SSRN, March 2018

Sovereign Wealth Funds: Mere Fad or value added tool for African states?

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Abstract

Sovereign Wealth Funds (SWFs) have gained considerable attention recently, representing a large and growing pool of savings. African SWFs and national investment funds have been gaining in prominence over the past few years, especially in natural resource exporting countries of Africa.

Acknowledging that there is controversy about the relative merits of the SWFs and their added value, this paper discusses the multiple interests of using SWFs by African states, particularly those exporting natural resources. Attempting to contribute to the answer to the question whether African countries need SWFs or not, this paper argues that a well-structured and governed SWF with a clear and sound mandate and professional management and staffing can serve, along its traditional functions, signaling, capacity-building, and governance purposes in African states. Beyond their role in stabilizing local economies, we contend that SWFs can therefore play an important role in fostering economic and social progress as well as governance and political accountability.

1. Introduction

SWFs have introduced a new way of understanding the relationship between the state and the private sector. Described as providers of some instruments of economic statecraft, SWFs are considered as both an important source of financial independence and “tools for facilitating autonomy and sovereignty” to governments or a powerful form of protection from the global economy preying on their currency and commodity fluctuations. They are deemed to bring the tools and opportunities of modern finance into the toolkit available to government, and to have become highly liquid organizational investors in an illiquid world. Moreover, it has been contended that, over the last decade or so, SWFs appear to have developed the potential to become an important instrument in good governance and development, especially for resource rich and capacity poor developing states.

In this context, the president of the African Development Bank argued that African states should establish SWFs to build liquidity and tax buffers needed to resist economic upheavals, especially in times of falling prices of commodities. Also, it is added that the developmental nature of many African economies makes the rationale for creating a SWF especially powerful.

The existence of SWFs could be traced back to the 1950’s when Kuwait established in 1953 a SWF to manage its foreign reserves . SWFs are commonly established out of balance of payments surpluses, official foreign currency operations, the proceeds of privatizations, fiscal surpluses, and/or receipts resulting from commodity exports. Since 1999 however, two economic phenomena seem to have promoted the growth of SWFs: on the one hand, the massive accumulation of foreign official reserves by central banks and, on the other hand, the nearly inexorable rise in the world price of natural resources, even if that has not been the case in recent years. Significant revenues from commodities over the last decade explain the rise of African SWFs because they have been established mostly in countries that are rich in natural resources, with oil-related SWFs being the most common and largest group10.

Even if a widely accepted definition of what exactly constitutes a SWF has been elusive, SWFs have been defined in general terms as “government-owned and controlled (directly or indirectly) investments funds that have no outside beneficiaries or liabilities (beyond the government or the citizenry in abstract) and that invest their assets, either in the short or long term, according to the interests and objectives of the sovereign sponsor” or “special purpose investment funds or arrangements that are owned by the general government. Created by the general government for macroeconomic purposes, SWFs hold, manage or administer assets to achieve financial objectives, and employ a set of financial strategies that include investing in foreign financial assets”.

SWFs have diverse legal, institutional, and governance structures and they form a heterogeneous group, comprising fiscal stabilization funds, saving funds, reserve investment corporations, development funds, and pension reserve funds without explicit pension liabilities. Other than saving for the rainy day, SWFs are deemed of central importance in their home countries in helping to achieve macroeconomic stability and in supporting highquality growth, and in helping to improve the management of public finances. Thus, alongside inter-temporal stabilization and diversification, SWFs can also serve transparency and accountability purposes.

SWFs are however different from other known separate entities that are used to manage national wealth, namely central banks, state holding companies and state-owned enterprises (SOEs). Contrary to SOEs, governments act throughout SWFs as investors rather than owners, buying non-controlling stakes in domestic and foreign companies to realize a (short or long-term) financial return, rather than to operate these businesses as state enterprises. Central banks and state holding companies on the other hand have very different priorities such as currency stabilization, funding of specific development project, or the development of specific economic sectors. In fact, the complexity and sophistication of financial management necessitate an innovative approach beyond traditional government apparatus.

Although western financial capitalism appears biased against more statist and interventionist form of capitalism, we believe that the State is and will be a crucial actor in constructing and maintaining social and economic progress in Africa. The overarching question this paper aims to address is whether a SWF is, in this context, a mere fad or a tool with real – or at least potential – added value that can contribute to the economic and social progress of the continent. This is part of the quest of turning the commodity bonanza into a stable source of progress that delivers on economic and social desirable outcomes.

Acknowledging that SWFs are not the panacea for the problems facing African (resource rich) countries, this paper however analyzes different current and potential purposes of SWFs. It argues that a well set-up and governed SWF with a clear and sound mandate and professional management and staffing can serve, along its traditional uses, signaling, capacity-building and governance purposes in African states. In effect, the establishment of a SWF must be part of a broader package of institutional reforms designed to improve the country’s capacity for resource revenue management. SWFs might therefore contribute in creating a genuine model of economic and social progress for the continent.

This paper is structured as follows. Section 2 briefly describes the traditional uses of SWFs. Section 3 points out the signaling and capacity-building functions of SWFs. Section 4 highlights the governance and accountability functions of SWFs and Section 5 concludes and raises issues that empirical researchers sorely need to address, especially since SWFs are dynamic organizations whose interests evolve over time.


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