The Bank of Israel said on Monday that after five years and $13.1 billion in purchases, it would be ending a program to buy foreign currency as of 2019 in order to offset the effects of natural gas production on the shekel exchange rate.
The announcement briefly caused a drop in the dollar against the shekel of 0.5%, but the greenback quickly stabilized and toward the end of the day recovered most its losses. The representative rate was set at 3.670 shekels, a loss of less than 0.2% and in late trading strengthened to 3.6881.
The Bank of Israel said it was stopping the forex-buying program in anticipation of the government’s sovereign wealth fund, known as the Fund for Israel’s Citizens launching operations next year and begin investing its assets abroad in 2020.
The central bank began buying foreign currency on a regular basis in 2013 when Israel began producing its first significant quantities of natural gas from the Tamar field. The result was a big drop in Israel’s bill for imported energy and its need to buy dollars to pay for it.
Bank of Israel officials were concerned that with dollar demand on the decline, the shekel would appreciate and make it harder for Israeli exports to sell their products and services abroad at competitive prices.
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Critics took the central bank to task for encouraging a less-than-strong shekel that raised costs of imported goods to consumers and even to manufacturers relying on inputs from overseas. But the Bank of Israel was concerned that a strong shekel risked serious harm to Israel’s export-oriented economy.
A similar phenomenon occurred in The Netherlands during the 1960s, when the country began producing major amounts of natural gas, leading economist to coin the term the “Dutch disease.”
Since 2013, the Bank of Israel has bought $13.1 billion of forex, including a planned $1.5 billion for this year alone. That has helped swell Israel’s foreign reserves to $133.9 billion, or a high 31.1% of gross domestic product, as of the end of last month.
Although the sovereign wealth fund will be performing much the same role as the Bank of Israel program, there will be a gap between when the bank stops its purchases and the fund begins its operations.
“Although we’re not talking about a huge sum, the idea that $1.5 billion in demand for forex will be lost over the coming year is expected to contribute to a mild appreciation of the shekel in the short term,” said Jonathan Katz chief economist at leader Capital Markets.
That could be good news for consumers by containing inflation and delaying an expected rise in Israeli interest rates, he added.
In addition, the Bank of Israel made clear on Monday that it might intervene even after the offset program has ended, using a policy to enter the market when it sees what it deems unusual forex movements.
“The bank will therefore continue to operate in the foreign exchange market in cases of exchange rate fluctuations which are not in line with fundamental economic conditions, or when conditions in the foreign exchange market are disorderly,” it said.
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The central banks has spent tens of billions of dollars intervening from time to time, although the last time it did was last January.
When it began its forex offset program five years ago, the Bank of Israel said it would only operate until the Fund for Israel’s Citizens began operations. That had been expected to be in 2018 when the government had been forecast to have accumulated the minimum 1 billion shekels ($270 million at current exchange rates) needed to begin operations. At the end of 2016, the money designated for the fund had reached 459 million shekels, but no new money was added last year. Treasury officials, however, said that during 2018 the cash pile grew.
The sovereign wealth fund is getting its money from the windfall-profit tax Israel has imposed on natural gas producers. It will be independently managed by a committee chaired by the finance minister. All its money will be invested overseas – creating demand for dollars – with annual allocations set aside for social, economic or educational purposes.