Is the shekel overvalued?

Shekel  / Photo: Shutterstock

Meitav Dash chief economist Alex Zabezhinsky argues that the shekel is justifiably strong, but questions why it is the world's strongest currency.

When asked why the shekel is a strong currency, economists always answer that Israel has a surplus of exports over imports, that overseas investments are flowing into Israel, and that the Israeli economy is growing and strong. All of this is true. The question, however, is not why the shekel is strong, but why it is the world's strongest currency. The shekel has strengthened the most of any currency against the US dollar in the past three, five, and even 10 years.

Israel indeed has a large current account surplus (surplus of exports over imports), but quite a few countries have the same surplus as Israel, or a larger one, in terms of GDP, including Switzerland, Singapore, Thailand, Norway, South Korea, and Sweden.

Foreign investments in Israel are really high (in terms of GDP), but are the same or higher in Hong Kong, Ireland, the Netherlands, Chile, and other countries. There are also quite a few countries with higher economic growth rates than Israel in recent years.

Together with the strong points, weak points likely to hurt the currency should also be kept in mind, such as the negligible interest rate and the sensitive geopolitical situation.

Incidentally, a surplus of exports over imports and large foreign investments do not necessarily generate demand for shekels. In many cases, an Israeli company's proceeds from exports do not pass through the local foreign currency market. For example, Teva's export proceeds can service its global activity. The same is true of the export proceeds and money raised by Israel's tech companies, most of which belong to global companies; only some of those proceeds are converted into shekels. It is also questionable whether all or part of the dollars from exits by Israeli technology companies are converted into shekels.

Evidence of this can be seen in the discrepancy between export and import activity and what happens in the foreign currency markets. In the first half of 2019, the non-financial business sector purchased a net of $7.8 billion, although the current account of the balance of payments showed a large surplus of exports over imports, which ostensibly should have made the business sector sell foreign currency.

The question of the shekel's strength is especially prominent, given the fact that residents of Israel sent almost $50 billion net from Israel for overseas financial investments in the past five years, while foreigners sent only $5 billion to Israel. In most cases, the financial investments had to reach the foreign currency market, which should have weakened the shekel.

Why, then, is the shekel the undisputed king of the world's currencies?

Perhaps because there is no threat looming against those gambling on the shekel becoming stronger. The interest rate in Israel has been near zero for along time, while the Bank of Israel has ruled out the option of a negative interest rate. It might have been preferable to leave the interest rate slightly higher in order to maintain such a threat, as was done in countries with an economic situation similar to that of Israel, such as Australia, New Zealand, South Korea, and others.

The negative interest rate in the Scandinavian countries, Switzerland, and Japan posed a new threat to the speculators. These countries also utilized other tools to weaken their currencies, including intervention in the foreign currency market and bond purchases.

Up until recently, Israel maintained intervention in the foreign currency market as a tool against speculators. It was not a major threat, but it nevertheless had a deterrent effect. Once the Bank of Israel stopped "fighting," i.e. intervening in foreign currency trading, the strengthening trend in the shekel quickly picked up steam. Until early 2019, the shekel at least weakened against the dollar when the dollar strengthened globally, Starting this year, however, the dollar has strengthened by 2% against the basket of the world's major currencies, but the shekel has strengthened against the dollar by 6%.

The recent strengthening of the shekel again aroused a dispute about whether a strong shekel is good or bad for the economy. There are arguments on each side, but as in any argument, the truth lies somewhere in between. Neither an excessively weak shekel nor a shekel that is the world's strongest currency is good for the Israeli economy. The shekel's crushing victory in recent years is an extreme phenomenon that is inconsistent with the economic figures for Israel.

The Israeli currency's excessive strength arouses concern that it is artificial, and not only detracts from exports, but is also liable to quickly reverse when the circumstances change - a frequent occurrence in the financial markets.

The author is chief economist at Meitav Dash.

Published by Globes, Israel business news - en.globes.co.il - on October 15, 2019

© Copyright of Globes Publisher Itonut (1983) Ltd. 2019

Shekel  / Photo: Shutterstock
Shekel / Photo: Shutterstock
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