Foreign currency traders at Barclays Capital (BCS) in Tel Aviv have been glued to their screens for the past week trying to cope with a sharp increase in trading volumes following the Bank of Israel's latest attempts to stem the rise of the shekel. Trading volume was running around $10 billion a day, more than twice the normal level. Spreads on shekel/dollar contracts widened substantially as the central bank changed its policy twice in the space of a week in an effort to dampen currency speculation.
The scene at Barclays Capital was typical of trading rooms at major local and foreign banks around Tel Aviv. In a three-day period beginning late last Monday, Aug. 3, the Israeli central bank bought an estimated 2 billion U.S. dollars in its latest effort to weaken the shekel. The currency's strength has contributed to a sharp decline in Israeli exports—compounding the domestic economic impact of the global downturn.
Over the course of three days last week, the immediate impact was a 5% devaluation of the shekel. But the market did an about-face on Aug. 10 after the central bank announced a new policy that is purposely intended to be less transparent: Instead of its previous program to buy 100 million U.S. dollars a day to help drive down the shekel, the bank now says it will continue to intervene in the foreign currency market as it sees fit, but without prior notice. Following the announcement, the exchange rate fell by 1%, to 3.87 shekels to the dollar (1 shekel = $0.2584).
Central Bank's Intervention Policy Exactly a week earlier, Bank of Israel Governor Stanley Fischer had expressed concern that the shekel's value wasn't moving in accordance with market forces, citing "unusual movements in the exchange rate that are inconsistent with underlying conditions." Fischer's dollar-buying binge has been intended to counteract the stronger shekel, but the bank is worried that increased activity by speculators is undermining its efforts—hence the shift to irregular and unannounced interventions. The highly respected bank governor made it clear on Aug. 10 that while daily purchases would stop, the bank's new policy sets no limit on the size of future foreign currency purchases.
"The governor has shown that he means business and is willing to back up his words with massive intervention to prevent a sharp appreciation of the shekel at a time when the economy is still in recession and exports have yet to recover," says Michael Sarel, head of economics and research at Harel Insurance & Financial Group (HARL.TA).
The Bank of Israel embarked on its intervention policy back in April 2008 when it announced plans to buy $25 million daily to weaken the shekel and increase the Jewish state's foreign currency reserves. The amount was increased to $100 million per day a few months later when the shekel hit 3.20 to the dollar ($0.3125), its strongest level in more than a decade.
The central bank's policy led to a 20% decline in the shekel's value against the dollar and a near-doubling of foreign currency reserves, to $52 billion. But the trend reversed itself in late July and by Aug. 3, the shekel was back up to 3.74 to the dollar ($0.2673). The same day, the Bank of Israel launched a massive new intervention. Reaction was mixed. "The governor cannot determine the direction of the market," says Aharon Navon, head of foreign currency trading at Barclays Capital Tel Aviv. "At most he can slow down the pace of the shekel's appreciation."
Genuine Rise in the Shekel's Value? Indeed, Barclays argues the shekel's rise may reflect genuine market sentiment. The British investment bank recently lifted its forecast for the Israeli economy this year, from an earlier estimate of a 1.8% drop in gross domestic product to a decline of just 0.9%. That should be followed by 3% growth in 2010. Barclays says the economy's recovery justifies the shekel's muscle, predicting it could rise on that basis alone to 3.60 to the dollar.
Israeli exporters aren't thrilled at the prospect, fearing a stronger shekel will delay economic recovery. Exports played a key role in Israel's five years of rapid economic growth, which came to a screeching halt in the second half of last year as the global recession took its toll on the local economy. "The Bank of Israel should continue to purchase dollars until the exchange rate reaches 4.20 [$0.238]," says Yehuda Zisapel, chairman of the Israel Association of Electronics & Software Industries and a leading high-tech entrepreneur. Zisapel figures that every one-tenth-of-a-shekel (10-agorot) drop in the exchange rate translates into 6,000 layoffs.
The Israel Export Institute is predicting that exports of goods and services will decline by 20% this year from a record $81.3 billion in 2008. "Half of the expected decline in the exports of goods and services in 2009 is the result of the weak dollar," claims David Artzi, chairman of the Tel Aviv-based institute, the leading lobby for the country's exporters.
Artzi wants the central bank and the Israeli government to declare open war on speculators who account for an estimated 60% of the daily volume in the foreign currency markets. A study by Financial Immunities, a local economic consulting firm, concluded that speculation by mostly foreign hedge funds and investment banks was the reason the dollar had lost more ground against the shekel than most other currencies.
Anti-Speculation Proposals "We cannot allow foreign speculators to dictate Israel's future economic growth," says Adam Reuter, the chief executive of Financial Immunities. The firm is recommending measures to further curb speculation, such as hedging by the Finance Ministry on Israel's foreign debt or requiring Israeli banks to demand higher margins from foreign players in the market. Reuter believes such moves could help prop up the dollar in the long term.
There are moves afoot in the Knesset for even more aggressive action to combat speculation. Knesset member Haim Katz, of the ruling Likud Party, is proposing a law that would impose a 35% tax on profits from foreign currency speculation. It would not apply to legitimate hedging activity by firms such as importers and exporters. It's not yet clear whether the bill will gain the backing of Prime Minister Benjamin Netanyahu, a well-known free marketer.
Past interventions by the Bank of Israel in the foreign currency market have led to a rebound in the dollar vs. the shekel. But in the past 18 months, the impacts have only been temporary. Even Stanley Fischer can't fight the tape. That being the case, Israelis may have to get used to their mighty shekel—at least until the market thinks otherwise.
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