Guardian

RECENTLY, Nigerian joined the leagues of countries with Sovereign Wealth Fund (SWF). However, many questions are being asked about the desirability of such fund in Nigeria and most importantly, what the country stands to gain from it.  In this piece, ENITAR UGWU, with experts’ views tries to address the issues raised.

IN the Nigeria economic clime the term Sovereign Wealth Fund (SWF) is certainly new.

However it must be stated that its introduction into our economic lexicon is borne out of past experiences and the current trend of events.

According to Wikipedia, a Sovereign Wealth Fund (SWF) is a state-owned investment fund composed of financial assets such as stocks, bonds, property, precious metals or other financial instruments.

Sovereign wealth funds invest globally. Some of them have grabbed attention making bad investments in several Wall Street financial firms including Citigroup, Morgan Stanley, and Merrill Lynch. These firms needed a cash infusion due to losses resulting from mismanagement and the subprime mortgage crisis. Most SWFs are funded by foreign exchange assets.

Some sovereign wealth funds may be held by a central bank, which accumulates the funds in the course of its management of a nation’s banking system, this type of fund is usually of major economic and fiscal importance. Other sovereign wealth funds are simply the state savings which are invested by various entities for the purposes of investment return, and which may not have a significant role in fiscal management.

The accumulated funds may have their origin in, or may represent foreign currency deposits, gold, SDRs and International Monetary Fund reserve positions held by central banks and monetary authorities, along with other national assets such as pension investments, oil funds, or other industrial and financial holdings. These are assets of the sovereign nations, which are typically held in domestic and different reserve currencies such as the dollar, euro and yen. Such investment management entities may be set up as official investment companies, state pension funds, or sovereign oil funds, among others.

There have been attempts to distinguish funds held by sovereign entities from foreign exchange reserves held by central banks. Sovereign wealth funds can be characterised as maximising long term return, with foreign exchange reserves serving short-term currency stabilisation and liquidity management. Many central banks in recent years possess reserves massively in excess of needs for liquidity or foreign exchange management.

Moreover it is widely believed most have diversified hugely into assets other than short term, highly liquid monetary ones, though almost no data is publicly available to back up this assertion. Some central banks have even begun buying equities, or derivatives of differing ilk (even if fairly safe ones, like Overnight Interest rate swaps). Sovereign wealth funds are generally not keen to publish information about themselves.

Speaking on the development, Chamberlain Peterside based in New York noted that hitherto, this bill, the Excess Crude Account (ECA) was the main financial nest-egg set up by Obasanjo’s administration about five years ago to provide a buffer for the country’s perennially precarious financial condition that was prone to the vagaries of incessant crude oil price fluctuation.

At its peak the ECA accumulated over $20 billion in 2007 before it was drawn down by late President Yar Adua’s cum Jonathan’s administrations.

Some might question - of what use is the funds anyway if not to help the country tarry along in difficult times? After all the money in the ECA came very handy this past 2-3 years on the heels of the global financial meltdown of late 2008, which was made worse by incessant militant attacks on the petroleum industry that drove production to the lowest level in 20 years. Save for this financial cushion, Nigeria and the respective state governments might have been in financial dire straights. I personally can’t argue with that assertion.

But thanks to a resurge in crude oil prices, the ECA (that will hopefully soon transform to SWF) currently stands at over $6 billion. Over the last few years since Nigeria devised a smart but controversial means of tucking away some of its windfall oil revenue in both the excess crude and foreign reserves accounts, the country has been speared the ugly episodes of boom-burst cycles that characterised its financial life and economy during the 1980s and 1990s.

It is to the credit of Obasanjo’s administration and the former Finance Minister, Mrs. Ngozi Okonjo-Iweala that such a creative policy tactic was conceived and aggressively pursued despite spirited opposition from the state governors and continued debate on its constitutionality, he said.

It makes you wonder how the country had thrived all along without such a downside-protection even when the bulk of its revenue (over 85 per cent) accrues from the export of a single product - crude oil. The SWF indeed will take public finance management to a whole new pedestal, but that’s if the usual Nigerian factor doesn’t bedevil the effort in prudently and sustainably managing the allocated funds.

The take-off fund is currently $1 billion as we are told, but better yet if the bulk of current ECA is transferred to the SWF a substantial start-off point will then be about $5-$7 billion, which is palpable by Nigerian standard but still a far cry and quite modest compared to the size of other notable SWFs, namely the Abu Dhabi Investment Authority - $875 billion, Singaporean Investment Fund (Temasek) $150 billion, Chinese Investment Corporation - $150 billion.

The gains of the SWF concept in any economy cannot be over emphasised. To be sure, Nigeria still maintains one of the highest external reserves level on the continent at over $33 billion. Which is sufficient to cover its import-bill for several months over thereby providing required balance of payment stability. The Nigerian SWF therefore must have a different profile. An investment philosophy that emphasizes savings/principal protection and capital appreciation element with conservative to moderate risk-appetite over a long-term horizon will be quite appropriate for the proposed SWF account.

Whereas the activities of the SWF – nay its funding mechanism and operating model should be synchronised with the country’s public finance policy strategy, depending on the specific mandate enunciated by the enabling legislation, the vision should be in not only squirreling away some money for the rainy day and for the future generation by not consuming all that we earn, but efficiently but carefully deploying portion of our resources in investment vehicles that should yield dividends (current income) and smoothen out oil-price volatility thereby providing downside protection.

At the end of the day, the country will be far better off by safeguarding portion of its export revenue while investing in vital sectors like critical infrastructure at home, or hard and liquid assets in the global market that can compliment the local economy and deliver multiplier effect on domestic productivity - the rest is in the detail, as they say.

To that end the investment policy statement should be clearly spelt out ahead of time and remain the overarching statute of the SWF. The caliber of professionals entrusted with co-ordinating activities of the fund is the second most crucial success-factor. Here again utmost caution and due process must be the abiding parameter in appointing personnel to key decision-making roles.

The easiest way to kill such a lofty idea is to install incompetent or tainted people with questionable finance industry background simply based on connection or political patronage. The third main issue is to give the fund and its operating team a free hand to run the show, of course with proper oversight by the presidency through the minister of finance and national assembly.

Similarly, former Minister of Finance, Olusegun Aganga had explained that the fund would straighten the fiscal framework of Nigeria for better management of resources.

He also noted that, It is expected to serve as a vehicle that would help achieve capital and reserve appreciation for sustainable development, as well as, serve as catalyst for attracting local and international investors to Nigeria, he explained.

Aganga said gains from excess crude would be managed by the fund in a more transparent and accountable manner because the fund would be private sector driven and a proposal has been drawn to ensure that a minimum 20 percent of whatever is available in the fiscal year is saved in the fund.

He said the fund would help augment the budget for sustained growth in times of falling currencies and would help boost the local industry especially agriculture and infrastructure development.

“The sovereign wealth fund is a good development for Nigeria because monies made available in the fund would be savings for the future generation.

“It is going to be managed by the private sector through a council made up of shareholders (Nigerians), all the state governors and representatives of the private sector but it would be presided over by the president or his vice and would also have a management board consisting of a chairman, manager and appointed staff based on proven track record,” he said.

Meanwhile, Wikipedia explained that such funds are typically created when governments have budgetary surpluses and have little or no international debt. This excess liquidity is not always possible or desirable to hold as money or to channel into immediate consumption. This is especially the case when a nation depends on raw material exports like oil, copper or diamonds.

In such countries the main reason for creating a SWF is because of the properties of resource revenue: high volatility of resource prices, unpredictability of extraction and exhaustibility of resources.

There are two types of funds, saving funds and stabilisation funds. Stabilisation SWFs are created to reduce the volatility of government revenues, to counter the boom-bust cycles’ adverse effect on government spending and the national economy. Savings SWFs build up savings for future generations.

One such fund is the government Pension Fund of Norway. It is believed that SWFs in resource rich countries can help avoid resource curse, but the literature on this question is controversial. Governments may be able to spend the money immediately, but risk causing the economy to overheat, e.g. in Hugo Chávez’s Venezuela or Shah-era Iran. In such circumstances, saving the money to spend during a period of low inflation is often desirable.

Other reasons for creating SWFs may be economical, or strategic, such as war chests for uncertain times. For example, the Kuwait Investment Authority during the Gulf war managed excess reserves above the level needed for currency reserves (although many central banks do that now).

The government of Singapore Investment Corporation and Temasek Holdings are partially the expression of a desire to bolster Singapore’s standing as an international financial centre. The Korea Investment Corporation has since been similarly managed.