Letter From Europe
Cross-border investment and sovereign wealth funds
THE recent sub-prime mortgage market meltdown in the United States forced big investment banks like Merrill Lynch, Citibank, Morgan Stanley, etc. to announce massive write-downs, creating a huge crisis of confidence in the entire financial system.
Unfortunately, its ripple effects are still being felt across the world. In order to stabilise the Western banking system and to stave-off a looming recession, state-run investment funds from Asia and the Middle East pumped many billions of dollars into these ailing institutions. Although this unexpected help in the form of much-needed cash came in very handy, it was received with misgivings about the investors' real intentions in certain quarters and brought the role of these investment funds under close scrutiny from Western politicians.
The questions that have been bothering the Western politicians are: What is it that drives the state-controlled investment funds from emerging countries to invest in the industrialised ones? Is it profit maximisation, prestige, access to advanced technology, or are there any ulterior motives like pursuing obscure geopolitical interests? Are they seeking a position of power to influence the world stage? Why don't they invest in their own countries?
In essence, thrift is what motivated the establishment of the first state-run investment funds. The idea was to put away a share of today's earnings or excess revenues from diminishing natural resources for a possible rainy day. They functioned very much like Revenue Equalisation Reserves or Stabilisation Funds.
Sovereign wealth funds run by some of the oil-rich Middle Eastern countries are good examples of this type of funds. Some Asian countries like China and South Korea have accumulated huge current account surpluses in United States dollars from their very successful export-based economies. Most of these reserves are kept in low-yielding American Treasury bills and other bonds. The rest is managed through sovereign wealth funds, which invest the money in riskier foreign assets with the apparent objective of earning higher returns.
The total amount of potential cash flow is significant. According to reliable estimates, although the sovereign wealth funds are now worth approximately $3 trillion, by 2015 they may grow to $12 trillion or more.
China currently holds nearly $1.4 trillion in foreign exchange reserves. One of the reasons why China's foreign exchange reserves are so high is because it has been buying US dollars to keep the value of the Yuan relatively low, or at least try to slow the rise of its currency against the United States dollar, the currency of its most important customer. If China wants to invest its reserves inside the country, it will be forced to sell dollars and buy the Yuan, which will inevitably push up the value of the Yuan. This policy, if adopted, will defeat the purpose of building up the reserves in the first place.
According to Jesse Wang, a senior Chinese government official, China wants to acquire " a broad portfolio of small stakes (minority stakes) in lots of companies, instead of purchasing controlling stakes in a few companies." He insisted that China was not pursuing any political agenda. Although the managers of other Asian and Middle Eastern funds have also issued similar statements, the fact remains that someone who invests such huge amounts of money in foreign countries inevitably acquires a position of influence on the world stage.
The West has often accused the emerging countries of practising protectionism, and insisted on the free movement of capital as an essential prerequisite for economic development. But now it seems that the West is veering towards protectionism. At the insistence of the Bush administration, the International Monetary Fund and the World Bank are critically examining the role played by these funds. They have also been asked to develop a code of "best practices" for these funds, like giving an undertaking never to speculate in currencies, as Soros did on the British pound in the early 1990s, and not to pursue national political agendas through their investments.
Some politicians are even asking for binding regulations to include "mandatory, audited disclosures of the funds' holdings, reciprocity for American investors and caps on the share of any one company that a government investor may buy." The managers of the sovereign funds are, of course, not willing to sign a code of conduct on a unilateral basis. They think that "it is hypocritical of the West to demand regulations when the failure to regulate American and European banks and hedge funds has led to a global economic crisis" in the first place.
Some have even suggested that it would be perfectly legitimate on the part of the Asian funds to want the Western nations to abide by certain rules of conduct as far as good governance is concerned. After all, until now, when the capital used to flow from the West to the East, it was always tied to undertakings given by the developing countries to follow the rules and regulations laid down by the West.
There should not be any doubts about the overall benefit generated by cross-border investment. It "helps the world economy adjust to imbalances and give countries stakes in each other's prosperity." One should also give due consideration to Western concerns about these investments and the West's insistence on a code of conduct for these funds.
Until now, the international financial system has been controlled by Western-dominated financial institutions like the IMF, the World Bank and the G-7. It is evident that they are no longer capable of governing the "emerging 21st century world order." The West must accept this fact. The time has come for nations from the East and the West to overhaul the post World War II financial system, first by giving due representation to countries from Asia, Africa and South America and then by developing a fair international code of conduct for all nations.
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