Viewpoint / The Guarantee Effect

The Prime Minister's Office and the treasury are optimistic that the Americans will be forthcoming on a $14-billion request for aid and loan guarantees, despite the enormity of the sums involved. Turkey and Jordan already got theirs, to prepare for the pending U.S. attack on Iraq, they point out. No reason why we shouldn't get ours.

The Prime Minister's Office reportedly even hopes the money will arrive before the elections come around, and lift the public's morale.

Despite the Israeli officials' optimism, the billions aren't in the bank yet; and after years of surpluses, the American government is in the red because of the economic slowdown and surging defense costs. But let's assume for the sake of argument that a deal is struck over the guarantees. Its effect on the shekel-dollar market will not be dramatic.

Look what happened the last time the Americans gave Israel loan guarantees. They did not hand over $10 billion. No, from 1993 to 1998, over five years, Israel issued various kinds of bonds on the American market, at a pace of $2 billion a year. The American government guaranteed repayment of the bonds, thereby reducing the cost of the offerings to 0.2 percent above the federal rate for T-bills of the same kinds - namely, 6.5-8 percent a year.

And what did Israel do with the money? Of the $9.3 billion worth of bonds it issued, about $4 billion was spent on infrastructure projects; and $1.8 billion was poured into state-owned companies such as Bezeq and the Israel Electric Corporation in the form of government guarantees, usually through Industrial Development Bank (which is in the throes of collapse).

Yes, you are right, we have not reached $9.3 billion - for good reason. Half a billion dollars were paid out to the investment banks to cover the costs of the offerings; another $1.5 billion went toward the end of the term to repay interest and principal on the money borrowed at the start of the term; and as for the rest, the government hasn't used it yet. It's still sitting in the Bank of Israel.

Since the government's currency conversions don't pass through bank dealing rooms, and since even a billion dollars a year isn't exactly revolutionary for Israel's budget, then, if the guarantees plan of this decade is like the last one of 1992, it will barely be felt in the local currency arena.

What a substantial guarantees program could do is stabilize interest rates and bolster a gradual reduction in the rates, as the Bank of Israel governor has been hinting, because it would reduce the government's cost of raising capital. The timing to raise money overseas is highly opportune. Interest rates on the dollar are at a 50-year low, and if the government manages to obtain an 0.2 percent spread with U.S. T-bills, then a 10-year issue would cost Israel interest of 4.5 percent - very little, by any criterion.

What effect there is will be chiefly psychological. The great guarantees-plus-aid plan to be proudly presented by the prime minister will reduce the probability that Israel's foreign currency credit rating will be downgraded. It will increase Israel's foreign currency reserves and ease fears of capital fleeing the country.

Going by experience, at some point, we'll probably learn that the government transferred most of the money to sweetheart projects rather than to growth-stimulating endeavors; but that won't happen for a long time. And the politicians involved will be history by then.

Putting aside the booster to the national mood, currency market players warn that expectations of the guarantees is already being incorporated into the shekel-dollar rates. If so, don't expect the shekel to budge on the day the guarantees are actually announced. And watch out for the scary scenario of the Americans actually deciding that it isn't such a great idea to transfer several billion from their pockets to Israel's.