Internal macro stability vs external vulnerability

Despite recent positive signs, there are still economic risks that may threaten economy in short run.

arie tal 88 (photo credit: )
arie tal 88
(photo credit: )
Recent published economic parameters indicate that the Israeli economy is on a path toward stabilization. However, there are still some economic risks that may threaten the domestic economy in the short run, and have an impact in the medium-long run. The Risks Still Exist: The major risk in the short run is the decrease in demand for Israeli goods and services (mainly technology) and the existing probability of a systemic risk, mainly from the United States and from the European Union. The other risks include rising unemployment, sooner than expected interest rate hikes, and future tax increases due to the rising of budget deficit. These risks support the view that the recovery will not be a V-Shaped. There are two high-probability scenarios: the first one is a W-Shaped recovery. This means that the period of recovery and expansion will be relatively short lived - unlike in a normal business cycle that normally lasts more than 40 months. The second scenario is prolonged and anemic recovery that will be followed by at least 2-3 years of feeble economic growth. Leading Indicators Rise, Led by Private Consumption and Export: Since the beginning of 2009, there are increasing signs that the recession's trough is behind us, and we are heading toward a recovery. The Israeli investors received a "ratification" that the domestic economy is financially stable after the credit rating company Standard & Poor's kept Israel's A-Stable rating. Also, domestic indicators such as private consumption, housing sales, and various fields of industrial production suggest that some industries stabilized in the second quarter. Moreover, the leading indicators index rose by 0.2 percent in June 2009 - the first increase since July 2008. The rise in June was due to an increase in exports. This is a good indicator since the export sector is the most important growth-engine of the Israeli economy. However, does it really signify a turning point? Despite the encouraging signs, investors cannot ignore the fact that the risks still exist and most likely will have implications in the medium-long term. First, the international trade sector remained very vulnerable. Second, there is still high uncertainty regarding the future developments abroad of the financial and credit market. Since the Israeli economy have a high dependency on demand from abroad, any major external shock will have a great effect on the economy. What about the Internal Problem? Even though the consumption sector shows signs of stability, there are internal risks that will most likely hurt consumers in the medium term. First, companies continue to cut operational costs and fire workers. The unemployment rate increased in May to 8.4% - the highest rate in the last 3 years, and it is expected to rise to 9% by the end of this year. The implications will be a reduction of total demand and a decrease in government's revenue from taxes, which will push government deficit further up. The government will have to increase taxes again in 2010 in order to decrease its deficit. In addition, if inflation will remain high the bank of Israel (BOI) will raise interest rate and/or reduce money supply to control inflation. According to the Makam Market (Zero-coupon notes), BOI is expected to start raising rates by the end of the year. Weak labor sector, tax increases and raising interest rates will have a negative effect on consumers and the business sector, including on housing. These factors might lead to a second phase of contraction already in 2011-2012 or to a long period of anemic growth rate, which will have a negative effect on the stock market as well. The writer is Chief Analyst and Strategist at Alumot-Sprint Investment House and also a regular writer for several leading financial papers and Web sites