Designing Israel’s New Sovereign Investment Fund

Today the OECD called on Israel to set up an independent sovereign fund to manage its looming hydrocarbon revenues. Given this is something Israel has actually been working on for almost a year, the OECD is actually just offering some encouragement to the Israeli government to continue its work in this area. Indeed, in early 2011 the PM’s National Economic Council, in conjunction with the Bank of Israel and the Ministry of Finance, commissioned the Milken Institute to examine how the country should structure a new sovereign fund to manage looming natural gas revenues. And, coincidentally, on the same day of OECD report, the Milken Institute released its report entitled “Structuring Israel’s Sovereign Investment Fund: Financing The Nation’s Future”. That should please the OECD wonks!

Anyway, the Milken report is a product of its ‘Financial Innovations Lab’, which brings together researchers, policymakers and practitioners to try to resolve intractable public policy challenges. In this case, it brought together academics, Israeli policy makers, and finance professionals to come up with some design recommendations for the Israeli SWF planners. Here’s a blurb describing the motivation for this project:

“...the expected capital inflow from Israel’s natural gas fields—billions of dollars in potential revenue—could double the country’s trade surplus and strengthen the shekel. And here, too, it could lead to local currency appreciation and higher prices, particularly among exports in the strong technology and manufacturing industries, which have generated much of the country’s recent GDP growth, foreign exchange reserves, and job and income creation. Higher prices in foreign currencies would make exports less competitive, manufacturing would drop off, and inflation risks would follow...Over the past few decades, many resource-rich countries, from Norway to Chile to Kuwait, have reduced this economic risk through the creation of sovereign wealth funds. These funds typically invest revenues from natural resource (commodity) exports in global markets rather than at home, targeting the returns for government expenditure and national development. The funds help smooth out the natural volatility of commodity price cycles and export income, and can be used as holding companies for their governments’ long-term strategic investments.”

You get the idea; the report talks, in detail, about how Israel could (or, rather, should) structure its new SWF to help overcome the ‘resource curse’. In this regard, it offers some useful insights about Israel and also has some detailed vignettes of other countries’ experiences with SWFs. I thought it was well worth a read. And I thought the high-level advice was sound. For example, the report calls on Israel to focus on the following principles:

The sovereign fund must have clarity of mission. In other words, the fund can’t have too many objectives if it is to achieve any of them.
The fund should have a formal governance framework that explicitly rejects political motives in the investment policy.
The government should designate the fund’s revenue source.
The government should clearly define the withdrawal and spending rules.
The fund must have a coherent investment strategy that is aligned with the fund’s primary objective.
The government must work to secure public support for the fund’s long-term mission through outreach and education.

That all seems very sensible and aligns with a lot of the stuff I’ve written over the past few years (see here, here and here). Now, we can all watch and see whether Israel uses this good advice as it takes its next step towards full membership in the SWF club.

Designing Israel’s New Sovereign Investment Fund

The OECD has called on Israel to set up an independent sovereign fund to manage its looming hydrocarbon revenues. Israel has actually been working on this for almost a year, so the OECD is really just offering some encouragement to the government.