Israel Seems Less Affected by Credit Crunch

 

Anja Hochberg, Head Economics & FX

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22.12.2008The ongoing financial crisis affects all countries through various channels: Most directly via the credit crunch, which gridlocked money and credit markets, but also through export links and the loss of purchasing power. The extent to which countries suffer from the crisis, varies significantly. Israel is a country that could be less vulnerable.

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"Israel will be Affected by the Global Recession"

Compared with countries on a similar development path, the Israeli currency - the shekel - has lost considerably less ground versus the dollar since the intensification of the credit crisis in summer 2008. Other emerging market currencies have suffered comparably more than the shekel as result of the ongoing forced global deleveraging process. Why? Because the Israeli equity and debt markets are substantially less exposed to foreign investors than other emerging markets. This is beneficial in a situation of uncertainty on the financial markets, when the home bias generally is dominant, leading foreign investors to liquidate their positions abroad.

Currency Movements

From an economic point of view, the Israeli economy is nevertheless set to weaken from above potential growth rates to a real gross domestic product (GDP) growth rate of 1 percent to 2 percent over the next 12 months. Exports have already lost steam and this will affect the small and very open Israeli economy, which has a 63 percent share of its exports going to the US and Europe. However, as most of the exports are medium- to high-technology goods, Israeli exports are geared to buoyant industries and not toward the downtrading US consumers.

Aggressive Rate Cuts

In addition, the Israeli central bank, the Bank of Israel (BoI), has cut interest rates aggressively. At the time of writing, we have seen another 50 basis points cut to a level of 2.5 percent. Before September 2008, inflation expectations were rather high so the BoI tended to show a rather hawkish stance. Given the pronounced change in inflation expectations and the significant slowdown in global growth, the BoI has reacted quickly to bring down the cost of credit in order to strengthen the economy's ability to deal with the very challenging economic situation.

On top of this monetary policy support, fiscal policy initiatives will also back the country's economy. The rather high share of public spending can certainly help getting such programmes quickly into action. The often mentioned "catching up" in certain areas of infrastructure could not only prove to stabilize the economy in the short term. It could also support potential growth in the longer term. At the same time, the region ranks first in various "Doing Business" surveys, indicating a very stimulating business environment. The global financial crisis will affect Israel's economic development. The prevailing set of business conditions, industry orientation, monetary and fiscal policy support should, however, limit the economy's downside potential.

Global Deleveraging

As large losses have been registered on assets in major markets, and as money market conditions tightened, there has been forced deleveraging of positions around the world affecting all asset classes. The consequence of this deleveraging is that market participants are liquidating their emerging market investments. They either repatriate their capital or use the proceeds to cover their loans. This is creating considerable outflows, particularly from countries that had been enjoying strong portfolio inflows during the previous credit boom such as South Africa, Brazil and many Eastern European countries.