Bank of Israel Governor Karnit Flug is unfazed by recent warnings from international leaders, including EU ambassador to Israel Lars Faaborg-Andersen, that Israel could face repercussions if the peace process breaks down, noting that the country’s economy has survived previous political storms and this time should be no different.
“The more favorable the outcome of the talks, the better the prospects for the economy,” Flug said at a press conference Sunday morning. “We have had a lot of experience with geopolitical shocks, and our economy has shown great resilience.” Israel’s economy is well-integrated with the other Western economies and is strong enough to survive any financial consequences of the breakdown of peace talks with the Palestinians, she added.
Flug spoke to reporters on the state of the Israeli economy in 2014, covering a range of topics from how the bank dealt with an overvalued shekel with heavy purchases of foreign currency, to positive news about the overpriced Israeli housing market. Flug described an economy that is healthy compared to the US, Europe, and developing countries, to the point that one foreign reporter asked Flug when she thought Israel would join the G-20 group of leading world economies. Flug declined to answer the question.
Israel’s macroeconomic statistics were extremely positive, Flug said. In 2013, Israel’s economy and per capita GDP grew at a rate nearly triple that of other OECD nations, and four times that of the Eurozone countries. Unemployment, at 6.3 percent, is among the lowest in the world, about half that of the European average. Israel has managed to rein in spending: debt to GDP ratio, a key statistic for determining a country’s creditworthiness, is 67.4% for Israel, compared to 110.3% in OECD countries, and 106.4% in the EU.
Among the biggest concerns in Israel is the high value of the shekel relative to other currencies. Against both the dollar and euro, the shekel has increased in value since mid-2011. This has created havoc for Israeli exporters, many of whom complain that the low exchange rate causes their products to be more expensive abroad, making it harder for them to compete.
The bank sympathizes with exporters, and has been employing what tools it has — such as cutting interest rates and buying up dollars — to keep the shekel’s value lower, Flug said. As undesirable as the low exchange rate was, it is a testament to Israel’s economic strength.
“This isn’t the result of speculation,” Flug said. “The shekel’s strength is due to fundamental factors, including a substantial increase in foreign direct investment in Israeli companies and the anticipation of a large international market for Israel’s natural gas deposits.”
The bank can do little beyond buying up dollars to take them off the market and give the shekel “breathing room.” The policy has had some effect, as Flug estimated that without the BOI buying dollars, which has remained constant since 2011, the shekel would have gained even more strength against the dollar — up to 10% more, which would have made exporters’ woes even worse.
The economy could still use some improvement. “From 30,000 feet up, everything looks good, but further down on the ground there are problems,” Flug said. The high cost of housing, the damper on growth from the large haredi and Arab communities who do not participate in the labor market and a lack of investment in education are among the issues.
Study after OECD study shows that Israeli students lag behind in science, math, problem-solving, and more, which Flug finds unacceptable.
“Given demographic trends among Arabs and haredim, it is crucial for the economy to improve integration into labor market and Israeli society,” said Flug. “But I believe this is being done. I have visited centers for vocational education geared toward Arab women, a group that has not participated in great numbers in the economy until now, but is interested in doing so.” There were similar programs for haredi Israelis as well, she said. “They realize they lack the skills and education to help them integrate successfully. I believe they are much more open to the labor market now.”
The high cost of living remains a thorn in the side of middle-class Israelis, who struggle to afford simple apartments, but Flug expressed optimism on the issue. The number of housing starts and completions in 2013 was the highest in over a decade, Flug said, citing BOI statistics. More building, especially in in-demand areas, and the government’s plan to eliminate value-added tax (VAT) charges of 18% for first-time home buyers, were good signs for the market.
“We’ve seen demand for housing stabilize over the past year, and as more homes are built, we will see prices stabilize and even fall,” she said
Lower housing prices, a stable and low rate of inflation, economic growth, more effective tax collection and a reining in of spending all mean that the next report will hopefully be even more glowing, the BOI chief said.