Did you know that the Republic of Nauru has a SWF? Actually, perhaps this is a more appropriate question: Have you ever heard of the Republic of Nauru? Chances are that the world’s smallest independent republic—an Island Nation in Microneasia—has not come to your attention. Still, Nauru has some great lessons for countries considering a SWF. Why? Because it appears to have unsuccessfully used a SWF to manage its resource rents. Indeed, the Nauru Phosphate Royalties Trust, which was established in 1968, has been almost entirely exhausted (i.e. squandered) due to poor governance and mismanagement of funds.
From a research perspective, this is a golden opportunity, one that Martin Gould of Australia’s Treasury has not missed. He has a new research paper that uses the Nauru fund—and those of Kiribati, Timor-Leste and PNG—to outline some important lessons on how to ensure that SWFs achieve their objectives. As Gould notes:
“A key challenge for developing countries endowed with natural resources is to transform those resources into sustained improvements in living standards. A number of Pacific island countries have utilised sovereign wealth funds (SWFs) to manage government revenue from exhaustible natural resources with the aim of improving development outcomes. Experience in the region has been mixed — some SWFs have aided intergenerational equity and macroeconomic stability while others have struggled to bring about improvements in wellbeing.”
I like this paper, as it draws some really useful lessons from the experiences of these Island nations. Here are Gould’s take-aways:
- If you have a high debt burden and a high borrowing cost, you should use your sovereign wealth to retire debt NOT set up a SWF. The chances of making returns within the SWF sufficient to justify not retiring debt are low (and the investment risks required to do so are high).
- All SWFs need a clear objective and mandate, with strict withdrawal guidelines and borrowing rules.
- The SWF should be integrated into the broader budget process.
- SWF assets should (in most cases) be held off-shore. This will mitigate Dutch Disease and increase the number of investment options.
- SWFs must be designed and governed according to international best-practice. For example, it needs professional investment management. And transparency around the operations of the SWF is vital.
I think these are all eminently sensible. And given that Gould draws these insights from successful and unsuccessful case studies, I think the advice is that much more powerful. In short, if you sponsor a SWF, you should spend some time getting to know Nauru and it’s failed attempt to manage commodity wealth through a SWF.