Thursday 26 Nov 2020 | 01:38 | SYDNEY
Thursday 26 Nov 2020 | 01:38 | SYDNEY

Sovereign wealth funds: A reader responds


Stephen Grenville

6 December 2007 08:59

Reader Kerry Duce responds to my post on sovereign wealth funds in Australia: 

The article rightly played down sovereign wealth funds but to me raised much more important policy issues that are driving the current debate. The article correctly identifies that the name can obscure the reality -  a universal sovereign wealth fund does not exist. Therefore, we need to analyse the various charters/mandates of these funds.  We then need to evaluate how well these funds have remained true to the mandate.

Clearly the current debate has arisen due to the rise of the Mid East and China funds. In context these funds reflect the saving-investment gap that exists regionally. These gaps need not be an imbalance that reflects exchange rates, but the most striking characteristic is that the emerging regions are net savers, funding investment in the developed world. This I consider is the strange result that needs to be analysed - sovereign wealth is just a reflection of this.

Diversification makes sense in the Mid East and Singapore, but for a large continental economy like China it is surprising that savings can run well ahead of investment at this stage of urbanisation. I share McKinnon's view that savings-investment gaps do not reflect exchange rates but rather choices with respect to sustainable levels of saving-investment. Large swings in exchange rates have done little to alter Japan's choice to save, or for that matter Australia choice to invest. At the end of the day it is the return on invested capital rather than source of savings which matters.  Over recent times the US has deployed its capital relatively poorly, and to date Australia appears to have deployed its capital fairly well.

A thought experiment - a large US financial may already be deriving some 50% of its earnings from the Asia Pacific region, but its share price is reflecting domestic US issues. What does it matter if the entity is partially re-capitalised using offshore funds from a sovereign wealth vehicle? As such the key issue turns on control - diversity of shareholders is good, but if holdings are concentrated in a sovereign fund this clearly presents issues as other shareholders are partly neutralised.  This then is an issue for the listed entity's legal structure, not the fault of a sovereign fund.

If a country is concerned about inter-generational equity with respect to resource exploitation, a resource rent tax dedicated to a sovereign wealth fund would appear to be the appropriate policy instrument to smooth commodity cycles. This could be achieved by some reduction in company tax as an offset. It makes sense, if the need is to diversify or smooth the commodity cycle, that these funds are directed towards long duration assets in offshore locations (eg. toll roads etc).