Gov't endangering Israel's economy? What are the signs?

Benjamin Netanyahu and government ministers in the Knesset  credit: Yossi Zamir
Benjamin Netanyahu and government ministers in the Knesset credit: Yossi Zamir

Doomsayers see political events in Israel undermining investor confidence. "Globes" surveys some indicators that will give early warning.

Various commentators and company executives have expressed concern recently about the possible economic consequences of the government’s plans, specifically of the changes to the judicial system and the generous coalition agreements that the Likud party signed with the haredi parties. Some warn that the government’s measures spell the end of democracy in Israel and prophesy economic devastation. But how will we know if the threat is real? Here are some economic indicators that will tell the decision makers within a short time in what direction the Israeli economy is heading.

The currency market - first to respond

The economic indicators are bound up one with another in a complex whole, and they will be listed them shortly. In general, though, the market that responds fastest to deterioration in the financial stability of a country or in the sovereignty of its institutions is the currency market. It is, however, difficult to determine the precise cause of volatility in the market, which itself is affected by a wide variety of indicators.

For example, the shekel weakened in December from NIS 3.41/$ to NIS 3.53/$. It’s difficult to determine whether this was because of rising fears on the part of investors over political developments in Israel, or whether it was a reaction to falls on the stock markets, or to a slight decline in exports. It could be that the right answer is all of the above, but the relative weight of each factor remains hidden in obscurity.

If so, how can the exchange rate be used as an indicator of actual danger? Weakness in the shekel, as in any currency, becomes worrying when it continues steadily for a long period, or when there are exceptional movements in the exchange rate in comparison with the currencies of similar countries.

On the subject of the exchange rate, it’s important to remember that the foreign exchange reserves of the Bank of Israel have swollen in recent years to a huge $194 billion. This happened as a result of large purchases of dollars as the central bank tried to stop the shekel from strengthening excessively versus the basket of currencies of Israel’s main trading partners.

In the extreme circumstances of a crisis that leads to a weakening of the shekel, which will fuel inflation and necessitate higher interest rates, the foreign exchange reserves can be used in the opposite direction. Theoretically, the Bank of Israel can sell its dollars to shore up the shekel. On the one hand, this has never happened in the past, but on the other hand Israel’s foreign exchange reserves have never been so high. They are currently much higher than the minimum level recommended by the International Monetary Fund.

Debt:GDP ratio - comparatively good

When GDP is much larger than government debt, investors can be more certain that a country will be able to service its debt. Last week, the Accountant General Department at the Ministry of Finance celebrated the release of fantastic numbers for Israel’s debt:GDP ratio. This ratio, which serves as an important indicator of a country’s financial stability, fell from 68% in 2021 to just 60.9% in 2022, almost bringing it back to where it was before the Covid-19 pandemic broke out. Most developed countries are contending with debt amounting to 80-90% of GDP.

When the debt:GDP ratio rises, the capital market responds accordingly. This is what happened in Italy, for example. Rising government debt in relation to GDP led to investors demanding a high risk premium, and yields on Italian government debt instruments soared. In a situation like that, if a country wants to embark on a plan to support its economy, it has to pay much higher interest rates on the debt that it raises for the purpose. This can snowball: high interest rates mean higher government expenditure, and the government then has to raise further debt at even higher rates, and so on and so forth.

A low debt:GDP ratio means that the decision makers can be fairly relaxed about an approaching economic slowdown, because the government is able to raise debt to support the economy without fearing economic collapse. This was Israel’s position when the Covid-19 pandemic started, but then a policy of unrestrained spending sent its debt:GDP ratio shooting upwards in 2020, from a historically low level 59.5% to 71.7%.

Fiscal deficit - a signal next month

The debt:GDP ratio goes hand in hand with the fiscal deficit. In general, the debt finances the deficit. Last year, it was the other way around; a fiscal surplus repaid debt. 2022 was the first year since 1987 in which, rather than a deficit, Israel recorded a fiscal surplus, of nearly NIS 10 billion, about 0.6% of GDP.

No-one expects the surplus to continue into 2023, but we will probably receive some indication of where we are heading next month, when Minister of Finance Bezalel Smotrich sets out the deficit framework for the next state budget. Smotrich has already signaled to foreign investors that he will not breach normal frameworks and will maintain a balanced fiscal policy, but he faces a stiff challenge from the welter of budgetary demands from his partners in the government.

What level of deficit will start warning lights flashing for investors? "If they set a deficit framework of 3% of GDP, that will be fine, and for a certain period Israel can even reach 4%, on condition that it’s a matter of expenditure that generates economic growth," says Psagot chief economist Ori Greenfeld. "If the deficit is fairly low, then the debt:GDP ratio will probably not rise in 2023, and may even fall slightly. As far as 2024 is concerned, that will very much depend on what the government does during the year, but I don’t see a situation in which the fiscal deficit balloons in an unprecedented way," he adds.

Government bond yields - steady investor confidence

Government bond yields are not so much an economic indicator as the capital market’s reflection of the various indicators. Since investors always try to anticipate developments, the bond market responds swiftly when a country is under pressure, and bond yields climb. As mentioned, this is what happened in Italy, and also in Turkey, in the period before economic crises broke.

A clear illustration of the brakes that the capital market applies when political developments are perceived by analysts as dangerous is provided by Britain. Last October, Liz Truss resigned as prime minister, after just a few weeks in the post. What led to her resignation was the controversial tax cuts plan that she and her Chancellor of the Exchequer Kwasi Kwarteng presented, which triggered a steep rise in government bond yields. That caused Kwarteng’s downfall, and, shortly afterwards, Truss’s resignation.

By global comparison, Israel’s situation is still good. Although yields on Israel government bonds are at their highest levels for some years, that is part of a worldwide trend of rising interest rates. In relation to other countries, government bond yields in Israel are still low, and reflect steady confidence on the part of investors.

The most recent manifestation of that came a week ago, when the Accountant General successfully completed a $2 billion debt offering of to foreign investors, consisting for the first time of green bonds. Amid high demand from some of the world’s largest financial institutions, the spread between interest rates on Israeli government bonds and equivalent US government bods remained stable. That is to say, current events are not making the market charge an additional risk premium. On the other hand, in the lead-up to the offering, investors asked again and again whether the government intended to set a normal deficit framework.

Another indicator is provided by the yield curve - the yield in relation to time to redemption of government bonds. In Israel’s case, the curve falls for longer term bonds, which means that the market sees a positive horizon for Israel. It hasn’t always been that way. Before 2006, when interest rates were high, the curve went the other way; that is to say, in order to invest in longer term government debt, investors demanded a higher risk premium from Israel. Happily, that is not the case at present.

Published by Globes, Israel business news - en.globes.co.il - on January 22, 2023.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2023.

Benjamin Netanyahu and government ministers in the Knesset  credit: Yossi Zamir
Benjamin Netanyahu and government ministers in the Knesset credit: Yossi Zamir
Dr. R  credit: Jonathan Bloom Wounded in his tank, now R develops protection systems

"I was close to death, but it sharpened my awareness of the products we develop for the IDF."

Ella Kenan  credit: Yossi Cohen A fighter of fake news about Israel

Ella Kenan saw online denial of October 7 happening straightaway. "I realized we had 24 hours, or we were doomed"

Liron Horshi credit: Jonathan Bloom Wiz's talent manager nurtures $1b workforce

Wiz's $32 billion sale to Google was rooted in the cloud security product if offers but could not have been achieved without the quality of its employees built by human resources chief Liron Horshi.

Yoav Shoham  credit: Eyal Izhar Yoav Shoham: AI isn't too smart, it's too dumb

AI21 Labs founder and CEO Prof. Yoav Shoham talks to "Globes" about dubious doomsday predictions, what should really concern us, and what could make Israel a global AI leader.

Insightec COO and general manager Eyal Zadicario credit: Ness Productions After 25 years of losses Insightec focuses on profit

Insightec COO and general manager Eyal Zadicario tells "Globes" about himself and the Israeli ultrasound company's long battle to change the medical world.

Amit Shaked credit: Tomer Lesher Driven to succeed but balancing ambition with wellbeing

At just 14, cybersecurity company Rubrik VP Amit Shaked began a B.Sc. in Computer Science and Math and mapped out his entire future, which included IDF service in the 8200 unit, and an inevitable huge startup exit.

Dr. Ola Gutzeit  credit: Ketty Hakim The doctor breaking new ground in fertility

"We know nothing about the female reproductive system," says Dr. Ola Gutzeit of Rambam Hospital. She seeks to change that, and hence change IVF for the better.

Google CEO Sundar Pichai  crediit: Shutterstock Why Google is paying so much for Wiz

Lagging its competitors in cloud and AI, and facing challenges to its core advertising business, Google could be looking to spend its way out of trouble.

Prof. Douglas Irwin  credit: Inbal Marmari "We will all be poorer"

Prof. Douglas Irwin, an expert on international trade, talks to "Globes" about the impact of President Trump's tariffs policy, and what Israel can do about it.

Rooftop solar panels credit: Shutterstock Does it pay for homes to install rooftop solar panels?

As the Israeli government steps up efforts to encourage homeowners to produce their own electricity from rooftop panels, "Globes" investigates the advantages and pitfalls.

UnitedHealth founder Richard Burke credit: Ken Easley UnitedHealth founder: US health system is broken

In an exclusive interview Richard Burke talks about the murder of the company's CEO, Donald Trump, his love for Israel, and investment in Israeli startup Korro AI.

Left to right: Karin Goldberg, Einav Laser, Dr. Arseniy Lobov, Dr. Paola Antonello, Dr. Merav Shmueli, and Prof. Yifat Merbl (center in black)  credit: Weizmann Institute Israeli scientists' discovery could lead to new antibiotics

Prof. Yifat Merbl of the Weizmann Institute and her team have found a natural source of anti-microbial substances in the "garbage can" of human cells.

Peter Kash credit: personal photograph Peter Kash confident about cancer cure breakthrough

In Israel for IATI's MIXiii International Life Science and Health-Tech week, the US investor talks about his life science portfolio and the opportunities Israel must seize.

Twitter Facebook Linkedin RSS Newsletters גלובס Israel Business Conference 2018