An economic slowdown? The pros and cons of Israel's weakening shekel

Published September 17th, 2014 - 04:55 GMT

After treading water for a long time, the US dollar has recently surged against almost all other currencies. One of the currencies chiefly affected is the Israeli shekel, which has weakened by 6.8% against the dollar since the end of July. This time round, in contrast to previous bouts of weakness in the shekel in recent times, it looks as though the trend is here to stay for a while.

While some market players think that the weakening of the shekel bodes ill for the Israeli economy, it is not certain that this is the case, at least not in the immediate term, for the Israeli stock market and those who invest in it. "Globes" asked macro analysts from local investment houses to comment on what lies behind the sharp upward movement in the shekel-dollar exchange rate, and the consequences it holds in store.

"The dollar has been strengthening for several weeks now, and the main reason for that is the state of the US economy, which has managed to gather itself together after the crisis, and now enjoys good macro figures in comparison with the rest of the world," explains Robert Carmeli, overseas funds manager at Migdal Capital Markets. According to Carmeli, while the global macro environment has become progressively weaker (Italy is sliding into a recession, Brazil suffers from negative growth, and China is struggling with weak production figures) the US economy is on a strengthening trend.

"From a monetary point of view, looking ahead we see that the US is coming close to the end of quantitative easing, and so the assessment is that we shall see an interest rate rise in the second half of 2015," he adds, "while, by complete contrast, President of the European Central Bank Mario Draghi recently cut the euro rate to a low of 0.15%, and in fact is signaling to the entire world that the European Central Bank intends to print more money. This means a weak euro and a strong dollar."

Psagot chief economist Uri Greenfeld also points out that the stronger dollar is a global story. "There is a tendency to attribute the strengthening of the dollar against the shekel to the Bank of Israel's interest rate cut, but the trend mainly stems from the strengthening of the dollar on world markets. This is not something within our control."

All the same, there is a local aspect. Some market players say that the real problem lies not in the strength of the dollar, but in the reasons for the weakness of the shekel. "It's true that the dollar has strengthened on world markets lately, chiefly against the euro, but there specific factors causing the shekel to weaken," explains Excellence Nessuah Brokerage analyst Gilad Alper. "In the end," Alper says, "a currency reflects the strength of the economy, and in my view there is a fair probability of the shekel continuing to weaken: the fears that the economy will enter a slowdown, that the Bank of Israel will cut its interest rate to zero, at the dispute in the government over the fiscal deficit and the prospect of higher taxes all these are things that can only make the economy worse."

In addition to these causes, Meitav Dash chief economist Alex Zabezhinsky mentions the activity of financial investors. "This year, the rate at which financial investments are leaving Israel is substantially higher than in previous years," he says. "In my opinion, the pressures weakening the shekel can also be expected to continue because of the widening of the trade deficit, as a result of a drop in exports of goods."

"The economy is slowing down sharply," Carmeli warns, "and when you combine this with the fact that Israel is part of the global picture, it's likely that the shekel will continue to weaken." In his opinion, by the end of the year the shekel-dollar rate will reach levels of NIS 3.75-3.8/$. "Whichever way you look at it, from our point of view the situation is bad. The dollar is strengthening worldwide, interest rate gaps are closing, which makes the US more attractive than Israel, the geopolitical situation is volatile, and both alternatives being discussed raising taxes or expanding the deficit are not good."

"A strong economy goes with a strong currency," adds Greenfeld, "but all the same, a change in the exchange rate trend could support exporters and the economy, because if it is accompanied by an improvement in the global economy, it could lead to stronger demand for Israeli exports, while at the same time the exporters also gain more financially."

Another point that Greenfeld mentions is inflation. "We have become accustomed to living in a low inflation environment, because the shekel kept strengthening, but I believe that the strengthening of the dollar could give a push to inflation. It's true that there are factors putting downward pressure on prices in Israel, including government measures on the cost of living, but I believe that the strengthening of the dollar could offset these factors, and bring inflation back within the government's target range."

Even if the future does not look rosy for the Israeli economy, the strengthening of the dollar will probably not in itself damage Israeli companies, many of which have learned the lessons of the past.

"The Israeli economy is more mature and more controlled. We are not in the 80s and 90s when any movement in the exchange rate caused higher prices," says Carmeli, "Consumers are stronger, and so I don't see a burst of inflation. In addition, you have to remember that Israel's relationship is not just with the US. We also import goods from Europe and the Far East, and most of the basket of currencies should weaken."

"The effect is better than people think"

"The main effect on local companies is positive, chiefly for the large exporters that pay salaries in shekels," Alper adds, referring among others to companies such as Nice Systems, Amdocs, Elbit Systems, and Israel Chemicals. "Check Point is a classic example, because this is a company with a huge proportion of its revenue in foreign currency, that, on the other hand, spends little on hardware and components, and whose main expense is the salaries of the people who write code, a proportion of whom are paid in shekels."

And what about investors? For the time being, it looks as though they will not be hit hard either, thanks to hedging against exchange rate exposure. Meitav Dash chairman Zvi Stepak points out in this context that financial institutions in Israel have raised their overseas investments considerably in recent years. While this move would have contributed to the devaluation of the shekel, given the fear that the strengthening of the shekel would reduce returns, the institutions hedged the currency risk. They thus turned the investment into a shekel-based one, and neutralized the currency element.

Stepak believes that the trend will now change. "The devaluation that has occurred recently obliges the institutions to rethink, and as soon as a momentum is generated it will increase. In this field, even investment managers in large institutions are swept along by the trend."

"Investment is exiting Israel much faster this year," adds Zabezhinsky, "while at the same time hedging against appreciation of the shekel has become less worthwhile, since the forward exchange rate has dropped by more than the spot rate, because of the narrowing of the interest rate gap between Israel and the rest of the world. In such a situation, it becomes less worthwhile to hedge overseas investments against appreciation of the shekel, which in the end works to weaken the Israeli currency."

"The effect of a stronger dollar is better than people think," Alper concludes, "Nevertheless, in this specific instance, the strengthening benefits shareholders in exporting companies, because when the value of the shekel is eroded and imports become dearer, it's the shareholders who gain. In other words, a stronger dollar perhaps bodes well for the stock exchange, but not for the Israeli economy."

By Lital Istamati


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