In a survey of the Israeli economy, Swiss bank UBS notes that the economy has been in a challenging and complex situation since the attack by Hamas on October 7, 2023, and sets out projections for the shekel on the basis of three scenarios.
"The GDP and fiscal hit to the Israeli economy since 7 Oct 2023 amid lingering uncertainty about the duration of the war, has taken the toll on Israeli assets," the banks analysts write. "In the immediate aftermath of the 7 Oct events credit spreads quickly priced in 2-3 rating downgrades (which have largely materialized since with the latest two-notch downgrade by Moody's); but also continued to cheapen further since -- a process that was also accompanied by an underperformance of local currency bonds (taking the 10 year yield gap to US Treasury bonds to levels last seen in 2013). The shekel has been stable in nominal terms after a short-lived selloff, but largely kept the cheapness built during the months leading to the war while a judiciary reform was in focus."
The survey was written before the missile attack on Israel by Iran last week, and so does not take into account escalation in the form of direct conflict between Iran and Israel.
The bank considers three scenarios for the next six to twelve months.
"Scenario #1 is a ceasefire across all fronts; under scenario #2 the intensity of war fades; scenario #3 is a broadening and extension of the Israel/Lebanon front (war ends only in end-2025)."
The survey states that scenario 2 is similar to that projected by the Bank of Israel in July.
Under scenario #1, UBS sees the shekel strengthening, with the shekel-US dollar exchange rate falling to a range of NIS 3.40-3.50/$. This, the bank says, will be led by the unleashing of pent-up demand for shekels via local hedges and internationals from a favorable starting point. In scenario #2, the bank says, "these dynamics would also likely play out…but to a much lesser extent." In this scenario, UBS sees the shekel-dollar rate in a range of NIS 3.60-3.70/$.
"Scenario #3 is consistent with lingering elevated fiscal risk premium and further rating downgrades, offset by possible BoI intervention," the survey states. In this scenario, the projected range for the shekel-US dollar rate is NIS 3.80-3.90/$. At around NIS 3.81/$, the current rate is within that range.
The survey also comments on developments in the fiscal deficit, which according to the Ministry of Finance’s forecasts will be 6.6% of GDP for 2024. The analysts say that, under scenarios #1 and #2, the twelve month deficit is about to peak, but that it will still be above the official forecast for the year. "The bad news is that the planned consolidation measures (targeting a deficit of 4.0% of GDP next year) face an implementation risk; while consolidation measures will also need to be stretched beyond 2025 as in all three scenarios defense spending will likely rise structurally (by 1%-2% of GDP)," the report states.
On the positive side, UBS does point out that, for all the challenging picture, there are also factors supporting the Israeli economy. One of the main ones is the pent-up demand for shekels on the part of investment institutions. UBS estimates that, when the geopolitical situation improves, these investors will probably want to return to the normal hedging levels, and in order to do so they could sell large quantities of dollars - up to $15 billion - which will support appreciation of the shekel.
In addition, the possibility exists that the Bank of Israel will intervene to stabilize the market in the event of a shock, especially since its foreign currency reserves are at a healthy 42% of GDP, more than $200 billion. At the beginning of the war, the bank announced a program of intervention of up to $30 billion, although it actually only used $8.5 billion.
Another factor supporting the shekel is the interest rate gap vis-à-vis the US and Europe, where interest rates are expected to fall significantly in the coming quarters, whereas in Israel, if there is any decline at all, it is expected to be moderate. The analysts do however state that "the process of households' reallocation towards foreign assets will remain in place."
On what will happen to the price of oil if the conflict expands, the analysts write that major disruption to Iranian oil exports will lead to a rise, but that it will be fairly moderate, amounting to just a few dollars a barrel. This is because the spare capacity of the OPEC+ countries amounts to about 6 million barrels a day, which compares with Iranian production of about 3.35 million barrels a day and Iranian exports of 1.7-1.8 million barrels a day.
Published by Globes, Israel business news - en.globes.co.il - on October 6, 2024.
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