Australia’s Future Fund is a sovereign wealth fund, of sorts. It’s small, and built for the purpose of providing for unfunded public service and defence employee pensions from 2020 onwards. It operates under tight controls. The fund has received contributions from a combination of budget surpluses, proceeds from the sale of the Government’s holding of Telstra and the transfer of remaining Telstra shares. Under its governing legislation, money cannot be withdrawn from the Future Fund until 2020, apart from meeting operating costs, unless the Future Fund’s balance exceeds the target asset level as defined by the Future Fund Act.
The bigger picture
But at $73 billion, Australia’s Future Fund is a minnow when compared with overseas sovereign wealth funds. Consider the big sovereign wealth funds listed by the Sovereign Wealth Fund Institute, such as the Abu Dhabi Investment Authority ($627 billion), Norway’s Government Pension Fund ($611 million), China’s SAFE Investment Company ($567.9 billion) and the China Investment Corporation ($439.6 billion), Saudi Arabia’s SAMA Foreign Holdings ($532.8 billion), the Kuwait Investment Authority ($296 billion), the Hong Kong Monetary Authority Investment Portfolio ($293.3 billion) and the Government of Singapore Investment Corporation ($247.5 billion). These funds are aggressively buying into the market. For instance, in April, Qatar’s sovereign wealth fund increased its stake in Anglo-Swiss miner Xstrata to five per cent, making it the third-biggest shareholder.
Support for a new Australian fund
There have been strong calls for Australia to set up a real sovereign wealth fund in light of the relative strengths of the Australian economy. Business supporters include Ralph Norris at the Commonwealth Bank, Mike Smith at ANZ, Fairfax chairman Roger Corbett and Tabcorp’s Elmer Funke Kupper. West Australian Premier Colin Barnett wants to ring-fence 2.5 per cent of all mining royalties and then channel the money into a future fund of sorts, specifically a West Australian fund that would be legally protected from government raids for at least 20 years. In February, Barnett used his Premier’s Statement – the first speech to Parliament for the year in which premiers traditionally spell out their legislative priorities – to commit the WA Government to bringing in a law to establish the fund this year.
The Organisation for Economic Cooperation and Development (OECD) has also been urging Australia to consider the creation of a “reserve fund endowed with all resource tax revenues to assist in shielding the budget and the real economy from the effects of revenue volatility”. Similarly, the International Monetary Fund (IMF) has called on Australia to establish a sovereign wealth fund to ensure future generations share in the returns from the mining boom.
“Some of the boost to government revenues could be saved in order to ensure a more equal distribution of its benefits across generations and reduce long-term fiscal vulnerabilities from an ageing population and rising health care costs,” the IMF said.
Not a panacea
The Australian Industry Group has argued that there is a case for a sovereign wealth fund, although it stresses the main focus should be on taxation and labour market reform. “There is some evidence that SWFs do immunise economies against Dutch disease [a situation where a resources boom pushes up the currency thereby damaging other industries]. For example, notwithstanding its role as a commodity exporter, the rate of decline of manufacturing as a proportion of GDP in the Norwegian economy has slowed relative to that of other industrialised countries over the past decade. Nevertheless, our analysis suggests that other policy initiatives also played a role.
“Thus, while a SWF is not a panacea and substitute for structural reforms (taxation reform, labour market reform, competition policy) that improve the competitiveness and the efficiency of an economy in dealing with ‘Dutch disease’, there is a strong argument to suggest that a mining-boom related SWF together with these other reforms can assist the competitiveness of the manufacturing sector.”
[breakoutbox][breakoutbox_title]Major players of the 21st century[/breakoutbox_title][breakoutbox_content]Sovereign wealth funds have existed at least since the 1950s, but their total size worldwide has increased dramatically over the past 10–15 years. In 1990, sovereign funds probably held, at most, $500 billion. Their total holdings now amount to an estimated $5.2 trillion.
More than 20 countries have sovereign wealth funds but they are highly concentrated, with the top five funds accounting for about 70 per cent of total assets. Over half of these assets are in the hands of countries that export significant amounts of oil and gas. About one-third of total assets are held by countries in the Asia-Pacific, including Australia, China and Singapore. Sovereign wealth funds differ from large institutional private investors such as mutual and insurance funds. Although they hold assets, they generally have no specific liabilities to be paid to shareholders or policyholders.
Sovereign wealth funds typically seek to diversify foreign exchange assets and earn a higher return by investing in a broader range of asset classes. That covers longer-term government bonds, agency and asset-backed securities, corporate bonds, equities, commodities, real estate, derivatives, and foreign direct investment.[/breakoutbox_content][/breakoutbox]
A champion in Parliament
One of the biggest champions of a sovereign wealth fund has been Coalition front-bencher Malcolm Turnbull, who is the first parliamentarian to push for an SWF. He argues that if Australia were to have a commitment to establish a new SWF, governments would be more likely to save than spend. And that would change the entire political psychology of political leaders who, when presented with a surplus, are sorely tempted to spend it on tax cuts, hand-outs to politically important interest groups and infrastructure, often in marginal seats. In a speech last year to the International CEOs Forum, Turnbull said Australia needs to make sure it doesn’t blow the bounty of the boom which, he warned, will not last.
“It seems very likely that a fairly large part of the recent gains will be relatively short-lived,” Turnbull said. “Despite the strength of emerging Asia, its economies are not immune to cyclical ups and down – not even China. And there is a lot of coal and iron ore around the world. The early 21st century boom has already elicited a supply response and will continue to do so – not least via capacity expansion in Australia, but also in Brazil, Guinea, Mozambique, Mongolia and many other places.
“So very few economists see the terms of trade remaining at their current lofty levels. The next year or so may be as good as it gets – although that is what everyone said last year, only to be proved wrong. On the other hand, the global economy has evolved since the turn of the century, with many more developing countries enjoying sustained growth than previously and as a consequence, most market analysts predict Australia’s terms of trade will remain materially higher than they were in the 1980s and 1990s for some time – at least a decade, and perhaps two or three. That is also what our top officials guardedly offer as their current best guess.
“But neither they nor we can be certain – and in any case history tells us that whatever broad direction commodity prices take in the future, they are likely to remain fairly volatile.
“Given the probably temporary nature of the income boost we are experiencing, and the fact that it arises from the consumption of finite (but abundant) resources, over recent months there have been numerous suggestions that Australia create a sovereign wealth fund.
“This would be a publicly owned vehicle to save some of the extra income from the boom and smooth consumption over time … A national savings fund of this kind would become a matter of real national pride, evidence that we have the discipline and vision to recognise that good times don’t last forever, that demographic changes will place greater demands on future budgets and that thrift is both virtuous and prudent.”
Still, Turnbull was not calling for immediate action. He said that such a fund should be established only after the Budget was back in surplus and the debt paid off.
Not all convinced
The Government has been unenthusiastic about the idea. The Treasurer, Wayne Swan, has said that the Government is focused more on superannuation. “We’ve got eight million sovereign wealth funds in this country, they’re called the superannuation accounts of Australian workers,” Swan has told reporters. “At the moment the government is intent on lifting our national savings in part by lifting the savings of low-paid Australians through contribution to their superannuation.”
The Business Council of Australia (BCA) argues that a sovereign wealth fund is not a priority. Instead, the focus should be on getting the budget back into surplus and pay off debt. In its Budget submission, the BCA has warned that Australia faces a conundrum with the growing significance of commodity prices, an ageing population putting pressures on the spending side and an uncertain global environment. The Government should build surpluses to withstand economic shock.
“The BCA recommends that the Government specify a new fiscal rule that targets a percentage surplus based on ‘recharging’ fiscal readiness around every 13 years for fiscal policy to be able to make a three per cent of GDP contribution to the economy,” the submission says. It also recommends that the Government “target a modest proportion of the surplus – to be known as an ‘intergenerational surplus’ – to provide for the projected fiscal gap that is expected to arise as a consequence of demographic pressures”.
[breakoutbox][breakoutbox_title]SWFs – success versus failure[/breakoutbox_title][breakoutbox_content]Norway’s $611 billion sovereign wealth fund is Europe’s biggest equity investor. It has equity holdings in Royal Dutch Shell, Nestlé, HSBC, Novartis, Vodafone, Exxon Mobil, Roche, Apple and GlaxoSmithKline. It has fixed income holdings in the US, UK, France, Japan, Germany, Italy, Netherlands and Spain. The fund has ethical guidelines that prohibit it from investing in companies that directly or indirectly contribute to killing, torture, depriving people of freedom or other violations of human rights in conflict situations or wars. The fund, in which Norway saves its oil and gas revenues from the North Sea, has become so large that it now owns more than one per cent of the world’s shares.
Nauru drew on royalties from the mining of phosphates for fertiliser in establishing the Nauru Phosphate Royalties Trust in 1968. Investments reportedly peaked at $US800 million (approx. $A798 million) in 1991. This was regarded as more than adequate to support a then national population of 4000. Assets included a landmark office tower in Melbourne (Nauru House), a shipping line and an international airline. Then things went bad.
Corruption, mismanagement and reckless borrowing by the Nauru Government saw a major erosion in the value of the fund. The Melbourne property was sold for $A339 million and there were debts of $A240 million.
By 2004 earnings from phosphate exports failed to cover the cost of production. Nauru now depends on foreign aid. The restructured fund was claimed to have $A60 million assets in 2007, supporting a population of 10,000 people. The Nauru fund is always cited as a case study of an investment platform that went wrong.[/breakoutbox_content][/breakoutbox]
The economists’ view
But HSBC chief economist Paul Bloxham says a sovereign wealth fund should be considered. “We should be thinking about having a sovereign wealth fund,” Bloxham says. “We should be separating a lot of the revenue we’re getting from the mining industry from revenue we get more generally, and that should be funding a sovereign wealth fund.
“In principle, we should have had a larger mining tax. I think there are good reasons to think that because it’s a non-renewable resource.
“The price of commodities is about three-and-a-half times higher than it was a decade ago in US dollar terms and our tax system runs off volumes. We should have made adjustments so that we got more revenue and we got more of the run up in prices.
“It would have been helpful if Australia had put aside some of the large amount of the revenue we were seeing as a consequence of the resources boom for future generations and for that potential rainy day. That would be a helpful thing to be doing. You could justify it on the basis that the resources under the ground don’t belong to the mining companies. They belong to the state governments, which means they really belong to the people, which means they should be putting more of it aside.” He concedes, however, that a larger mining tax is not politically feasible and that the Government’s revenue position right now would not allow it to set up a sovereign wealth fund. But, he says, it should be considered down the track.
Saul Eslake, chief economist with Bank of America-Merrill Lynch, says that while he supported the idea of a sovereign wealth fund in 2005, it’s now “academic” because the Budget is in deficit [ed: at that time].
However, he said, assuming the Budget would eventually get back into surplus and Australia’s debt was paid off, and assuming the resources boom would last, a sovereign wealth fund could be used as a way to ensure future surpluses would come in above the politically accepted level of one per cent of GDP. Rather being funded out of a mining tax, he says, it should be funded out the surplus each year. But that, he says, would impose a discipline on governments not to spend it on tax cuts, handouts and infrastructure in marginal seats.
“A sovereign wealth fund is to prevent the current generation of citizens from squandering the wealth that comes their way because they happen to be running the country at a time when China and India are doing what they do,” Eslake says.
There are powerful arguments on both sides. The debate is likely to continue for many years to come.
