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State-owned investment vehicles in
Asia and the
Middle East have spent at least $40 billion in the past couple of months
to buy significant stakes in Citigroup Inc., Morgan
Stanley, Merrill Lynch & Co. and UBS AG.
However,
the Indian government has decided to sit out the great
fire sale of Western banks and securities firms.
By not
having a sovereign wealth fund in place—and by showing
no desire to set one up—isn’t
India
forgoing a rare chance to buy strategic assets on the
cheap in the world’s developed economies?
Libya
has set aside $100 billion for a fund;
Saudi Arabia
may join the bandwagon, the Financial Times reported
last month.
Now,
India isn’t an oil exporter. But neither are
China
and South Korea, both of whom have established
state-owned investment vehicles. China Investment Corp.
last month invested $5 billion in Morgan Stanley, while
Merrill Lynch this week accepted a $2-billion check from
Korean Investment Corp.
India
can easily afford to use part of its $276-billion
official foreign reserves—slightly bigger than
Korea’s—to chase risky assets. So why isn’t it joining
the game?
There
are good reasons.
India’s
reserves may be unduly high but they are neither the
result of windfall commodity-price gains that the
government is free to spend nor an excess of the
nation’s savings over domestic investments.
In other
words,
India
doesn’t yet have sovereign wealth.
Other
people’s money
The
foreign-currency accumulation that has taken place in
India in the past few years has been on account of
financial flows; the current-account part of the balance
sheet that captures trade, tourism and money sent home
by Indians working overseas has been in deficit.
That
makes India very different from other big,
developing-country holders of reserves in the region.
Most of them have built up their war chests via
sustained current-account surpluses, Donghyun Park, a
researcher at the Asian Development Bank in
Manila,
said in a recent study.
For
India, the motivation for accumulating dollars may be to
preserve export competitiveness, the same as China or
Korea, but since the resultant foreign reserve comprises
foreign—rather than national—savings, it doesn’t
represent either the government’s or the people’s
wealth.
Most of
this capital is free to leave the country tomorrow.
It isn’t
terribly risky to tie up a few dollars of this money in
illiquid assets. But what if there’s another investment
proposal that’s too good to refuse, and then another?
Too
conservative?
“Consideration of a sovereign wealth fund for India may
ideally await more comfortable current account and
significantly improved fiscal situations,” Reserve Bank
of India Gov. Yaga Venugopal Reddy said in a speech in
Mumbai in October.
Not
everyone agrees with such a conservative approach.
“As
India’s forex reserves continue to balloon, as do their
costs, it may be time for India to reconsider its
reserve-management policies going forward and be more
willing to increase its risk-taking appetite,” Ramkishen
Rajan, an economist at the George Mason University in
Arlington, Virginia, wrote recently on the web site
rediff.com.
India
should have a serious debate about setting up a
sovereign fund, he said.
Rajan
has a point about costs. Following the subprime crisis,
developed-country interest rates earned by the Indian
central bank on its reserves are on a declining trend.
The local borrowing costs paid by the Indian government
to finance the acquisition of reserves are high and
steady.
A better
way
One way
out of this money-losing proposition is for the central
bank to slow down its reserve buildup. That may cause
further appreciation in the Indian rupee, which has
gained almost 13 percent against the US dollar since the
beginning of 2007. Exporters are unhappy, especially in
categories where they have to compete with Chinese
rivals.
Another
approach may be to either curb foreign inflows or
encourage outflows; both have been tried with limited
success.
A better
strategy might be to use the reserves to raise the
productive capacity of the economy.
As
Columbia University economist Arvind Panagariya notes in
his forthcoming book on India, labor-intensive
manufacturing for the world market is yet to begin in
earnest in the country.
One
reason for that is lack of infrastructure, especially
power and port capacity. This is where
India
should pour some of its foreign reserves for maximum
gain in welfare.
Financing infrastructure
The
government doesn’t have to finance the entire cost of
these projects. That will need $475 billion, much more
than what the central bank has in its reserves and what
it can spare without causing the economy to overheat or
weakening its foreign credit rating. State support is
required merely as a catalyst to supplement commercial
loans, and only to the extent that foreign currency is
needed to import machines and equipment.
That’s
precisely what the Indian government proposes to do.
A more
creative use of reserves may be to deploy them to
mitigate risks on private-sector investments, says Park
of the Asian Development Bank. “Contingent liabilities
in the form of guarantees would not result in debt and
could boost national productivity,” he says.
Modernizing its own economy is a bigger priority for
India right now than chasing returns in US and European
banking stocks. Before India starts worrying about
investing sovereign wealth, it must first create it. |
