason – Maintain Competitive Advantage

Under-valued Exchange Rate Implies Huge
Inflows of Foreign Currency (e.g. Dollars)

With Pegged Exchange Rate These Dollars
Add to The Stock of Reserves

Government Tries to Avoid Domestic
Inflationary Pressures Through Sterilization

This Only Adds To The Existing Current
Account Imbalances

Undervalued Exchange Rate Attract
Speculative Capital Inflows

In Thin Financial Markets ‘Sterilization’ Might
Increase Domestic Interest Rates Causing Even
More Capital To Flow In

Reserves Stock Pile Even More

More Sterilization

Is This Sustainable????
 Direct Fiscal Cost or ‘Carrying Cost’

Difference Between The Interest On Domestic

Currency Bonds And Return On Reserves

Valuation Losses From Currency Appreciation


Effectiveness of Sterilization Depends on The
Demand For Government Bonds By Bank And
Non-Bank Institutions

As Stocks Of Government Bonds With Banks
Grow They Might Expand Credit Further Thus
Reversing The Impact Of Initial Sterilization
Operation

Interest Costs Of Sterilization Grow As Banks’
Demand For Government Securities Is Finite

With Imperfect Sterilization Expansion In Bank
Credit Can Fuel Property And Asset Bubble

Expectations Of Future Currency Appreciation
Can Attract Short Term Capital Flows Fueling
Equity Prices

Together This Can Make Macro Economic
Management More Difficult

Higher Reserve Requirements, Tax On Interest
Payments, Direct Credit Controls

Cause Inefficiencies In The Financial Sector

Large Issuance Of Public Sector Debt Might
Crowd Out Private Sector Issuance Thereby
Hampering The Development Of Domestic
Private Bond Market

So Far China Has Escaped These Ill Effects But
For How Long?
16

14

12

10

M2 Multiplier Reserve Ratio


State Administration of Foreign Exchange
(SAFE) (1997)

Reserve Bank Of India (RBI Act Of 1934)

Objective s –Liquidity, Safety And Returns.

Reserve Pooling

Contingent Credit Lines

International Insurer And Lender Of Last
Resort (IMF!)

Lower External Debt

Flexible Exchange Rate Regimes.
Suggestions! Comments! Questions!
Thank You!