The Indian way

The sovereign wealth fund should comprise investments of retail investors to spread the benefit of foreign inflows

By Mohan Sule

Many bogus reasons have been put forward against India setting up a sovereign wealth fund. These funds, goes one argument, are typical of autocrats such as the UAE and Kuwait. Yes, the US, Australia and Japan do not seem interested but Norway and Singapore, both democracies, though the latter a benign dictatorship, have their own funds. Exporters of natural resources such as Saudi Arabia and Russia, it is pointed out, use sovereign funds to manage their wealth. Yet Venezuela is still to enter the fray. Countries with a current account deficit, where foreign exchange inflows through exports, services and remittances are lower than outflows through imports, should keep away. This has not prevented Brazil from establishing one. May be India can prove to be another successful exception. It is not the government’s job to maximize wealth through portfolio investment, goes another conventional wisdom, nor should it be in the business of acquiring companies. Instead, countries should use their cash surpluses to build social infrastructure or leverage them to cut taxes to boost productivity. The problem is India cannot be conveniently compartmentalized. Similar to developed countries, its economy is manufacturing and knowledge based. At the same time, there is a large public sector, whose objective is to create jobs as well as to ensure equitable distribution of resources at fair or even subsidized prices. Just like other emerging economies, it attracts foreign capital flows but, unlike many of them, is dependent on import of commodities and is not export oriented. Like China, the domestic market is a magnet for overseas investors but, in contrast to the Communist giant, the foreign investment is not sufficient to blunt the energy-import bill. With characteristics of both the developed and emerging markets, India is uniquely placed. Rather than splitting hair over if it should have a sovereign fund, the need is to debate how the fund should function.

China’s plentiful reservoir of foreign exchange eliminates the need for better returns as long as it keeps the yuan undervalued for export competitiveness. More than high prices, it is worried about disruption in supplies of commodities. As a result, its sovereign wealth fund’s overreaching objective seems to be to snap up mines and oilfields for domestic consumption rather than to make profit from them. India, on the other hand, is trying to make its public sector market oriented by divesting government stake and use the proceeds for welfare programs. It is getting out of many core sectors in favor of the private sector, opting for royalty sharing. The country is betting on nuclear energy to reduce dependence on oil for energy needs. As such there is no need for the sovereign fund to buy assets abroad to secure commodity needs, which can be done by private companies or even public sector enterprises like ONGC Videsh. Hence, India’s sovereign fund will need to have a goal that is different from that of other countries. It could be a mix of buying stakes in overseas companies directly or through the stock markets, using the derivatives market to hedge against commodity price fluctuations, or diversifying the country’s asset base by investing in governments bonds and real estate abroad.

In a marked departure, India’s sovereign fund should be based on retail subscription by selling dollar-denominated units. The Indian currency mopped up can be used to sterilize foreign capital, which otherwise the Reserve Bank of India buys to keep the rupee from appreciating, but triggering inflation in the process. The benefits of foreign investment, therefore, would be spread across investors rather than remaining confined to a set of stocks or companies. Like in the primary market, the ceiling for subscription should be Rs 2 lakh to ensure a diversified base. The fund can combine the features of close- and open-ended schemes, with a 10-year lock-in from the date of subscription, which would always be open. The investment mix can comprise local and overseas bonds, equity and other assets. In fact, the sovereign wealth fund could also bid for PSU divestment stake or distressed assets abroad, hold them and dispose them to local investors later. The government may retain the call option to buy back units once the assets have generated returns above inflation or distribute dividends to those who prefer to continue till maturity, when units could be redeemed at net asset value. A sovereign wealth asset management company with professional fund managers would be a better option to the central bank. India, thus, can show the world how to harness its huge human resources and, in the process, spread wealth to investors rather than the government treasury being the sole beneficiary.

Mohan Sule