Investment markets are in line for a fresh boost of liquidity as Asian governments begin to actively manage the massive reserves of foreign exchange they have accumulated.
The prospect of big new investment players entering the market has been welcomed by some analysts as an additional source of liquidity that will underpin demand, but raise alarms among others who fear that political agendas may be pursued on financial markets by 'sovereign wealth funds' (SWFs).
The rise of the funds is partly due to the trend of the United States dollar's decline and the resulting intervention on foreign exchange markets by Asian central banks to stem the appreciation of their currencies against the dollar and keep their export engines running and, more directly, the result of the sustained trade surpluses generated by Asian exporters.
The combined outcome had been the accumulation by Asian central banks of total reserves in excess of US$4trillion, noted the International Monetary Fund in its October report Regional economic outlook - Asia and Pacific, with China accounting for the bulk of this year's growth because of its surging trade surplus (see table). Reserves of this level were well above what may be needed to grease the wheels of the financial systems of many central banks, so the banks were now considering the launch of SWFs, noted the IMF.
'The objective of these entities is to increase returns on foreign currency holdings, although in some cases, for example South Korea, they have a secondary objective to help develop local capital markets,' it noted.
Singapore was one of the first countries in Asia to set up a sovereign wealth fund. Temasek Holdings, part of the government of Singapore's investment arm, now manages a portfolio of assets worth more than US$100billion.
Among the sovereign investors that will begin to exert growing influence on the investment scene will be: The China Investment Corporation, established earlier this year and which could deploy up to US$200billion of the country's US$1.4trillion of official reserves; The Korea Investment Corporation, capitalised in 2005 with funds of about US$20billion to invest on behalf of the Bank of Korea and the South Korean government; The Australian Government Future Fund, established in May last year, with an initial transfer from government budget surpluses of A$18billion (HK$126.84billion).
A report from US investment bank Merrill Lynch released last month forecast that assets under management in Sovereign Wealth Funds could grow more than fourfold by 2011, surging from US$1.9trillion to US$7.9trillion.
Merrill Lynch economists expect this wave of extra liquidity to benefit world financial markets and in the research report 'The overflowing bathtub, the running tap and SWFs,' foresees that SWFs will probably direct far greater allocations towards riskier assets such as equities and corporate bonds with cumulative net flows of US$3.1trillion to US$6trillion into these asset classes.
Alex Patelis, head of international economics at Merrill Lynch, said: 'SWFs are also likely to mandate external fund managers to invest the bulk of their assets - providing a major structural boost for the global asset management industry. Investors should rejoice in the more balanced global economy and the impetus that SWFs will provide to continued growth and development of global asset markets.'
However, Peter Redward, Barclays Capital chief economist for emerging Asia, said concerns about the impact that such funds might have on investment markets were overdone.
The emergence of such funds comes against the background of a bid by Chinese state-owned oil group China National Offshore Oil Corp (CNOOC), to acquire US oil producer Unocal that was abandoned after a storm of protest from US critics in congress that the deal would threaten the US national security and its economic interests.
The first investment by China Investment Corp earlier this year - a 9 per cent non-voting stake acquired for US$3billion in a New York-based private-equity firm - was completed in June and managed to avoid controversy.
'I am not too worried about them [SWFs],' Mr Redward said. 'Once the inevitable US current account adjustment takes place and central banks become concerned about the need to combat inflation, these global imbalances will resolve themselves. Sovereign wealth funds as a share of the global economy will then begin to decline, and we saw this in Taiwan in the late-'80s.'
In the meantime, concerns expressed by some critics over the ability of SWFs to manipulate market outcomes was misplaced, Mr Redward said.
'Think about it. Global wealth, [the market value of all physical assets including equities and property,] is roughly 2.5 times global GDP. So if you are talking of global wealth of US$100trillion maybe US$4trillion of reserves, you are only talking of reserves being equivalent to 4 per cent of global wealth.' Furthermore, unlike hedge funds which 'punched well above their weight' on markets because they employed a high ratio of debt in their portfolios, SWFs were unlikely to leverage their positions, he said.