Ending forex purchases to offset gas sales meaningless

Amiram Barkat

The Bank of Israel will continue to purchase foreign currency outside of the program framework.

The shekel briefly spurted yesterday following the unexpected announcement by the Bank of Israel of the termination of its foreign currency purchases in the framework of the program for offsetting the effect of natural gas production on the exchange rate.

The jump in the shekel rate was probably merely an initial response by investments in forex markets, because according to all assessments, cessation of foreign currency purchases in the framework of the program will have no real effect on the exchange rate. It is important to emphasize that the Bank of Israel has not altered its policy in the forex market; it can freely purchase foreign currency outside of the program framework, as it has frequently done in recent years. Here are the answers to some questions about the Bank of Israel's foreign currency purchases.

What is the foreign currency purchases program for counteracting the effect of gas?

Former Bank of Israel Governor Prof. Stanley Fischer initiated the program in response to an exceptional isolated event that created a panic at the Bank of Israel. In March 2013, the Tamar Israeli natural gas reservoir began supplying Israel with gas. Power stations of Israel Electric Corporation (IEC) (TASE: ELEC.B22) and other consumers switched to consumption of local gas instead of imported fuels - diesel fuel, oil, and coal - for which IEC paid in foreign currency.

Furthermore, reports of imminent signing of deals for exports of gas from Tamar aroused market expectations of a flood of foreign currency streaming into the economy and greatly strengthened the shekel, generating an effect known as the Dutch disease. The rumors caused a wave of speculative purchases, as a result of which the shekel appreciated 12% against the dollar within a short time.

Fischer decided to halt this trend by committing the Bank of Israel to buying a quantity of foreign currency that would offset the real effect of gas production on the exchange rate. The Bank of Israel is now discontinuing this program at the end of five years, during which it purchased a total of almost $14 billion.

Why was it decided to close down the gas program now?

The decision's timing was not random. Every year about November, the Bank of Israel Monetary Committee convenes to decide the volume of dollar purchases for the coming year in the framework of the plan. The decision is taken on the basis of a professional estimate that tries to assess by how much foreign currency purchases were reduced by the substitution of local gas for imported oil and coal paid for in foreign currency. The amount was $1.5 billion in recent years, and it can be assumed that the amount in 2019 will be similar. The Committee, however, concluded that the program was no longer needed.

What effect will closing down the program have?

The announcement yesterday of the termination of the gas program by the Bank of Israel stated that there was a connection between the decision to end the foreign currency purchases in 2019 and the expected establishment of the sovereign wealth fund in the same year. Fischer initiated the foreign currency purchases program only as a temporary solution to the shekel appreciation pressure created by gas production. The permanent solution to this problem should be the Israel Citizens' Fund, which was created to invest taxes paid by Yitzhak Tshuva and his partners in the gas reservoirs on their excess profits from the sale of the gas outside of Israel.

What is odd about this story is that according to the announcement, the gas fund will begin investing money overseas only in 2020. Why was it not decided to continue the program for another year, until 2020? The real reason is that there was no real justification for the program other than maintaining the Bank of Israel's credibility. As Psagot Investment House Ltd. chief economist Ori Greenfeld explains, the amount involved is relatively small, and the fact that it was published ahead of time and carried out during the year rendered its actual influence on the exchange rate negligible. The annual volume of purchases in recent years was $1.5 billion, about half of the daily turnover in the forex market.

Was the reason the end of Governor of the Bank of Israel Karnit Flug's term?

The possibility that outgoing Governor of the Bank of Israel Karnit Flug wants to leave her future successor an empty desk was mentioned in the markets as a possible explanation for the fund's closure. The Bank of Israel said in response, "The exchanges of governors did not constitute a consideration in any form."

What is happening with the sovereign wealth fund?

Not much. The law for establishing the fund was enacted in 2014, but the fund will be created only in 2019. The reason is that collection of the special tax is due to begin only after the gas developers' accumulated profit exceeds a given ceiling. The updated time for this according to the Israel Tax Authority's forecasts is late 2019.

During the proceedings for establishing the fund, the Bank of Israel expected that NIS 72 billion would be accumulated in the fund by 2040, but the Bank of Israel published a more pessimistic forecast in 2015. Meanwhile, it appears that the government is in no hurry to establish the fund. By law, the fund is to be composed of a council and investment committees. An appointments committee headed by a retired judge, with participation from the Prime Minister's Office director general, the Ministry of Finance director general, and the deputy governor of the Bank of Israel must recommend the committee members. Not a single member of the council has been appointed yet.

Published by Globes, Israel business news - en.globes.co.il - on November 13, 2018

© Copyright of Globes Publisher Itonut (1983) Ltd. 2018

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