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IMF wakes up to threat from sovereign funds

AFTER European policymakers and Reserve Bank of India, the International Monetary Fund is now awakening to the potential threat by the sovereign wealth funds (SWF). 

    In its latest World Economic Outlook released on Wednesday, the fund has expressed concern that the growing presence of SWFs have the potential to impact global financial stability and the key parameters in the US markets if they choose to diversify their currency portfolio mix. Though many central banks that promote such funds predominantly hold their foreign exchange reserves in dollars and dollar-based assets, the same does not hold true for stylised SWFs. “Compared to reserve assets, which are predominantly dollar-denominated and generally held in the form of US Treasury bills or agency securities, the stylised SWF portfolios are more diversified across both asset classes and currency exposure.’’ the IMF has said. 
    An IMF analysis suggests that the pattern of global capital flows would change significantly, with advanced economies facing lower capital inflows and emerging economies attracting substantially larger inflows.This suggests reduced inflows into government bond markets, with attendant implications for interest rates. The shift away from reserve assets could have the most significant effect on markets in the United States, if countries diversify away from dollar holdings, the fund said in its report. 
    Market estimates suggest that assets under management of SWFs exceed assets managed by hedge funds ($1.9 trillion)—and account for about onefourth to one-third of foreign assets held by the central banks of the economies that have floated such SWFs. Although SWF assets remain small relative to total global financial assets (about $190 trillion), they are large compared to the stock market capitalisation of even mature market and also some debt and capital markets in emerging economies. But SWFs’ portfolios is often invested in nonfinancial assets, such as real estate. SWF assets are projected to surpass the stock of global foreign exchange reserves in the not-so-distant future and to top $7 to $11 trillion by 2013 . 
    Thus it is clear that SWFs will play an increasingly prominent role in global financial scene. Against this background, a key concern is the impact of the growing presence of SWFs on the pattern of global capital flows, asset prices, and financial stability more generally.

Article from ET dated 10th October 2008