If in 2021 the sharp appreciation of the shekel halted some of the price rises of imported products, and moderated the rise in the Consumer Price Index (CPI), since the start of 2022, the situation has changed dramatically. This has come about as the Israeli economy can expect a new wave of price rises due to the jump in global commodity prices, as the shekel is weakening due to the 20% fall in the Nasdaq index from its peak in November.
Israel is always under pressure from the strength of the shekel, due to a trade surplus in exports of goods and services, incoming investments, and exits by tech companies. In other words, the movement of capital into the Israeli economy floods the market with foreign exchange and the value of the shekel rises. But an additional factor has been responsible over the past year for the strengthening of the shekel and that is hedging of overseas investments by local institutional investors.
"To reexamine the hedging by institutional investors"
The correlation between the shekel exchange rate and the overseas financial markets is directly connected to the hedging of investments by the institutional investors that manage our pension funds. In order to comply with the policy terms for savings investments, on days when there are rises on overseas markets, as happened throughout most of 2021, institutional investors sell dollars so that the supply of dollars on the local market rises accordingly and the shekel strengthens in response. So as the value of their investments in dollars rises, the institutional investors need to sell dollars to meet the point of balance set by their investment policies.
On days when overseas markets fall, the situation is reversed and to meet those same investment policies the institutions need to buy dollars because the value of their overseas investments have fallen, thus reducing supply of foreign currency on the domestic market and strengthening the dollar against the shekel.
In the past two months, the institutional investors alone have offset the influx of foreign currency from exports and investments. The falls in foreign markets have done the work for the Bank of Israel, which has not needed to purchase foreign currency to moderate the strengthening of the shekel in order to limit the damage to exporters.
In 2021, the Bank of Israel purchased $35 billion in foreign currency to moderate the strengthening of the shekel, averaging $5 billion a month in the first half of the year. But since the start of 2022, the Bank of Israel has only bought several hundred million dollars in foreign currency.
The Bank of Israel partly explains the weakening of the shekel on the interest rate gap between Israel and he world due to the more financially "hawkish" policies in the developed world and geopolitical tensions. In the Bank of Israel Monetary Committee's discussions during the most recent meeting in February on the interest rate decision, the correlation between the fall in overseas financial markets and the demand for dollars by institutional investors was debated but no policy on how to deal with the issue was proposed.
BlackRock Israel head Anath Levin, a member of Minister of Finance Avigdor Liberman's economic cabinet, proposes reexamining the issue of hedging by institutional investors due to the influence of their hedging on the foreign exchange market. "The returns are measured in shekels, and the investment portfolios are growing at a faster pace than the domestic economy, and the overseas investment component continues to grow from 15%-20% a decade ago to close to 40% today. This is correct in managing risks and correct in investment opportunities and this is correct in the systematic spreading of risk for savers whose entire world depends on the domestic economy. But the derivative effect is that the institutions are forced to hedge to the shekel growing parts of their investments."
"The shekel is pushing the rate of inflation higher"
Another factor causing the weakening of the shekel is related to the strengthening of the dollar worldwide. During times of crisis investors flock to save havens like the US dollar and as the American currency strengthens worldwide, so the shekel weakens accordingly.
Bank Mizrahi-Tefahot chief economist Ronen Menachem said, "Together with housing and fuel, the shekel is pushing the rate of inflation higher, especially looking at the next two months. The weakness of the shekel stems from the appreciation of the dollar worldwide and, as mentioned, the strong correlation between the stock market and the shekel.
"After the Bank of Israel purchased billions of dollars last year, the shekel is depreciating and this is expected to continue while the war in Ukraine lasts. In addition, the fall in overseas markets harms the rate of high-tech export growth, which was the central factor in the strengthening of the shekel and the rise in tax revenues for the state in 2021."
Published by Globes, Israel business news - en.globes.co.il - on March 10, 2022.
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