Sovereign Wealth fund as an Economic and Foreign Policy Tool

Sovereign wealth funds, as defined by the U.S. treasury, are government investment funds, funded by foreign currency reserves but managed separately from official currency reserves. The SWFs invest their money primarily in forein countries, i.e, a Gulf SWF will invest heavily in non-Gulf assets. Currently, the SWFs hold assets to the tune of $3.8 Trillion. Generally, the SWFs are funded by the Forex Reserves, Public Sector Enterprise Reserves, Public Pension / Welfare funds or Surpluses arising out of Exporting some commodities. States / Countries like UAE, Singapore, China etc... hold vast amount of assets via SWFs. SWFs are created by countries to create wealth for their country that can result in lower taxes for citizens or to better manage revenues for an export dependent country to counter the boom and bust cycles in trade. This is a brief background about SWF in a nutshell.

Does India already have a SWF?

The answer is both "Yes" and "No". Indian PSUs do invest in foreign countries and that is an equivalent of SWF. For eg., ONGC Videsh Ltd is a subsidiary of ONGC that primarily invests in foreign countries and is a kind of SWF. And is is not and SWF in true sense as the profits of ONGC Videsh are shared by all shareholders of ONGC and that includes private parties also. Further, all the investments made by ONGC Videsh are for purely Economic reasons.

Now, the question that arises is "Does India need a SWF and what should it be used for?"

This question has been mooted by the Finance ministry and RBI and they agree that it may be a good idea to have SWF with an initial investment of $10 Billion.

Firstly, lets discuss about the advantages India has with a large warchest in the form of SWF.


1. India can invest heavily in countries that are rich in natural resources and hence can secure its future requirements at ease.

2. The larger the SWF, the greater the firepower India has and the easier it becomes to compete with companies like China to get access to natural resources

3. A large SWF ensures that India has sizable interests in the world financial markets and hence can learn about the best in class practices from the firms it has invested in

4. A concerted investment strategy in the strategic industries in friendly / target countries means that India has a larger say in the final outcome of a key economic policy or foreign policy

5. India can undertake larger self-sustainable development projects in Africa, South America etc... and hence secure the support of those govts. in larger global forums in the areas of economy, defense and politics

6. The greater the amount of assets India controls in a country, the higher is the sway Indian diplomats have on the foreign and economic policy. Examples can be a neutral country supporting India over key issues like global warming. Economically, the target country can relax the trade barriers for India. In terms of defense, the country can technically be impelled to support india in case of a conflict with a state.

This blog is about discussing a new kind of SWF that can easily be 5 to 10 times the size that the govt is considering.

As per the current plan, the Govt of India is more interested in investing about $10 billion from our mammoth Forex reserves of about $280 billion in SWF that will invest in foreign assets. A central bank maintains Forex reserves with the primary intention of managing the foreign exchange rate stability and about $100 billion will give more than sufficient fire power to RBI to achieve that. As most of the current FOREX reserves are in Gold or US Treasury bills, the remaining $180 billion earn a measly 3-5% p.a. This is a bad economic decision by choice!!!



There is no point in India trying to stick to the conventional route of investing surplus money in SWFs. The following are some of the Unconventional routes it can take:

- Given the kind of advantages SWFs have, India can definitely afford more money from its Forex reserves. India can easily invest about 25% of its forex reserves without any impact on the monetary policy, i.e, ~$70 billion.

- LIC has about $173 billion portfolio of investments. As LIC is a fully govt. owned insurance company with a large float, the govt. can pass a law where in LIC is obligated to invest 10% of its portfolio via SWF. Dissolving this 10% portfolio of domestic investments won't have an impact on the domestic markets as there is always sufficient FII or MFs or DII money ready to make these investments in domestic market. So, LIC can potentially contribute $17.3 billion to SWF

- Employee Provident Fund is currently managing a portfolio of $50 billion with a view to pay out PF to claimants and the avg annual rate of interest it pays out is 8.5% p.a. Currently, this is a loss making portfolio as the ROI < 8% p.a A better way of managing these funds can be diverting 20% of this portfolio to SWF where you can earn higher economic returns and achieve strategic national interests. This contribution can be close to $10 billion

- New India Assurance is another Public Sector Insurance company with a $6.4 Billion portfolio. Applying the same logic as the one we have for LIC, a 10% redistribution of portfolio to SWF can potentially provide $640 MM to SWF

- In India, banks are required to invest close to 25% of the deposits they collect in Govt bonds to maintain the SLR prescribed by RBI. And these bonds are very low interest paying instruments for the banks. Currently, banks buy a variety of instruments from State govts that have very bad finances. As of now, the size of SLR holdings by Banks in India stand at $93 Billion. If the govt imposes a bit of Fiscal discpline in curtailing excessive borrowing by states with bad finances and divert 10% of these funds to SWF, the contribution can be as high as $9.3 Billion

- Indians have invested about $140 Billion via MFs in the Capital markets. A small regulatory change wherein all the MFs are mandated by law to invest 1% of their assets in bonds issued by Govt of India that invest in SWF will fetch $1.4 billion


Adding up all these contributions, the potential size of SWF can be $110 billion and this is 11 times the size of what our govt wants to launch. And if you have notices the sources of these funds, the govt doesn't need to borrow more or undertake massive cost cutting exercises. All it needs to do is show will power to redistribute the capital within in the system in a very small way.

If we assume that an SWF of $110 billion is launched and the following assumptions are made about future:

- The current size of India GDP is $1.25 Trillion and it will grow at avg pace of 8% p.a for the next 50 years (This is very optimistic and believe me the more optimistic the assumption on this is, the more conservative the estimate of the impact of SWF is)

- The contribution to SWF from the above sources grows at 15% p.a

- SWF earns Returns of 15% p.a (very conservative), pays out 6% p.a as Cost of funds (Conservative given the yield on SLR instruments and the govt. can actually make this as a law) and has about 1.25% as OPEX (based on MF financials and Economy of Scale)

- All the profits from SWF are reinvested at the same rate of return and expenses

- The SWF is launched in 2009 end

As per the above assumptions, the size of India's GDP at the end of 2040 will be $14.7 Trillion and the size of SWF will be $16 Trillion. Further, by the end of 2050, Indian GDP will be $32 Trillion and SWF will be $68 Trillion

The US GDP is $13 Trillion today and if we assume that they replicate their historic growth rate of 3% p.a, the US GDP will be only $44 Trillion in 2050.

In my argument, I have assumed that Indian GDP will continue at 8%. In reality, it may grow at far lower pace and hence India may be much smaller than US based on GDP in 2050.But the kind of clout India as a country will have in the world financial markets and economy just because of the size of its Asset holdings in foreign countries that can touch $68 Trillion under conservative estimates. And this calculation hasn't spoken about the kind of Investments Indian Private companies will make in the same time!!!

Bottom line: India need not wait to be an economic super power till it becomes a major player in global politics and economics. By realigning its capital right now, India's economic power will have a multiplier effect!!!!