Journal Article - Middle East Institute

Sovereign Wealth Funds in Small Open Economies

| Apr. 24, 2018

The small open economies of the Gulf and Southeast Asia are pioneers in the establishment of

Sovereign Wealth Funds (SWFs). The SWFs of countries like Qatar and Singapore are among the

world’s largest in terms of total asset size relative to Gross Domestic Product. This article looks

at the different compulsions behind the setting up of SWFs by small open economies.

Sovereign wealth funds (SWFs) are not a new phenomenon for small open economies. Between

the 1960s and 1980s, a significant number of small open economies such as Brunei, Singapore,

Qatar, Kuwait, and Abu Dhabi established SWFs. This period saw dramatic changes in the global

economy. It was a period of global inflation, increases in trade rivalries and protectionism,

prolonged recession, volatile foreign-exchange markets, skyrocketing interest rates and debts,

and structural adjustments.1

Policy makers in economies with excessive surpluses have to make choices regarding the

allocation of these surpluses. Objectives such as return maximisation for future generations or

the stabilisation of fiscal revenues as well as development considerations influence these choices

and thereby the variations in SWFs.

Confronted with windfall revenues, many of these economies started to create SWFs in an

attempt to adjust to the new international economic environment. For example, Kuwait created

the Kuwait Investment Board in the early 1950s and the London Kuwait Investment Office in the

early 1960s. In the 1970s, Qatar created the Qatar Investment Board — a predecessor of the

Qatar Investment Authority. Likewise, Abu Dhabi created the Abu Dhabi Investment Authority

(ADIA) in the 1970s, and the Singapore government established Temasek, a commercial

investment company, in the same decade. In the 1980s, Singapore created the Government of

Singapore Investment Corporation (GIC), and Brunei established the Brunei Investment Authority.

In small open economies, the most common form of organising government enterprises involves

the establishment of development-type SWFs. Development SWFs are developmental vehicles

that allocate resources for priority projects. Examples of state holdings that are described by the

SWF literature as Development SWFs include: Temasek (Singapore), Qatar Investments under the

Qatar Investment Authority, the Investment Corporation of Dubai, and Mumtalakat Holding


Small open economies differ in terms of their resource endowment. While a number of them —

specifically GCC economies and the island economies of the Pacific — are abundantly endowed

with natural resources (e.g., oil, gas, phosphates), others, such as Hong Kong and Singapore,

possess few natural resources. Differences in resource endowment generate distinct models of

SWF capitalisation and different future growth scenarios.2 Consequently, Qatar’s SWF shares

more similarities with the Abu Dhabi Investment Corporation (ADIC), in terms of structural

constraints, than with Singapore’s Temasek.

What is special about SWFs in some small open economies, like Qatar and Singapore, is that these entities are the largest SWFs worldwide in terms of total asset size vis-à-vis GDP.3 Because these SWFs are so large in relative terms, their trajectories are particularly critical for the future wellbeing of these countries. In contrast to large economies such as the United States, small open economies are fully exposed to international price fluctuations and adjustment pressures through capital flows. Small open economies cannot influence the key macroeconomic variables such as prices, interest rates, or income beyond their borders.

International capital mobility, combined with a high degree of openness and limited domestic markets, puts pressure on governments of small open economies with low public deficits and large fiscal surpluses to recycle their surplus funds via SWFs. These large surplus funds may result from revenues from natural resources (e.g., oil), revenues from the public enterprise sector, a positive trade balance, or tax revenues. Small domestic financial markets constrain the recycling process. In order to recycle surplus funds, authorities can either develop their domestic financial markets or allocate the money to international markets. In contrast to larger economies, such as China, the option of channelling these funds into domestic investments is limited for small open economies because of the risk of creating bubbles. This makes international investments specifically attractive as a means of risk diversification for small open economies.

Among small open economies within similar macro-structural groupings (e.g., the city states of East Asia, the oil/gas-exporting economies of the Middle East, and the phosphate exporting island economies of the Pacific), there are significant SWF-type variations (see table). High levels of external pressure, such as increased capital mobility, currency volatility, and international competition, can influence whether or not a country decides to establish an SWF. The sources of external pressure relate to international financial and trade integration and industrial competition. Governments create particular types of SWFs to address aspects of international competition, diversification, currency volatility, and capital mobility that arise from these pressures.

Scholars explain SWF variations by examining a set of macro-level variables in a given socioeconomic context, taking into account factors such as an ageing population and the need for economic diversification in order to create new jobs. 4 Some of these scholarly accounts are prescriptive and offer a set of operational roadmaps to policy makers considering the establishment of an SWF. For example, Das et al offer recommendations to policy makers by drawing on best practice derived from the experiences of existing SWFs and macroeconomic and financial theory.5 They outline five different types of SWF variation: reserve investment corporations, pension reserve funds, fiscal stabilisation funds, fiscal savings funds, and development funds. In order to strengthen their insights from best practice experience, Das et al. highlight the importance of institutional arrangements as well as the need for adequate reserve and foreign debt levels when setting up a SWF. Their suggestion that “policymakers should optimally consider both their sovereign assets and liabilities together with their macroeconomic objectives, when setting up a SWF” draws attention to the central role of macroeconomic factors.6

But domestic macro-economic factors are not the only ones influencing the structure of SWFs.

As governments realise the potential impact of global finance on domestic institutions they

respond with the creation of SWFs. Monk describes SWFs as self-insurance mechanisms for

governments to manage uncertainty by maximising state autonomy.7 As such, SWFs can be

described as the “insurer of last resort”. As a means of self-insurance, SWFs can serve two

functions that would appear to be contradictory. These are (i) safeguarding domestic institutions

and commitments (e.g., macro-economic stability, superannuation commitments) against

pressures from international financial forces; and (ii) at the same time, taking advantage of these

forces by deploying a substantial part of sovereign wealth towards international financial markets

in order to maximise their premiums.8 According to Monk, in fulfilling these two functions, SWFs

are “desired form[s] or instrument[s] of nation-state investment”.9 This explanation indicates

that SWFs are structural mechanisms that support existing domestic commitments and

institutions of nation states against the pressures of globalisation.

Furthermore, SWFs serve as substitutes or institutional complementarities for missing or

underdeveloped domestic market institutions. From such a perspective, the major reason behind

the establishment of sovereign investment corporations, such as Singapore’s GIC, China’s

Investment Corporation, and the Korean Investment Corporation, would be to recapitalise and

develop an underdeveloped or non-existing financial market. As for stabilisation SWFs, these

could be seen as institutional structures aimed at smoothening fiscal revenues in countries such

as Qatar, Kuwait, Bahrain, Saudi Arabia, and the UAE, which lack extractive institutions (i.e., a

taxation system).

During the 2000s, virtually all of the small open economies established SWFs.10 What makes the

study of SWFs in small open economies especially interesting is their relative and absolute weight

in their domestic economic contexts. In terms of absolute weight, SWFs of small open economies

account for nearly half of the 20 largest global SWFs.11 In terms of size relative to domestic

economic indicators, SWFs from small open economies surpass those of larger economies. While

the Chinese Investment Corporation — with assets of US$332 bn — is equivalent to around 6 per

cent of China’s GDP (2010), Temasek’s and GIC’s combined asset size is equivalent to 135 per cent

of Singapore’s GDP. The same pattern holds for SWFs of other small open economies such as the

GCC economies and the island economies in the Pacific (see table). There are only two small open

economies where the SWF is equivalent to less than 20 per cent of the GDP. In 21 of the 30 small

open economies, the SWFs are significantly larger, with their size relative to GDP ranging from

more than 20 per cent to more than 300 per cent.

For more information on this publication: Belfer Communications Office
For Academic Citation: Braunstein, Juergen and Mattia Tomba. Sovereign Wealth Funds in Small Open Economies.” , (April 24, 2018) .