Gateway to Israel:

A sweet new year: Certainty is just around the corner

Gateway to Israel (photo credit: Courtesy)
Gateway to Israel
(photo credit: Courtesy)
Sincelast year’s apples were dipped into honey, the world of Israeli economic policyhas been in a state of upheaval. Following a dramatic and stormy year, thisRosh Hashana brings with it the promise of greater economic politicalstability
Asfamilies around the country ate honey cake and pomegranates for the start ofthe Jewish new year last September, a crisis over the state budget was alreadybrewing, one that would fell the government and lead to new elections withinless than a month.
Insteadof hitting the 2 percent of GDP deficit target, the government’s overspendinghovered at around 3%, necessitating tax increases and budget cuts. By January,the final deficit figures grew to 4.2%, the result of overly-optimistic revenueestimates made two years earlier, when the two-year budget for 2011-2012passed. In the election battle, Labor leader Shelly Yacimovich called thedeficit “monstrous,” and up-and-comer Yair Lapid demanded that the governmentstop using the middle class as an “ATM” to fill its budgetary needs.
Followingelections, the new government’s first order of business was to attend to thebudget; failure to pass one would trigger yet another round of elections. Yetby the time Lapid (a self-proclaimed economic novice) was appointed FinanceMinister, drafted the budget proposal, put it to a vote in the cabinet, pushedit through the finance committee and finally passed in the Knesset, it wasnearly August. In the middle of it all, S&P downgraded Israel’s creditrating from AA- to A+.
In itsfinal form, the budget declared 2013 a lost cause, setting the deficit targetto 4.65%, but put a plan in place to bring it down to 3% the following year. Todo so, Lapid had to pass several unpopular measures: raising Value Added Tax,increasing income taxes for the second year in a row, pushing forward highercorporate taxes, and scaling back a slew of welfare benefits. Notably, benefitsaimed at Ultra-Orthodox families were slashed and redefined as part of aneffort to push one of the poorest segments of the population into the laborforce.
As if theuncertainty surrounding the budget were not enough, just days after theelection, well-respected Bank of Israel Governor Stanley Fischer announced hewould be stepping down in June. Although reforms Fischer initiated toprofessionalize the Bank, such as installing a 6-person committee to makeinterest rate decisions, would lead to a smoother transition, Prime MinisterBinyamin Netanyahu and Lapid failed to nominate anyone during Fischer’s finalfive months.
Eventually,the two chose Jacob Frenkel, who had run the Bank from 1991-2000, during whichhe helped tame Israel’s overly-robust inflation. While Fischer had utilized anumber of policy tools to try and attack the various issues affecting Israel’seconomy--keeping inflation moderate, reducing inequality, keep the housingmarket in check, and moderating the shekel’s strengthening--Frenkel was seen asmore of an inflation hawk. Analysts wondered if he would have the adaptabilityto deal with the wider set of issues facing Israel, and whether he was willingto intervene in markets the same way Fischer was.
It turnedout to be a moot question; a scandal over alleged shoplifting in a Hong Kongairport, which Frenkel vehemently denied, led him to withdraw his candidacy amonth after his nomination. Perhaps fearing similar public scrutiny, the secondnominee, Bank HaPoalim chief economist Leo Leiderman, withdrew his nominationafter just two days.
Amid thebrouhaha, an upheaval was also underway at the Tel Aviv Stock Exchange. Boththe director and the chairman announced their resignations amid clashes withthe Israel Securities Authority. Replacements have yet to be named.
Yet afterall the tumult, a period of remarkable uncertainty in Israeli fiscal andmonetary policy is drawing to a close, paving the way for smoother sailing inthe new year. The budget for the rest of 2013 and all of 2014 is fully laidout, and a new BOI governor is expected to taking the helm of Israel’s monetarypolicy by the time the “chagim” are over.
Thequestions going forward will instead focus on how successfully the governmentwill implement market reforms--such as building new ports, breaking up bigconglomerates, and tackling the inflated price of housing--and whether it willstumble on policies governing Israel’s newfound natural gas and otherresources.

Thepost-Social Protest era?
In thepast year, the start-up nation continued doing what it does best, with severalmajor exits. Google, IBM, and Berkshire Hathaway all made major investments inIsraeli companies (Waze, Trusteer, and Iscar, respectively), while theintroduction of natural gas was expected to add a full percentage point to thecountry’s GDP growth.
Acombination of continued global economic flailing and internal regulatoryconflict, however, hampered Israel’s markets, which limped along. Tradingvolume dropped to its lowest level in eight years, less than a quarter of its2010 levels.
“It’s nota recession. We’re still growing, but far less,” says Bank HaPoalim’s head ofequity research.Yaron Fridman. “Unquestionably, it’ll revitalize. The questionis when.”
Interestingly,it was not the biggest companies pushing the growth. Breaking down the 8.86%growth in the TA-100, the index of the top 100 companies, the index thatexcludes the top 25 companies grew 26.19%. The TA Midcap-50, which includes thefirst 50 companies smaller than those on the TA-100, soared by 46.51%.
Many ofthe big companies that had tough times were influenced by outside events: Drugmanufacturer Teva lost a patent dispute on its drug copaxone in the UnitedStates, while the Israel Chemical Corporation suffered losses when a tiffbetween major foreign potash dealers sent the price of the chemical plummeting.
Companiesadjusting from the changes brought about from 2011’s social protests, whichcoincided with an increase in Israeli consumer’s sensitivity to price, surgedback to life this year. For example, popular reforms to the telecommunicationscompanies, which sent the prices of mobile phone subscriptions plummeting, ledcompanies to lose up to half their value amid new competition.
“Thisyear was the recovery from the social protests. These companies, at the end ofthe day, still have value. At a certain point the market understood that,” saysFridman . Because the big telecommunication companies still provide theinfrastructure, they continued to get income. Chains like Shufersal, asupermarket, also figured out that lowering their prices could keep theircustomers coming back. Real estate, services and the financial sector alsoposted healthy gains.
Withuncertainty affecting specific companies and sectors but an overall positivetrend, says Fridman, investors should look for a diverse portfolio. “Instead ofstock picking, this is the time for indexes,” he says. “There is a feeling thatwe’ll see a big improvement because we’re coming from a weak place.”
Theopposite is true of the bond market, says Ilan Buchbut, who heads BankHapoalim’s Fixed Income desk. “We’ve seen an increase investors’ appetite forrisk, with a trend of money moving to riskier bonds,” he says.
“Unlikethe diversified equity portfolio, many bond-holders are not taking enough riskinto account, so you should really be picking specific bonds. The indexes aresolid, but it’s better to pick them.”
Lookingto the future, after a year in which recession continued to plague Europe andpolitical dysfunction somewhat hobbled the United States recovery, globaleconomic trends are at last taking an upward turn. For Israel’s economy, thatis sweet news for a new year.