Bank of Israel under fire over decade-long currency intervention

By Steven Scheer

JERUSALEM (Reuters) - The Bank of Israel has a problem. After spending almost a decade and huge sums trying to curb the shekel, the currency is still rising relentlessly - to the dismay of the country's exporters.

In 2008 the central bank began what was supposed to be a temporary fix. The plan was to buy large amounts of dollars and halt a rapid rise in the shekel, partly to protect exporters who account for more than 30 percent of economic output and form a strong domestic lobby.

But after purchasing more than $70 billion over the years, the bank is still struggling to soften the exchange rate and prevent Israeli exports from becoming relatively more expensive on world markets.

In the past 12 months, the shekel has gained 6 percent against the dollar , 11 percent against the euro (EURILS=) and 10 percent against a basket of its main trading currencies. This has taken it in recent weeks to a 15-year high versus the euro, a 2-1/2 year peak against the dollar and its strongest level ever against the basket.

With the Israeli economy growing well, some experts and former policymakers say intervention is no longer necessary and may be pointless. Buying dollars amounts to little more than a subsidy for sometimes inefficient exporters, at the expense of the rest of the economy, they argue.

"Few people thought it should be a permanent part of policy," said Barry Topf, who as head of market operations at the central bank in 2008-2011 helped to develop and implement the foreign exchange plan. "The policy has been in place for nine years. It has to be re-evaluated."

The purchases started under former governor Stanley Fischer, now vice chairman of the U.S. Federal Reserve. In principle a staunch opponent of intervention, he accepted its temporary need to stabilize the market after the shekel had leapt.

While Fischer expressed hope at the time that intervention would be used only rarely, Topf said there had been no exit strategy other than to "hope for interest rates in the world to turn higher and that would rectify the situation".

The opposite happened following the global financial crisis. To spur economic growth, many central banks cut borrowing costs sharply and some adopted policies such as negative interest rates and bond purchases to flood the financial system with cash. Often these measures remain in place.

In contrast, Israel's economy largely weathered the crisis and has outperformed much of the West since, culminating in 4 percent growth in 2016. With the benchmark interest rate at 0.1 percent for the past two years - a measure aimed at pushing inflation back up to the government's 1-3 percent target - intervention is the only option to weaken the shekel.

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Bank of Israel Deputy Governor Nadine Baudot-Trajtenberg told Reuters last week that the shekel had become more overvalued and did not reflect economic realities. She noted that when Israel's two percent annual population growth rate is factored in, the rise in per capita income is not much greater than in many Western countries which have static populations.

The bank would continue to intervene "if we think the exchange rate will depress the economy", she added.

Many economists believe buying dollars is futile since the shekel's strength stems from factors that are not expected to go away for some time. They note annual capital inflows of over $10 billion from foreign companies buying Israeli ones. And while Israel runs a modest trade deficit, the broader current account achieved a $12.4 billion surplus last year.

GRAPHIC: Shekel vs dollar and euro http://tmsnrt.rs/29xVm5V

GRAPHIC: Foreign trade openness http://tmsnrt.rs/28IjBh8

FIGHTING THE MARKET

Part of the surplus boost is due to the start of natural gas production in 2013, which reduced energy imports. "If you are importing less petroleum and coal it will put long term pressure on the shekel (to strengthen)," said Bank Leumi chief economist Gil Bufman.

The central bank began a program to offset the impact of natural gas on the currency and has bought more than $10 billion since May 2013 under this scheme.

"I am not sure the way to go is forex intervention because you have enormous pressures for (shekel) appreciation over the long term that are not going to go away," Bufman said. "Are you going to fight the market forever? The market has the ability to beat the central bank."

He and others believe the government needs to take over the reins from the central bank and help business to compete better with a strong currency, starting by reducing red tape.

In the World Bank's 2017 Ease of Doing Business Report, Israel fell to 52nd place from 49th.

At the same time, the government should help manufacturers modernize equipment to become more efficient, offer more job training, allow businesses to write off capital investments for tax purposes in one year, and hook up smaller firms to the natural gas network, economists argue.

Omer Moav, professor of economics at Hebrew University, believes one solution lies in removing barriers on imports such as tariffs and red tape, which would weaken the shekel by bringing in more dollars. That would help exporters as well as lowering prices for the economy. "Why export more than import? Why does that make sense?" he said.

Finance Minister Moshe Kahlon said this week he would not abandon exporters and that Israel needed policies to boost productivity and strengthen local industries.

"Israel's economy (in 2016) ended one of its best years ever and the strengthening of the shekel is a direct result of the strong economic data," Kahlon said.