Last month the Finance Ministry completed a $3 billion foreign bond issue. The debt was sold in London in two tranches – $1 billion at 0.68 percentage points above the current interest rate on 10-year U.S. Treasuries, or 2.6% annually, and $2 billion at 1.15 points above 30-year Treasuries, or 3.2% annually.
Above and beyond that are the costs of undertaking the sale – the roadshow to market it to investors and the fees to the investment banks that manage the offering.
Israel is one of the few Western countries to issue bonds on foreign currencies – no less than 13 to date. They are costly. On average they carry interest rates two points higher than the interest Israel pays on shekel-denominated debt, which costs the government hundreds of millions of shekels.
The Finance Ministry accountant general, the official in charge of raising money for the state, justifies these extra costs on the grounds that they “widen our base of investors” and “build [for Israel] a yield curve in foreign currency in global markets.”
But sources in the financial markets say that much of that dollar debt issued abroad ends up in the hands of local institutional investors. They are barred from buying into foreign currency bond issues, but attracted by the high yields the bonds carry, they buy the debt later in the secondary market.
Meanwhile, the Bank of Israel in recent months stepped up foreign currency purchases – $7 billion since the start of October – with the goal of preventing the already strong shekel from appreciating further. Today, it’s sitting on reserves of nearly $130 billion, that are invested in dollar securities overseas.
The central bank’s dollar mountain has yielded a very low rate of interest, about 1% annually on average over the past four years. In 2017, its portfolio of dollar and euro holdings yielded 3%, its highest since 2009, but in 2018 the return fell to just 0.18%. (The 2019 figure hasn’t yet been released.)
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The Bank of Israel puts about 15% of its foreign currency holdings in share indexes, a relatively risky investment; the lion’s share is held in foreign government bonds, which are safer but pay particularly low rates.
The result is an absurd situation in which the treasury is paying out on average 3% a year on foreign currency-denominated debt while the Bank of Israel is earning 1% a year on its foreign investment holdings. That’s a yawning gap of two percentage points that costs Israel about $60 million annually. Over 20 years, that adds up to $1.2 billion, not counting the cost to the Finance Ministry of issuing the debt.
Michael Raviv, who teaches economics at Tel-Hai College, said the situation lacks any economic logic. “The government is acting like a person depositing his money in a bank at 1% a year and then taking out a loan at 3% a year,” he said.
The Bank of Israel Law bars the central bank from buying Israeli government bonds, but the law, contends Raviv, is no longer relevant. The central banks of the United States, Japan and Europe buy their own government bonds in huge amounts as part of their policy of quantitative easing.
“The Bank of Israel Law needs to adapt to the change and enables the Bank of Israel to buy dollar bonds at yields that are higher than it gets now,” he said.
The Bank of Israel only began accumulated such massive foreign currency reserves over the past decade. Policymakers didn’t consider the possibility of a situation where the cost of raising capital would be higher than the returns the central bank is earnings. “At the end of the day, it’s the same public purse and there’s no reason to separate the return on investments from the cost of debt,” Raviv said.
During the 2008-09 global financial crisis, the Bank of Israel, then under the leadership of Prof. Stanley Fischer, bought more than 15 billion shekels ($4.4 billion, at current exchange rates) of Israeli government bonds, so there is a precedent for doing it.
Nevertheless, it remains a complicated issue. The Bank of Israel’s purchase of Israeli government bonds may be regarded as tantamount to the government’s printing money – that is, indirectly financing the government’s budget deficit. That is precisely the case that the central bank made in response to a query from TheMarker.
It also violates the principle of central bank independence, for which Fischer fought hard as governor of the bank.
“The question is how to solve the problem while preserving the separation of powers and the Bank of Israel’s independence,” said a senior financial markets executive, who spoke on condition of anonymity. Finance Ministry sources said the decision was up to the Bank of Israel. The treasury has no authority to intervene, they said.