Gov’t plans to spend sovereign wealth fund

Last week the Ministry of Finance published the first annual report of the Citizen’s Fund, the sovereign wealth fund. After many years of delays, money finally started to flow into the fund from the profits of Israel’s offshore gas, as set by the Sheshinski Committee in 2010.

In the middle of 2022 the first NIS 1 billion was deposited in the fund, which became operational. By the end of 2022, the fund had accrued $617 million, or NIS 2.2 billion at the current exchange rate. According to the latest forecasts for the Citizen’s Fund, another $10-12 billion will be collected from royalties and taxes from the owners of Israel’s offshore gas fields.

The annual report opens with an introduction by Bezalel Smotrich, who as Minister of Finance also serves as chairman of the fund’s council. He writes, “The Israel Citizen’s Fund was set up to keep some of the profits from the natural resources – for the benefit of future generations,” The problem is that this statement contradicts the government’s stated intention to change the fund law, so that it can make immediate use of the amounts that have just begun to accrue.

While Smotrich boasts of a “long-term vision for the benefit of all of our children, grandchildren and great-grandchildren”, the Ministry of Finance is already preparing for the directive that will break into the grandchildren and great-grandchildren’s savings bank.

Coalition aspires to chain the Sovereign Wealth Fund Law

In January, just before the upheaval began in Israel over the planned judicial overhaul, “Globes” revealed that S&P had sent an enquiry to the Ministry of Finance about the sovereign wealth fund. The ratings agency requested to know if the sovereignty of the fund, which is currently managed abroad, would be harmed. The various ratings agencies and foreign investors quickly understood that the sovereign wealth fund was the tip of the iceberg, which the Israeli economy is sailing towards.

Since then the focus of concern has been on the weakening of the independence of other institutes of the state, mainly the Supreme Court and to a lesser extent the Bank of Israel, which coalition MKs want to take under their control. All of these have a common denominator that worries the markets: the breaking of the existing rules established over many years and the subjugation of professional positions by politicians.

In contrast to the judicial overhaul legislation that progressed at a swift pace after the inauguration of the government until it was paused last month by Prime Minister Benjamin Netanyahu, the legislation required for withdrawing funds from the wealth fund has not yet been put forward by either the prime minister or Ministry of Finance. The move has not yet officially been initiated, but the coalition has already held closed talks on the subject. It is clear that there will be resistance to the move from within the Ministry of Finance, if and when the practical steps are promoted for opening the fund.

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Meanwhile, the Ministry of Finance Accountant General Division believes that there are risks in opening the sovereign wealth fund. The Budgets Division is also not enthusiastic about the government’s mechanism to bypass the budget for funding its plans. On the other hand, Smotrich’s aides support the plans to use the sovereign wealth fund for current needs.

If the government does succeed in getting its hands on the fund’s money, it will receive a relatively small amount although there will be a powerful flood of money into the fund in the future. Every year one or two billion shekels will flow into the fund from the energy companies as well as returns from investments, which amounted to 1.2% in 2022, despite the fall in the markets. The fund money is somewhat vaguely earmarked for infrastructures. Almost any government plan can be defined as infrastructures, whether physical or human, what is the money being kept for?

There is currently no prioritization mechanism for the distribution of money from the fund. Subject to any bill to be tabled by the prime minister, a situation could come about in which the funds are withdrawn without proper supervision, unlike the funds from the state budget. So will the infrastructure money be used for national projects, such as building hospitals, another airport or railways? Probably not. Such infrastructures will continue to come from the state budget.

A more likely scenario is that the relatively small amount of money will be more suitable for filling specific and sometimes sectoral holes, which reflect the composition of the government coalition. For example, one of the ideas already thrown up has been the use of funds to establish classrooms for educational institutions that do not teach core studies (math and English) and so do not receive full funding from the state.

Ironically, Netanyahu foresaw what would happen

Ironically Netanyahu was the first to predict that politicians would try to take control of the fund and use the money for purposes for which it was not intended. More than a decade ago, even before one cubic meter of natural gas was produced from Israel’s offshore fields, Netanyahu demanded that the fund’s sovereign position be strengthened in legislation to ensure that future generations would benefit from the profits of the gas discoveries. The then and current Knesset Finance Committee chairman MK Moshe Gafni, asked to toughen the legislation and prevent any possible loophole to deny citizens of future gas revenues.

It was Netanyahu who conceived the idea of the wealth fund in 2010, shortly after the gas discoveries. A person working in those days with Netanyahu, Gafni and other politicians on the legislation on the status of the wealth fund, recalls how they tried to put into it more and more protections against the early opening of the fund. When he asked them why they actually demanded to restrict themselves, they replied that “sometimes you have to protect politicians from themselves.”

Prof. Eugene Kandel, who at the time served as chairman of the National Economic Council and headed the council that established Israel’s sovereign wealth fund told “Globes” that he opposes attempts to change the usage of the Israel Citizens’ Fund.

He said, “The fund was set up after years of thorough work, and everyone agreed that it should promote three goals: distribution of revenues from natural gas for future generations, providing a security cushion for exceptional macro events, and third, preventing the ‘Dutch disease,’ (over-strengthening of the shekel). These three goals have not changed, but suddenly, and without any preparatory work being done, we were surprised to find this thing in the coalition agreement. I can’t figure it out. I have no explanation as to why a subject that was discussed rigorously and thoroughly, like very few things in Israel, becomes a political matter. It is very strange, because coalition agreements usually include things that are political, not professional. It will not advance any of the three goals.”

Kandel insists that there is no economic feasibility in financially investing the fund in infrastructure projects. “It’s a bit funny to do that, because the money that will accumulate in the fund in the coming years is trivial compared with the money held by institutional investors, which can go to infrastructure and does go to infrastructure. They have almost two trillion shekels and the fund, in five years, will have less than $10 billion. If really there are projects that have a high return, so send them there. And if there is a high return for the economy but low for investment, then it is better for this fund, which is financial and wants to achieve the three goals, to invest elsewhere.

Kandel compares what the government wants to do by the using the fund to setting up infrastructures with a family inheritance. “Basically, they say that they want to leave a road instead of money for future generations. It’s like parents deciding to buy a couch to bequeath it to their children instead of leaving money.

When asked if setting up infrastructures is not a worthwhile investment for future generations, Kandel responds. “If they want to use the money for infrastructures, then you don’t need the fund. Just put the money straight into the state budget. The problem is that very quickly the money won’t go to infrastructures but for coalition needs and defense.”

Kandel says there was also criticism of the government’s plans last month during a Knesset debate by the Committee Supervising the People’s Fund chaired by MK Lior Sonn Har Melech of Otzma Yehudit, which he attended. Prof. Eitan Sheshinski himself participated in the discussions and protested what the government wants to do. He said, “It bothers me as a citizen that there is a clause in the coalition agreement that might convert the fund into a small amount of cash for the state.”

The committee’s discussions were exceptional with two veteran professors appointed a decade ago by Netanyahu to set up the sovereign wealth fund coming to the Knesset to protect it. They seemed shocked by the possible change and warned about wasting the inheritance of future generations. But there was almost nobody listening to them.

Except for Sonn Har Melech himself, no other MKs bothered to come along to discuss the matter. Sonn Har Mele3ch summed up, “The main message today is to protect the fund’s money. We heard economist today who are very disturbed over this issue.”

Meanwhile the fund has less money than expected

Another difficulty in withdrawing money from the fund is that the vast majority of it is not liquid. According to the investment policy, most of the amount is invested in stocks (60%), and the balance mainly in corporate bonds (36.5%). Only a small amount of the money is held in cash assets (3.5%). This amount of cash is intended for the use of the government. According to the Fund Law, in each one of the first ten years of its activity, the fund will transfer to the state budget an amount equal to 3.5% of its assets.

The past year has been the first in which the state will earn money from the “Sheshinski tax” that was imposed on the energy companies a decade ago. However, the dividend from the fund, which currently stands at about $21 million dollars “only”, is still negligible compared to the state budget and tiny compared to the promises made to the citizens of Israel in recent years.

The amount accumulated so far in the fund is significantly lower than initial forecasts. A decade ago, the Bank of Israel estimated that at this stage the fund would have accumulated over $4 billion – six times more than the amount the fund currently in the fund. Moreover, the latest forecast of $12 billion in the fund by 2032, is well below the $72 billion previously predicted by 2037.

Published by Globes, Israel business news – en.globes.co.il – on April 11, 2023.

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