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The past two decades of liberalization in the financial account helped open up the Israeli economy, expand the country's financial account, and improve the economy's financial status, according to a study released Wednesday by the Bank of Israel.
"Prior to liberalization, the main concern... was that local saving would be transferred abroad. However, this has not, so far, taken place due to high local returns on investment, home bias, and tax discrimination that has been abolished only recently," the study's authors said.
Nonetheless, liberalization did lead to higher total capital outflows - particularly by the Israeli business sector which, they said, "achieved a new level."
The study's authors also found that the growing involvement of non-residents in Israeli capital markets helped make the markets more efficient and enabled the economy to exploit the advantages of globalization and successfully integrate into international markets.
The significant growth in non-resident activity in the Israeli economy - which accelerated in 1993, 1997 to 2000, and 2003 and reached an unprecedented high level in 2004 - "appears to be related mainly to the economic situation in Israel and in worldwide capital markets," the study said.
The liberalization process likely provided further encouragement for the capital inflows, indirectly supporting processes resulting from geopolitical developments, globalization, the development of Israeli high-tech, and a concurrent trend of investment in emerging markets.
Despite capital inflows, exchange rate volatility did not increase and is still considerably lower than in Western and other emerging economies. Allowing the exchange rate to float increased awareness of foreign exchange risk, leading the business sector to increase use of hedging instruments. Israeli households, in contrast, remain largely exposed to exchange rate fluctuations.
The study found that although liberalization increases the economy's exposure to shocks, it compels business and financial sectors to cope with risks and requires policymakers to conduct a disciplined macro-economic policy to "withstand the constant test of the markets."
The financial account includes government assets, private assets held abroad, local assets held by foreigners, real estate, stocks, and bonds.
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