Sovereign wealth funds: relationship with macroeconomic factors and relevance to India

Abstract

Sovereign Wealth Funds (SWF) have existed since 1950s but with the recent credit crisis in US they have suddenly come into limelight. The western world fears that this rise of SWFs will mark the revival of government ownership of companies in an indirect manner and have imposed severe regulations on their investments. This study is an attempt to understand the working philosophy of these funds and explore their relationship with macroeconomic factors of host as well as target countries. The approach was to first identify the relevant macroeconomic factors which favors formation of a SWF. It was found based on empirical observation that one of the major macroeconomic factors favoring SWF formation is current account surplus. The report then delves into pinning down effects of SWF investments on the target country. It was discovered that SWFs may act as both stabilizers and de-stabilizers of the financial markets and their investments could raise serious political concerns. The existing regulations to address these concerns were studied and best practices for sovereign wealth funds were established. The relevance of the above findings was explored in Indian context and a simplistic analysis was made to ascertain whether India should go for a sovereign wealth fund or not. The preliminary results show that India has substantial excess foreign exchange reserve and it makes perfect economic sense to invest these funds abroad to maximize returns. This will involve investing a major chunk of existing reserves in foreign assets and the political aftermath of such a decision will remain a big challenge for the government.