Designing an Israeli development financing platform: Towards Sustainable Development Goals
Israel’s dazzling success in high-tech innovation has diverted attention from issues that threaten its long-term economic growth. Over the past decade, growth has been driven by investments in people and technology. Meanwhile, exports as a percentage of GDP have declined by nearly a quarter, as Israel’s traditional trade partners, mostly mature economies in Europe and elsewhere, also show signs of slow growth and productivity. Declining goods exports reflect a sharp decline in labor productivity and employment in tradable goods, and the disadvantage to export services—a dangerous spiral that
needs immediate correction. Yet the Israeli firms most likely to succeed at exporting their innovative technologies to new markets come up against the limited access to these markets and high costs of capital.
Essentially two key dimensions are missing:
1. Need to leverage public and private funding to help Israeli business and capital markets participants expand their access to fast growing emerging country opportunities.
2. Need for a “one stop shop” for catalyzing and channeling such financing as well as for project development assistance and technical support in the preparation, development, structuring and implementation of projects in emerging markets. To scale up its success as a technology innovation leader and achieve the growth necessary to ensure future security, Israel must acquire new trading partners for developing its high-tech know-how. These
will be the fast-growing developing markets, mostly in Africa, Asia, and Latin America, that are already responsible, in the aggregate, for nearly 60 percent of the global economy. As they participate more in global trade, their middle classes grow and, the aggregate demand for all goods and services rises. Yet they too face risks to sustained growth, including demographic shifts toward much younger populations who need education, training, and employment; and the challenges of climate change affecting resource demand and internal migration. Even though these countries witnessed increased inflows of foreign investment, those investments are rarely channeled into the kinds of infrastructure that will help them achieve the UN’s Sustainable Development Goals—investments in human capital, technology and the environment. Moreover, capital flows to these important developing economies are trending downward, resulting in recent underinvestment. Israel’s initiative into international development leverages not only finance, but technology to increase resources for achieving the SDGs and the importance of Israel as a trade partner eager for co-innovation, disruptive technologies, and cooperative relations for growth. Israel is well positioned to transfer technology solutions to new startup nations. It has operated like a “Global Laboratory”. It draws from its own experience with scarcity since the state’s founding to help them participate in sustainable, knowledge-based growth. Its own story exemplifies how ingenuity overcomes adversity, deprivation, and isolation. It has faced numerous challenges they face today— including of health and education; water, energy, and food security; and the related cybersecurity needs in these areas—and answered them all with cutting-edge, high-impact technologies that can be delivered elsewhere. Its companies are adroit, quick to test, adapt, and innovate. Their greatest problem is not even of their making: it’s how to compete for investment dollars by generating investible projects attractive to large institutional investors—and how to overcome the high costs of doing so. The Government recognizes that strengthening Israel’s trade role in international development—and, specifically, the role of its export entrepreneurs—is the only sure course toward strengthening both the economy and creating enduring ties of economic cooperation. To determine what kinds of programming and financial structures would best support the ability of private firms to export their projects, products, and services, the Government issued Government Decision No. 4021 in July 2018, with the most far-reaching and crucial element of that mission to date: exploratory work toward the creation of development financial institution (DFI). This is a financial facility, government-sponsored but independently run, that would invest in and offer support to private Israeli firms’ projects, products, and services that promote sustainable growth in developing countries. Because investors and businesses alike are generally reluctant to target these kinds of projects in these markets, they need financial tools—including equity, guarantees, loans, and bonds—specially designed to address flexibility, growth, and returns to compensate for the development, currency, environmental, and performance risks. The resulting projects will be structured to crowd-in private capital to leverage government-sponsored investment and guarantees toward this objective of international development.
This is where a DFI excels. Israeli businesses, most of which are small and focused on small-scale projects, cannot compete for funding with firms from other countries. The innovative nature of their high-tech work requires risk mitigation to lower the cost of capital for projects delivering technology transfer and increase efficiency. Except for export trade credit in the form of bank loan guarantees, they have no other access to domestic capital for larger projects that generate demand for a portfolio of technology solutions. Some companies may be able to secure specialized financing from sources outside Israel, but they are the exceptions. A DFI would allow for the organizing, or “pooling,” of multiple projects to create a portfolio of investments that distribute and share the risk and returns. In sum, the DFI would address the unique barriers and opportunities for Israeli businesses; adapt solutions tailored to them; and provide financial instruments that reduce investor risk and capital costs. Israeli-based financial instruments will level the playing field for local companies by enabling them to draw more private and foreign capital due to the decreased risk, and to create capital structures that enable better margins for project performance, affordable capital for projects and end users, and allow competitive returns to investors. The DFI being explored would offer more than financial instruments as well. In keeping with other DFIs that have been launched (or are being redesigned and renamed for “relaunch”) in recent years—in Canada, the US, and, as in Israel, under consideration in Australia, for example—the Israeli DFI would offer technical, financial, management, and advisory expertise and services throughout the life of a project, from design and development through implementation and operations. In addition to building economic growth at home, the DFI will bring significant value added through financial diplomacy that supports technological and economic development and fieldwork promotion. This report that follows is based on a Financial Innovations Lab held in January 2019, hosted by the Milken Innovation Center/Blum Lab for Developing Economies and the Prime Minister’s Office. It describes market conditions for Israeli companies, projects in developing economies, lessons from best practices among DFIs, and the recommended DFI structure for Israel.