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FINANCE: Developing Nations Rack up Hefty Foreign Reserves

Thalif Deen

UNITED NATIONS, Jul 17 2008 (IPS) - As the global economy continues to be jolted by volatile financial markets, bank failures, a spreading credit crunch, and rising food and energy prices, some of the developing nations have accumulated three-quarters of the world’s reserves, amounting to a staggering 4.3 trillion dollars.

China alone has increased its foreign reserve holdings from 0.1 to 1.7 trillion dollars between 1999 through end of March this year, according to the latest figures released by the United Nations.

Among developing nations, India has been ranked number three with 300 billion dollars in reserves, just below two industrialised nations: Japan at 993 billion dollars, and Russia at 493 billion dollars.

India is still ahead of South Korea, designated an industrial nation, with reserves amounting to 264 billion dollars.

As of September 2007, some of the countries with the largest sovereign wealth funds (SWFs), mostly in oil and energy rich nations, include: the United Arab Emirates (875 billion dollars); Norway (341 billion); Singapore (330 billion); Saudi Arabia (300 billion); Kuwait (250 billion); and China (200 billion dollars).

SWFs are defined by Forbes as “pools of money derived from a country’s reserves, which are set aside for investment purposes that will benefit the country’s economy and citizens.”

The reserves and SWFs have one thing in common: they are all state-owned, in contrast to foreign direct investments (FDI), which are both public and private. The SWF assets of developing countries are estimated at around 3.0 trillion dollars.

The largest of the SWFs is the Abu Dhabi Investment Authority, maintained by the United Arab Emirates. Other major SWFs include the Qatar Investment Authority and China’s State Administration of Foreign Exchange (SAFE).

“This has given developing countries a greater buffer or ‘self-insurance’ to cope with external shocks,” says the “World Economic and Social Survey 2008”, released to coincide with the month-long meeting of the U.N. Economic and Social Council (ECOSOC), which concludes Jul. 25.

According to the survey, a level of reserves covering about three months of imports was long considered adequate. But one of the lessons drawn from the July 1997 Asian financial crises was that developing nations should also have adequate reserves to cover their short-term external debt.

“At present, however, developing countries have been accumulating reserves well in excess of that more recent standard,” the study says.

Both low- and middle-income countries have reserves that are almost twice as the sum of the value of three months of imports and the stock of short-term external debt.

China’s reserves are three times as great. And reserves of the 50 least developed countries (LDCs) are now close to that range, the study points out.

Asked if these countries are investing their reserves, Rob Vos, director of the Development Policy and Analysis Division of the U.N.’s Department of Economic and Social Affairs, said: “Yes they do.”

“Even if we say they are holding reserves, they may have some in cash or gold in the vaults of the central Bank, but most will go into ‘safe’ financial assets abroad, most in U.S. Treasury bills these days – and helping the United States to finance its deficits,” he said.

“Safe” implies that rates of return are typically lower than average market investments or potential returns when these resources would have been invested at home, said Vos, the main author of the U.N. report.

Holding reserves makes economic sense to have a cushion against unexpected external shocks – e.g., a sudden increase in the price of oil for oil-importers – and investing resources in “safe” and liquid assets abroad is equally sensible.

“However, many developing countries now have been hoarding reserves much beyond what reasonably can be seen as needed for this precautionary motive,” Vos told IPS.

Then holding the “excess” reserves in foreign assets with low returns makes less economic sense.

“Moreover, as we indicate in the report, quite a few developing countries with high levels of reserves also have high private capital inflows at the same time,” Vos said. “To the extent these inflows also contribute to the accumulation of reserves, we call that component ‘borrowed reserves’.”

A rate of return has to be paid on those private capital inflows (interest payments if loans, profit remittances if FDI), which typically is higher than the return on the Treasury Bills. There are “carry costs” on holding reserves that way, which is estimated for all developing countries at about 100 billion dollars per year.

He said that developing countries, aware of such costs, but in some cases also to smooth revenues from oil or other commodity exports, have been creating SWFs which have more of a savings motive than a precautionary motive.

The resources in SWF’s typically are invested in higher-yielding assets, including shares in Western firms, but also in investment projects in other developing countries.

In a political twist to the story, the Wall Street Journal last week quoted a report from the McKinsey Global Institute which said some of the mountains of petrodollars are also likely to used “to advance anti-American political agendas”.

According to the McKinsey report, “The rise of a broader range of countries with SWFs heightens concerns about the potential non-economic motives and political ramifications of their investments.”

And Venezuela’s President Hugo Chavez is accused of “financing his Western hemisphere crusade against American influence with petrodollars.”

Asked if some of these new-rich developing nations should be investing their monies in the global South, Vos told IPS that it should be clear that monies are being invested, but mostly in low yielding assets.

The opportunity costs are, especially for reserves held beyond what is needed for covering three-to-six months of imports and the level of short-term debt (in case of a sudden drying up of capital flows), that such excess reserves could well be spent in the form of infrastructure at home and other investments, strengthening their economies.

Alternatively, for countries that are already fast growers, such as China or the major oil exporters, one could recommend more of SWF resources be invested in developing countries, “or what we propose in the report, is to place as capital in (regional) development banks to raise new financing resources for economic development in Southern countries.”

In the U.N. report, Vos said, “We give a back-of-the-envelope calculation of how much additional development financing could be created this way.”