23 September 2011

Zimbabwe: Understanding Sovereign Wealth Funds - An MTP Perspective


IN my previous installment, I argued an Act of Parliament designating diamond or mineral resource revenues a fund for long-term development.

That fund could then be used to industrialise the economy and kick-start sustainable economic growth and development.

This week, I want to discuss sovereign wealth fund (SWF) as a source of funding not just for the medium-term plan (MTP), but also for long-term development in an inter-generational sense. I want to start by congratulating the Ministry of Economic Planning and Investment Promotion for drafting a comprehensive blueprint. The plan touches every sector and pillars of the economy.

However, beyond the drafting of a comprehensive plan, there is need to secure funding for the plan. A number of sources of funds can be identified, examples of which include debt, privatisation proceeds, sovereign wealth fund, pension funds, tax revenue, public-private sector partnerships, among others.

I intend to discuss sovereign wealth fund which is one of the major sources of finance for the MTP that the ministry identified. Questions such as: What a SWF is? How it is created? Where do the resources to create the fund come from? need to be answered and will be addressed in this discussion.

Defining a SWF

SWFs are large pools of assets or investments owned and managed by government directly or indirectly. There is a number of defining characteristics of SWFs the world over, namely, that they are State-owned; they are managed separately from official foreign exchange reserves; they have high foreign currency exposure; they have no explicit liabilities; they have risk tolerance and they have long-term investment horizons.

Resources for creating SWFs

SWFs are normally created from: foreign exchange reserves; commodity export revenue from commodities such as diamonds, gold, platinum, coffee and tea, tobacco, cotton, etc; proceeds of privatisation and fiscal surpluses

Types of sovereign wealth funds

In the history of nations, a number of fund types have been created depending on the challenge to be addressed or the vision the political leadership has about the envisioned development trajectory of the nation. Examples of types of SWFs include:

- Stabilisation funds

These are normally set up by resource-rich countries so that they provide budgetary support and insulate the economy from international commodity price volatility. These funds are set up in boom times and will be drawn upon when commodity prices tumble and also when there is a shortage of reserves e.g. reserve fund of Russia, which is a stabilisation fund.

- Savings funds

These are funds set aside by government for long-term wealth creation to meet future needs. The fund is set up from commodity revenues or fiscal surpluses.

Economic sustainability requires that national wealth be non-decreasing over time. The Hartwick rule is at the heart of this principle. It requires that resources generated from mineral exports be reinvested in other forms of capital (physical, financial and human) to offset depletion.

The rule states that a resource-rich country must invest depletable natural capital revenue such as mineral proceeds into man-made physical and human capital so that future generations benefit from the same natural endowments although in a different form, that is, man-made capital.

The idea is to promote inter-generational equity by diversifying the economy away from natural resource dependence to industrialisation and service sector development. The Alaska Permanent fund of the US is an example of a sovereign fund.

However, institutional weaknesses and poor governance in developing countries often lead to resource curse - a situation in which resource-rich countries are growth disasters. Why? Rent seeking behaviour and state capture by some powerful interest groups may lead to recurrent as opposed to capital expenditure.

To circumvent these challenges, a commitment rule that establishes credibility and transparency in resource rent handling can be enacted in the form of a constitutional provision that designates a certain proportion of the rents from certain minerals to long-term developmental projects, infrastructure and industrialization. A constitutional provision is the easier way to go because it is difficult to change/amend.

Pension reserve funds

These are funds set aside to specifically fund future pension expenditures. They are owned by government and are treated as SWFs.

Looking at African countries, we see that oil-rich countries that set up SWFs recently have managed to accumulate huge funds of at least US$57 billion. The only exception is Nigeria which has only established a SWF just recently in 2004 and the fund is a paltry US$500 million.

It is surprising because Libya set the fund later in 2006, two years later than Nigeria, but has managed to accumulate US$70 billion. This indicates governance challenges and the attendant resource curse problem in Nigeria.

Looking at Botswana, it has accumulated about US$7 billion in SWF assets since 1996. However, diamonds and other non-oil minerals are low-value minerals compared to oil and the size of this fund indicates a committed governance paradigm that stops at nothing but building a strong developmental state.

Zimbabwe has every reason to learn from these countries if it will successfully set up the fund. In order to realise maximum financing, there is need to carry out country studies of those nations that managed to create and sustain SWFs. The institutional, administrative and policy frameworks guiding the operation of such funds should be particularly paid attention to.

That notwithstanding, I have a few views on how the SWF for Zimbabwe can be operationalised:

i. The fund must be a semi-independent quasi-governmental investment special purpose vehicle;

ii. The fund must be set up by a constitutional provision so that it will not be a stop-gap measure, but will remain in the nation for generations to come;

iii. The fund must be accountable to the House of Assembly;

iv. The fund must provide capital to domestic firms; a nd

v. The fund must manage domestic assets and dispose of non-performing loans

In conclusion, I think with the mineral endowment of the country, recovery, growth and development can easily be attained if there is such a commitment on the part of our political leadership. Setting up a SWF is the best way to go.

- Disclaimer: The views expressed in this article are those of the author and not necessarily of the Zimbabwe Economics Society (ZES). ZES articles are co-ordinated by Lovemore Kadenge and he can be contacted on lovemo

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