Commentary: Fischer's tough call

By NITZAN COHEN
September 13, 2009 14:59
4 minute read.
The Bank of Israel.

The Bank of Israel.. (photo credit: Ariel Jerozolimksi)

Among last week's horrible news, one positive headline was a source for optimism: "The recession is over," the newspapers screamed, after the Central Bureau of Statistics reported that gross domestic product had grown 1 percent in the second quarter of 2009.


Putting aside the academic debates about the formal definition of a recession, not many of us were surprised by the positive reports; in the last few months you could see filled shopping malls, hotels with no vacancies, and crowded restaurants and bars.



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On the other hand, the labor market is still fragile, even though a mild improvement was recorded in past two months. Business firms' profitability is shrinking, especially in the export sector, and businesses are still busy cutting expenses.



The Israeli economy has so far been very lucky compared to other countries, but the basic threat is still there. Being an exports-driven economy, with a significant financial segment in the general service sector, the local economy is very vulnerable to negative developments in its prime export markets - the US and the EU - and to financial turmoil in global markets.



The major role of the export sector in the nation's production and labor market is the reason behind the massive intervention of the Bank of Israel in foreign exchange markets over the last 18 months. Exporters were hit by a double blow: demand from their target markets fell sharply, and the wild appreciation of the shekel threatened to ruin them.



Bank of Israel Governor Stanley Fischer decided to help the beleaguered firms the only way he could, by buying dollars in the open market until the reserves reached a record $52 billion. But this action had its costs.





The dollars were bought by the extensive printing of shekels, which stimulates inflation. Combined with the sudden recovery in domestic demand in the second quarter, Fischer's intervention contributed to an inflation rate of more than 3% since the beginning of the year, way beyond the inflation target the government had set for the central bank.



Since price stability is the real raison d'être of the central bank, Fischer last week declared he was eliminating the daily $100 million purchase plan, only a few days after he briefly increased this dose to $500m. From now on, he said, the bank would buy dollars in a sporadic way according to "special market developments."



The market reacted, as expected, with a sharp fall toward a shekel-dollar rate of NIS 3.75, but then recovered a little bit after the first punch of this "sporadic action" last Tuesday.



The bottom line is that Fischer's life has become much more difficult. Growing inflation, together with a real-estate market that is starting to show signs of a bubble, should necessitate an immediate increase in interest rates. But this might slow down rising prices, and it would also hamper growth and put pressure on businesses through added expenses.



Foreign-exchange markets would be a disaster. The interest rate on the dollar is expected to stay at a zero for a long time, so raising the rates here would almost certainly draw hungry herds of speculators trying to take advantage of the interest gap, and the dollar would collapse under the pressure of foreign capital inflows.



The central bank no longer can help exporters, but the Treasury can. Our finance minister should stop running from one television studio to another and start using his special prerogatives to alter tax regulations and issue a 35% tax on short-term capital inflows from overseas.



But even such an extreme measure can only soften the blow. If the dollar drops in global forex markets, it will continue to decline here as well. The likelihood of NIS 3 shekels to the dollar is very high, and it's about time everyone starts realizing that.



Considering the mighty forces hastening this new grim reality, the Treasury's role becomes even more important. Instead of trying to look for solutions in forex markets, it can do a lot to help exporters and the entire business sector. The best thing it can do is to lower the heavy tax burden on employers' shoulders.



By eliminating the most unjust tax of them all - the "employers tax," which fines people for supplying jobs to others - and by decreasing the employer's payments to "revenue department B," also known by its deceptive name, the National Insurance Institute, the government can keep businesses from going under, while at the same time boosting the weak labor market. The gap in the state's budget from reducing those taxes can be filled with revenues from the tax on short-term speculation, as suggested above.



At the same time, exporters must learn to live without the central bank's forex protection and should focus on developing new clientele in the fast-growing markets of East Asia. If all these measures will be taken, the Israeli economy could eventually benefit from this severe crisis and emerge from it stronger than ever.




More about:Stanley Fischer


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