New oil, gas finds: Is East Africa ready for sovereign wealth funds?

But critics say that sovereign wealth funds are not suited for East Africa’s current economic and demographic profile, arguing that governments are better off using the profits from natural resources to reduce the huge public debt and provide citizens with basic health, education and social services today.

Kwame Owino, CEO of the Institute for Economic Affairs in Nairobi, argues that countries with poverty, unemployment, and current account deficits should not rush into sovereign wealth funds just because they suddenly have foreign exchange surpluses.

“If you look at the characteristics of countries that have successful sovereign wealth funds, they are all small, with very little debt, and at least $10,000 gross national income per capita — none of which describes East Africa today,” he says. “They were already rich before setting up the funds, and that is one of the things that makes them profitable.

Mr Owino argues that the region is caught up in the “hype” of sovereign wealth funds.  “If the intention is to provide a stabilisation fund against volatile commodities, no problem. But if the intention is to spare wealth for future generations, we have very basic needs; the priority should be to provide infrastructure, health care and education today, and pay off some of our debt. I am totally opposed to the idea of valuing future generations more than the present one,” he says.

Jason Braganza, senior analyst at Development Initiatives, a poverty and development research NGO, agrees, saying that East Africans have “more urgent needs” than setting up what is essentially a savings account, and adding that such funds are premature, particularly in Kenya’s case.

“The fund presupposes that we will have oil flowing very soon, but that is not known for sure. We don’t know the commercial viability, or how long the reserves will last. We need to re-examine the rationale for setting up such a fund,” he says.

But Dr Ikiara contends that the two are not mutually exclusive. “Having a sovereign wealth fund does not mean that we cannot use it for infrastructure and health. The government can borrow from the fund and still invest in securities and projects abroad. We can structure the fund in a way that takes care of both today and tomorrow,” he says.

Conflicting political interests are also a problem that governments have to negotiate, particularly in the context of devolving power to sub-national units as has been done in Kenya.

In Nigeria for example, the $1bn Nigeria Sovereign Investment Authority is facing opposition by state governors, who currently receive a portion of national oil revenues and would rather share the cash out today than save it for the future. These are tensions that are likely to play out in Tanzania as well as it negotiates a new constitution, particularly when crafting resource-sharing agreements between the mainland and Zanzibar.

But the lack of transparency is the biggest criticism of sovereign wealth funds, which are generally under a cloud of suspicion for their opacity, making it difficult for regulators and citizens to perform any kind of oversight — leading to the widespread perception that such funds could end up being slush funds for politically-connected people to spend at their discretion.

The Linaburg-Maduell Transparency Index, developed by the Sovereign Wealth Research Institute, rates the transparency of government-owned investment vehicles using indicators such as the availability of up-to-date independent audited accounts, information on ownership percentage of company holdings, and on total portfolio market value, returns and management remuneration. A fund needs a score of at least eight to be ranked transparent.

This year, none of Africa’s sovereign wealth funds was rated transparent; neither were funds managed by China, Saudi Arabia, Oman or the UAE.

In Angola, for example, the country’s sovereign wealth fund was accused of splurging on a $350,000 luxury office block on Savile Row in London in the exclusive Mayfair District in November. Launched last year, the $5 billion fund is chaired by Filomeno dos Santos, the son of Angola’s President José Eduardo dos Santos. The younger dos Santos denied the accusations. 

The research suggests that funds with politically-connected managers are more likely to take larger stakes in the firms they invest in, while independent external managers take smaller equity stakes, especially when investing in domestic firms.

Instead of investing in small liquid stakes, as those with external managers do, politically managed funds take larger and potentially controlling equity stakes in domestic firms — suggesting that these investments are targeted at supporting and potentially propping up local firms, rather than optimising the investment returns of the fund.

But it is not only corruption that is worrying governments, investors and regulators as state-owned investments funds circulate in the market, looking for an opportunity to plug into.

In the wake of the 2007-2008 US mortgage crisis, sovereign wealth funds made much needed cash investments in struggling Wall Street banks including CitiGroup, Merrill Lynch, UBS and Morgan Stanley estimated at $37 billion, amounting to 63 per cent of the total investments for such funds globally in 2007.

This led US critics to worry that foreign nations were gaining too much control over their domestic financial institutions, and that these nations could use that control for political reasons, choosing to invest in sectors not for the economic returns but as a leverage instrument for foreign policy purposes.

In a 2007 Congressional hearing on sovereign wealth funds before the US Senate Banking Committee, Indiana Senator Evan Bayh captured the fears aptly, in his testimony before the Committee:

“Unlike private investors, pension funds and mutual funds, government owned-entities may have interests that will take precedence over profit maximisation. Just as the US has geopolitical interests in addition to financial ones, so do other countries. Just as we value some things more than money, so do they. Why should we assume that other nations are driven purely by financial interests when we are not?”

The taskforce paper on the establishment of Kenya’s sovereign wealth fund even explicitly acknowledges political motivations of setting up such fund, stating that “the very concept of a sovereign wealth fund has turned into  a significant symbol of the self determination of the state…[they] have been seen as valuable instruments for preserving a nation’s autonomy in global affairs”. This fear could lead to investment protectionism in ‘recipient’ economies, potentially damaging the global economy by restricting valuable investment dollars.

In Asia, the political blow-back from state-backed investments for strategic reasons already played out, when in January 2006, one of Singapore’s sovereign wealth funds, Temasek Holdings, purchased from the family of then-Prime Minister Thaksin Shinawatra a controlling stake in the Thai telecom company Shin Corporation, which included taking control of space satellites used by the Thai military.

The transaction made the Prime Minister the target of accusations that he was selling an asset of national importance to a foreign entity, hence selling out his nation. The result was a political crisis in Thailand, which eventually led to the ousting of Thaksin’s government later that year.

No shift in power

Sovereign wealth funds thus embody an intersection between politics and finance that echoes that of the late nineteenth century, when private capital moved around the world in search of opportunities that would bring high returns.

But a 2011 research paper from Winston-Salem State University cautions that emerging economies should get their priorities clear — if the intention is to save for future generations and finance social and economic development at home, then the aggressive pursuit of profit should be the overarching driver.

The paper indicated that the actual financial performance of the funds have remained modest, and recommends that until sovereign wealth funds are successful in reaping significant financial returns, “emerging nations may be better off investing surplus funds in removing production bottlenecks at home”.

Despite the fears of foreign domination which has made Western governments jittery, the researchers say that internationally, the rise of sovereign wealth funds is “unlikely” to indicate any significant shift of power from western financial establishments to the emerging nations.