Iran threat may dampen investment here

Israel's economy is strong, but geopolitical risk is concerning.

Trader watches the stocks 311 (photo credit: AP)
Trader watches the stocks 311
(photo credit: AP)
Geopolitical risk, especially increased tensions with Iran, could scare off investors interested in Israeli companies, Citigroup Inc. said in a report released Wednesday.
“Underlying economic fundamentals are strong in Israel, especially relative to other developed markets, but we are concerned by the geopolitical risk,” Citigroup analyst Michael Klahr was quoted as saying in the report titled Assessing Geopolitical Risk and the Investment Case for Israel. “There exists significant geopolitical risk due to an adversarial relationship with the Palestinians, Hizbullah (in Lebanon) and perhaps more worryingly with Iran.”
Citigroup cited the “ongoing conflict with the Palestinians that at times has taken a military turn, most recently in the Gaza offensive in late 2008, and there are the increasing tensions with Iran that have risen markedly since President Ahmadinejad came to office in 2005.”
Ongoing military conflict over the past 18 years has not impeded Israel’s economic growth a great deal, the report said.
The economy grew at an annual rate of 4.2 percent from 1980-2009 and maintained high fiscal credibility and low sovereign risk, it said.
Real GDP growth in Israel since 1960 has averaged 5.5% annually, well ahead of the global GDP rate of 3.5%.
“Non-existential geopolitical risk relates to the conflict with the Palestinians and with Hizbullah (and the PLO before them) in Lebanon, and in our view, does not constitute a threat to Israel’s existence,” Klahr said. “Existential geopolitical risk, such as the 1967 wars with Egypt, Syria and Jordan, and more recently, the threat of conflict with Iran, in our view, were, and could be, a threat to the country’s existence.”
Growth in tourism could have been significantly higher without the backdrop of military conflict over the years and the ongoing struggle with the Palestinians, the report said. Tourism accounts for less than 5% of GDP, far lower than Greece, Spain and Portugal, despite good weather, beaches and an abundance of historical sites.
Defense expenditures were 17% of total government spending in 2007, far higher than other OECD countries, the report said.
“In the absence of military conflict, this is money that could be put to better economic use, in the form of infrastructure, education and other higher return on investment over the long term,” Klahr said. “Nevertheless, Israel’s overall long-term economic record is undeniably a good one in a global context.”
Leading Israeli stocks have averaged returns of 20% annually since 1992, driven by strong GDP growth (4.2%) and declining inflation and interest rates, the report said.
“Israeli equity returns over the past two decades are in line with emerging markets such as Mexico and Hungary and well ahead of developed markets such as the US (+7%), Spain and Portugal (+10%), France (+6%), Germany (+5%), the UK (+4%) and Japan (-2%),” Klahr said. “Difficult to see much evidence of the negative impact of political uncertainty here.”

Citigroup said the Israeli market presented a compelling long-term investment opportunity, but it advised caution in the near term.
“The case of Israel would suggest that under certain conditions, even repeated military conflict over many years can have a relatively limited economic impact,” Klahr said. “However, it is important to stress that the past isn’t always a good guide to the future.
“If Iran really is an existential threat to Israel and there is an outbreak of prolonged hostilities, then that is bad news for the Israeli economy and asset prices, regardless of strong underlying fundamentals and economic policy.”