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Does India need a sovereign wealth fund?

Thursday 24 November 2011 - by Kavaljit Singh

In a bid to emulate other BRIC nations India could be on the cusp of creating its own sovereign wealth fund. The idea has certainly gained traction with business and political leaders, says Kavaljit Singh, director of India's Public Interest Research Centre.

New Delhi will soon take a final call on the issue of setting up of a sovereign wealth fund. The idea of setting up an Indian SWF has been going around since 2007 when China established its major sovereign wealth fund, China Investment Corporation, with an initial capital fund of $200bn.

However, this time the proposal has received strong support from India's corporate leaders who recently suggested the establishment of a state-owned SWF primarily to secure access to natural resources and pursue strategic investment opportunities overseas.

With the strong backing of corporate leaders, a SWF may soon be a reality and India will join other BRIC nations having such a fund. Although the initial capital of the proposed fund is still under discussion, it is unlikely to exceed $10bn.

Despite the excitement in official circles, the necessary preconditions for establishing a sovereign fund are missing in India. It appears that New Delhi is blindly following a "me-too" approach rather than understanding the rationale behind setting up such funds.

The main policy rationale behind setting up a SWF is not to secure access to natural resources or acquire strategic assets abroad, as perceived by New Delhi. Such funds are established to manage excessive foreign exchange reserves, commodity exports, the proceeds of privatisations and fiscal surpluses. For instance, China established CIC to manage its excessive forex reserves, which reached $3.2tn by August 2011.

SWFs help in diversifying and improving the return on a country's foreign exchange reserves or commodity revenues. Like central banks, SWFs deploy surplus forex reserves; but since SWFs are set up to diversify investment, they undertake long-term investments in illiquid and risky assets, whereas central banks typically undertake short-term investments in low-yielding liquid assets, such as government securities and money market instruments.

SWFs are typically patient investors with long-term investment horizons. Since they have no explicit liabilities, they can remain committed to their investments in the hope of booking higher returns in the future. Also their funding sources tend to be fairly stable, which makes them less sensitive to market volatility. Unlike hedge funds and private equity funds, SWFs are not prone to withdrawals by investors that could force them to liquidate their market positions quickly.

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