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The Wealth of Nations: SWFs and their Impact on Economic Growth

May 29, 17:52 UTC+3
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Governments establish sovereign wealth funds (SWFs) to maintain financial stability during crisis and to use them as a global investment tool. Most of these funds are financed by hydrocarbon export revenues. Financial crises force governments to rethink their SWF management strategy. Russia sticks to a conservative policy with its SWFs, which means that weaker oil prices hamper funding and reduce the anti-crisis buffer.

A sovereign wealth fund is an investment fund (often state-owned, although there are exceptions – Alaska Permanent Fund (US), China Investment Corporation, etc.) that invests in equities, fixed income, real estate, and/or other FX-denominated financial assets.

  • SWFs mainly serve to cover the budget tdeficit in an adverse economic environment or to build up surplus export revenues that can be later invested into various projects.
  • The first SWFs were established during the 1950s (Kuwait, Venezuela) and did not become widespread until the turn of the century. Some of the largest SWFs are the Government Pension Fund of Norway (SPU), the Abu Dhabi Investment Authority (United Arab Emirates), etc.
  • In 2004, the Russian Government established its Stabilisation Fund to accumulate revenues from the export duty for oil and the tax on oil mining operations when the oil price exceeded the set cut-off price. In 2008, the Stabilisation Fund was split into the Reserve Fund and the National Wealth Fund.

The booming quantity and quality of SWFs was mostly due to strong oil prices in the early 2000s. However, the commodity market crisis has forced SWFs to alter their strategy in favour of investment in high-yield stocks and alternative assets (for example, real estate).

  • The Government Pension Fund of Norway invests in high tech companies (Apple, Alphabet, Microsoft) and non-oil-and-gas assets (Nestle, etc.).
  • Last year, the Public Investment Fund of Saudi Arabia invested USD 50 billion in overseas assets (mostly tech companies). For example, in June 2016 the fund invested USD 3.5 billion in Uber.
  • The Qatar government plans to open an office in Silicon Valley (US) to diversify into technology startups.

Russian SWFs ensured a relatively painless financial crisis of 2008–2009 and have since been supporting the nation’s economic stability, which has depleted their resources

  • In December 2016, for the first time in its history, the Reserve Fund dipped below RUB 1 trillion. As of late April 2017, it stood at RUB 931.25 billion, or USD 16.34 billion, while the size of the National Wealth Fund amounted to RUB 4.1925 trillion, or USD 73.57 billion.
  • According to the 2017 federal budget law, the Reserve Fund will be fully used up this year, and the government will move on to the National Wealth Fund. The plan is to cover the budget deficit with RUB 1.061 trillion from the Reserve Fund and RUB 663.5 billion from the National Wealth Fund.

However, the growing oil prices have mitigated the risk of the buffer being fully depleted.

  • The country may maintain the Reserve Fund and do without capital injections from the National Wealth Fund. To make it possible, oil prices need to remain at USD 50 per barrel, as all the extra revenues (upwards of USD 40 per barrel) will be channelled to the Reserve Fund.

Due to their structure, Russian SWFs accumulate practically no money amid low oil prices.

  • The Ministry of Finance reported a USD 0.16 billion increase in the Reserve Fund during January–April 2017, while in rouble terms there was a drop of RUB 42 billion (from RUB 973 billion to RUB 931 billion). In other words, the interest on the Reserve Fund assets invested in foreign currency accounts with the Bank of Russia fails to offset the exchange rate gap upon the revaluation of assets.
  • Around 40% of the National Wealth Fund's assets have been allocated to infrastructure projects (Baikal–Amur Mainline, Trans-Siberian Railway, etc.), ROSATOM projects, and Russian Direct Investment Fund (RDIF) initiatives. However, in 2015 it was resolved to not draw from the National Wealth Fund to finance new projects, and some of the approved projects may have their financing suspended. According to the Ministry of Finance, the annual interest on the loans issued by the National Wealth Fund to projects amounts to 6.5% in foreign currency and 23.63% in roubles. The annual US and EU sovereign bond yields (in dollars and euros, respectively) are 1%. 
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