The government will make an initial investment of NZ$700 million, which will grow to around $1 billion as it earns interest over the next 10 to 15 years, Prime Minister Helen Clark said yesterday.
The fund will be spent on research and development and supporting innovation and is expected to receive additional top-up contributions each year from leading food companies such as Fonterra and kiwi exporter Zespri.
This will bring it up to around $2 billion in 15 years.
New Zealand's dairy companies, particularly Fonterra, are already major players on the world market, exporting substantial volumes of ingredients around the globe.
These firms have fared especially well in recent months with high prices for dairy products on the world market.
But Clark said that the country's competitive advantage in agricultural products was "no longer a given".
"We need to lift our levels of innovation on the farm, in the factory, and in the laboratory to keep ahead of the rest of the world."
She added that the new fund will have a strong focus on making the food industry environmentally and economically sustainable.
"That is both the right thing to do for the environment - and the smart thing to do, as we have much to gain from being viewed by our trading partners as sustainable producers and suppliers."
New Zealand has cultivated an image as a producer of 'natural' foods but it is concerned about the potential impact of the 'food miles' debate which has emerged in Europe in recent years.
Some environmental groups have attacked the country's exporters for contributing to pollution because of the long distance to Europe, now known as 'food miles'.
Economic development minister Pete Hodgson said: "We have tended to be low-key in trumpeting our talents for smart environmental solutions, but we can now capture global opportunities as the world becomes more aware of sustainability."
New markets and emerging competitors are also potential challenges ahead for the industry, said the government.
Much of the fund will be spent on science and research to develop innovative methods to give the industry an advantage in the future.
Agriculture and fisheries minister Jim Anderton said there were examples of small companies in New Zealand where research, development, and innovation has seen profits leap to millions of dollars a year.
"Investment in innovation pays huge dividends down the track for both the industries and the country."
The fund, called New Zealand Fast Forward, will be managed independently as a partnership between officials, industry bodies and companies.
It will not make payments directly to producers, which could breach commitments under international trade rules.
New Zealand's dairy, meat, horticulture and seafood industries account for around 60 per cent of the nation's exports and employ a fifth of all workers, according to the government.