The shekel has depreciated 8% this month against the US dollar and 6% against the euro. This worrying trend has both direct and indirect implications for the State of Israel's national debt, which swell massively if the Israeli currency continues to weaken.
According to "Globes" calculations, the change in the shekel exchange alone has increased the national debt by NIS 10 billion. The Ministry of Finance Accountant General issues bonds to foreign investors in dollars and euros, which are therefore linked to forex fluctuations. According to the Ministry of Finance, every percent that the shekel weakens against the dollar increases the debt by NIS 1 billion and every percent the shekel weakens against the euro lifts the debt by NIS 300-400 million.
No real panic, meanwhile
Compared with other countries, Israel is well protected against foreign currency trading fluctuations on the debt. The state has a debt portfolio of a little over NIS 1 trillion with the shekel market fulfilling most of the financing needs of the state coffers. About 85% of the debt is in shekels but even the relatively small balance in foreign currency amounts to the considerable sum of NIS 150 billion. Of the debt that the Ministry of Finance manages in foreign currency, the great majority is in dollars and the balance mainly in euros (about 27%).
Despite the immediate jump in debt as a result of the weakening of the shekel, the problem is mainly long term. The national debt portfolio is managed in annual terms and the average debt is close to 10 years maturity. So this is not a situation in which tomorrow morning the Ministry of Finance will need the dollars, which have become more expensive, in order to pay off the entire debt. The immediate payments are on the interest on the debt, and most of the Accountant General's dollar interest expenses are hedged one year ahead. In other words, the interest on the existing debt in foreign currency will not rise in the immediate term (in contrast to the interest on new debt raisings, which are rising in Israel and most of the world).
But in the long term the weakening of the shekel will fuel inflation and make imports of goods and services more expensive. Some of the bonds issued by the Ministry of Finance are linked to the Consumer Price Index (CPI), which causes the debt to swell by millions of shekels. Another risk is that increasing inflation will force the Bank of Israel to continue hiking interest rates, which increases the debt even more.
Data from recent years show that about half of the national debt - NIS 500 billion - is linked to the CPI. Inflation today is at a 14-year high, with an annual rate of 5.4%, and each percentage is worth billions of shekels. However, the volume of index-linked bonds from the state's debt portfolio may decrease in the coming years, with the cessation of the issuance of designated bonds in recent months.
Change in the balance of forces could hit the shekel
According to the analysts, the trends of the last few days might only be just the start. In the markets, the steep depreciation of the shekel is interpreted mainly as investors' growing fear of the weakening of the independence of the judiciary and the Bank of Israel following government reforms. The legislation to change the balance of power between the politicians and the courts was launched this week despite warnings from investment houses and international credit rating agencies.
If all this was not enough, comments by Minister of Foreign Affairs Eli Cohen and Knesset Finance Committee chairman MK Moshe Gafni suggested attempts to weaken the independence of the Bank of Israel.
The Ministry of Finance is trying to reassure investors and attempting to convey a "business as usual" atmosphere. At the moment there are no plans to take hasty steps such as bringing forward the repayment of debts in response to further weakening of the currency. However, even there if the sharp fluctuations of the last few days continue for more than a week then the red lights are likely to flash on.
The continued weakening of the shekel, combined with other indicators such as bond yields and insurance premiums on it, will return Israel to negative debt-GDP ratios, after a significant improvement over the last year - in 2022 the country's debt-GDP ratio fell from 68% to 61% only, using budget surpluses to close the debt.
Published by Globes, Israel business news - en.globes.co.il - on February 23, 2023.
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