Lehman's Damocles index points to trouble for Israel

"The ever widening trade deficit is gradually eroding Israel’s current account surplus."

Lehman Brothers' Damocles is an external-crisis measure that looks at ten monthly indicators that are often recognized as possible predictors of external financial crises. The investment bank gives Israel a positive Damocles score of 28, the first time in five years that the country's is positive. Generally, a higher figure implies a higher risk of "external financial crisis".

Lehman Brothers notes that Israel's current account is still in surplus but looks set to move into the red by next year if not earlier. Foreign direct investment flows have slowed compared with last year but the basic balance is still relatively strong. However, the strength of domestic demand is reflected in the ever widening trade deficit that is gradually eroding Israel’s current account surplus. The key risk to the balance of payments is a prolonged and broader weakness in US growth, continued strength of domestic demand given the buoyant labor market and the sharp appreciation of the shekel. The rate differential versus the US has been a key driver of the shekel, so Fed policy in the second half of the year will be crucial for shekel-dollar exchange rate.

Lehman Brothers notes that Damocles has uncovered a marked deterioration in emerging markets risk following many quarters of low, stable, scores. The warning comes at a time when growth, inflation and commodity prices pose new challenges.

Lehman Brothers calculates its Damocles for 28 countries: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hong Kong, Hungary, India, Iceland, Indonesia, Israel, Malaysia, Mexico, Peru, South Korea, the Philippines, Poland, Romania, Russia, Slovakia, Singapore, South Africa, Taiwan, Thailand, Turkey and Vietnam. The sample period spans January 1996 to March 2008.

The ten indicators employed in the index are foreign reserves/imports; foreign reserves/short-term external debt; broad money/foreign reserves; external debt as percentage o GDP; short-term external debt as percentage of exports; current account as percentage of GDP; domestic private credit as percentage of GDP; real short-term market interest rate; stock market index; and real trade-weighted exchange rate. The index looks at changes in these indicators as measured against certain thresholds for each one.

Published by Globes [online], Israel business news - www.globes-online.com - on June 29, 2008

© Copyright of Globes Publisher Itonut (1983) Ltd. 2008

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