India should desist from setting up a sovereign wealth fund (SWF) using its high, but depleting foreign exchange reserves of around $250 billion, a Securities and Exchange Board of India (SEBI) study has warned.

Unlike the Gulf wealth funds started in the 70s and early 80s, funded by oil revenues, Indian foreign exchange reserves are mostly in the capital account and hence cannot be compared with petro-dollar, or pure trade receipts, the report pointed out.

"India's foreign exchange reserves are built on capital account inflows and hence it is subject to capital flight, said a report prepared by SEBI officials.

In contrast, the Gulf sovereign funds generally generated relatively higher returns, ensuring smooth flow of income to the holders of the fund. Return on investment was the main criterion of investment for the funds.

In the decade of nineties, social benefits became the main criterion and subsequently, investing the funds safely became the main concern. In the decade of the twenty-first century, countries created SWFs out of their foreign investment pattern.

''Funding an SWF from capital account surplus is risky since the capital flows can reverse their direction any time," SEBI said in the bulletin.

SWFs that manage foreign assets, are broadly categorised as exchange reserves, stabilisation funds and savings funds and are deployed over longer periods by rich and developed countries. However, for the developed countries that also joined the queue along the former, these funds are used as instruments for short term investments.

These funds essentially came from current account surpluses over a longer term unlike in the case of India where these have come from direct remittances from overseas countries or from capital transfers.

Over last five years, the oil-rich Gulf countries invested sovereign wealth funds in a wider portfolio and experienced an average growth of 6.5 per cent in assets for relatively longer term to accumulate their GDP. As a result, the volume of their SWFs have also increased to a great extent. Currently, the oil exporting countries control at least two third of public and private debt securities, equity, private equity, real estate etc, the report pointed out.

By the end of 2007, total assets under management controlled by a sovereign wealth fund grew 18 per cent to reach $ 3.3 trillion as commodity prices surged and the foreign exchange reserves of some Asian countries continued to rise.

The Morgan Stanley in its research report mentioned that, the SWFs could reach $12 trillion by 2015, and surpass the size of the world's total official reserves before 2011.

It also pointed out that the dominance of oil connected SWFs will gradually decline and the non-commodity SWFs will increase in volume. Since 2005, at least 16 SWFs have been created.

In the absence of proper checks, "the SWFs could be misled to promote domestic political or foreign policy objectives which contradict with the guidelines of Santiago principles," the report noted.

The Santiago principles lay down the code of conduct for transparent and non-political functioning of the SWFs.

While giving a clean chit to the SWFs, the study also raised concerns about "corruption or even underperformance" due to mismanagement of the SWF by the political class.

In many west European countries and the US, it is widely believed that the governments through the SWFs are not only looking for economic benefits but may be attempting to achieve political influence as well, the report said, adding, "There are no evidences so far to suggest political or other motive behind investments by SWFs in other countries."

Sovereign wealth funds are created through transfers of assets from controlled pools of assets designed as a vehicle of official foreign exchange reserves. These funds invest in invest in a large array of assets for a relatively longer time horizon. Though these funds appear to be saviours and bastions of growth for many companies in the west, the grim global outlook have raised many controversies regarding their pattern of investment, transparency and their role in influencing the economic decisions in recipient countries.