The wealth fund bonus

The recession is proving to be a problem for countries which were profligate in the boom times of 2009 onward. Countries which binge-spent, are facing the effects of that today. In particular, developing countries where the economy is dependent on commodity exports (like oil) are facing severe problems.

Nearly all economies in the world will be impacted negatively because of COVID-19. But countries which have saved and invested their tax revenues will do far better than countries which splurged before.

A sovereign wealth fund is an investment vehicle for the government. Most governments get money for their sovereign wealth funds from the production of a commodity like oil or from tax revenues. Whatever money they get from selling that commodity or from tax revenues, they invest it in various assets like stocks, bonds, real estate, or sometimes owning companies outright.

This does two things for the government: it diversifies it from the main economic activity in its country, and it provides a source of savings which it can draw upon in future times.

This not only provides a source for stabilizing government expenditures in a downturn, it can also provide a source of capital for companies in and outside the country.

The current economic crisis is the best example of that. Countries with sovereign wealth funds are drawing down on past investments to fund spending today. Take the case of Singapore:

Singapore’s two SWFs Temasek and the Government Investment Corporation have been invested in stocks, bonds and real estate in Singapore and around the world. This produced incomes when the economy was doing well, and the invested money could be used during budget shortfalls.

That is exactly what has happened this time. Last month the President of Singapore authorized the government to draw on $21 billion of past reserves from the sovereign wealth fund. Singapore does not need to borrow in the open market or ask for loans from the IMF, or ask other countries to bear its debt (like Italy and Greece). This is also a source of capital for domestic industries.

They have financed the growth of crucial industries including banking, airlines and telecommunications. Temasek is the largest investor in many large Singaporean companies including :- Singapore Airlines, DBS and Singtel.

To make things better, Singapore has no net debt, and is rated AAA by all three major credit rating agencies.

The same is true for Norway with its massive sovereign wealth fund. Norway had a large discovery of oil in the 1960s. In 1990, they wanted to start diversifying the economy, and provide a base for the future.

Yngve Slyngstad, The CEO of the Norwegian Sovereign Wealth Fund. Source: Bloomberg

The Norwegian wealth funds are the largest in the world amounting to almost 1.2 trillion of assets. The government of Norway is allowed to remove only 3% of the fund every year, so the value of the investments is preserved.

As a result of these investments made many years ago, today these governments are safe economically from the pressure of the coronavirus.

We do not know what economic misfortune will hit a country many years in the future. But looking at history, it is enough to say that the will be some problem or the other. It is prudent when the recovery starts, for governments to start looking at setting up a sovereign wealth fund. It would reduce the dependence on the debt markets, and provide capital for domestic industries.

While they may not see the benefits of it immediately, the next few generations will definitely see the benefits of a Sovereign Wealth Fund.