Analysts divided on whether BoI can curb the shekel

Amir Yaron  / Photo: Rafi Kotz, Globes

The Bank of Israel fears for exports and jobs, but are massive foreign currency purchases effective help?

Will the Bank of Israel's new and dramatic policy succeed in halting the appreciation of the shekel? The announcement by the central bank on Thursday that it would buy $30 billion in 2021 caught the market by surprise. The immediate reaction to the announcement was a reversal of the trend, as the shekel-dollar exchange rate shot up: from a low of NIS 3.13/$ on Wednesday to NIS 3.26/$ at the close of trading on Friday. The sharp rise is attributed to investors who rushed to close positions (through stop-loss orders). But the assessment for the coming week is that the rate will drop somewhat and the shekel will resume its appreciation.

Consensus view: No long-term effect

Analysts and traders spent the weekend before today's reopening of foreign exchange trading attempting to assess the chances of success of the Bank of Israel's move, which it has never tried before on such a scale, in the war against the appreciation of the shekel that it has been waging since 2008. Since that time, the bank's foreign currency reserves have grown to $173 billion (the Bank of Israel invests the foreign currency that it holds; its portfolio yielded a return of 6.1% in 2019 and the average annual return for 2017-2019 is 3.1%).

The prevailing view on the market is that the move will not materially change the long-term trend of a strengthening shekel. Chef economists and strategists at the banks, such as Gil Bufman at Bank Leumi (TASE: LUMI) and Modi Shafrir at Mizrahi Tefahot Bank (TASE:MZTF), believe that the size of the intervention could moderate the strengthening trend in the short term, but that on the whole the basic forces pushing the shekel-dollar rate downwards will win out.

Others, looking at the unprecedented scale of purchases by the Bank of Israel in 2020, reached the conclusion that if $21.1 billion failed to stop the shekel against the basket of currencies, "what good will another $8-9 billion do?"

The Bank of Israel is already very close to the rate of foreign currency purchases announced in the new program. "In the last three months of 2020, the Bank of Israel bought dollars at an annual rate of $27 billion, and the shekel continued to strengthen," says Ori Greenfeld, chief economist and strategist at Psagot Investment House Ltd.. "So will the Bank of Israel's new move change anything? It caused a jump, but it's not certain that it will do any more than that."

Minority view: 2021 will be different

On the other hand, there is a minority among the analysts and traders that holds that the move could succeed. This view is based on two arguments. The first is that the rare combination of forces that pushed the shekel-dollar rate downwards so strongly in 2020 will not be repeated in 2021.

"In 2020, all the stars lined up as far as the shekel is concerned, and the chances of that happening again in 2021 are not high," foreign exchange market players told "Globes". The first "star" is the current account surplus: the rise in inward investment, the robustness of technology exports during the coronavirus pandemic while imports plummeted, Israel's accession to the global government bond index - all these factors, most of them one-time events, created a huge surplus for Israel on its current account. It is estimated that nearly $20 billion more were converted from foreign currency to shekels than the other way round, from shekels to foreign currency. In a normal year, the gap amounts to $10-15 billion at most.

The second "star" is the 40% jump in the Nasdaq index and sharp rises in other market indices. The rises in overseas stock and bond indices force Israeli financial institutions to raise their hedges against foreign currency-denominated holdings, which is equivalent to huge sales of dollars. What are the chances of Nasdaq rising 40% in 2021 as well? Not high.

The third "star" is the 9% decline in the value of the US dollar against the euro.

Greenfeld, however, thinks that there is no reason to believe that macro-economic trends will change in 2021. "We may see a degree of recovery in imports, and that will reduce the pressure on the shekel, but on the financial side, I am not at all sure that we will see a reduction in pressure, and it may even rise. Israel seems to be exiting the coronavirus crisis faster than other countries because of the vaccinations.

"GDP will rise and the debt:GDP ratio will improve, which will leave Israel's sovereign credit rating at its current level. The economic forces still support a strong shekel, and now you should add to that the clear global trend in the value of the dollar, which still has plenty of room to weaken. Biden now wants another big aid program, and the Fed will have to print a lot more dollars in 2021."

Supporting employment and psychological warfare

Helping exporters is the justification that stood behind the Bank of Israel's latest move. The fear on the part of the members of the bank's Monetary Committee is that the strong shekel will set off a further wave of layoffs in an economy that is already in deep crisis. Purchasing dollars will perhaps not reverse the trend, but it will buy time for enterprises to adapt themselves to the new exchange rates. Deputy Governor of the Bank of Israel Andrew Abir actually said explicitly, "I prefer to be on the side of buying too many dollars rather than on the side of buying too few with the result that people lose their jobs."

Greenfeld actually warns against the success of such a move. "The Bank of Israel is in effect applying artificial respiration to industry, and that's fine. But, in the end, the Bank of Israel has been holding the exporters' hands since 2008, and buying dollars is not a solution that can replace structural measures that will, for example, encourage imports, such as lower customs duties and parallel imports. Apart from that, let's say that it succeeds and the Bank of Israel really does strengthen exports, then it thereby helps the forces strengthening the shekel to remain in place. And then what will the Bank of Israel do in 2022? Buy $50 billion? Ultimately, the exchange rate is a mirror of what is happening in the economy, and not the other way around."

To return to the minority that believes that the central bank can succeed, the second consideration that could assist in this is psychological. Investors who flocked to the shekel are likely to flee from it if they fear that the risk is too high, market players argue.

Abir stressed the psychological message in his briefing for reporters after the dollar purchasing decision was announced, when he said that the bank would continue buying dollars even at NIS 3.4/$ or NIS 3.5/$. " If anyone sold dollars the other day, I'm sorry, tough luck," he added. In an interview with Bloomberg, he sharpened the message, saying that the bank would definitely buy at least $30 billion, leaving an opening for a future increase in the volume of purchases.

"As far as investors are concerned, there's an asymmetric risk here," say market players. "The Bank of Israel is providing them with partial protection against a fall in the shekel-dollar rate, but they are completely exposed to a scenario of sharp depreciation of the shekel, and that's a more significant consideration than people think."

Published by Globes, Israel business news - en.globes.co.il - on January 18, 2021

© Copyright of Globes Publisher Itonut (1983) Ltd. 2020

Amir Yaron  / Photo: Rafi Kotz, Globes
Amir Yaron / Photo: Rafi Kotz, Globes
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