Limitations of a SIF

Precommitment to rules for early withdrawals, including any safety valve allowing crisis access to SIF funds, is equally essential. Safety valve provisions must spell out the precise conditions that can be considered an emergency or crisis and specify the mechanism for using funds from the SIF for purposes beyond those originally contemplated. For instance, under Section 42 of the nTmA Act 2014, the minister for Finance may direct ISIF funds to finance credit institutions to remedy an economic or financial crisis in Ireland.

When considering the setup of a SIF, it is important to bear in mind the fiscal risks the government may undertake through the SIF and, conversely, the risks the SIF is exposed to through the sovereign.36 For instance, SIFs set up under a state holding company model, and funded by retained earnings related to a portfolio of state-owned enterprises (SOEs), can be exposed to uncertain and potentially large liabilities of those state assets. In addition, deterioration of the sovereign’s credit risk can in turn affect the SIF’s credit rating and hinder its ability to issue debt. Symmetrically, the fund might create fiscal risks for the government by its own transactions. For example, if the SIF issues debt or makes investments in subsidiary companies, it may indirectly incur contingent liability for the sovereign because of a perception of implicit government guarantee through the participation of a SIF.37 The sovereign must therefore provide limits on the purpose and extent to which a SIF may incur debt. Implicit state guarantees could generate perverse incentives for the fund’s management, in particular encouraging excessive risk taking. Ideally, the sovereign must also make an unambiguous statement of fund independence in its establishment law, including a renunciation of any implicit guarantees, and the law should make provisions for the SIF’s bankruptcy and resolution. A SIF backed 100 percent by a sovereign that does not have defined procedures for bankruptcy and resolution risks perpetuating the perception that its liabilities are implicitly backed by the government budget. In the absence of such an unambiguous statement, a second-best policy would be for the sovereign to make any guarantees explicit. If the state accepts liability for a portion of the SIF’s debts through a guarantee, then such a guarantee should be explicitly recorded in the government’s budget. The sovereign must carefully manage the potential risks that could arise from perverse incentives for SIF management to transfer value from the SIF to external entities.

LIMITATIONS OF A SIF

Although SIFs are designed to bring advantages to the table, they are not an overall fix for investor constraints or a substitute for good fiscal management. Even a well-functioning SIF does not substitute for the benefits of a strong regulatory framework, overall strong governance, and rule of law as relevant to investment and doing business. Enabling environment pitfalls for private investment—like insufficiencies in legislation for commercial contracts—require policy reforms that cannot be efficiently addressed by a SIF. Public capital SIFs are also not a substitute for a good fiscal management framework. As discussed earlier, without a clear purpose that adds value relative to other policy alternatives, a SIF will simply serve to fragment the government’s investment program and complicate government oversight of public expenditure and fiscal risk. Particularly for public capital SIFs, the government must have capable fiscal management to efficiently oversee a SIF’s activities and liabilities.