What should we do with a sovereign wealth fund?
The Government of Bangladesh (GOB) has just approved setting up a sovereign wealth fund (SWF) to channel government funds into projects considered vital for the country. A SWF is typically owned and supervised by the central bank or the finance ministry. Sovereign Wealth Fund Institute data indicates that more than two third of $7 trillion funds globally is resource related (mainly oil, gas and mining). China SWFs are an exception, drawing upon huge trade surplus.
The most common mandate of a SWF is to earn superior return on "excess" foreign exchange (FX) reserves by investing abroad and seeking diversified FX returns while minimising the risks of home currency appreciation and a sluggish economy. SWFs for internal development finance are a small minority at best [World Bank Group, 2014: Sovereign Wealth Funds and Long-Term Development Finance]. Many emerging economies are instead obtaining development finance from the foreign investment of rich SWFs abroad [V. Fotak, X. Gao and W. Megginson, 2016, A Financial Force to be Reckoned With? An Overview of Sovereign Wealth Funds]. In fact, many of the home-oriented SWFs became "conduits for corruption, patronage and financial mismanagement" [National resource Governance Institute, 2015, Six Reasons Why Sovereign Wealth Funds Should Not Invest or Spend at Home]. Yet, India launched its maiden SWF in 2015 for internal project finance, but met only limited success in attracting private participation.
Intriguingly, most SWFs are set up in countries with authoritarian governance [Fotak et al, 2016]. Also very few developed economies have a SWF.
The USD 10 billion SWF will be an entity managed by the finance ministry, with five instalments of $2 billion from the FX reserves of Bangladesh Bank (BB) and paid for by new GOB borrowing. This will reduce BB's FX reserves by 33 percent over five years and simultaneously reduce money circulation outside BB by about BDT 80,000 crore.
First, the main rational cited for funding the SWF with BB's FX reserves is the ready availability of "matching" FX funds requirement of projects when they are financed with FX loans from foreign banks. It is not clear, however, why the GOB could not obtain the necessary FX from BB in an expedient manner if and when needed. If $10 billion FX is with the SWF, the idle amount needs to be invested in a liquid form so that it can be tapped easily. But there is no reason to believe that the SWF managers would earn better return on such liquid investments than BB. Meantime, BB would lose access to this $10 billion for its policy implementation.
Second, as the domestic banking sector would mainly purchase the planned Treasury Bonds issuances by the GOB for this purpose, loanable funds will end up diverted to the SWF from the private sector clients. Further, to the extent the GOB is unable to raise and repay the funds due to budgetary pressure and market circumstances, BB will end up remaining invested in the SWF, but without any control over the use of the SWF funds. It is also not apparent how this mechanism would enhance the returns on BB's FX reserves, an often cited reason for central bank's involvement in a SWF.
Third, it is debatable whether SWF is necessary and the best way to finance Bangladesh's infrastructure projects. This is clearly not the chosen means of development finance for most emerging economies (not resource-based) and the vast majority of SWFs worldwide do not invest much in development projects at home. It is not known how the financed infrastructure projects would generate revenue, be profitable and thus pay back the SWF's investment with return in excess of the GOB's borrowing cost.
Fourth, the prospective power projects may, in principle, generate revenue and are bankable. But the past track record indicates that the private corporate partners end up reaping excessive benefits at the cost of the Republic and the users. Unless the experience reverses, it might not be prudent to draw down BB's FX reserves to this end.
Fifth, there is a history of huge cost overruns in the infrastructure and power projects of Bangladesh. The estimated cost of the key Padma Bridge has already gone up by more than 200 percent. The Rooppur Nuclear Power project is not yet fully finalised with the Russian agency and its estimated cost has already soared from about $2-$3 billion to around $12 billion. While the Russian agency will provide a loan, the rate is not concessional. Additionally, GOB has to pay Russia for ongoing consulting, nuclear fuel purchase and waste management using FX. It will be undesirable if the BB's FX reserve ultimately ends up in countries such as Russia with little FX earnings prospects for Bangladesh from there to replenish the reserve.
Sixth, given the miserable performance history of state managed enterprises, especially the financial institutions, the nation is better off with a BB owned and managed SWF if there is to be one. Except for the electronic fund transfer mishap, BB has provided stable and able financial leadership in the rather turbulent sea of politicisation, patronage, graft, scams and crashes. Further, empirical evidence indicates that the performance of SWFs deteriorate with political leadership involved in governance [S. Bernstein, J. Lerner, and A. Schoar, 2009, The Investment Strategies of Sovereign Wealth Funds, Harvard Business School Working Paper].
To conclude, the enviable $30 billion plus FX reserves of BB was built on the back of Bangladeshi labour toiling under a punishing desert sun in the Mid-East and inadequately compensated young females risking and sometimes losing their lives in some unsafe RMG factories. They have duly earned the first right to any beneficial use of this reserve. It is also in the nation's interest to keep nourishing the golden geese. It is thus only fair and strategically prudent to create a BB owned and managed SWF that will invest in ventures such as pension, insurance, housing and education schemes for the low-income wage earners abroad and RMG workers at home and their families, state of the art manufacturing facilities for the smaller RMG factories under a lease and buyback plan, and the like.
The writer is Professor of Practice, Finance Department at McGill University, Canada.