Living With a Muscular Shekel

The Bank of Israel isn't desperately soaking up dollars in order to pamper exporters. It's trying to save your job.

Two hundred shekel currency banknotes pass through a counting machine in this arranged photograph at Israel's central bank in Jerusalem, Israel, on Monday, Aug. 19, 2013.
Bloomberg

If you weren’t one of the only Israelis not to buy a new car this year, don’t feel bad. While the others were buying a set of wheels at a shekel that averaged 3.8406 to the dollar in 2016, you can go into the showroom knowing that if you buy today, your shekel will buy 5.5% more car on a dollar basis, all other things being equal. 

Since the start of the year, the shekel has gained about 6% against the dollar – a third of that in the past week, even as the U.S. currency was strengthening against most other world currencies. 

It means that even people who bought their cars last year at the less favorable exchange rate will be enjoying cheaper gas. They can wake up in the morning to a less expensive bowl of Kellogg’s Corn Flakes, chat on a cheaper iPhone and ponder where to spend their next vacation in Europe, knowing that the euro has sunk even more rapidly than the dollar.

The catch is that the muscular shekel that makes imports cheaper also makes it harder for Israeli companies to compete in export markets. Those same people now going on a strong-shekel shopping spree might find themselves out of a job before the bill comes in. If export businesses have to offset the effects of the exchange rate, they’ll cut costs elsewhere and jobs are an obvious casualty.
 
That’s bad enough in an economy that generates about a third of its GDP from exports, but the problem goes deeper, because lots of local businesses in the home market will have a tougher time competing with imported competition.

So, those who say that the Bank of Israel’s desperate attempts to keep the shekel from strengthening are wasting the public’s money just to preserve exporters’ profits miss the point: The bank is doing it to keep the public’s jobs. Israel can’t sit back and enjoy the strong shekel.

Perfect storm

In the short term, the best solution is to grin and bear it: The currency’s latest advance is the product of a perfect storm of factors. 

One is the government’s preliminary figures on fourth-quarter GDP, which showed the economy growing unusually quickly, most notably exports. Then you have the weakness of the euro, due to the latest round of European Union crises, and the monthly surge in demand for shekels by exporters who need to convert their dollars to pay employees and taxes. 

Finally, the Bank of Israel is close to maxing out on the pile of foreign currency reserves it is prepared to amass. It seems that speculators have been betting that this time, the BoI would try its hardest to stay out of the market.

It did, for a while, but Wednesday and Thursday it stepped in to the tune of $650 million or so. However, the intervention isn’t working in any significant way so far. 

The short-term solution to the strong shekel lies not in Jerusalem but in Washington. The market is betting that the Federal Reserve will raise U.S. interest rates this month, which will relieve some of the pressure on the shekel by making it less attractive to hold.

The long-term problem of the strong shekel is another matter. 

The GDP figures that are said to have spurred the latest gains for the currency aren’t quite as good as they seem. As Nadine Baudot-Trajtenberg, the deputy governor of the Bank of Israel, told Reuters on Wednesday, the Israeli economy is doing well, but not particularly better than its trading partners.

Early Dutch disease

However, measured against the kind of figures that influence the shekel, we are doing really well. 

Israel has been running current account surpluses for years. We’re drawing in huge amounts of foreign investment. The government is reducing its debt relative to GDP. Development of the Leviathan gas field is formally under way, as of last week, which will mean more exports – and if deals selling gas to Egypt and/or Turkey are reached, a lot more. The Tamar field, which is geared mainly to the domestic market, has already reduced Israel’s energy bill.

When the first big quantities of gas were discovered a decade ago, we were warned about the risk of “Dutch disease” – when a country’s currency becomes overvalued due to big energy exports, undermining the competitiveness of other industries. We’re suffering some early symptoms.

Taking all these factors into account, it’s is hard to see how the Bank of Israel can play King Canute and order back the tide of economic fundamentals and the market forces acting on them. Israel is going to have to learn to live with a strong shekel.

But there are steps the government can take to offset its effect. It’s already cut corporate taxes this year, but it could do a lot more to make the business environment more efficient – cutting red tape, breaking cartels, upgrading education, spending more on infrastructure. 

These are long-term processes that aren’t going to save industry overnight, but the main exchange rate challenge Israel faces is the long-term one, and they can address that. If we can succeed, Israelis can have their car and drive it too.