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
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.
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
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
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.