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The National Funds and their Impact on the Economy

Introduction:

The National Funds, also known as Sovereign Wealth Funds (SWFs), are government owned organizations that typically use commodity export revenues, foreign exchange reserves, privatization proceeds and fiscal surpluses to globally purchase various types of assets or alternative investments such as venture capital. These investment vehicles can serve many purposes all of which will be beneficial to the country, so in this article I will look at different cases when these funds can be set up and what are their economic benefits.


Why you should set up one:

The most popular reason for creating a national fund is being resource rich Economy, in which case, fund can help manage large inflows of export revenue and shield economy from volatile commodities prices. The most famous SWFs that were set up for this reason belong to Norway (which we will talk about later), Saudi Arabia and the UAE, some of the world oil richest countries. Another reason for setting up one, is having large foreign exchange reserves whose value will be influenced by exchange rates and whose usefulness may become equal to zero in the case where other countries will not agree to exchange their currency for yours. For example, China, the biggest foreign currency holder, that in the June 2022 had forex reserves of 3.48 trillion dollars of worth, sum that is nearly three times more than Japan have, the second holder. When the country has this much money in foreign reserves, the appreciation of your home currency by 5%, for example, will lead to loss of 174 billion dollars’ worth of foreign reserves in terms of purchasing power in your economy and considering the fact that if the fund would return 8% annually, it will take only 9 years to double the money invested, the opportunity cost of holding foreign reserves becomes unbearable. Obviously, China has already created one, it is called China Investment Corporation, a wholly state-owned company under the supervision of the State Council of the People's Republic of China, which has 1.35 trillion dollars’ worth of assets as of 2023 and which managed to get an astonishing return of 14.27% in 2021. Further popular reason to create SWF is if the government is left with lots of money after few consecutive fiscal surpluses and privatization proceeds, both of which the Australia had. In the early 2000s, when Australian prime minister was John Howard, large public firm “Telstra” was privatized and there were strong global economic conditions together with rise in prices of commodities which Australia actively sold to China, Australia decided to create its own fund, that now has over 160 billion AUD in assets and whose interest helps Australia to repay its national debt and will help to fund the increased costs of pensions in future due to aging of average citizen.


The Norway case:

In the early 20th century, Norway was known to be one of the poorest countries in Western Europe having citizens leave to Northern America in search of better living prospects with economy massively suffering after WW2. But luckily enough, after decades of being known as just fishing and shipping economy, in 1969 the Ekofisk oil field was found which opened doors to transform it into oil powered leading world economy. Since 1969 the Norway invested more and more into oil sector, and It got to the point in 1990 when Norway sold 9 million barrels per day, government earned more than 100 billion dollars per year from oil and when oil accounted for 25% of its GDP, which was the time when Norwegian government decided to create its SWF, known as Government Pension fund Global (GPFG). Nowadays, this fund is one of the biggest national funds in the world with 1.3 trillion dollars in assets (which is 1.5 time more than the GDP of Norway), so If the Norwegian government were to give all of the money in the GPFG to its citizens, each person would get about $250,000. With that sum of money in fund and with its annual returns of 6%, the SWF acts as a buffer against future economic downturns or potential declines in oil revenue, ensuring long-term financial stability and that future generations will benefit from the black gold wealth, even when the oil is gone. The Norway could just use most of the newly earned money to build new modern cities and skyscrapers like some middle eastern countries did after they found oil, but this approach would lead to a volatility since real estate sector is cyclical and volatile, which exposes economy to crises like 2008 one, whereas having SWF can act as a buffer. Also, pouring money into construction might lead to projects that aren't necessarily aligned with the real needs or strategic interests of the country and it can lead to inflation in the economy if there is sudden surge in construction sector. Besides SWF benefits to its Norway, it also positively impacts world economy in a various way. The first one is that SWF investments provide stable capital to financial markets due to Norway long term investment approach which decreases potential market volatility and ensures liquidity. Also, because Norwegian national fund follows ESG investing philosophy, it promotes companies around world to adopt sustainable practices and provides already sustainable companies with funds to develop them even more, making world better and fairer.


How SWFs could have helped some failed countries:

In 1960s and 1970s Nauru was the country with nearly highest GDP per capita and real GDP growth rate, due to it extracting large phosphate deposits, which actually were bird deposits accumulated on the island over thousands of years, but after the phosphate reserves have finished in 2000s, the economy become a failure and is now known to be “The country that ate itself. Dependent on Australia, environmentally degraded, with one of the highest obesity rates due to the favourable conditions while its economic rise, and with no other significant sources of income, it became just a failed state which wasted all the richness they once had. Another economic failure of the 20-21st century is Venezuela, which achieved record annual inflation of 1,000,000% in 2018. After Venezuela discovered oil in 1914, its oil industry started to grow and it got to the point where black gold was making up 90% of the Venezuelan exports which inevitably led to Dutch disease (case where large exports from rising industry create large inflows of foreign currency that result in appreciation of your own one, which makes imports more price competitive and export less price competitive hence damaging other industries in the economy) and together with few major drops in this commodity prices and bad presidents from 1970 to 2010, the Venezuelan economy was killed. By some estimates, Venezuelan economy shrank by 50% from 2013-2019, being one of the largest collapses outside war and systemic state failure, it also have had defaulted on its debts, due to not having enough money as oil prices fell and it was over relied on this sector, had food and medicine shortages due to inflation and had 5.4 million people leave Venezuela in 6 years after 2014. Had both nations established well-managed Sovereign Wealth Funds during their boom years, they might have weathered the downturns better. For Nauru, an SWF could have invested phosphate revenues globally, diversifying income sources and providing funds for post-phosphate economic transformation. Venezuela, with an SWF, could have saved excess oil revenues during high-price periods, investing them in diversified assets. This fund could have been used to stabilize the economy during oil price drops, avoiding drastic budget cuts and maintaining essential services. In essence, a forward-thinking approach with national funds could have provided these nations with economic resilience against commodity price volatilities.


Conclusion:

As of 2023, there is only slightly more than 60 countries that established SWF, while there are over 190 countries in the world and there are reasons for it. As we already know from previous paragraphs, several conditions must be met to have enough money for establishment of SWF, which some countries might not have. In addition, some countries may decide to use their excess revenue to pay interest on their large debts, to meet immediate development needs if a country has poor HDI, for example, or to stimulate the economy during a recession. And even though, there is lots of ticks to get for country to create its fund, which may partly explain why so many states doesn’t have one, there is still between 22 and 35 rapidly growing, commodity export-oriented economies in the world which doesn’t have their own national fund, while having a possibility a possibility to ensure economic stability and wellbeing of future generations with smartly managing current large sums of money.

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Convidado:
07 de ago. de 2023

Can you please give a more detailed opinion on the Emirates. On the one hand, this country has a Sovereign Fund, on the other hand, it has invested billions in real estate. What prospects, from your point of view, await the country over the next 5 years, a crisis similar to 2008, or another scenario? Thank you

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Kirill Derevytskyy
Kirill Derevytskyy
09 de ago. de 2023
Respondendo a

Apologies for the confusion in the last response. The property prices in UAE have actually grown for about 90% in last year, and although some people may think that it can indicate bubble, this growth can be explained by growth of population, low taxes attracting foreigners and recovery after covid. Additionaly, analysts say that the mortgage market is in the perfect stance, and that increased demand is real and can be met by market, so I would assume that bubble is not forming and if it is, then it won't burst soon.

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