119) Sovereign investing

India’s persistent current account deficit will make it difficult for anyone to justify the deployment of a sovereign wealth fund.

With India’s foreign exchange reserves climbing over $300 billion and capital inflows still surging in, it was only a matter of time before the notion of an Indian Sovereign Wealth Fund gained popularity. A few days ago, the Prime Minster’s Council on Trade and Industry, suggested a $5-billion Indian Fund to buy assets abroad. At first glance the idea is tempting. After all, given the low returns on investments by the Reserve Bank of India in US treasury bonds and western central bank securities and the high cost of managing the inflows, any move to earn higher returns on reserves considered more than adequate to meet external contingencies, would definitely be to the nation’s advantage. That is the rationale for Singapore, China and Abu Dhabi, among others, launching sovereign funds with corpuses that range between $300 billion (GIC of Singapore) and $900 billion (Abu Dhabi Investment Authority). By that token alone, the $5 billion Fund suggested by the Council is far too modest, assuming, of course, that the country can afford to have one in the first place. And there is the rub.

Leave alone the political flak that emerging-economy sovereign funds have been drawing from the West with their acquisitions in iconic Wall Street firms and sensitive properties such as ports. The question that must first be addressed is whether conditions are right for India to launch such a fund. More than size of the foreign exchange reserves, it is the nature of the current account that is crucial to determining whether a sovereign wealth fund is appropriate. Countries that do have one invariably enjoy massive current account surpluses occasioned by large exports of manufactured goods — China, for instance — or of such primary commodities as oil or gas, as with Abu Dhabi. India’s persistent current account deficit renders it difficult to assess the adequacy of reserves over and above which the “excess” could be deployed by a sovereign wealth fund.

Yet that does not mean India’s large reserves cannot be invested productively. Indian firms have been on an acquisition spree overseas with the RBI consistently raising the ceiling on forex use. Last year witnessed some of the most dramatic acquisitions by Indian entities of western assets. Unlike many sovereign wealth funds whose financial acquisitions have been eroding in value of late, India’s companies both in the private and public sectors have been drawing dollars to buy energy assets overseas that promise to create substantial value for the domestic economy. India may not need a sovereign fund to replicate these efforts.