Deutsche Bank maintains a largely positive view of the way the Israeli economy is coping with the global financial crisis and recession. But although analyst Caroline Grady notes some recent slowing of the pace of deterioration, she warns that recovery "remains a long way off". She has adjusted her growth forecast for 2009 to a slightly worse -1.2% from its previous -1.0%.
After talking with the Bank of Israel, Grady sees monetary conditions remaining "loose" and believes that Bank of Israel will for the time being continue purchasing foreign currency.
"Our impression from the meetings was that the Bank of Israel are likely to continue to buy $100 million a day for at least the coming months. Although there is no explicit dollar-shekel, or target on reserves accumulation since the previous $40-44 billion ceiling was surpassed, the Bank did note that they wanted to see reserves cover 100% of short term debt. This has now been achieved with reserves at $45.1 billion by end April and short term external debt at $33.3 billion as of December…Our best guess is that the Bank will first announce a decrease in the amount of daily purchases rather than a full withdrawal from the market," she writes. Grady does not see any imminent Bank of Israel withdrawal from the government bond market.
On inflation, Grady says, "The most recent Bank of Israel statement noted that the risk of Israel slipping into deflation had receded and that the recent economic data was no longer deteriorating at such a rapid pace and therefore confirmed our view that 0.5% was the floor in rates…Barring a substantial deterioration in the data and the absence of any discussions of this in the minutes we do not see another cut as likely. That said, rate hikes are probably a long way off too.
"Another reason not to expect rate hikes anytime soon is the view at the Bank of Israel that a recovery in Israel would lag that of the US. The Bank recently revised down its forecast for 2010 GDP growth to 1% and expects a contraction of - 1.5% this year. While we are less pessimistic on Israel’s prospects for 2010 given the relative strength of the country’s banking sector and the fact that the economy had good momentum going into the slowdown, it remains the case that the domestic economy is very weak and any substantive turnaround will take time. But given inflation expectations still remain towards the lower end of the Bank’s 1-3% target range and helpful base effects will mean inflation begins to drop in YoY terms during the coming months a further uptick in inflation expectations is unlikely."
Noting that political horse-trading over the budget had led to a temporary abandonment of the 1.7% cap on the annual increase in government spending, and that lower tax revenues in any case meant projected fiscal deficits of 6% of GDP in 2009 and 5.5% in 2010, Grady remarks, "That extra spending will be financed via a temporary VAT hike is far from encouraging." She surveys the options for covering the revenue shortfall, and the effect on the debt:GDP ratio, which it has been a central aim of fiscal policy to reduce.
"With a deficit target that is three times larger than 2008, Israel faces an onerous financing requirement," she writes. "In our discussions with the Finance Ministry last week they confirmed their intention to issue a second Eurobond later this year following the $1.5 billion issue in February. This would be the first time that Israel had issued twice in one year (this excludes the $4.1 billion issued in 5 bonds between 2003 and 2004 bond under the US guarantee program).
"While this would take some pressure off the local market, even on the basis that Israel can issue another $1.5 billion (this was the largest issue the country had ever done), at around $12.3 billion equivalent, this still leaves a significant shortfall. Moreover, the NIS 41.3 billion in tradeable debt falling due this year must also be refinanced or rolled over.
"Through end April, net domestic borrowing stood at NIS 11.3 billion and net foreign borrowing at NIS 4.4 billion giving a total of NIS 15.7 billion in debt financing. This surplus financing will likely be drawn down later in the year and the government debt ratio looks set to return to 2005-2006 levels."
Published by Globes [online], Israel business news - www.globes.co.il - on May 14, 2009
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