‘Sovereign investment fund would protect against war'

Milken Institute report says New Zealand, Norway are models to emulate.

December 13, 2011 23:23
3 minute read.
Leviathan holds 453 billion cu.m. of gas [file]

Leviathan 311. (photo credit: Courtesy of Albatross)

Israel must establish a sovereign-wealth investment fund from future offshore natural- gas revenues to protect against catastrophic risks like war, economic crisis or natural disaster, a report published this week by the Milken Institute concluded.

A secondary goal of such a fund would be to build up revenues to cover pension obligations, health care or other assets affecting Israel’s human capital, it said.

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Recent discoveries of underwater gas fields – led by the Leviathan and Tamar fields, which between them contain an estimated 700 billion cubic meters of natural gas – are expected to turn Israel into a natural-gas exporter in the coming years.

Milken’s report was based on a workshop the economic think tank supervised in Los Angeles earlier this year. Participants in the workshop, or Financial Innovations Lab, included Bank of Israel Deputy Governor Karnit Flug, National Economic Council head Eugene Kandel, Finance Ministry Director-General Haim Shani and other senior Israeli officials.

The workshop participants recommended that Israel use the New Zealand Natural Disaster Fund as its model. That fund is governed by the Earthquake Commission – a “Crown entity” controlled by the New Zealand government, but which operates as a private corporation. It currently holds about NZ$5.6 billion ($4.3b.) and was instrumental in enabling a quick recovery from the 6.3-magnitude earthquake that struck Christchurch, New Zealand’s second-largest city, in February.

The Israeli government is not financially prepared for a catastrophic quake and remains exposed to this and other risks from weather, fires, war and economic downturns that could endanger the country’s national security, the report said.

New Zealand also sets a good example example on how to use a sovereign-wealth fund to meet future social-security shortfalls, according to the report. It said Israel, which still has a $120b. budgetary pension obligation, should designate a fund based on the New Zealand Superannuation Fund and Norway’s Government Pension Fund-Global.

Like the earthquake fund, the New Zealand Superannuation Fund is financed by capital contributions from the government and governed by a separate Crown entity. The government plans to allocate about $2b. a year to the fund over the next 20 years. The Norwegian pension fund is completely funded by Norway’s petroleum sector through royalties, company taxes and excess-profit tax. Investment returns are transferred back to the government’s fiscal budget to fulfill pension liabilities, the report said.

The workshop participants also noted that Israel could use a sovereign fund to enhance its foreign credit rating to AA (two rungs below AAA) because international markets interpret foreignexchange accumulation as a sign of good governance and sustainable fiscal position, the report said.

“The existence of a sovereign-wealth fund suggests that there are government guarantees on domestic financial-sector deposits, and the financial system as a whole becomes more credible as the fund’s assets grow,” the report said. “This higher sovereign-risk rating would reduce sovereign, corporate and private project borrowing while simultaneously strengthening the country’s emerging role as a bilateral creditor in expanding international trade.”

The report said using a sovereign fund to invest in global markets would help Israel avoid “Dutch Disease” – a term coined by The Economist to describe the negative impacts on an economy of large inflows of foreign capital. The name refers to the damage done to Dutch manufacturing and exporting industries after rapid increases in oil and gas revenues in the late 1950s and early 1960s caused the real exchange rate to appreciate.

Prime Minister Binyamin Netanyahu and Bank of Israel Governor Stanley Fischer both support establishing a sovereign-wealth fund. Like the Milken report, Fischer recommended last December that Israel invest its income abroad, to moderate the short-term effect of gas revenues on the exchange rate.

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