India considers setting up sovereign wealth fund

India is considering setting up a sovereign wealth fund, with a slightly different structure considering the country has fiscal and current account deficits. Sovereign wealth funds in other countries have resulted from excess reserves of central banks and monetary authorities.

Y.V. Reddy, governor of the Reserve Bank of India, says currently under consideration is a sovereign fund structure in which a separate entity or company will purchase foreign currencies from the central bank. In return, the Reserve Bank of India will receive shares of the fund, which will be able to invest in higher yielding assets that are off-limits to the central bank under its current mandate.

ôIndia is watching with great interest the development of global codes, standards and practices with regard to sovereign wealth funds,ö Reddy says, ôboth in view of the presence of sovereign funds in the Indian financial markets and the ongoing debate on establishing an Indian sovereign fund.ö

Reddy reckons sovereign funds have existed in the market place for a long time. However, these funds have only attracted reaction and interest recently because of a sudden proliferation in midst of financial turbulence in global markets.

While much of the debate has been devoted over transparency issues and accountability, he points out in reality, many countries are in fact still struggling with even the basic definition of these funds.

India might have already set up such a sovereign wealth fund, without even realising it, Reddy notes. He says IndiaÆs finance minister set aside $5 billion in his 2007 fiscal budget for a special purpose vehicle (SPV) named India Infrastructure Finance Corporation. The SPV, which has a mandate to finance infrastructure development projects, is wholly owned by the government and is backed by government guaranteed bonds issued in foreign currencies.

Now India is considering setting up a second vehicle to manage its foreign reserves. At present, returns on the Reserve Bank of IndiaÆs reserves are constrained by a mandate that puts greater emphasis on safety and liquidity. A sovereign wealth fund will not have those constraints.

ôAs the sovereign wealth fund will be a public enterprise, it will be required to conform to the applicable governance, transparency and disclosure standards,ö he says.

However, the central bank will see challenge in maintaining reserve adequacy if it is to divert its balance sheet to risky assets. India is currently carrying both fiscal and current account deficits.

Reddy notes that the pros and cons of setting up an Indian sovereign wealth fund are still under debate. The central bank is monitoring sovereign wealth fund issues worldwide, including GermanyÆs legislation to block unwanted deals.

India, he says, has no intention of blocking sovereign wealth fund investments in its market.

ôIn India, the regulatory regime governing capital inflows does not recognise sovereign wealth funds as a distinct category,ö he says. ôTheir investments are subject to normal regulations governing capital flows under the category of Foreign Direct Investment and Foreign Institutional Investments.ö

In strategic sectors such as banking and infrastructure, however, investors are to be scrutinised beforehand and need to fulfil due diligence requirements, he says.

ôNo discrimination is made between a domestic investor and a foreign investor, or between sovereign wealth funds and others,ö he says, ôas long as the policy criteria are met.ö