Some increase in the transparency both of the strategy and objectives of the funds and of recipient countries’ approach to inward investment should help dispel concerns and ensure they are a force for greater global financial integration rather than a prompt for a new wave of financial protectionism. SWF’s recent investments in global financial institutions have been helpful in easing the current financial market turmoil. And the fact that they, and their central banks, are looking for higher returns and greater asset diversification should be beneficial both to the EMEs and to the recipient countries since it should improve the efficiency of global asset allocation. But that positive story should not conceal that the growth of SWFs is also a result of persistent global imbalances in trade. These imbalances have helped create vulnerabilities in financial markets and in the wider economy. Our current experience is one more illustration of how painful the unwinding of such imbalances can be.
In a quarter of the cases, which were mainly countries with limited real exchange rate depreciation, annual GDP growth fell by 3½ percentage points on average. 11 There are dangers too for surplus countries. Large foreign exchange inflows are not easy to sterilise. They tend to contribute to asset price bubbles and higher inflation which itself can undermine economic and financial stability. The effect of such inflows into China and oilexporting countries have been compounded recently by their exchange rates being pegged or managed against the falling dollar. This has contributed not just to the build up of reserves and SWFs but also to the build up of inflationary pressures within these countries. No one would blame EMEs for the current turmoil in Western financial markets. It has been generated at home by the widespread mispricing of financial assets; this has been most obvious among the assets based on the US housing market but it is not confined to that sector. However the way that the boom developed did owe a great deal to global imbalances. The “savings glut”, to quote Ben Bernanke 12, that developed in the oil exporting countries and China contributed to the fall in real long-term interest rates. 13 In the UK, for example, real long-term interest rates, measured by the difference between the nominal 10-year government bond yield and the annual rate of inflation, fell from around 3.9% in 1997 to 1.6% in 2005. A similar pattern was also evident in the US (Chart 6).