The new Israeli shekel for the most part has been a relatively stable currency over the last decade. The economy rebounded from an economic slowdown that began in 1997 lasting until mid 1999 when real GDP growth surged by 5.5 percent. However, the fallout of the Russian financial crisis and other global economic hotspots including Asia during 1997-98 led to an exchange rate shock and devaluation of the shekel in late 1998. During December 2001, the Bank of Israel (BOI) cut interest rates by 2 percentage points thus resulting in a quick responsive 20 percent depreciation versus a currency basket for the shekel. Similar to many other countries in 2001-02, Israel has been greatly impacted by the slowdown in the global economy coupled with increased domestic security concerns. Volatility both in the shekels value and in Israeli interest rates was the story in 2002. In 2003, even with the heightened state of security with frequent suicide bombing attacks, the shekel has held remarkably steady against both the Euroland euro and the US-dollar (‘USD’).
POLITICS: Israeli Prime Minister Ariel Sharon since March 7, 2001 of the Likud Party - right leaning. Israel is a multi-party democracy, opposition is the Labour party. The State of Israel was established in 1948, national security and its existence remains politically its number one issue. The conflict with Palestinians has brought terror to Israeli citizens. In fact, more Israeli citizens die in traffic accidents each year than by the violence resulting from bombings, etc. An American poll conducted by Newsweek in 2002 suggested that only 34 percent of Israeli adults thought Israel would remain a Jewish state in 50 years time. At present, Israeli-Arabs consist of 20 percent of Israel’s population coupled with the fact that they have a much higher birth rate than Jewish Israelis. Over the long term, Jewish Israelis may indeed be the minority.
ECONOMY: advanced diversified market economy that is integrated into the global economy with a large component of government participation. Currently, the Israeli economy is in a mild technical depression with mixed economic conditions. The domestic economy has contracted over the last 2 years, its worst economic recession since inception as a nation. Strong real GDP growth during most of the 1990’s resulted in a great rise in Israeli living standards (until 1997 when GDP growth fell by 2 percent) of which this economic growth was partly derived from a massive influx of 800,000 Jewish immigrants from Russia 1989-97. However, by year 2001, the Israeli economy has fallen into recession with declining exports and investment levels attributed to the technology burst, dramatic collapse in tourism visits and the revival of Palestinian uprisings. In year 2002, the economic performance was one of the world’s worst as the economy contracted and domestic consumption fell 2.5 percent.
The economy has diversified into hi-tech, biotechnology and e-commerce/knowledge based industries. It is this hi-tech area of the economy is blossoming with Isreal home to now over 100 Israeli technology companies listed on the NASDAQ stock exchange in the United States with market capitalization in the hundreds of billions USD. As well, the economy is diversifying into other industries (ie. casinos - gambling) since natural resources are scarce and limited. Tourism arrivals for year 2001 are down 50 percent due to increased violence. Industries include cut diamonds, defense contractors, high-technology products, biotechnology, medical, aviation, computers, large infrastructure projects, large public sector including banks and power (ie. electrical), etc. Imports for Israel include rough diamonds, military hardware, oil, grain and consumer goods. Persistent current account deficits have been offset by transfer payments and foreign loans as the United States has been a large source of economic aid including miltary hardware shipments. Since the 1973 accord, the United States provides Israel with $3 billion USD/year in aid of which $2.2 billion USD is directed towards U.S. military hardware and $800 million USD as a financial grant.
As the Palestinian-Israeli conflict has intensified over the last three years when the Palestinian intifada started in September 2000, the Israeli economy is becoming more isolated. It is estimated that the conflict is costing Israel upwards of $1 billion USD/year in loss economic output from lower tourism arrivals, lower construction starts and declining agricultural output. If this conflict can be solved, peace would result in an economic boom for Israel and a stronger shekel. For comparison, Palestinians living in the West Bank and Gaza, unemployment & poverty is at over 50 percent reflecting a huge disparity in wealth to Israel. A worsening humanitarian situation is well underway as Palestinian total GDP is at only $3 billion USD.
Economic Statistics
GDP (2002) as measured by purchasing power parity is at $122 billion USD with corresponding GDP/Capita at $20,000 USD. As measured by market prices, GDP is at $98 billion USD with GDP/Capita valued at $15,900 USD (2002). GDP growth for year 2000 at 6.4 percent, year 2001 declined 1 percent and 2002 recorded a contraction of 1.1 percent and year 2003 to remain flat to negative 0.5 percent growth. Relatively low inflation with year 1998 at 8.6 percent, 1999 at 1.3 percent, 2000 at zero, 2001 at 1.4 percent, 2002 at 6.5 percent. The trade deficit for year 2002 came in at $2.7 billion USD. Current account deficit is forecasted at a 2 percent shortfall for year 2003, year 2002 deficit at 2.1 percent of GDP, 2001 at 1.7 percent shortfall, 2000 at 1.7 percent, 1999 at negative 3.2 percent.Year 2000 was a record for foreign direct investment (FDI) recorded at $4.3 billion USD. Fiscal 2003 budget deficit projected as high as 5 percent of GDP after year 2002 recorded a shortfall of 4 percent. Gross external debt is at over 60 percent of GDP although net external debt is low. Year-end 2002 debt/GDP was measured at 104 percent due to the high public debt levels as it is estimated that 50 percent of the Israeli economy is in public hands. Unemployment for year 2002 is at 10.4 percent. Services represent 67 percent of the economy. Remittances from Israeli citizens abroad are worth $300 million USD/year.
POSITIVE: life expectancy average is 79 years, high literacy rates, modern telecommunication system, offshore natural gas energy resource potential, free trade agreement with the United States, plans underway for a government bond market, many Israeli companies abroad are doing well with head offices based in Israel. CONCERN: security issues, environmental, few natural resources, tax increases to cover conflict with Palestinians, Israel depends on Palestinian cheap labor.
BANKING SYSTEM: official reserve assets held at the central bank as of September 2003 were measured at $25.2 billion USD. Higher loan losses have taken place over the last difficult three years. October 2003 interest rates are at 6.1 percent well down from December 2002 at 9.1 percent when rates were raised in June 2002 to combat higher inflation and a weaker shekel at that time.
REGIONAL ANALYSIS: Egypt, Jordan, Syria, Lebanon
At present, Israel holds military superiority in the region. If the region could secure long-term peace, an unprecedented economic boom would result to the benefit of everyone. It is unlikely a violent confrontation between Israel-Egypt will return as Egypt would lose their U.S. annual economic subsidy. More recently, on October 5, 2003, Israel bombed terrorist training camps in Syria, its first strike on Syrian soil since 1973. This attack is inflaming Palestinians and other Arab countries. The risk for a wider Middle East war and conflict is increasing? The risk is prevalent. Another unthinkable risk is the possibility of deposed Iraqi mass weapons program with smuggled weapons being moved to Syria along with key Iraqi engineers and their program knowledge. In Lebanon, the militant Islamic geurilla group Hezbollah ‘Party of God’ is always a threat as its stated goal is for the destruction of Israel along with an Islamic revolution for Lebanon. It should also be stated that Israel’s military pulled out of southern Lebanon in May 2000.
KNOWLEDGE: issue of security and existence as a nation for Israel as it is surrounded by Arab countries who have had a long violent history with Israel. Today, Israel is in an era of unconventional warfare after the Yom Kippur war ended in October 1973. Suicide bombings are a validation of the Palestinian Authority national movement designed to make life intolerable for Israel to force it to the bargaining table to make political compromises as it has done so in the past by giving up land for security. Peace in Middle East will begin with a democratic independent Palestine under new leadership with the removal of Yasser Arafat, it is difficult to make peace with dictatorships.
The problem for Israel is that in the Islamic world Israel is viewed as a staunch ally of the United States. Will the United States bring peace to the Middle East now that Iraq has been disarmed with a close eye now on political stability within Saudi Arabia. In the long term, BI.C believes this is a positive development with United States presence, but the short term will remain dicey. As reported in the Los Angeles Times on October 12, 2003, Israel has cruise missile capability to deliver nuclear strike capability from submarines in the Mediterranean Sea, land based systems and air with the use of F-16 fighter jets. It is suggested that Israel holds up to 200 nuclear weapons and is currently the only nuclear power in the Middle East. Security is Israel’s number one issue as survival as an entity is paramount now considering that Iran is reporting to be in the process of developing its own nuclear warhead program motivated by Israel’s offensive capability. Israel is within striking distance of Iran, Israel maintains its portfolio of weapons strictly as a deterrent.
CURRENCY: ISO Symbol ‘ILS’, new Israeli Shekel, Israeli New Shekels, sheqel. At time of review on October 12, 2003, the shekel had an exchange value of 4.419 ILS to 1 USD. Surprisingly, the resilient new Israeli shekel is up 7 percent year to date for 2003. During June 2002, the record low for the shekel came as the currency almost fell below 5 ILS to the USD only after when Israeli interest rates were raised to support the shekel.When compared to the euro (‘EUR’), the shekel has stayed in a tight trading range during year 2003 trading in a range from 4.91 to 5.24 ILS to 1 EUR. Floating exchange rate regime with inflation targeting since 1992. The shekel is fully convertible as all capital controls have been removed.
CURRENCY HISTORY: the shekel has peformed relatively well over the last few years. Historical valuations include the average exchange in 1994 valued at 3.01 ILS to 1 USD, November 1995 at 3.067, December 1996 at 3.27, January 1997 at 3.27, January 1998 at 3.57, January 1999 at 4.08, October 1999 at 4.27, September 2001 at 4.337, June 2002 at 4.935, February 2003 at 4.86, June 2003 at 4.38. Currency crisis dates include March 1991.
CURRENCY FORECAST: the continued violence will be a concern to investors as lower FDI levels may prevail. Expect the shekel to stay under the risk of further downside pressure against the EUR as the downside risk remains greater than the upside as no foreseeable Middle East peace agreement seems to be attainable in the near term. Macroeconomic variables are also being hampered by a mixed global economic performance and conflict risk as the domestic Israeli economy continues to deteriorate. Falling tax revenues may push the fiscal deficit to 5 percent of GDP. On the plus side, the shekel is strongly supported with large foreign exchange reserves as they adequately cover short-term liabilities and healthy capital account surpluses from FDI, grants, foreign aid and remittances.
UPDATED: October 12, 2003.
