India declines to join the SWF herd

It didn’t get much notice, but the Indian government stated in Parliament that it had deep-sixed a plan to set up a sovereign wealth fund (SWF). The idea of an Indian SWF makes an appearance every two years or so. After wasting a few hundred man-hours of the bureaucracy’s time, it is examined and then dropped – only to be brought back in a new form.

The good thing is that there is no sign of the Indian SWF ever happening and its size seems to be shrinking. I can remember talk of an Indian SWF of about $ 25 billion two years ago. This year’s avatar is only $5 billion.

SWFs, for the uninitiated, are government-owned investment funds that use excess foreign exchange reserves as their capital base. Remember the Abu Dhabi fund that bailed out Dubai? Or the Chinese fund that bought a big chunk of Blackstone? All SWFs.

The standard purpose of an SWF is to get a higher return on the reserves. Most countries buy US Treasury bills with their foreign exchange reserves. Especially now, they give a miserly, if safe, rate of return. So the idea is to take some of the reserves and gamble it on something a little more renumerative. When Chinese foreign exchange reserves rose beyond the $ 2 trillion mark, Beijing skimmed off $ 200 billion and set up a SWF.

India’s most recent SWF proposal, a joint proposal by the Ministry of Petroleum and the Ministry of External Affairs, revolved around a fund to buy strategic mineral assets. This had also been the idea behind the earlier, larger, one. Five billion dollars won’t get you much oil and gas, but the target this time seems to have been rare earth deposits.

Thankfully the proposal was shot down. The explanation given by Minister of State for Finance Namo Narain Meena: “It was felt at that time that a number of avenues for funding of acquisition abroad were available and that money was not a constraint for Indian companies to acquire assets/companies abroad.”

Which underlines a significant fact. Namely, that the Indian government doesn’t buy strategic mineral assets. Its few oil and gasfield buys have been commercially driven – in other words, the financing came from commercial banks and the investment must therefore give a healthy return on investment. (The supposed battle between India and China over oil and gas is a myth.)

The real buyers of mineral resources overseas in India are private companies and they are driven by their specific corporate needs. Rare earths would fall into this category. So long as Indian private firms can raise capital, they don’t need an SWF to help them. Most, I suspect, would prefer to stay away from anything run by the Indian government anyway.

What about getting higher returns for India’s foreign exchange reserves, the purpose of most SWFs? India has less than $ 300 billion of reserves. A healthy but hardly a heady amount. I would have to check, but I think Taiwan probably has more. They are largely kept as IMF Special Drawing Rights which, being calculated on the basis of a basket of currencies, are hedged against exchange rate fluctuations. It also keeps a large chunk in gold. The return on the latter is probably hefty. But ultimately the point of reserves is safety, not growth. Only if there is a huge mountain of the stuff does it make sense to gamble a bit. And India has enough but not too much.

Indians argue some of their reserves should be used to build up their creaking infrastructure. Well, New Delhi more or less did this in 2007 when it set up the India Infrastructure Finance Corporation. It is wholly state-owned and its capital base comes from government bonds issued in foreign currencies – ultimately being backed by $ 5 billion worth of the country’s reserves. This is an SWF, once removed. But it invests into India rather than outwards. Nonetheless, I think it actually fulfills the US Treasury’s definition of a SWF.

The only real argument for India to have an SWF, it seems, is that so many other countries around it have one. For me, the strongest argument against one is that it would run a risk of becoming just another badly-run, scandal-prone state-owned enterprise. And India has way too many of those already.

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