The Boom in African Sovereign Wealth Funds
Jan 11th 2013
Despite sustained global economic uncertainty, global sovereign wealth funds (SWF) assets have increased to USD5.16 trillion in 2012 from USD3.98 trillion in 2011. There is a strong positive association between the value of total SWF assets and commodity prices. In recent years, with the sustained rise in commodity prices, significant revenues from commodity exports have led to the establishment of SWF in a number of African countries, especially by oil/gas exporters. Currently, 58% of SWF assets worldwide are derived from oil and gas revenues. Major global players of SWFs include China, Middle East and Norway which cumulate more than two-third of global SWFs’ assets.
Currently Africa accounts for 14 SWFs with a total amount of USD114 billion in 2009, representing 3% of global SWFs. The largest sovereign funds are the Libyan Investment Authority and Algeria’s Revenue Regulation Fund with respectively USD65 billion and USD56.7 billion of total assets. However, in comparative terms, this is disproportionately lower than the Norwegian Government Pension Fund’s USD656 billion and USD627 billion managed by Abu Dhabi Investment Authority, the world’s two largest sovereign funds.
Africa’s contribution could increase in future with the establishment of new SWFs. In 2012, three SWFs have been launched in Angola, Ghana, and Nigeria while the Tanzanian government has announced plans to create its sovereign fund to manage the country’s revenues from new gas and oil discoveries.
In addition, recent major oil and gas discoveries in East and West Africa are likely to give new opportunities for more African SWFs in the mid-term to foster management of revenues from these new resource discoveries.
Motivations behind SWFs
The main purpose of a SWF is to ensure that resources of a country are preserved for future generations. Yet, there is controversy about the merits of such funds. On the one hand, advocates for SWFs argue that these funds can help boost economic growth and prosperity for current and future generations. Conversely, critics posit that these funds could give too much power to governments and could switch the global economy away from liberalism and therefore hamper market competitiveness.
Moreover, SWFs could be a source of threat of national security in recipient countries if they are used by investors for political rather than economic purposes.
A SWF is also set in order to stabilize government fiscal and/or foreign exchange revenues and macroeconomic aggregates by smoothing out fluctuations in prices of export commodities.. A majority of Africa’s SWFs are established for the purpose of price and revenue stabilization. Over the past years, resource-rich African countries have accumulated significant excess reserves from exports of natural resources. In the short term, because of commodity price fluctuations observed during the past years, countries have put in mechanisms to smooth their revenues/expenditures in order to ensure a better control of government expenditure planning. By creating SWFs, policymakers try to smooth the volatility of resource-driven revenues by lowering the effect of boom and bust cycles resulting from volatility in commodity prices. In this way, SWFs could be used to absorb large foreign exchange surpluses.
Furthermore, wealth diversification is another motivation for the widespread use of SWFs around the world. Prudent diversification of the natural resource generated wealth reflects a responsible approach for management of the country’s assets. In some countries, the decision to create SWFs may be triggered by other factors such as supporting sustainable spending by the government, and reducing political temptation for malfeasance and corruption in the use of natural resource revenues. Thus, investing in SWFs rather than in traditional central bank’s reserve assets could reduce opportunity costs of reserves holdings and could shift the focus on return generation by the fund.
What Role SWFs could play in Africa?
Promoting intra-African investments and enhancing productivity: African SWFs can enhance productivity and spur intra-African investment through allocating part of their assets to growing sectors in Africa. For instance, the newly launched Angolan SWF is designed to target investments in Sub-Saharan Africa primarily in infrastructure and hospitality sectors. Other Sub-Saharan African sectors targeted by the Angolan Fund include agriculture, water, power generation and transport. Thus, African SWFs may benefit from the growth potential of African countries which offer significant wealth creation opportunities.
Fostering the role of the private sector: The SWFs are generally oriented towards investments in global financial markets rather than in emerging or developing countries. However, African countries can use their own SWF assets to invest in domestic companies to boost growth and to create jobs through spurring private sector’s role. The SWFs in Africa may position themselves beyond the objective of macroeconomic stabilization and focus on maximization of investments and returns especially in domestic assets. Moreover, SWFs can indirectly foster the private sector by supporting sound fiscal and monetary policies. This can prompt a fiscal-friendly environment for private sector companies.
Difficulties Hampering the Development of African SWFs
African SWFs are encountering many challenges that slow their expansion. Governance, especially lack of transparency and accountability are the most important issues facing SWFs in Africa. Recent evidence indicates that African SWFs have low levels of transparency as measured by the Linaburg-Maduell Transparency Index. In Nigeria for instance, lack of transparency has led to constant political wrangling between federal governments and states. Over the long term, lack of transparency and accountability, and weak institutions could lead to risk of expropriation and corruption. African SWFs are also facing internal risk management issues including operational and financial risks which tend to be high for new organizations in developing countries.
Professor Mthuli Ncube is the Chief Economist and Vice President of the African Development Bank, and holds a PhD in Mathematical Finance from Cambridge University, UK, on “Pricing Options under Stochastic Volatility”.