What could political compromise do to the shekel?

Shekel versus US dollar  credit: Tali Bogdanovsky
Shekel versus US dollar credit: Tali Bogdanovsky

With talk of compromise on the government's judicial overhaul plans again in the air, "Globes" asked market analysts how they see the foreign exchange market responding.

The past couple of days have seen considerable toing and froing over the government’s judicial overhaul plans. A compromise proposal by President Isaac Herzog was reported to have Prime Minister Benjamin Netanyahu’s consent, but this was immediately denied by the Likud party. Then, yesterday evening, Netanyahu called on Benny Gantz, leader of the opposition National Unity party, to enter into talks to reach a compromise on the issue, a call that Gantz rejected, saying that Netanyahu could not be relied upon, and in any case was captive to the interests of the extremists in his coalition.

The assessment by political commentators is that Netanyahu apparently hopes that talks will persuade the High Court of Justice to postpone hearings on petitions to strike down recent legislation partially enacting the government’s planned reforms and to force Minister of Justice Yariv Levin to convene the judicial selection committee in its current format (which he intends to change), and will present an appearance of consensus that might improve his chances of obtaining a meeting with US President Joe Biden. As for Gantz, compromise may not be in his interests, as his party is doing well in opinion polls.

What will be the effect on the shekel? The answer appears to depend on whether there is a real intention on the part of the government and opposition to restart negotiations on a compromise formula for the legal system. On Monday, the shekel weakened, at one point surpassing the NIS 3.82/$ level. Later in the day, it began to strengthen, as reports emerged of a new attempt by President Herzog to achieve a compromise, with Netanyahu’s support. The exchange rate against the US dollar fell below NIS 3.8, while against the euro the shekel was even firmer, with the rate falling a full percentage point to NIS 4.07/€, as the US dollar also strengthened against the euro.

This is not the first time that the shekel has responded strongly to rumors of a possible compromise on the judicial reform issue. When President Herzog first called for compromise on the basis of an outline that he proposed, at the beginning of the crisis, the shekel strengthened by more than 2% against the dollar.

The volatility in the shekel is a substantial factor in fueling inflation. In the Bank of Israel’s interest rate announcement on Monday, the bank’s Monetary Committee stated, "The depreciation of the shekel in recent months has contributed to the increase in the rate of inflation and its development in the coming months will have an impact on inflation dynamics," the Bank of Israel Monetary Committee wrote.

In an interview with "Globes" after the latest interest rate decision, Yaron again stressed the connection between shekel exchange rates and the judicial reforms. "There is no doubt that, since the start of the year, the shekel has disconnected from the close connection it had with the financial markets abroad, and we see an excess depreciation of over 10%, which translates into excess inflation of 1.5%. It (the shekel) reflects the uncertainty that has grown in the economy and the risk premium that arises from the constitutional processes," he said.

It would appear, then, that the market yearns for a compromise on the judicial overhaul. Any statement on proposals and possible compromises from any source generates positive sentiment on the market, even if it is short-lived.

"Globes" asked market analysts what effect a compromise might have on the foreign exchange market, and to what extent the shekel might appreciate. They were reluctant to give specific numbers.

Ori Greenfeld, chief strategist at Psagot Investment House, says that it’s difficult to assess what effect positive developments on the political front might have on exchange rates. "The truth is that this is something difficult, and even impossible, to know, since there is no way of estimating the economic value of the currency at any given moment," he says.

A senior market source told "Globes": "In the end, a solution to the political crisis, and a calming of the uncertainty, will lead to the shekel strengthening, but there are other factors affecting the exchange rate."

He explained that the interest rate gaps between Israel and the US along the entire yield curve contribute to the shekel depreciating against the dollar, so that even if the excess depreciation caused by the political crisis disappears, we still won’t see the exchange rate at the level it was at a year ago, of NIS 3.2/$.

Nevertheless, the source says that a rate in the range of NIS 3.5-3.6/$ is certainly possible, and that as global inflation recedes and central bank interest rates fall, we should see a trend of further appreciation of the shekel.

Ronen Menachem, chief markets economist at United Mizrahi Tefahot Bank, told "Globes": "The acceptance of this or that compromise proposal will not completely remove the matter from the agenda. There will still be concern over it, and the protest measures will also probably continue in some format or other."

Menachem adds that, besides the question of the legal reforms, experts do not see the security tensions reducing in the near future, and they too do not strengthen the shekel. He thinks that the Bank of Israel’s assessment that the internal crisis is responsible for 10% of the shekel’s depreciation is realistic. "It can be estimated that appreciation of 10% from its current level may quantify the most that the currency could gain if the confrontation over the legal issue abates."

If follows that, according to Menachem, in that scenario, the shekel-dollar rate could fall to about NIS 3.45-3.5/$.

IBI: Only steps towards cancelling the legislation will have an effect

IBI Investment House chief economist Rafi Gozlan said, talking to "Globes": "The degree of confidence in consensus or a compromise over the legal reform is not high, to put it mildly." Gozlan stresses that if we are to see calm on the markets, real steps will have to be taken towards cancelling the legislation. "As long as the current composition of the government remains, and the legislation is still on the table, there may be lulls from time to time, but it’s hard to see a change of direction from the upward trend in the economy’s risk premium."

Gozlan says that even if the politicians enter into negotiations on the matter, the shekel will appreciate only slightly, after the unilateral steps that the government took earlier in the year, despite attempts at compromise.

Hapoalim: Institutions will reduce currency exposure

Modi Shafrir, chief financial markets strategist at Bank Hapoalim, told "Globes": "The foreign exchange market is in waiting mode, and moves one way or the other could have an effect on it. Fears of a constitutional crisis and continued internal tension in Israel could lead to further depreciation. On the other hand, the possibility of compromise exists."

Shafrir too shares the Governor of the Bank of Israel’s assessment that the shekel is suffering from excess depreciation of 10%.

Furthermore, Israeli financial institutions have raised their foreign currency exposure sharply since the crisis began. "According to the figures we have, every percentage point by which the institutions raise their exposure means about $6 billion going overseas."

Shafrir says that if we see the political arena calming down and the sides reaching a genuine compromise, we should also see the currency exposure of the financial institutions returning to the level it was at before the crisis, and the shekel strengthening accordingly.

Meanwhile, coalition leaders have come out against the president’s new proposal. Minister of Justice Yariv Levin, for example, ruled it out, and said that "the opposition won’t agree to it either."

The objections to the proposal reversed the appreciation of the shekel, and the rate is now back above NIS 3.80/$. Once more, the foreign exchange market has proved to be a seismograph of events in the political arena.

Published by Globes, Israel business news - en.globes.co.il - on September 6, 2023.

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

Shekel versus US dollar  credit: Tali Bogdanovsky
Shekel versus US dollar credit: Tali Bogdanovsky
Twitter Facebook Linkedin RSS Newsletters גלובס Israel Business Conference 2018