Why A Sovereign Wealth Fund Will Not Solve India’s Capital Shortage

A sovereign wealth fund will hurt, not help, economic expansion and job creation in India says Romar Correa

(Photo: Unemployed Indians waiting in line to apply for jobs.)

September 25, 2024

By Romar Correa*

Government-run companies, or public sector enterprises as they are called in India, fill in the blank spaces of an economy which are ignored by private companies. Given their focus on earning profits, private owners do not invest in businesses where demand, supply and pricing are not favorable.

In India, the original role of government-run enterprises was to invest large sums in major infrastructure schemes like road and rail networks. Also, in the 1950’s, India’s economic planners and officials set up government companies to supply coal, iron, steel, power, and other inputs to private firms at a lower cost, often by selling at a loss. Yet, for decades, government enterprises faced charges of a casual attitude to profits and an unmotivated workforce.

My reflections here are prompted by the following news in The Mint - and other Indian newspapers: The Indian “government plans to pool its shares in listed public sector companies (as well as the Specified Undertaking of the Unit Trust of India…) to build India’s first sovereign wealth fund …The fund will sell new and existing shares, receive dividends, raise money from strategic investors, and borrow against its shares to raise capital for its investment corpus.”

Sovereign wealth funds (SWF) were first set up by countries to conserve, invest and grow profits gushing in from their sizeable exports of a natural resource. In fact, today, 59% of the $12.4 trillion held by SWFs are funds generated by natural resources, as in the case of oil-rich Norway and Saudi Arabia. In sharp contrast, India has no major natural resource exports which can fund its SWF.         

The commitment of the Government of India to relinquish control of its companies to the private sector is established. Also, it is well-known that India has abandoned central planning, including its modern rewrite in terms of signals and feedback to investors and markets. As a result, government investments make no distinction between profit-making and chronically loss-making government-run enterprises, and, between enterprises producing non-essential goods and those producing intermediate goods and items of mass consumption.  

Consider the case of a profit-making Indian government-run enterprise employing a skilled workforce with regular job training. The market value of the company, with shares owned primarily by the government, conveys information about its financial operations even in imperfect capital markets.

When the government transfers ownership of the enterprise to its SWF, the implications cannot but be negative across the board. The market value of the company will likely take a hit as investors would expect it to sell shares or raise debt to fund its investment plans, since it will not be receiving funds from the government. Also, investors may wait to buy the company’s stock at a cheaper price after its shares are pooled with those of loss-making government-run enterprises in a SWF.

Even if we assume that the mixing and matching of former government-run enterprises and private funding obeys the dictates of financial markets, the following basic questions must be addressed.  

First, a SWF cannot ignore the government’s responsibility of allocating funds to social welfare-enhancing schemes, which was one of the original goals of setting up the government-run enterprises in India. The SWF will have to demonstrate that social welfare would have been less if the enterprise was allowed to continue as a government-run entity. In the extreme event of the firm shutting down due to losses, rendering thousands of workers jobless, the SWF would need to place the unemployed in alternative jobs paying comparable salaries.

Second, how does a SWF differ from a private investment fund with which it must compete to attract funding from Indian and foreign investors? A SWF can exploit its privileged position, given the backing of the government, to expropriate profitable government-run companies as is expected in the Indian case. In India, an SWF can also go further, by raising cheap equity and debt capital from government-run banks, insurance companies and other financial institutions.  

The managers of India’s SWF can do no more than offer good returns to investors, including the upper middleclass in India and foreign funds. What then happens to the social welfare goals of government-run companies? Private funds do not have to meet social welfare goals since their purpose is clear and unchanged, namely profits for investors.

Third, what will ensure that the SWF has a stable, long-term focus, unlike private funds which are formed and dissolved frequently? Since the goal of an SWF is to maximise profits, they allocate and re-allocate investments solely with an eye on expected return. The information set to which they respond is identical to the one relied upon by private funds. The difference is that shocks to a SWF, in the case of India, may ramify through the economy since many of the government-run companies play a key role in coal, iron, steel, banking, insurance and other businesses.

Also, since sovereign means political, India’s SWF will likely be a victim of electoral results with a new government reconstructing the portfolio of its predecessor.

The setting up of a SWF will hasten the transformation of private Indian non-financial firms into corporations that also indulge in financial engineering. The forthcoming nexus is likely to be a threesome in a crony capitalist setup. A financial entity could be a subsidiary of a large corporation with fingers in every slice of the Indian business pie. Also, foreign funds including foreign SWFs, may use the Indian SWF as vehicle to profitably expand their investments in India.

Both Indian and foreign private investors will likely be fattened by a SWF which owns stakes in profitable government-run companies in India. Akin to some of the physical infrastructure in India, built for its ability to catch the eye rather than usefulness and soundness, the Indian SWF is likely to totter and collapse – may be after the easy profits have been skimmed by private investors.

The ability of government-run companies to create more jobs – which India acutely needs – by raising more capital to invest in expanding and setting up new operations would be hamstrung by their having to compete with the SWF for funds from private investors. So, the objective of the Indian SWF is a mystery, especially since its set up is unlikely to also not solve the acute shortage of capital investments that India faces.

Does sovereign in the term SWF carry any weight? A hint might be provided by the discussions surrounding sovereign debt. All depends on the credibility and reputation of the sovereign. Venezuelan sovereign debt carries implications different from United States sovereign debt. What will be the reputation of India’s sovereign wealth fund?   

*Romar Correa retired as the Reserve Bank of India Professor of Monetary Economics, Bombay University.