Dec 11, 2011
In a new report, "Structuring Israel's Sovereign Investment Fund: Financing the Nation's Future," the Milken Institute explores the policies necessary to turn a temporary resource boom into a lasting national advantage.
"Israel has a unique opportunity to transform a sudden and temporary bounty of natural resource wealth from its offshore natural gas discoveries into an intergenerational endowment — an investment fund that will strengthen national economic security by insuring against risks of natural, geopolitical, or economic catastrophes while investing in Israel's most important resource — its human capital," said Glenn Yago, one of the report's authors and Senior Director of the Milken Institute Israel Center. "Our report is a roadmap for policy makers on how they can most effectively accomplish this, as well as the pitfalls for them to watch out for."
Last January, Prime Minister Benjamin Netanyahu and Bank of Israel Governor Stanley Fischer called for Israel to create a sovereign fund to manage the anticipated billions in revenues derived from the development of natural gas resources. The report released today is based on a Milken Institute Financial Innovation Lab — held earlier this year, conducted at the request of Israel's National Economic Council in conjunction with the Bank of Israel and the Ministry of Finance. Participants included Karnit Flug, Deputy Governor of the Bank of Israel; Eugene Kandel, head of the Israel National Economic Council; Haim Shani, Director General of Israel's Ministry of Finance; Eran Heimer, Senior Deputy Accountant General of the Ministry of Finance, and other experts from the private and public sectors.
Even before the anticipated natural gas revenues begin, Israel possesses considerable financial resources that argue for a national investment fund, with more than $70 billion in existing foreign exchange. The energy bounty from the offshore Tamar and Leviathan gas fields alone will add to that considerably: when they reach full output, the fields should generate more than 20 billion cubic meters (BCM) of natural gas each year.
If the government of Israel enacts policies to allow for exportation, processing and gas-related industry production, Israel could be ready to export at least 10 BCM annually within a decade. This could raise the country's trade surplus by one-third, or approximately $2 billion, which in turn could add considerable pressure for currency appreciation.
The report analyzed the effect of a similar discovery of oil and natural gas in the Netherlands in 1959. After the initial surge in national wealth, the massive increases in Dutch revenues caused an appreciation of the real exchange rate, making exports less competitive, fuelling domestic inflation, and contributing to the loss of tens of thousands of manufacturing jobs.
Participants in the Institute's Financial Innovation Lab considered how Israel can avoid coming down with "Dutch disease," and looked at models of what have been called "sovereign wealth funds" across the globe. Some 50 such funds — from Norway to Chile to Kuwait — have differing objectives and risk profiles, with their experiences offering useful benchmarks.
Lab participants concluded that the primary goal for a "sovereign investment fund" flowing from Israel's offshore natural gas wealth should be to build a reserve for catastrophic risk arising from natural disaster, war, or economic crisis. A secondary goal would be to build up revenues to cover pension obligations, education, health care, and other needs affecting Israel's human capital.
Additional recommendations of the report include:
- Create a governance framework. To shield the fund from political influences, the fund must remain independent, transparent, and subject to checks and balances. Lab participants noted that good governance would have the additional benefit of strengthening Israel's sovereign credit rating to AA.
- Specify the revenue source. The report recommends that the sovereign investment fund should invest Israel's fiscal surplus and foreign exchange reserves, in addition to investing natural gas commodity revenues and royalty payments. The government must also determine what share of commodity revenues to transfer into the fund.
- Define the withdrawal rules and design the investment strategy. The fund's goals will determine how the government will spend the returns, and its investment policies must follow its mission.
The full report can be found at http://www.milkeninstitute.org/publications/publications.taf?function=detail&ID=38801292&cat=finlab
To interview report author Glenn Yago, contact:
Conrad Kiechel, Director of Communications