SWFs to pump $5trn into developing countries

Low interest and higher commodity prices to boost sovereign fund assets next decade, says World Bank

Sovereign wealth funds are expected to shy away from US Treasury Bills and pump $2.7 trillion (Dh10trn) to $5trn into the developing countries by 2017 split between equities and bonds, according to World Bank estimates.

Projected to have assets worth $17trn under management by 2017, the study projected that two global factors will increase the size and number of SWFs.

On the one hand, interest rates in the G-7 will stay low for a while. Seeking higher returns, capital will flow into promising developing countries. Those countries' central banks will accumulate foreign currency reserves and will try to invest them in something more profitable than the traditional US Treasury Bills.

It said the combination of fiscal rules and independent overseers and high commodity prices will give momentum to the accumulation of revenues into sovereign wealth funds.

"Pre-crisis estimates of SWF assets ranged from $13.4trn to $17.5trn by 2017. If the foreign assets under SWF management were to be invested under the reasonable assumption of a mix between the portfolio allocations of Singapore and Norway before the crisis, we could expect SWFs to invest about 20 to 30 per cent of their assets in developing countries, of which 45 per cent would be allocated into equities, 45 per cent in to bonds, and 10 per cent into private equity, real estate, and commodities," according to World Bank's report ‘The Day After Tomorrow’.

At least $2.7trn to $5trn of total assets theoretically could be invested in developing countries by 2017 - equally split between equities and bonds.

"If one excludes the regions where these funds originate that is, Asia and the Middle East, these assets could represent eight to 16 per cent of the combined gross domestic product (GDP) in developing countries in Latin America, Africa, and Eastern Europe; one to two per cent of their market capitalisation of traded companies; and 10 to 19 per cent of the total debt securities in these regions," it said.

It said external imbalances, on the one hand, are expected to somehow diminish in the medium term, because surplus countries may be under pressure to increase internal demand. On the other hand, the crisis and its associated policy response actions to support the global economy might create mounting incentives for central banks to allocate even more foreign reserves into SWFs, and for the SWFs to seek higher yields and diversification.

Quite naturally, where SWFs invest is also going to be governed by a number of considerations. Although developed countries, and the United States in particular, have been the main recipients of SWF investments to date, a shift in attention toward developing-country securities is likely to increase because of the economic prospects of developed countries in the medium and long terms.

Despite differences in investment strategies and appetite for risk and liquidity - reflecting different objectives, liabilities structure, and so forth-the desire to diversify their portfolios in the hope of maximizing returns for acceptable levels of risk is a common feature of all SWFs and will support such a shift albeit gradually, the report said.

In September 2009, China Investment Corporation (CIC) took $1 billion minority stake in the Hong Kong-based Noble Group, a commodities trading and supply chain manager. JP Morgan said that other deals worth $50bn of investments are likely to materialise between the CIC and companies in developing countries.

Stefano Curto, one of the report's authors, said SWFs could play a role in purchasing government bonds issued by the G-7 countries, but a gradual shift toward the investments of developing countries may be the most likely outcome.

As reserves accumulate, SWF strategy will focus initially on a rebalancing from low-yield assets into high-yield equities. Diversification away from the G-7 is definitely going to be more gradual and incremental.

SWFs will avoid a further depreciation of US dollars, and that, in turn, could generate large revaluation losses for the central banks' dollar-denominated assets and a slowdown in the accumulation of future reserves.

As long as countries in which SWFs are fed by the accumulation of reserves resist the appreciation of their currencies, a full diversification away from the dollar will be difficult. At the consolidated level (including central bank purchases), there is already some evidence of portfolio rebalancing.

The sale of Chinese holdings of US Treasury debt in December 2009 - ceding its place as the world's biggest foreign holder of US debt to Japan - provides clues about China's appetite for loaning money to the US. China pared its Treasury holdings by $34bn to $755.4bn. Japan's holdings total $768.8bn, according to US Treasury estimates.

Curto said over the 2010-20 decade, SWFs have the potential to boost global wealth by helping recycle large savings in surplus countries toward more productive investments, particularly in the developing world. Over the medium term, many developing countries will continue to depend on external savings to finance critical investment, since excluding China and major oil exporters, developing countries are (on average) net importers of capital.

On the supply side, major fiscal stimulus packages in advanced economies are likely to result in a general re-pricing of sovereign debt risk and the associated cost of borrowing and in more limited access to and a crowding-out of credit for developing-country borrowers, forcing some of them into fiscal austerity if they do not find alternative resources.

In this context, SWFs could bridge the gap between the growing investment needs and the reduced supply of external resources, thereby sustaining growth, accelerating progress toward the Millennium Development Goals, increasing economic integration, and helping build the foundations for a multipolar world. Africa, in particular, may benefit most from SWF resources, given its relatively weak starting point in trade, regional integration, infrastructure, and private sector development.

The current global savings glut may have similarities with the recycling of the savings of oil countries that fuelled the debt crisis in the 1980s. In the 1970s and early 1980s, these windfalls were deposited in banks in the West and were eventually on-lent to developing countries in Latin America and elsewhere.

Today, these windfalls may take the form of SWFs directed, for example, to African countries that are becoming increasingly attractive investment destinations, are growing at the fastest rates in the past four decades, are reforming institutions and improving governance, and, most important, have had their government balance sheets virtually wiped free of external debt as a result of the heavily indebted poor countries and multilateral debt relief initiatives, it added.

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