Column : Questions about sovereign wealth funds

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: much more diversified portfolio which includes agency and asset-backed securities, corporate bonds, equities, commodities, real estate, derivatives and FDI. Also, given this diversification, SWFs typically make little use of leverage and tend not to have explicit liabilities such as workers’ pensions.

This finding, compounded with the earlier insights into lack of democratic accountability in countries that have SWFs, leads to the third question about optimum management . Given the lack of rigorous international transparency norms for SWFs, is it more optimal to retain forex management with the central bank? The authors provide a nuanced argument for why the answer depends on country-specific factors. Apart from the potential gains of higher returns by SWFs, they find that for low levels of public foreign assets, assigning portfolio management independence to the central bank is advantageous in the sense of preventing “sudden stops” or rapid outflows of capital. However, for a large enough foreign asset base, the opportunity cost associated with low returns from “safe” foreign assets provides enough impetus for establishing a SWF. This finding is also dependent on whether the central bank holds the responsibility for financial stability (such as in India). They find that the “threshold” of the foreign asset base that justifies setting up of a SWF falls considerably if the central bank is also mandated to ensure financial stability.