Commentary: Why Sovereign Funds Help Global Economy

Financial OPEC

The initiative of global financial system modernization can come from the SWF-holding countries since they are mostly interested in this. Saudi Arabia and the United Arab Emirates have already begun to negotiate on a voluntary code to regulate their SWFs. This could be the beginning of a new integrative process that Western partners should not ignore. The SWF-holding countries have enough resources and incentives to establish new global financial organizations to get maximum benefits on a cooperative basis.

In particular, one can foresee establishment of a new financial organization similar to OPEC as an alternative or a counterpart to the IMF-2 model of SWF-country integration. Its urgent task would be to coordinate political steps against adoption of anti-liberal legislation in the western countries. Moreover, one should not exclude some coordinating activities in the global financial markets in the future. The SWF-countries have similar goals with distinct priority to long-run yields on financial investment. But in some cases, they could agree about market spheres of interest and coordinate on the strategies of making strategic investment in order to minimize mutual losses and increase pressure on recipient countries. Importantly, attempts of large-scale capital market transactions do not pass without consequences even in the case of failure. By imposing new bans, the developed states would damage the reputation of their markets, entailing serious credibility problems. Coordinated and consistent actions of SWFs will eventually enforce the recipient countries to make concessions.

Such a model of integration is not a pure product of imagination. Recall that OPEC originated in 1960 as a political response of oil-producing countries — initially Saudi Arabia, Venezuela, Iraq, Iran and Kuwait - on unfair pricing by the cartel of trans-national oil companies. The repeated longstanding attempts to take control over the world oil price and to shift profits were unsuccessful and not taken seriously by the developed countries. But ultimately, OPEC's activity resulted in the oil price shock of 1973/1974 and subsequent upward oil price trends that caused dramatic reallocation of incomes in favor of oil-producing countries.

It should be noted that the first-generation sovereign funds of Arabian countries emerged after this first strategic success of the OPEC. If a fair mode of oil income distribution prevailed originally, the oil-producing countries had no incentives to establish their cartel and coordinate on export quotas. Similarly, the current tendency of protectionism against the SWFs can reinforce integrative activity of exporting economies in the financial sphere.

The cooperation of SWF-holding countries on the basis of mutual interests will improve their bargaining position relative to the Western partners. And the best way to reach agreement concerning the global capital market is on a multilateral basis rather than destructive unilateral steps on prohibitive measures. Clearly, the latter is the way to global disintegration and trade wars that are inadmissible in the 21st Century.

Developing countries need full-fledged participation in the world capital markets, just as developed countries need the potential future profit streams of these emerging markets. As was mentioned in the last G-7 meeting statement, “cross-border, market-based investment is a major contributor to robust global growth.”  

Andrei Vavilov is Chairman of the Institute for Financial Studies, founder of IFS Hedge Fund in Russia, a member of the Russian Federation Council and former First Deputy Minister of Finance of Russia.

© 2008 CNBC.com

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