Where does government revenue and national wealth really end up? Well, it does go into healthcare, education and infrastructure of course. But is that it? Not really. The money also goes into a state-owned pool of wealth that is aimed to do more: invest on behalf of the government itself!
An SWF is a state-owned pool of money that is invested in various financial assets. The money typically comes from a nation's surplus reserves of wealth. The first-ever sovereign wealth fund (SWF) was the Kuwait Investment Authority, established in 1953 to invest excess oil revenues. Activity was limited for several years until three major SWFs were established: Abu Dhabi's Investment Authority, Singapore's Government Investment Corporation and Norway's Government Pension Fund. Over the last few decades, the size and number of SWFs have increased significantly. Today, there are more than 91 SWFs with net assets amounting to nearly USD 8.2 trillion.
SWFs invest in a wide range of asset classes including government bonds, equities and foreign direct investments. Many nations use them as a way to accrue profit for the benefit of the nation's economy and its citizens: through investing via SWFs, countries generate revenues which can be channelled back into the economy for infrastructural development, investment in domestic assets, et cetera. Today, many SWFs are also engaging in international investing; this not only offers the advantages of diversification but also offers a range of sociopolitical perks.
The National Infrastructure and Investment Fund (NIIF) is India’s first and only SWF. It manages funds of over USD 3.4 billion. Three key funds are maintained by the NIIF: the master fund, the fund of funds and the strategic investment fund. The master fund is an infra-related fund with the primary objective of developing roads, ports, and airports; the fund of funds invests in the funds operated by fund managers having a history in infrastructure; the objective of the strategic investment fund is to invest mainly in the equity-linked instruments. Each of these funds has made and continue to make great strides in India’s progress as an economy and nation; several examples attest to this. The master fund recently formed a USD 3 billion ports and logistics platform called Hindustan Infralog Private Limited in partnership with DP World; this platform aims to focus on acquiring stable businesses with strong growth potential and seek to scale those businesses with a combination of capital, operational expertise and relationships with global customers. Even the fund of funds and the strategic investment fund have taken multiple advantageous steps to prove their value to the country. However, India’s SWFs as a whole, both in terms of size and diversity, are significantly smaller in comparison to several other nations.
Today, the largest SWFs in the world are the Government Pension Fund Global (Norway), the China Investment Corporation and the Abu Dhabi Investment Authority. These funds own assets worth nearly USD 3 trillion: almost equalling India’s nominal GDP at present. However, it is imperative to consider why these funds are so large and what fuels their investments. Established in 1990, the Norwegian wealth fund was created to funnel Norway’s extensive petroleum sector revenue into diversified assets. The revenue generated by the oil industry and oil reserves of Abu Dhabi - that exceed USD 900 billion - is pooled into the Abu Dhabi Investment Authority and used to make diversified investments around the world. The Kuwait Investment Authority too is designed to help Kuwait pool, invest and grow its wealth from oil and oil reserves. One important trend is noticeable: the primary use of these SWFs is to diversify investments and grow resources. Through diversification, a country can reduce its risk by safeguarding itself against market volatility and adverse market cycles while also opening up new opportunities for revenue generation. However, diversification as a factor is only significant if a country produces a limited number of commodities. As seen in the given examples, a key reason for the expansion of SWFs is the fact that the owner countries mainly produce only a few commodities such as oil. Contrastingly, India produces and specialises in a variety of commodities ranging from textiles to pharmaceuticals. The need to reduce risk and diversify becomes significantly lesser; this is the chief reason for India not having an SWF as large as Norway or Saudi Arabia. However, this is not to say that the NIIF is adequate for the Indian economy and that further development of Indian SWFs is not necessary.
There are two key paths that India has followed and must continue to follow to augment its SWF structure and operation. First, the government must make the functioning of its SWFs, specifically the NIIF, much easier and cost-effective than it currently is. The central government has recently, in alignment with the same suggestion, granted 100% tax exemptions to SWFs for their investments in the infrastructure sector. This would incentivise investments in Indian infrastructure and ultimately lead to the socially desirable outcome of infrastructural development within the country. Similarly, if India could reduce the burden of regulatory costs and compliances while itself investing in the SWFs, these funds will almost certainly become more efficient and bolster the economy while making sustainable societal change. To that end, the government could allocate a certain proportion of its annual public expenditure to contributing to India’s SWFs while incentivising more investments through a reduction in costs and other burdens. Second, international investment from other, larger SWFs must be highly encouraged. The Abu Dhabi Investment Authority signed the first international investment agreement of worth USD 1 billion with the NIIF in October 2017. The Asian Infrastructure Investment Bank invested USD 200 million in NIIF in June 2018. Such investments have played a major part in the growth of the NIIF as a whole and offer the benefits of globalisation and cooperation as well. Apart from implementing tax concessions and lowering costs for international stakeholders, the Indian government could also offer rewards for investments of a certain value and structure contracts that provide strong incentives for investments in India. Such measures are being implemented to a certain degree as of today, however, considerably more progress must be made for substantive change to be made.
At a time when the economy of India truly needs a source of fuel, the importance of a strong SWF that combines domestic and international contributions is higher than ever. The NIIF, especially the strategic investment fund, must take decisive action to boost the economy by supporting national stakeholders while also creating positive impacts across societies and smaller economies. The value of SWFs is often underestimated not only in India but in several other parts of the world. However, the past and the present provide clear evidence: maintain robust and purposeful SWFs, prosperity and progress will follow.
Author: Kavan Shah
A 16-year-old student pursuing the IB Diploma Programme at Dhirubhai Ambani International School, Mumbai. Passionate about finance and mathematics - and therefore, obviously, Moneyball and The Big Short.