P R W P
6776
Sovereign Wealth Funds and Long-Term
Development Finance
Risks and Opportunities
Alan Gelb
Silvana Tordo
Håvard Halland
with Noora Arfaa and Gregory Smith
e World Bank
Poverty Reduction and Economic Management Network
Public Sector Governance Unit
&
Sustainable Development Network
Oil, Gas and Mining Unit
February 2014
WPS6776
Public Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure Authorized Public Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure AuthorizedPublic Disclosure Authorized
Produced by the Research Support Team
Abstract
e Policy Research Working Paper Series disseminates the ndings of work in progress to encourage the exchange of ideas about development
issues. An objective of the series is to get the ndings out quickly, even if the presentations are less than fully polished. e papers carry the
names of the authors and should be cited accordingly. e ndings, interpretations, and conclusions expressed in this paper are entirely those
of the authors. ey do not necessarily represent the views of the International Bank for Reconstruction and Development/World Bank and
its aliated organizations, or those of the Executive Directors of the World Bank or the governments they represent.
P R W P 6776
Sovereign wealth funds represent a large and growing
pool of savings. An increasing number of these funds
are owned by natural resource–exporting countries and
have a variety of objectives, including intergenerational
equity and macroeconomic stabilization. Traditionally,
these funds have invested in external assets, especially
securities traded in major markets. But the persistent
infrastructure nancing gap in developing countries
has motivated some governments to encourage their
sovereign wealth funds to invest domestically. is paper
proposes some basic elements of a conceptual framework
to create a system of checks and balances to help ensure
that the sovereign wealth funds do not undermine
macroeconomic management or become a vehicle for
politically driven “investments.” First, the risks and
opportunities of domestic investment by sovereign wealth
funds are analyzed. Central issues are the relationship of
sovereign wealth fund nancing to the budget process
and to the procurement systems of sector ministries, as
well as the establishment of appropriate benchmarks and
is paper is a product of the Public Sector Governance Unit, Poverty Reduction and Economic Management Network;
and the Oil, Gas and Mining Unit, Sustainable Development Network. It is part of a larger eort by the World Bank to
provide open access to its research and make a contribution to development policy discussions around the world. Policy
Research Working Papers are also posted on the Web at http://econ.worldbank.org. e authors may be contacted at
hhalland@worldbank.org.
safeguards to ensure the integrity of investment decisions.
e paper argues that a well-governed sovereign
wealth fund, with a sound mandate and professional
management and stang, can possibly improve the
quality of the public investment program. But its
mandate should not duplicate that of other government
institutions with investment mandates, such as the
budget, the national development bank, the investment
authority, and state-owned enterprises. Establishing rules
on the type of investment (for example, commercial and/
or quasi-commercial) and its modalities (for example, no
controlling stakes, leveraging private investment) is one
way to ensure separation between the activities of the
sovereign wealth fund and those of other institutions. e
critical issue remains that of limiting the sovereign wealth
fund’s investment scope to that appropriate for a wealth
fund. If investments that generate quasi-market returns
are permitted, the size of the home bias should be clearly
stipulated and these investments should be reported
separately.
Sovereign Wealth Funds and Long-Term Development
Finance: Risks and Opportunities
Alan Gelb, Silvana Tordo, Håvard Halland
with Noora Arfaa and Gregory Smith
1
JEL classification codes: E00, E02, E03, E61, E62, H40, H 43, H44, H54.
Keywords: Sovereign Wealth Fund, (SWF), Macroeconomic Policy, Fiscal Policy, Public
Finance, Public Investment, Domestic Investment, Wealth Management, Intergenerational
Equity, Project Evaluation, Public Private Partnerships, Capital Stock, Infrastructure
Investment
Sector Boards: Public Sector Governance (PSM), Energy and Mining (EM)
1
Alan Gelb (agelb@cgdev.org) is a Senior Fellow at the Center of Global Development in Washington, DC. Silvana
Tordo (stordo@worldbank.org) is Lead Energy Economist for the Sustainable Energy Department, Extractive
Industries of the World Bank. Håvard Halland (hhalland@worldbank.org) is a Natural Resource Economist for
the Poverty Reduction and Economic Management (PREM) Network of the World Bank. Research support and
comments were provided by Noora Arfaa (
narfaa@worldbank.org), Operations Officer, and Gregory Smith
(gsmith@worldbank.org), Young Professional, both at the World Bank. The authors are grateful Ekaterina
Gratcheva (egratcheva@worldbank.org), Lead Financial Officer, World Bank, Financial Advisory and Banking
Products, Treasury and Christian B. Mulder (cmulder@worldbank.org) Senior Manager, World Bank, Reserves
Advisory and Management Program, Treasury, for providing extensive comments and material. The comments
of peer reviewers Shanthi Divakaran, Roberto de Beaufort Camargo, Carlos B. Cavalcanti, and other reviewers
Jeffrey D. Lewis, Jeff Chelsky, Nadir Mohammed, Michel Noel, Marianne Fay, Sudarshan Gooptu, Harun Onder,
William Dorotinsky, and Axel R. Peuker are gratefully acknowledged. The views in this paper are entirely those
of the authors and do not necessarily represent the views of the World Bank, its executive directors, or the
countries they represent.
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I Introduction
Sovereign Wealth Funds represent a large and growing pool of savings. Many are owned by
natural resource exporting countries and have long-term objectives, including inter-
generational wealth transfer. Traditionally these funds have invested in external assets,
especially securities traded in major markets for a number of reasons including sterilization
and lack of domestic investment opportunities.
Over time, and in part reflecting low returns in developed countries after the financial crisis,
their investment holdings have broadened to include real property and investments in
developing economies. Potentially competitive returns in developing economies and the
sharp reductions in traditional sources of long-term financing after the financial crisis have
contributed to fuel a growing interest among national authorities in permitting, and even
encouraging, the national SWF to invest domestically, in particular to finance long-term
infrastructure investments. Such pressure is inevitable, considering the fact that many
countries with substantial savings, several of them recent resource-exporters, also have
urgent needs. A number of existing SWFs now invest a portion of their portfolios
domestically and more are being created to play this role.
Is it appropriate to use SWFs to finance long-term development needs? Does it matter
whether these investments are domestic or foreign? This paper considers these issues, in
particular the controversial question of using SWFs to finance domestic projects motivated,
in part, by their perceived importance for development. In particular, the paper focuses on
commercial or quasi-commercial domestic market investments by SWFs in resource-driven
countries and explores the conditions that affect their ability to be an efficient and prudent
investor while fostering local economic diversification and the mobilization of private
capital.
At first sight the fit between the long-term goals of the SWF and the long-term investment
needs of developing countries appear to align. As a specialized investor, a high-capacity
SWF might also be able to bring appraisal skills to the table to help improve the efficiency of
the investment program. However, domestic investment by the SWF risks to: (i) de-stabilize
macroeconomic management and (ii) undermine both the quality of public investments and
the wealth objectives of the fund. The source of these risks is essentially that the SWF is
owned by the same entity – the government – that seeks to promote the domestic public
investments. These risks may be mitigated but not eliminated.
Naturally no approach is risk-free. For example, the level of fiscal spending can be
benchmarked by fiscal rules that emphasize sustainability, but may not be contained;
spending may also be of low quality, especially if dependence on rents weakens the
incentives for taxpayers to scrutinize expenditure. Building up large external savings funds
runs the risk of their being raided by future governments, either directly (funds are used for
purposes other than those originally intended or planned contributions are not paid) or
indirectly (through unsustainable accumulation of public debt). On the other hand, in some
views the risks of using SWFs to finance domestic public investments are so serious as to
recommend that SWF portfolios should be confined to foreign assets with all public
investment funding being appropriated through the budget.
With this backdrop, section II of the paper summarizes the limited available information on
SWFs that are permitted or mandated to invest domestically. Section III considers the
macroeconomic and management issues around the level and effectiveness of fiscal
spending and domestic public investment in resource-producing countries, and notes the
risks that may be associated with involving the SWF in their financing. However,
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recognizing that some countries have already embarked on this course Section IV proposes
approaches to mitigating these risks. Section V summarizes our conclusions.
The first priority is to ensure that domestic investments made by the SWF are considered in
the context of the public investment plan and phased to ensure a sustainable flow of
investment spending rather than destructive and costly boom-bust macroeconomic cycles.
The second priority is to create a clear separation between the government as promoter of
investments and as owner of the SWF: domestic investment by the SWF should not be used
to finance public expenditure bypassing budgetary controls. At the same time it is necessary
to build capacity for the SWF to operate as an expert, professional, investor that can
contribute positively to the quality of the public investment program. Possible approaches
include: (a) screening investments for commercial or near-commercial financial return; (b)
investor partnerships, including possibly other SWFs and development lenders as well as
private investors, to diversify risk, and increase implementation capacity; (c) institutional
design of the governance of the SWF to credibly insulate it from political pressure,
strengthen accountability, ensure oversight, and bring technical skills to bear on
investment decisions; and (d) full transparency, in particular on individual domestic
investments and their financial performance.
Some of these elements are already included in good-practice principles for SWFs, in
particular the Santiago Principles although these principles were not formulated with a
particular focus on domestic investments and may need to be strengthened in that regard.
Some countries may be able to mitigate the risks through such mechanisms. Others, with
weaker governance, will find it an uphill struggle. Especially for such countries, the risks of
using SWFs to finance development spending may outweigh the potential benefits.
II The Diversification of SWF Investments
Rich natural resource reserves, primarily hydrocarbons and minerals, offer great
development opportunity but they also expose producing countries to difficult policy
questions. How much to save for the long term and how to invest the savings? How much
to set aside in precautionary reserves to cushion the potentially damaging impact of volatile
resource markets? How to phase in large investment programs to avoid hasty and wasteful
spending in the face of absorptive constraints? SWFs can be set up to play a number of roles
(Table 1) but it is important to stress that they are only a mechanism to help address such
issues, and their establishment is no substitute for strengthening fiscal management or
improving governance (Dixon and Monk 2011). Unfortunately many countries have created
funds only to undermine them or to render them irrelevant through poor or inconsistent
policy.
