The decision by Bank of Israel Governor Stanley Fischer to increase intervention has only intensified the issue of an exit strategy. In the most optimistic scenario, the very possibility of intervention will persuade the market to take into account the new rules of the game.
The second day of Fischer's latest step into the foreign currency markets has been a success. The shekel-dollar exchange rate rose over 3% in inter-bank trading today to NIS 3.86/$, continuing the depreciation that took place immediately after the Bank of Israel's announcement about its intervention in the market. But Fischer does not know, and will not know over the coming days, if the decision will lead to the right results from his point of view: reversing the appreciation of the shekel and creating conditions that will enable him to withdraw from intervention.
Fischer has a double message for the foreign currency market. Firstly, market activities must take into account that the Bank of Israel can intervene at any moment, with nobody knowing in advance about the timing and the quantity of dollars that will be purchased.
Second, although the Bank of Israel cannot work against global currency trends - in other words, it will not seek to offset the weakening of the dollar in international markets that result from global developments - he will intervene, should he choose to do so, to offset volatility originating in the local foreign currency market.
Fischer's intentions are clear: to provide the shekel-dollar exchange rate a kind of support level - a floor price - by inserting a risk factor into daily forex trading. Sellers of dollars will not know whether the central bank will intervene at some point should the shekel appreciate, and they will have to take this unknown variable into account. For this tactic to work, Fischer must ensure that his actions are shrouded in mystery, to prevent traders from guessing his moves, and periodically cause dollar sellers to lose money so that the credibility of his actions is that much greater.
However, beyond the poker tactics against speculators, the strategic question is far more important. The Bank of Israel decided that it must protect exports by supporting the exchange rate, even as it is committed to the principle that it should allow the market to get along on its own and to price risks realistically.
Hence the importance of an exit strategy, which has been a headache for Fischer for weeks. His decision to increase his intervention in the foreign currency market merely reinforces the importance of an exit strategy. Under the most optimistic scenario, the very possibility of intervention will persuade the market to grasp the new rules of the game, and avoid the necessity of an actual intervention, but there is now way of knowing in advance if this will work.
From the perspective of monetary policy, increasing intervention will boost the absorption of shekels. The Bank of Israel credits the accounts of the commercial banks for the dollars it buys from them. In order for this money not to find its way to loans and credit, the central bank has to persuade the commercial banks to increase their short-term deposits at it. The Bank of Israel's tool of persuasion is the interest that it will pay on these deposits. In other words, every shekel of intervention in the foreign currency market means a sure profit for the commercial banks. The intervener is the Bank of Israel, but it's the commercial banks that reap the profits.
It is possible that this is a blessing from the Bank of Israel's perspective because it will help boost the commercial banks' profits. But this still leaves the question of how to correctly price risk, as well as the ramifications caused by the success of monetary policy depending on the amount of the commercial banks' deposits with the Bank of Israel.
The Bank of Israel hopes to evade these questions, and to hope that market conditions in the future will enable it to achieve the hoped-for turnaround, whether through a strengthening of the dollar on international markets, or through a resumption of foreign demand that boost exports. If these two conditions are met, the Bank of Israel can quit the market and revert to its previous policy.
Published by Globes [online], Israel business news - www.globes-online.com - on August 4, 2009
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