The National Pensions Reserve Fund (NPRF) was established in April 2001 but is only now beginning to make headlines. The NPRF now stands at €7.7 billion (about 8 percent of Irish national income) and, starting from the beginning of 2002, about half has now been invested in the international capital markets, writes Philip Lane
Pending the appointment of fund managers, the fund was held on deposit during 2001. Given the poor state of global equity markets, this was extremely fortuitous and the fund earned a respectable 4.4 percent (on an annualised basis) in interest income from April 2001 to December 2001.
Some politicians criticised the Minister for Finance, Mr McCreevy, for maintaining the annual payment of 1 per cent of GNP into the fund when a return to budget deficits threatened and when there was an urgent need to engage in a high level of public spending, particularly to redress deficiencies in public infrastructure and the health service.
Moreover, there was an accusation of fiscal accounting fudges in transferring assets from the Central Bank and the Social Insurance Fund to preserve a Budget balance. Most recently, the Chairman of the Fund Commission, Mr Donal Geaney of Elan, is dealing with a major decline in the value of his own firm's shares.
The Fine Gael leader, Mr Michael Noonan, has called for the fund to be invested in domestic infrastructural projects, rather than the purchase of overseas assets. This view is also largely adopted by the Labour Party's finance spokesman Mr Derek McDowell.
A noteworthy development in this regard is that Dr Michael Somers, the head of the NTMA, which has responsibility for managing the fund, has expressed an opinion that part of the next tranche of fund investments could indeed include investment in Irish road and bridge projects. With the first tranche exclusively allocated to international equity and bond investments, this represents a remarkable new direction for the fund.
THE IDEA is that the fund could act as a provider of private equity in projects that are organized on a "public-private partnership" (PPP) basis. It is envisaged that a PPP approach will be employed for a significant number of projects under the National Development Plan, thereby providing potential investment opportunities for the fund.
This development is a cause for severe concern. Substantial domestic investments by the fund would increase its exposure to political interference. Although the commission appointed to make investment decisions has independent authority under the legislation, this is not an absolute guarantee of political independence, since the commissioners have fixed, limited terms in office and the composition of the commission could easily be altered through the re-appointment process.
The ongoing political acceptability of the fund also requires a high degree of public acceptance of its role. This could be threatened by acting as an equity investor in Irish infrastructural projects. Imagine a scenario in which a road project turns out to deliver extremely high returns to its private investors. This would be good news for the fund in terms of its financial performance but could be politically unpopular, if the high profits are generated by expensive tolls that are resented by the average local commuter and the haulage industry.
One of the putative benefits to PPP arrangements is the transfer of project risk from the State to private investors. Depending on the specifics of the contract, it is the private investors who are meant to bear the risks of cost overruns or low usage rates. A true transfer of risk hardly occurs if the private investor is itself a Stage agency: the taxpayer ends up holding the ultimate liability, contrary to the spirit of the PPP approach. The ongoing Enron scandal of course highlights the importance of ensuring a true risk transfer taking place in partnership schemes.
INVESTING in domestic PPP projects also appears risky in terms of the fund's mandate. It is plausible that the private equity return on domestic infrastructure projects will positively depend on the state of the domestic economy. If the economy booms, usage of toll bridges and roads will be high and the private investors will do well. Conversely, an economic slowdown will reduce toll revenues and the private investors will correspondingly suffer.
This is a dangerous pattern of risk in terms of achieving the goals of the fund. A booming economy would mean high tax revenues, making the financing of future pensions more affordable and the role of the fund less critical. More sluggish economic growth would increase the reliance of the government on investment income from the fund. For this reason, the fund should concentrate on overseas investments that provide diversification from domestic economic risks.
To address these concerns, it would be useful to know more about the reasoning behind the fund's investment strategy. The allocation of the first tranche of investments in international capital markets was largely based on a consultant's report that has not been publicly released and the justification for its geographic and sectoral breakdown has not been explained. Under the establishing legislation, the Oireachtas Committee on Public Accounts is free to interview the chairman of the commission and the chief executive of the NTMA. Accordingly, the Committee has an important duty in throwing a spotlight on the operations of the fund.
Philip Lane is a professor of economics at Trinity College, Dublin. His views here are expressed in a personal capacity.
Vincent Browne is on leave