Europe must present a single market to SWF's.

• Author: De Lecea, Antonio
• Position: Finance - Sovereign wealth funds - Viewpoint essay

Sovereign wealth funds have become the latest topic du jour in international finance; their rapid expansion is sparking political debate on both sides of the Atlantic and, it is fair to say, fuelling a certain amount of anxiety as well.

Sovereign wealth funds are nothing new. The very first fund was established by the Kuwait Investment Office in 1953 and the number of funds jumped in the 70s and 80s as rising oil prices allowed oil producers to set up funds.

Despite this, SWFs have aroused political debate because of the various perceptions (or misperceptions) that surround them. First, some see the funds as a potential risk to the stability of financial markets. Although they have been there for quite some time, it is only in the last few years that we've seen a worldwide increase in both their number and size. For example, since the turn of the millennium, about 20 new sovereign wealth funds have been set up, including Russia's Reserve Fund and National Welfare Fund, Korea's Investment Corporation and the China Investment Corporation. The sheer magnitude of the capital under sovereign wealth fund control has exploded. From current levels of two trillion dollars, they are expected to reach more than $12 trillion before the middle of the next decade.

While the numbers may be huge, we should be careful not to overstate their impact; the total assets of sovereign wealth funds still only account for about one twentieth of those held by private sector participants.

Sovereign wealth funds have also been a rather stabilising force during the current financial turmoil because of their long term investment horizons and relative lack of commercial liabilities. They complement other investment actors and are better placed than most private investors to withstand market pressures in times of crisis.

Even if SWFs are not necessarily a threat to financial stability, the large and persistent global imbalances underlying their recent rapid growth do pose serious concerns for the global economy. For countries with large deficits like the

U.S., the danger in the imbalance is if investors are no longer willing to finance the deficit and a rapid reversal of capital flows occurs. For surplus countries, the fear with the imbalance is that large foreign exchange inflows often contribute to asset price bubbles and higher inflation. And for the world economy, a disorderly correction of global imbalances could disrupt international trade and fuel protectionist...