What's Up with the Shekel?
Updated: Dec 12, 2021
After reaching unprecedented heights in November, the month finished off as somewhat of a rollercoaster for the shekel. The currency, which peaked mid-month, dipped when the Bank of Israel announced its interest rate decision and Omicron variant spooked the markets. A new report indicates that foreign currency purchases also played a role. But even market turbulence and the Central Bank's best efforts can't seem to keep the shekel down.
Israel's currency has been on a slow and steady upward trajectory over the past decade. Recently, it accelerated to a 26-year high against the dollar and an all-time high against the Euro.
What's behind the sudden surge? How does it affect the Israeli economy and can we expect the trend to continue?
What Caused the Shekel to Rise?
To a certain extent, the strength of the shekel is reflected in the economy. The Ministry of Finance predicts 7% growth for 2021. The inflation rate is expected to stay within the Bank of Israel’s target range of 1%-3%. Unemployment, still higher than before the pandemic, is declining.
Most importantly, Israel exports surpass its imports. According to Amir Yaron, governor at the Bank of Israel, exports are on the rise. The demand for shekels to pay for goods and services is higher than the demand for dollars. On a global scale, the economy is flourishing, and particular sectors and developments stand out for their contributions to this growth.
The Israeli Tech Sector
Many Israeli economists predict $35-$45 billion will be invested in Israel this year, primarily into the high-tech industry. Israeli companies are "profitable and attractive", according to economist Paul Rivlin. The tech sector thrived during the pandemic. Its fast-moving innovations helped supply the increasing demand for cybersecurity, digital business solutions, and other technologies. This led to record foreign investment in Israeli tech firms, creating an unprecedented number of "unicorns", or tech companies valued at over $1 billion.
The tech sector boost continues impact on the Israeli economy. The country is starting to feel the trickle-down effect as many new jobs open for people with a variety of skills. High-tech companies need more than programmers and cybersecurity experts. They need product developers, marketers, sales team members, customer support staff and more. Former Bank of Israel deputy governor Nadine Baudot-Trajtenberg believes there is now potential for inclusive economic growth, which hasn't happened in the past 20 years.
Natural gas production has also contributed to economic prosperity. Israel began pumping fuel years ago, and we are starting to reap the benefits. Fuel that companies began pumping in 2013 helped us cut back on energy imports and thereby increased the country’s surplus.
The Investment Trend
While a notable influx of investment capital resulted from high-tech opportunities, there were other factors as well. For example, in 2020, Israel was added to the World Government Bond Index (WGBI). This motivated foreign investors to purchase government bonds.
Another development had an astounding effect. Israeli institutional investors benefited from the rise in stock market prices in the USA. Once their shares rose, they hedged their investments by purchasing shekels. Institutional investors sold $30 billion, the same amount purchased by the Bank of Israel to blunt the shekel's rise. The investors essentially offset the bank's purchases, resulting in a stronger shekel.
Implications of a Strong Shekel
A strong shekel is good for importers and consumers. During a period of worldwide inflation, it helped keep inflation at bay. Costs went down and Israeli's can enjoy increased spending power when traveling abroad or ordering online. For a country with one of its major cities rated most expensive in the world, this could be excellent for locals.
While a strong shekel sounds like bad news for exporters, exports are still rising. In the short term, it may hurt these industries and even result in closures. To offset this setback, either the Bank of Israel would need to intervene to lower the shekel, or the government could lend support to companies exporting goods.
Economists are divided when it comes to the solution. While some, like Baudot-Trajtenberg, believe certain industries that are worth saving, others like Gilad Alpert, head of foreign equity research at Excellence-Nessuah, believe the government should abstain from intervention. Alpert claims that currency fluctuations are a normal part of an economy and if exports go down, the shekel will go down again.
Whether or not the Bank of Israel will intervene is another question. According to Yaron, “We are constantly examining developments in the foreign exchange market, and the bank continues to conduct policy by the state of the economy and continued economic activity." Some experts, like Bank Hapoalim chief economist Victor Bahar, presume the Bank of Israel will temper the currency with smaller foreign currency purchases. He figures it will be closer to $10 billion a year instead of $30 billion. Baudot-Trajtenberg commented that any intervention by the central bank won't prevent the shekel from getting stronger. What it can do is slow the currency's growth enough to give affected sectors time to adjust accordingly.
Will the Shekel Keep Rising?
Predicting the path of the shekel is an impossible task. As we learned in the past few weeks, the markets are more volatile than ever. A new strain of Covid, security threats, political developments and other unforeseen events can cause currency fluctuations.
Although economists hesitate to assume the shekel’s course, they do weigh in on Israel’s economic developments and the possible consequences. Most experts claim that start-ups will continue to grow as long as funds are available. Since start-up capital is associated with the strength of the stock market, it is believed that investment will continue to a lesser degree. It was easy to raise funds when the stock market was high, but a downturn in this area will complicate matters. While funding is likely to continue, it cannot necessarily remain at the same level.
Baudot-Trajtenberg does not believe that the hedging trends will continue. She states that "once the foreign stock markets stabilize or if there will be a market plunge...then a lot of this flow will stop coming to Israel."
This week, the Omicron variant and its effects on the tourism industry set the shekel off balance. Since we don't know that much about the new strain of Covid, we can't predict how long the country will be shut to tourists and how effective vaccines will be at keeping the infected numbers low.
Still, Modi Shafrir, Chief Strategist at Mizrachi-Tefachot, and most experts surveyed assess that if trends continue as they have been until now, the shekel will continue to stay strong. The Central Bank can only mitigate the trend.