Euro zone crisis and sovereign wealth funds

June 17, 2010

Two academics from the Fletcher School at the Tufts University have written a special guest blog for Macroscope on the impact of the euro zone debt crisis on sovereign wealth funds.

Dr. Eliot Kalter is a senior fellow, The Fletcher School at Tufts University, Sovereign Wealth Fund Initiative, and president of E M Strategies, Inc. Thomas F. Holt, Jr. is an adjunct professor of law, The Fletcher School and partner in the global law firm K&L Gates LLP.

“While Sovereign Wealth Funds (SWFs) vary widely in their size and investment objectives, continuing tensions in the euro zone and in global markets more generally can only accelerate their concerns about investing in the West.  Significantly, in a last month’s meeting of SWFs in Sydney, the political focus shifted from questions raised by recipient countries about SWFs’ accountability and transparency to the risks inherent when investing in heavily indebted countries and the need to improve existing risk management frameworks.  Although SWFs account for less than 6 percent of total assets held by global institutional investors, they are an important barometer of global capital flows because of their clean balance sheets, long-term investment horizons and ability to invest large and growing amounts of capital quickly. 

 The European Union’s $1 trillion bail-out plan is a significant effort to prevent Greek contagion, but its ultimate success will depend on the ability of countries vulnerable to market uncertainties to confront not only the immediate liquidity threat but also more deeply rooted insolvency issues. The need to reduce dependence on financing unsustainable fiscal deficits cuts deep, even prompting France earlier this week to join the Mediterranean countries in making difficult  policy decisions with the announced intention to raise the minimum retirement age to 62.  But even if such measures are implemented, there is no guarantee that they will have the desired effect.  Concerns must then be raised about the financial, social and political impact of the required fiscal austerity on already vulnerable economic recoveries, falling real wages and weak financial systems. 

 The ongoing shift of financial and economic power away from the traditional centers of the U.S. and Western Europe has been accompanied by increased SWF investment in emerging market countries.  Whereas SWFs have been amenable to risk adjusted returns in Western countries, the euro zone crisis can be expected to accelerate this migration to markets with higher potential growth rates than those of their Western counterparts.

 The ongoing euro drama makes it clear that in assessing risk SWFs will need to go beyond traditional quantitative modeling and thoroughly examine countries’ socio-political dynamics.  This includes the need for a clear-eyed assessment of a country’s political ability to confront growing public sector indebtedness and the willingness of its citizens to accept fiscal austerity.  SWFs and investors more generally must now deepen their understanding of recipient countries socio-political risks and develop strategies that take into account countries’ financial, political and social interests and priorities.”

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