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Economy Feb 25, 2013

India abandons a stupid idea: no sovereign wealth fund

By R Jagannathan

An idea born more out of hubris than good sense is bound to die an unsung death. And so it is with the much-touted India sovereign wealth fund (SWF).

The idea was dusted up in the first years of UPA-2, where the government assumed that 9-10 percent growth was a given, and thus India can dream big on the world stage, buying this oilfield and that coalfield. But we now know that the dream was unreal. Living consistently beyond our means has impoverished not only the exchequer, but the country as well. We are now down to a new normal growth of 5 percent.

Today's Indian Express notes that the sovereign fund idea has been dropped because the country does not have the foreign exchange resources to create one. One would have thought that was basic: if you don't have your own surplus cash, you don't invest.


A 5 percent CAD means the country needs annual capital inflows (including debt) of over Rs 500,000 crore, or $90-100 billion every year. Reuters

It's like borrowing on your credit card and investing in stocks in the hope that the capital gains will cover the cost of the credit. In 99 cases out of 100, this bet won't work.

Sovereign wealth funds are usually created out of huge current account surpluses - where a country has more dollars that it can spend by exporting more than importing over a sustained period of time. This is why China has several sovereign wealth funds. Norway, which obtained a bonanza from the discovery of North Sea oil, created a fund to invest this unexpected wealth for meeting the needs of future generations.

Now consider India's case. This year we will run a current account deficit (CAD) of nearly 5 percent of GDP - even worse than in 1991. To meet our consumption expenses, we are borrowing hand over fist from the rest of the world by opening up our debt markets to foreign institutional investors (FIIs), making it lucrative for non-residents to invest in bank deposits, and allowing Indian companies to take on more foreign debt through external commercial borrowings.

A 5 percent CAD means the country needs annual capital inflows (including debt) of over Rs 500,000 crore, or $90-100 billion every year, give or take a bit depending on what this year's GDP turns out to be. And this money can as easily flow out. And we want to create a sovereign wealth fund.

The last time India had a CAD surplus was in the last three years of the NDA, from 2001-04. The UPA has simply squandered this hard-fought surplus and India has never seen a surplus since. But some bureaucrats were still talking about a sovereign fund for about three years now.

The country's stock of external debt ($365 billion as on 30 September 2012) is 25 percent higher than its foreign exchange reserves, and rising even faster due to the CAD crisis. The gap between reserves (excluding gold) and external debt is now a clear $100 billion.

We are borrowing abroad to pay our oil bills, and the oil marketing companies are borrowing even at home because the government does not have the money to hand over their subsidy money in time. And we want a sovereign wealth fund.

Wealth funds are for the wealthy, people with money. Investments have to come from incomes and savings, not borrowings and consumption.

An economist PM should know this better than anyone else. And yet, the Express tells us that last July, the PM"s Office "directed the economic affairs department to submit a concept paper on a $20-billion SWF. One option being touted was to develop special investment instruments through which PSUs could channel their cash surpluses into the SWF, which would then be used to shop overseas."

Can beggars be shoppers?

Now, the finance ministry has put its foot down. The Express reports that the ministry's expenditure department has said that "the current reserve position of the government does not allow a SWF. PSUs with strong intrinsic financial strength... should come forward to acquire assets on their own."

In short, rich public sector undertakings should buy assets abroad, if they can afford it. The country itself is scraping the bottom of the barrel.

Sovereign wealth fund, RIP.

(To read some of our earlier stories on sovereign wealth fund, click here, here, here, and here)

by R Jagannathan

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