Israel's reliance on tech a risk as economic winds change

Auto-tech Photo: Shutterstock
Auto-tech Photo: Shutterstock

A decline in overseas demand and more selective investment could make the locomotive of the economy falter.

The initial estimate for Israel's GDP growth in the first quarter reveals that the economy has entered a slowdown, with GDP actually shrinking by an annualized 1.6%. If up to now the technology industry has been the locomotive of the Israeli economy, the current figures, and Minister of Finance Avigdor Liberman's response, now show a problematic picture, to the extent that commentators are talking of the possibility of stagflation, and even a recession.

"Of all the economic data, what most concerns me is the decline in Israeli high-tech exports following the declines on Wall Street," Liberman said at the Israel Institute of Energy and Environment National Energy Conference. "As far as inflation is concerned," Liberman said, "we are part of the global economy, and the two most important economies, the US and Germany, are posting high inflation, and there too housing prices are rising sharply."

Liberman sees weakness in the technology sector, and the fear is that this will hit tax revenues. Exports of services fell by an annualized 17% in the first quarter (although that comes after a 35% annualized rise in the previous quarter). Analysis by the Ministry of Finance last year found that every 1% rise in the Nasdaq 100 Index, which is closely correlated with the performance of Israel's technology sector, contributes revenue of NIS 12 billion. Since the index completed a 25% decline from its peak last week, Liberman's concern is understandable. The Bank of Israel, incidentally, has been warning for the past six months that the government should not continue to rely on tax revenues from the technology sector.

The figures were an unpleasant surprise, as analysts had expected a positive growth figure, and besides that certain weak points were revealed that are liable to affect the economy adversely as time goes on, the more so in an inflationary environment. A slowdown alongside rising prices, or stagflation as it is known, could be in the offing.

Mizrahi Tefahot Bank chief economist Ronen Menachem believes that last week's numbers from the Central Bureau of Statistics do not indicate weakness in the technology sector. "Although the GDP figures are attracting attention, according to the foreign trade statistics released a few days ago, high-tech exports rose by an annualized 12% in February-April, in the trend figures, following a 21% annualized rise in November -January. Since this sector accounts for nearly 40% of total industrial exports (excluding diamonds), this is a figure that continues to support the economy and strengthen it," he writes.

Nevertheless, he adds, "If the high-tech sector does weaken, this will be keenly felt in the local economy, both because of its importance to GDP and employment, and because a long list of industries and sub-sectors support it day-to-day and earn their livelihoods from its needs."

Effect of interest rate hike

Although Israel's GDP fell by an annualized 1.6% in the first quarter of this year, in comparison with the first quarter of 2021 it rose by 9%, putting Israel in a high position among the OECD countries. But in the comparison between the first quarter of this year and the final quarter of 2021, Israel is third from bottom among those countries that have released growth statistics, keeping company with Sweden and Norway.

The April inflation figures, which show inflation exceeding the target range, support a large interest rate hike, but the GDP figures and the fear of a slowdown support a more gradual rise in interest rates. Leader Capital Markets chief economist Yonatan Katz estimates that the chances of an interest rate rise of just 0.25% next week, rather than 0.4%, have grown. "It could well be that some members of the Bank of Israel Monetary Committee will prefer to be more cautious in the interest rate dose they apply," Katz writes.

Other worrying indications

In any event, we are not yet in an economic recession, defined as a decline in GDP in two successive quarters, and for the time being there has been no deterioration in the labor market, with unemployment at a five-decade low. All in all, then, we are looking at a descent from the high growth levels that the economy was experiencing. The initial growth estimates do, however, expose certain vulnerabilities and indications of the state of the economy that the Bank of Israel will take into account when it comes to set its interest rate next week.

The causes for concern come from private consumption, which has levelled off as Israelis flock abroad, sending the imports of goods and services item up 17% in the first quarter. The decline in vehicle purchases is also a worry, as GDP excluding net taxes on imports, a large part of which come from vehicle imports, fell more sharply, by an annualized 3%.

Beyond that, it could be that the wealth effect, which soared as housing prices and financial markets rose, will wear off, given the sharp falls on the stock markets this year. The wealth effect in Israel, chiefly generated by the flourishing technology sector, contributed to a 10% rise in private consumption last year. Technology will continue to be the locomotive of the economy, but the weakening will probably manifest itself in company downsizing and slower salary rises.

It could therefore be said that the economy is currently paying the price of last year's strong growth, when Israelis did not travel overseas and spent their money in Israel, while high-tech exports boomed. Economic conditions have now changed. Venture capital investors will be more selective, and the reliance on high tech poses dangers to the economy in a period of rising interest rates and a decline in investors' appetite for risk.

Published by Globes, Israel business news - - on May 19, 2022.

© Copyright of Globes Publisher Itonut (1983) Ltd., 2022.

Auto-tech Photo: Shutterstock
Auto-tech Photo: Shutterstock
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