Estimates of these effects must however be interpreted with caution: they rely on fragile assumptions, amounting to an equivalency between the development of risky sovereign holdings and a lasting decline in global risk aversion. Before jumping to such a conclusion, one should keep in mind that if private savings had not been  5  Warnock, F. and Warnock, V. (2006) - International Capital Flows and U.S. Interest Rates, NBER working paper. 6  BIS Review 119/2007  intermediated in public balance sheets, they might as well have been invested directly in risky assets. Yet the impact of SWF investments on some small and illiquid financial markets, such as gold, commodities and real estate might be high. To the extent that SWFs attempt to hedge macroeconomic risks for their country, difficulties could arise insofar as the best existing hedging instruments may be less liquid than bonds and equities. The risk of a potentially disruptive impact on asset price dynamics should then be acknowledged for large SWFs, as underlined by the 2007 IMF Global Financial Stability Report. Investment criteria By their very nature, the criteria used for sovereign portfolio strategic asset allocation are not exclusively related to value-enhancing considerations, but may also encompass other policy objectives. Among the main non-financial criteria, ethical and environmental concerns are sometimes put forward. The Norwegian Government Pension Fund, for instance, established in 2004 its “ethical guidelines”, excluding investments in weapons production industries or polluting sectors.

While theoretically feasible through issuance of central bank bills, large-scale sterilisation proves problematic in practice, especially in emerging economies, which are not always fully equipped with market-based policy instruments. In order to effectively control exuberant credit expansion, emerging economies have often had to recourse to large increases in reserve requirement ratios or even non-market policy instruments such as the rationing of credit. In a context in which credit and interest rates are largely administered, the fiscal cost of sterilisation can effectively be transferred to the banking sector, and ultimately to bank customers and stockholders; but that does not remove the opportunity costs of sterilisation for the private sector or the monetary risks of incomplete sterilisation. The bottom line is that in economies where largescale foreign asset accumulation needs to be sterilised, it is very likely that capital allocation efficiency will be reduced, especially if non-market instruments have to be used. Foreign reserves and international competition A second risk is that reserve hoarding may exacerbate trade competition and emphasise regional tensions. Emerging economies compete in their exports towards developed economies, as much as they compete with developed economies. As noted by Aizenman 4 “in a world with symmetric emerging markets competing in similar industries, competitive [reserve] hoarding tends to dissipate most competitive gains, leading to a “beggar-yourself” [outcome] and excessive hoarding”. By contrast “in an asymmetric world, an emerging market with low enough cost of sterilisation may win the hoarding war […] akin to the “beggar-thy-neighbor” outcome of asymmetric Tariff Wars”.