The Bank of Israel is doing everything it can to temper the appreciation of the shekel, but there’s only so much a central bank can do, Bank of Israel Governor Karnit Flug said last Sunday. Unfortunately it’s not enough for exporters, especially in high-tech, according to Dr. Shlomo Markel.
Markel is a vice president at Broadcom, a US-based multinational that has extensive operations in Israel. Over the past decade, Broadcom bought 11 Israeli companies, and has over 1,000 employees here.
With the company invested in the country, Broadcom is sensitive to the shekel’s strength, Markel said. “Let’s face it, there are plenty of reasons for foreign companies not to locate in Israel. There’s a lot of bureaucracy and Israel is far away from the other centers of technology. The advantage of Israel for multinationals traditionally has been that they could get first-rate talent for a reasonable price.
“But with the strong shekel, Israel loses that advantage,” said Markel. “We are now getting to the level of costs in California.”
For an Israeli company exporting from Israel, the high value of the shekel makes it harder to compete with products from countries with more favorable exchange rates. On the world market, products are priced in dollars or euros, while costs of raw materials and labor for Israeli companies are in shekels. Those costs are fixed, but Israeli exporters must sell their product or service in dollars or euros. When the shekel is high, exporters get fewer shekels for the same amount of foreign currency, squeezing shekel profits.
The situation is more difficult for a multinational. When a foreign company buys an Israeli start-up or opens an Israeli research and development center, they acquire a staff that is paid in shekels. When the company keeps its books in dollars or euros, the fluctuating exchange rate plays havoc with their books, making it difficult to allocate funds for salaries. When the shekel is stronger, the company loses money because it has to pay more in dollars or euros in order to pay the same amount in shekels.
“Israeli has great technology talent, but it’s a global marketplace and there is great talent elsewhere as well,” said Markel. “If Israel prices itself out of the market, tech companies will just go elsewhere for talent.”
In her remarks Sunday, Flug said the bank was doing everything it could to keep the shekel’s value lower, mainly by purchasing massive amounts of dollars, a program started in 2011. Things would have been worse if the bank had not begun that policy, Flug said.
Unfortunately, Markel said, it’s not enough. “The bank only has so many tools at its tools at its disposal, and if the bank can’t keep the shekel’s value lower, it is the responsibility of the government to do so.”
Officially, Flug, the Finance Ministry and the Prime Minister’s Office, are as concerned as Markel at the shekel’s high value. But there is a natural conflict of interest for government, says Markel. Just as a strong shekel makes it harder for foreign companies to do business in Israel, it makes it easier for the government to pay back debt in foreign currency, since it needs fewer shekels to obtain the same number of dollars or euros.
Flug presented charts that showed how Israel was reducing its debt to GDP ratio – meaning that the debt requires fewer local resources to pay off. The charts show large annual reductions in the ratio coinciding with the shekel’s increase in value, both beginning in 2008, when the shekel fell below 3.5 to the dollar for the first time in nearly a decade.
The government must make a choice, Markel said. “High-tech makes up 90 percent of industrial exports, and we have not yet begun to feel the effect of gas exports, which will raise the value of the shekel further. High-tech is an engine that is responsible for much of Israel’s recent prosperity, and it’s in the government’s interest to preserve it.”
Markel has some ideas for legislators. Capital gains, for example, are paid when an individual cashes in an investment, such as stock options issued by tech companies. “When I sell those options, which are denominated in dollars, I have to pay capital gains in shekels on the dollar amount, which means I have to sell dollars to buy shekels, which drives the shekel’s ‘price’ up even further, since more ‘customers’ are chasing the same amount of shekels, like we all learned in Economics 101.”
Instead of collecting capital gains on dollar-denominated profits in shekels, the government can just take them in dollars, said Markel. “They are just going to turn around and use the shekels it gets to buy more dollars, as has been their policy. Why not just cut out the middleman, and lessen the pressure on the shekel in the first place?”
The Bank of Israel should be more aggressive in cutting interest rates, Markel added. “In my opinion, the rate should be zero percent, or at least lower than the rate in the US. A higher interest rate attracts speculators, who buy shekels and drive the currency’s value higher. The lower the interest rate, the less speculators will be interested, and the shekel will drop in value against foreign currency.”
In statements accompanying recent interest rate cuts, the bank stressed that cuts could continue only if they did not prompt inflation. In addition, a lower interest rate traditionally means more interest in the real estate market, translating into higher housing prices in a country where home prices are out of reach for many. Won’t lowering interest rates to zero increase pressure on home prices even further?
Possibly, said Markel, but it was a matter of making choices. “It’s not clear that dropping interest rates lower will lead to more speculation in the real estate market, but even if it does, the Knesset can pass legislation to protect first-time home buyers, as it is doing with its plan to cut the 18% VAT [value-added tax] costs on apartments up to NIS 1.6 million in value.”
Bold decisions need to be made, Markel noted. “Home prices may go up, but if the shekel’s value remains high, I can guarantee you that those prices will fall, because no one will have money to buy homes, as high-tech jobs move out of Israel. That would be a tragedy for Israel, and a shame for the multinationals that have gotten so much value from the Start-Up Nation. But the bottom line is the bottom line.
“As an Israeli, these issues concern me a great deal” Markel said. “As a vice president at a multinational, I see these decisions being made all the time. Something must be done, and soon.”