We are not Kazakhstan

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rates return to areas of low foreign rates of return. Two-year US government bonds, a favourite of central banks,  yields less than 3.0%.  But this misses the point that during the 1990s developing countries ran large deficits and ended in economic rout, while during this decade, we have had unprecedented voluntary surpluses in developing countries and unprecedented growth. One way to square this circle is that high reserves have led to a powerful drop in the risk premia investors demand when investing in emerging economies. 

If reserve building was a good thing, how should reserves be managed? Reserves are an insurance policy and like any insurance policy, the insurer must invest in assets that can be turned into hard currency quickly and are unrelated to any deterioration in the condition of the insured. You can’t insure against a monsoon by investing in housing developments in monsoon areas—however attractive the yields may be.

Reserves held in excess of insurance needs might be invested alternatively, but this is too easily said. The temptation to use reserves for populist purposes will be very hard to avoid if domestic investment is allowed. Best not to permit it. There is a reason why most surviving SWFs are in countries where democracy is less energetic than in India: Abu Dhabi, Kuwait, Russia, China, Qatar, Brunei, Libya, Kazakhstan, etcetera. Norway is a notable exception, but even there, the pension fund is a political football.