Do Taiwan And Hong Kong Need Their Own Sovereign Wealth Funds?

The author is ANZ greater China chief economist Liu Li-Gang

The concept of sovereign wealth funds (SWFs) has emerged recently in Greater China.

Hong Kong’s Financial Secretary mulls to establish a "Future Fund" to prepare for population aging that will potentially create fiscal financial pressure in forthcoming decades.

About a year ago, Taiwan’s Minister of Finance Chang Sheng-Ford proposed to consolidate the four under-performing publicly-owned funds into a single SWF.

While many SWFs were born under diverse macroeconomic frameworks with customized institutional setups and objectives, the common theme is to invest for the future.

For Hong Kong and Taiwan, the crux is not whether they are managed under a new SWF but whether the government has a will to set an investment performance target explicitly and achieve a positive real rate of return.

Historically, the government revenues of Hong Kong and Taiwan have been growing with their GDP in tandem. Wise investments in the local economy are perhaps the best way to uphold their fiscal positions in the future.

Aging has been the common factor driving the current SWF debate. For instance, in Hong Kong the government projects that in less than 30 years’ time, the number of elderly population aged 65 and above would surge from the current 1.0 million to 2.6 million in 2041.

These figures suggest that by 2041, around one in three persons will be elders, up from the current level of one in seven. This has triggered the concern about the need to set up an endowment to meet the fiscal pressure from this changing demographic profile.

In Taiwan, the investment performance of the different publicly-run pension funds failed to meet expectation, partly due to the prolonged period of low interest rate. Establishing a more proactive investment organization may be able to lift the long-term investment return and cover future pension liability.

While SWFs are often referred as heavy weight government-owned institutional investors that are actively seeking investment return, its sources of funds, investment and governance structure are far from homogeneous. This is partly because the governmental investment entities have different histories with a variety of macroeconomic backdrop.

Typically, SWFs evolve from previous commodity boom, oil in particular. The theory is that since petroleum resources are non-renewable and the wealth will gradually approach zero in the future, there is a need to generate positive long-term real rate of return on financial assets by deploying the oil money.

The governments expect that the investment return will be large enough to cope with population growth rate and aging. Clearly, this strategy requires that a considerable share of the petroleum revenues are saved and invested in a SWF. Norway’s Global Pension Fund Global and Abu Dhabi Investment Authority are potent examples of this category.

The common theme is to invest for the future and maximize long-term investment returns, typically 20 years. For Australia and New Zealand, pre-funding future pension liability motivated the establishment of Australia’s Future Fund and New Zealand Superannuation Fund.

The Australia’s aims to achieve an average annual return of at least the consumer price index of 4.5% to 5.5% per year over the long term and withdrawals from the fund are planned to start in 2020.

The New Zealand fund is expected to begin withdrawal in 2029/2030. Until then, all investment income is going to be reinvested in the fund. For a small open economy like Singapore, the concept of "saving for the rainy day" was adopted a few decades ago and its Government of Singapore Investment Corporation (GIC) and Temasek Holdings have been active investors in the SWF world.

Governments should view the problem holistically. Hong Kong and Taiwan should deploy their sovereign wealth and reserves in the areas including infrastructure, education and healthcare that will deliver economic value.

(The article has been edited for clarity)


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