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Future of Finance

AS SOON AS HIS TEACHING DUTIES END WITH THE academic year, Eric Parrado, a professor of economics and finance at Adolfo Ibáñez University in Santiago, Chile, hits the road. Since completing a three-year stint in 2010 as international financial coordinator for the country’s Ministry of Finance, where he managed as much as $22 billion in assets for Chile’s sovereign wealth and stabilization funds, Parrado has blazed a new career as an independent adviser to resource-rich countries. The 42-year-old, who is also an active member of the financial advisory committee overseeing Chile’s sovereign wealth funds, travels the world, collaborating closely with governments to help draft fiscal policy and design new sovereign wealth funds in anticipation of future windfalls. Over the past two years, he has worked with Colombia, Mongolia and Nigeria, and he recently began advising Panama.

“Among the lessons I’ve learned is that these countries realize that fiscal discipline is extremely important,” says Parrado, who spent two weeks in Ulaanbaatar, Mongolia, in July, helping the newly elected coalition government lay the foundation for a new sovereign wealth fund framework. “In the wake of the financial crisis, their governments see sovereign wealth funds as a key mechanism for attaining and retaining fiscal discipline, as well as a means of providing self-insurance in a volatile and unfriendly global economy.”

The need for greater fiscal prudence is obvious and pressing. Even as the European sovereign debt crisis rages on, threatening to derail the fragile global economic recovery, a quiet revolution is sweeping through resource-rich emerging and frontier markets. From Israel to Tanzania an unprecedented number of sovereign wealth funds are being established as governments seek to protect their domestic economies from macroeconomic risks, mitigate the potentially destabilizing effects of sudden resource wealth — such as hyperinflation and a decline in manufacturing (so-called Dutch disease) — and save for future generations. If anything, the global financial crisis, which has hit debt-ridden developed markets hard, has only served to catalyze those goals, adding momentum to a decadelong trend that has sparked a flurry of fiscal policymaking in some of the farthest reaches of Asia and Africa. The changes are happening slowly, but the trend is discernible in every public consultation period, legislative proposal and parliamentary vote now taking place.

The surging popularity of sovereign wealth funds can be attributed to a rare convergence of risk factors and opportunities. As early as 1999 a gravity-defying market trend took hold as secular demand drivers in emerging markets — including population growth, income expansion and industrialization — started to nudge commodity prices higher. By late 2001 they were soaring. Although the prices of oil and metals plunged in 2008 with the global financial crisis, those fundamental drivers are still in effect. Commodity prices have recovered strongly, if unevenly, over the past four years. Faced with historically high prices and the potential for greater volatility, many resource-rich countries are now choosing to act quickly and take advantage of a rare commodities supercycle by creating sovereign wealth funds for a variety of purposes: fiscal stabilization, future savings or economic development.