Focus on Gazprom, Not Sovereign Wealth Funds
by Anders Aslund, Peterson Institute for International Economics
Op-ed in the Moscow Times
November 8, 2007
© Moscow Times
Until recently, the world of finance appeared to move toward transparent, publicly traded private corporations, but recently an opposite trend is apparent. Nontransparent forms of investment, such as hedge funds, private equity funds, and sovereign wealth funds, are surging.
Meanwhile, the global trend toward privatization has been somewhat impeded. Central banks have accumulated large international currency reserves, and they have prompted the creation of new sovereign wealth funds. A couple of countries, such as Venezuela and Russia, are even experiencing outright renationalization.
What do these new developments amount to? Recently, Financial Times columnist Martin Wolf wrote about “a brave new world of state capitalism.” Attention is increasingly turning to the rapidly expanding sovereign wealth funds.
In a new Policy Brief of the Peterson Institute, Senior Fellow Ted Truman has sorted out many of the issues involved. Currently, sovereign wealth funds are assessed at $2 trillion to $2.5 trillion, and some forecast that they will grow to $12 trillion by 2015, which is the current level of the US gross domestic product (GDP).
During the oil boom in the 1970s, early sovereign wealth funds arose in oil-producing emirates such as Kuwait and Abu Dhabi, which has the largest fund of $600 billion to $700 billion. Norway established a fund for its excess oil income in 1990. As an exception, Singapore has accumulated two large funds not based on oil incomes. China and Russia have recently instituted large sovereign wealth funds. Moscow’s soaring stabilization fund of $148 billion is the fifth-largest sovereign fund.
The origin of these funds is rising international reserves based on large current account surpluses. In OPEC countries, these surpluses are due to extraordinary oil revenues; in China, they are due to undervalued exchange rates; and in Russia, they are due to both circumstances. China’s international reserves of $1.43 trillion are the biggest in the world and amount to about half of its GDP. Russia’s international reserves of $441 billion exceed one-third of its GDP.
To a considerable extent, these large international reserves are a reaction to the Asian and Russian financial crises of 1997 and 1998. The countries that were hit by this crisis realized that they could not rely upon the International Monetary Fund as a fire brigade and that they needed to create their own sufficient reserves. It is commendable that the East Asian and former Soviet states have adopted such conservative fiscal policies.
The ballooning reserves, however, are a result of undervalued exchange rates. By purchasing foreign currencies and issuing rubles, the Central Bank is boosting the money supply and generating inflation. Indeed, the country’s dominant economic concern today is rising inflation. The government would be well-advised to let the ruble exchange rates appreciate to reduce inflation. As a consequence, the excessive reserve accumulation would dwindle.
Nor does it make much sense for Russia to hold sterile reserves amounting to one-third of its GDP. Investing its reserves cautiously in treasury bills, the state generates little return on this huge capital. That is the reason why Western countries do not maintain larger reserves than necessary. The real nightmare is that the reserves will be stolen, which the Finance Ministry obviously worries about.
The natural conclusion in countries with large international reserves is to transfer some reserves to a national wealth fund—either a stabilization fund designed to safeguard against oil price fluctuations, as in Russia, or a fund for pensions or future generations, as in Norway, Singapore, and Kuwait. These funds are built up by state savings through budget surpluses.
Russia’s stabilization fund is easy to defend as a cushion for great fluctuations of the prices of oil and gas, which comprise 63 percent of the country’s exports. A pension fund, like the one in Norway, also makes sense, as long as the state takes the main responsibility for pensions.
Funds for future generations, as Russia will introduce in February, are a paternalistic idea, however, because they assume that citizens are so irresponsible that they cannot be entrusted with their own savings. It would make more sense to cut taxes and let citizens save and invest themselves.
The nature of the political regime matters as well. The only democratic country with a large sovereign wealth fund is Norway. Since the Norwegian fund was established in 1990, every incumbent government has lost elections because the opposition has proposed all kinds of expenditures from the abundant fund. It is difficult to democratically defend a public fund that exceeds the evident needs of international reserves. The natural conclusion is that it should not be formed at all.
Rather than discuss the problems of sovereign wealth funds, we should focus on their poor justification. If international reserves exceed a certain level, exchange rates should appreciate, which should impede the accumulation of reserves. A certain stabilization fund for export price fluctuations can be defended, but only within reasonable limits. Funds for future generations may make sense in places such as Kuwait and Abu Dhabi, which have finite natural resources, but they make no sense in large, multifaceted countries like Russia or China.
The current Western concern is that sovereign wealth funds from oil-producing countries and China will buy up large swathes of Western economies. A similar worry arose with Arab investments in the late 1970s and with Japanese real estate investments in the late 1980s. But inexperienced foreign investors tended to lose money and they had amazingly little impact. Do you remember when Mitsubishi bought half of Rockefeller Center in Manhattan in 1989 at the top end of a real estate boom? They lost big.
In Russia, the fund for future generations is likely to be the most transparent and cautiously managed public money. The tentative policy is to let the fund be professionally managed by several external companies in small and diversified investments. Global stock markets are likely to be happy with the Russian contribution. It is less obvious that Russia’s taxpayers should welcome it.
The outside world is most concerned about Gazprom investments—and justifiably so. With a market capitalization of $280 billion, Gazprom is a far greater financial force than what Russia’s fund for future generations will be for a long time. Moreover, Gazprom’s policy is explicitly monopolistic, prohibiting competitors and independent companies from access to its pipelines. Although Gazprom is publicly traded and files international accounts, it is not very transparent, as is evident from its insistence on using RosUkrEnergo as an intermediary for gas trade with Ukraine. By bringing former German Chancellor Gerhard Schröder on board, Gazprom has illustrated its interference in European politics.
Western policy should focus on the transparency and deregulation of state-dominated monopolies such as Gazprom and its counterparts in the West, rather than concentrating on the comparatively benign wealth funds. Sovereign wealth funds, however, are more likely to be a cross than a benefit to the nation.