from Follow the Money

Sovereign Economic Development Funds ….

May 12, 2008

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Sovereign funds argue that they are only interested in financial returns.

And to be sure, they do care about financial returns. Losing money generally isn’t good for a sovereign fund’s long-term health. But many are also expected to at least try to invest in ways that contribute to the economic development of their home country. This is often quite explicitly part of the fund’s mandate. Qatar’s investment fund indicates that its investment criteria include “economic synergies or benefits for Qatar and its people."

Gerald Lyons of Standard Chartered has recognized that sovereign investments are sometimes motivated by concerns that go a bit beyond risk-adjusted return. Stephen Foley reported a while back:

Gerard Lyons, chief economist at Standard Chartered bank and a leading expert on SWFs, said in a recent panel discussion in Washington that funds’ behavior is likely to be a mixture of commercial consideration and "state capitalism", where investments are likely to reinforce particular government goals, such as spurring the development of natural resources in Africa – already a key area of Chinese government investment.

Finding investments with positive spillovers and synergies is often hard -- see Reuter’s Alan Wheatley for an excellent discussion of the constraints sovereign funds face. The most obvious way to promote domestic economic development would be to invest at home rather than to invest abroad. But if a fund exists to manage surplus foreign exchange accumulated to resist pressure for appreciation, it has to invest abroad.

Or at least appear to invest abroad. An investment abroad that triggers a reciprocal domestic investment doesn’t produce a net outflow.

Examples of investments that seemed geared toward promoting the home country’s own economic development are not hard to find.

Mubadala’s investment in Ferrari likely contributed to Ferrari’s decision to build a theme part in Abu Dhabi.

Dubai’s interest in the NASDAQ stemmed from its desire to cement its position as a regional financial center.

Dubai now seems to intend to use its sovereign fund – DIC – to raise the profile of the Dubai International Financial Center. DIFC has had trouble attracting listings. No problem. Firms that the DIC invests in will be encouraged to list on the DIFC. Roula Kalaf in the FT, last week:

DIC is putting $500m into the $1bn fund, set up with Hong Kong-based First Eastern Investment Group, and designed to invest in small and medium-sized companies with the hope of bringing some of them public on the Dubai International Financial Exchange.

While expressing his disappointment with the performance of the DIFX to date – it still has few companies trading and one expected initial public offering was pulled last week – Mr Ansari insisted that the exchange was headed for “revolutionary change” once its tie-up with Nasdaq is implemented.

The new Saudi fund -- which thinks of itself as an investment fund rather than wealth fund -- also seems to have a mandate that is focused as much on domestic economic development rather than increasing the returns on the Saudis investment abroad. The Saudi finance minister, quoted in Reuters:

"The focus at the beginning may be on the technology sectors, especially in the fields that could attract technology to the kingdom in alliance with global companies," Ibrahim al-Assaf told Al Arabiya television. The focus would be on investments inside the world’s largest oil exporter, where opportunities abound, Assaf said, adding foreign investment was not ruled out.

Countries have long required that companies wanting to do business with their government show their bona fides by buying locally made parts. Airline orders are an example. Seeking to use the state’s buying power to spur economic development isn’t new.

However, the scale of the funds now at the disposal of many emerging market governments is something that is new. The Gulf’s city-states efforts to use their foreign investments to bolster their efforts to transform themselves into regional financial centers hardly seem to threaten US or European interests – or jobs. Europe, though, has been far more worried by the purchases of a stake in EADS by a Russia’s state bank. And it does seem -- based on the Wall Street Journal’s reporting -- that Russia’s government hoped that VTB’s stake in EADS would prompt EADS to do more to support Russia’s aerospace industry. MORE FOLLOWS

Gregory White, Bob Davis and Marcus Walker of the Wall Street Journal:

Russian state-controlled bank OAO Bank VTB, where Mr. Kudrin is chairman of the board, revealed in September 2006 that it had accumulated a 5% stake in aerospace giant European Aeronautic Defence & Space Co., which owns airplane maker Airbus.

VTB executives said they were investing simply to make money, but senior government officials made clear broader Kremlin goals were also at play. Days after the bank’s stake became public, Mr. Putin’s top foreign-policy adviser, Sergei Prikhodko, said Russia might raise its stake to over 25% -- enough to block major decisions. If it were armed with such a bargaining chip, Russia could then push for cooperation between EADS and Russia’s ailing aerospace industry, Mr. Prikhodko said.

This bear hug went too far for France and Germany, the countries with the biggest ownership stakes in EADS. Paris and Berlin see EADS as a sensitive strategic company, not least because it supplies military technology, including the ballistic missiles for France’s nuclear submarines. Falling partly under Moscow’s sway would threaten EADS’s cherished aim of winning more business in the U.S., the world’s largest defense market.

At a meeting in France with Mr. Putin in late September 2006, French President Jacques Chirac and German Chancellor Angela Merkel told him they didn’t want another partner for their prized aerospace company. They said EADS’s inner circle of controlling shareholders, which include the French government and Germany’s Daimler AG, wouldn’t allow anyone else in.

France and Germany didn’t object to foreign governments making purely financial investments in EADS. In 2007, the government of Dubai would buy a 3% stake in EADS, arousing no major fears. But the Kremlin, many West European officials believed, might use its investments to strong-arm its partners.

Kremlin officials sought to ease the controversy during a private dinner with German business leaders at Berlin’s luxurious Hotel Adlon early last year. Russian presidential aide Igor Shuvalov said the purchase had been a gesture of support for the Franco-German company, and he was surprised at the ferocity of the response, participants say. But he only deepened suspicions of Moscow’s motives when he added that Russia might dump its stake if EADS wasn’t more forthcoming about cooperation projects with Russia’s aerospace industry.

Concerns about Chinese investment in Australia’s resource sector are also mounting, in part because many in Australia are still trying to figure out Chinalco’s motives for buying into Rio.

Despite briefings by chairman Xiao Yaqing in Britain and Australia, we still don’t know why Chinalco borrowed so much for the venture. To earn a fat profit by realising its holding as BHP is forced to up its bid? To reap increased earnings by backing negotiations for a higher price for the ore Rio sells? To please China Inc by blocking the BHP bid for Rio, and to slash the price for Rio’s ore? Simply to make BHP’s bid harder?

While some investment moves are transparently obvious, similar questions may be asked of other would-be deals in the sector. Oddly, despite China’s reputation for being a long-term player, its business sector sometimes suffers from the reverse, rushing to meet politically driven short-term timetables.

And I wonder how various African and Latin countries will respond to China’s reported plans to secure its supply of agricultural imports by investing abroad.

It sounds though like China -- or at least is China’s agricultural ministry-- wants its own sovereign agricultural development fund. The state soybean fund? I suspect most parts of China’s bureaucracy have their own idea for how to make better use of China’s external assets ...

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