Thursday, April 10, 2008

An Investment Fund for India

Shyam Ponappa / New Delhi September 07, 2006

We must build a GIC-type fund for investment.

A General Reserve …

There are at least four reasons for India to create a general reserve fund without any further delay. The first is the motivation for other country funds: diversified investments with good returns and reasonable safety are much better than government bonds with low returns—especially when they are bonds in America or some other country. There is one exception based on regional self-interest, and that is an investment such as in Asian bonds, if they were to develop as a viable alternative. Why provide cheap capital to others, instead of applying the lessons of well-run national funds over the last 30 years and profiting thereby?

The second is the rationalisation of the government’s holdings in public sector undertakings (PSUs), and distancing the government from direct management. Aggregating state holdings in an investment fund will facilitate less day-to-day political interference in PSUs as various committees have recommended, most recently the Arjun Sengupta Committee on Public Sector Enterprises. Although not strictly necessary, this could encourage a more public-interest oriented policy perspective for government, allowing for a broader, non-partisan approach. This would enable the strengthening of state-owned enterprises on conventional business lines, if possible.

… And an Investment Fund

Third, some of our burgeoning currency reserves (and future surpluses?!) could be channelled into an investment fund. Just 10 per cent of India’s foreign currency reserves will make for a $16 billion corpus. All we need thereafter are judicious investment decisions (!), the returns from which could finance development and infrastructure. Financing infrastructure with primary reserves, however, is definitely not advisable (see “FX Reserves & Infrastructure”, Business Standard, June 16, 2005).

These returns can be sizeable. Singapore’s Government Investment Corporation has funds about the same as our currency reserves. Under the chairmanship of Lee Kuan Yew, it earns 9.5 per cent, well over returns on our reserves, and has been doing so for 25 years. In 2005-06, the RBI had average foreign currency reserves of Rs 629,067 crore ($136 billion), and earned Rs. 25,569 crore (just over 4 per cent). Another 5.5 per cent would have added over Rs 34,000 crore.

With Low Inflation and Interest Rates

The fourth reason has major implications for domestic investment: investing overseas would reduce our excess liquidity if the RBI took appropriate measures. If it could lower inflation through fine-tuning reserve ratios, jawboning, and well-applied lending norms (easily said, but so very difficult to do!), this would enable lowering interest rates. With that, we could ride the magic carpet of cheap capital, as Japan has done.

We have to make several critical choices though, once we choose this path. For instance, if inflation dropped but interest rates were not reduced, there would be no magic carpet ... Another decision is whether to make “strategic investments”, like the Kuwait Investment Authority or Singapore’s GIC, or to decide that national interests should not influence investments, or to use a combination of financial and policy considerations. Alternatives include diversified investments on commercial considerations, as with Norway’s Pension Fund, or encouraging private sector investments overseas as an adjunct to foreign policy, as with America’s Overseas Private Investment Corporation. While a recent editorial in this newspaper referred to OPIC having a minor role in US FDI, OPIC’s facilitation of $164 billion in 35 years would be significant for India. A related choice is whether to manage by legislative committee as in Alberta’s Heritage Fund, or through financial managers as in Norway’s Pension Fund.

These dilemmas should not dissuade us from grasping the nettle in our best interests. In a way, this calls for a future orientation that we have long bucked against. Witness our preoccupation with building to meet historical capacity and always falling short, whether in energy and power, or in transportation or in communications, schools, sanitation … It is the same when we wrangle over sectarian rights for more of a share of what is available, reflecting a rationing-and-shortage mindset, instead of concentrating our efforts on creating more.

A strategic approach demands nurturing a long view, a capacity for deferred gratification, and, most of all, non-partisan collaboration for common goals. Equally, it requires the application of Deming’s “right knowledge”, as against the naïve assumption that good intentions will do. That is, we need to adopt a multi-disciplinary, collegial approach, with robust project management from goal setting to execution. Further, let us not be carried away by free-market rhetoric and naïve disregard for the realpolitik of public-private partnerships in world markets. This shows in suggestions that the World Bank’s Multilateral Investment Guarantee Agency already supports investments by smaller companies, or that our government should not champion national interests in investments. Ask yourself, why does the US have a national fund to promote private sector investment (OPIC)? Recognise that governments support national interests.

Alberta’s and Norway’s Funds

It is instructive to consider the different approaches of some funds and their results. Two examples of similar size of capital sources and time frame are Alberta and Norway.

Created in 1976, Alberta’s Heritage Fund was set up with an overlay of political decision making. The plan was to allocate 30 per cent of annual energy royalties. An economic slump in the 80s led to this being cut to 15 per cent, with the balance going to fiscal expenditure. As the economy worsened, the allocation was cut altogether, with all the capital being used to develop infrastructure, provide incentives to the energy sector, and keep taxes low (including maintaining zero sales tax). The Heritage Fund, now a little over Canadian $14 billion, has averaged returns of 5.7 per cent annually, somewhat under half that of more successful Canadian pension funds such as the Ontario Teachers’ Fund.

Like Alberta, Norway initially spent its oil royalties on social programs and economic stimulation. There were sometimes mixed results, because the kroner appreciated, depressing Norwegian exports. About 10 years ago, Norway changed its stance, setting up the Petroleum Fund, later renamed the Pension Fund, which invests with geographic and sectoral diversification being key criteria. It is now Canadian $165 billion, with average returns of around 4 percent because of its conservatism. While governments still withdraw funds for expenditure, there is a (tough) formal process, and responsible governments limit withdrawals to no more than the returns. Norway’s strategy of putting everything into the fund and living off the returns is working.

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