The sovereign wealth fund – Concept and performance

The hot topic of the day is the “sovereign wealth fund” (in short, SWF). House Bill 6839, filed by the Speaker of the House and joined by neophyte congressman and son of the President, seeks to create the Maharlika Wealth Fund, which is designed to become an SWF with corporate powers.

The bill has moved up the legislative mill and is now in advanced reading in the lower house. If approved at the House, concurrence by the Senate, even with amendments, could lead toward passage into law.

The initiative to set up the Maharlika Fund came from President Marcos. This much is known from public comments made by Secretary of Finance Benjamin Diokno and Congressman Joey Salceda, the vice chair of Ways and Means Committee at the House, who is steering the legislative effort.

The inspiration for the model must have come from his recent visits to Indonesia and Singapore, and from efforts to understand the SWF concept so that it directly feeds into strengthening the domestic financing of more infrastructure investments in the country.

Singapore is home to two major SWFs (GIC and Temasek). Indonesia recently (in 2020) set up the Indonesia Investment Authority, which is designed to extend support to development projects within that country, using it as a vehicle to attract co-investors from foreign sources. The existence of many examples of successful and quite large SWFs must have stimulated interest in this mechanism as a tool for expanding the options for raising and expanding wealth.

The SWF model. A SWF is a state-owned investment fund from government money or resources. The fund is created for a specific purpose or purposes.

The funding is generally sourced from government savings that come from trade surpluses, earnings from natural resources sales, earnings from state corporations and authorities, proceeds from privatization sales, and budgetary appropriations. Trade, balance of payments and budgetary surpluses often create large gains in currency values and these also become sources of support for SWFs.

SWFs are created for specific purposes. A listing of such purposes could include: (1) for economic stabilization; (2) to save and preserve inter-generational income and welfare transfers within a country; (3) to protect and enhance pension funds; (4) to develop strategic development funds; and (5) to enhance and preserve international reserves in terms of investments and in terms of currency.

Among the notable SWFs today is the Norwegian Fund, which is worth $1.2 trillion. It is considered the biggest and one of the most successful. Some other notable funds include the Abu Dhabi Fund, the China Fund, the Kuwait Fund, and the Singapore Fund.

SWFs are run as business enterprises. They involve large amounts of money, but running them does not guarantee success. Investment decisions can go wrong. They operate under uncertainties and are exposed to major business risks. Of course, there are stellar successes too. But there are outstanding failures and disasters as investment funds.

A sovereign fund works within the framework of a country’s economic policy. Its objectives and internal operations have to be in synch with the overall framework of national policy.

When they succeed, their achievements also enhance national development. When their operations run counter to the national economic policy framework, they could undermine the national effort.

In this context, the IMF, speaking thru its deputy managing director (John Lipsky) summarized some of the important conditions for success of SWFs that participated in a meeting in Chile in 2008:

First, the operations of the SWF must be integrated with the overall economic policy framework, otherwise they could create, for instance, parallel budgets that could undermine other critical national operations.

Second, the work of such funds and of country economic policy framework need to be integrated with relevant international agencies on the collection of data and economic statistics.

Third, SWFs are successful when they have well-designed funding and withdrawal rules that are consistent with their stated goals.

Fourth, clear accountability procedures are important to prevent misuse of public resources and to gain public support for the fund.

Finally, the SWF’s success is driven by responsible investment policies that are consistent with the overall policy objective.

Some of these ideas form a part of the so-called Santiago Principles concerning the desirable operations of SWFs.

The Maharlika Fund proposal. The current bill in the House became a target of public reaction as soon as it became known that it is seriously moving up the legislative process.

One of the most serious points being raised has come from the Foundation for Economic Freedom. It is joined by a number of important local organizations that often speak on economic issues.

It is clear that there is much to be debated concerning the proposed fund.

Let me quote some of the important points made in its statement below:

“…[T]he government must prioritize the management of fiscal deficit and public debt to avoid impediment to the delivery of public services and prevent a downgrade of sovereign investment credit rating.

…[I]n other countries, commodity-based SWFs are designed to optimally manage the windfall from the disposition of natural resources for the benefit of future generations, recognizing that such natural resources are exhaustible and commodity prices are uncertain in the long run.

…[N]on-commodity-based SWFs are designed to manage the accumulated foreign assets from persistent external trade surpluses and surpluses of state-owned enterprises (SOEs), with the objectives of preserving the value of their capital and realizing returns on investments in order to keep the long-term sustainability of the fund.

“In contrast, the Philippines has neither commodity-based surpluses nor surpluses from external trade and SOEs, Although the country is rich in mining resources, they remain undeveloped because of restrictive laws.”

The existential threat of the moment is to set the economic fundamentals right, strengthen the economic recovery, and bring the fiscal deficit and the trade deficits under control.

(To be continued)

For archives of previous Crossroads essays, go to: https://www.philstar.com/authors/1336383/gerardo-p-sicat. Visit this site for more information, feedback and commentary: http://econ.upd.edu.ph/gpsicat/