Booming global markets kept shekel ‘too strong,’ says ex-Bank of Israel deputy head

Weakening of Israeli currency as markets react to Omicron variant shows strong link between shekel and global stocks, says Nadine Baudot-Trajtenberg

Shoshanna Solomon

Shoshanna Solomon was The Times of Israel's Startups and Business reporter

Illustration photo of the new 100 Israeli Shekel bill. December 31, 2017. (Nati Shohat/Flash90)
Illustration photo of the new 100 Israeli Shekel bill. December 31, 2017. (Nati Shohat/Flash90)

Israel’s shekel has been “too strong and under undue pressure” — propped up by the until now booming international stock markets — and a market correction, as we are seeing in recent days, or even a stabilization of global capital markets, will weaken the nation’s currency, which hit a 26-year high earlier this month against the dollar, former Bank of Israel deputy governor Nadine Baudot-Trajtenberg said in an interview with The Times of Israel.

Global markets are reacting with alarm to the spread of the COVID-19 Omicron variant, sending the Dow Jones Industrial Average to its biggest single-day drop of the year on Friday and wiping out November gains for the S&P 500 index.

The shekel saw its representative rate set at NIS 3.0740 to the dollar on November 17, the highest rate since 1995. The shekel weakened against the dollar on Thursday and Friday, and the representative rate was set at NIS 3.1810 to the dollar on November 26, on jitters about the Omicron variant.

Baudot-Trajtenberg said on Sunday: “We have exactly the event that supports this: the markets are going south in light of the new variant and the shekel has indeed weakened. It just goes to show the strong link between the two.”

The currency had been propped up by the global weakness of the greenback, booming global stock markets, and a COVID-induced push toward technologies, which has benefited Israeli tech firms. In addition, large Israeli institutional investors have been hedging their investments in foreign stock markets by selling foreign currency reserves.

The shekel has also been buoyed by the strong fundamentals of the Israeli economy. The nation has a big surplus in the balance of payments current account because its exports exceed imports, mainly due to its strong high-tech industry, which is seeing rapid revenue growth and attracting large amounts of foreign investment.

Former Bank of Israel deputy governor Nadine Baudot-Trajtenberg (Bank of Israel)

This foreign investment increased significantly during the pandemic, as the world increasingly went online and underlined the importance of technologies, leading to record foreign investment in Israeli tech firms, sky-high valuations for both privately held and publicly traded tech firms, and the creation of an unprecedented number of tech unicorns, or private companies valued at over $1 billion.

“The shekel has been strengthening for 10 years and this long-term trend is a reflection of the fact that the Israeli economy is doing well and there are lots of funds coming in,” said Baudot-Trajtenberg.

The big question, she added, is whether at this time “there is an unusual constellation that is temporary, keeping the shekel too far from what we could estimate is an equilibrium level.”

And the answer is yes, she asserted. During the past two years there has been a “disconnect” between the financial markets, the capital markets, and the real economy, she explained, causing global stock markets and especially the US stock market and the tech industry to see sky-high valuations.

One of the reasons for the booming startup economy was because the stock market has been exuberant, said Baudot-Trajtenberg. “If it were not that exuberant then it would not be that easy to raise funds. That has brought a lot of foreign funds to Israel that, in normal stock market behavior, we would not see. We would see some, but we’d not see the amount that we have seen during the past 1.5 years.”

Economists in Israel are forecasting that there will be some $35-$45 billion of foreign investment in Israel this year, largely because of its tech sector.

The other major impact on the currency is the hedging by Israeli institutional investors, she said. These investors are investing large amounts of money in foreign markets, particularly in the US, and are benefiting from the rise in stock market prices there. But because their liabilities are in shekels, they don’t want the share of their assets to be too exposed to foreign currency fluctuations, so when they see the shares rise, they also hedge against this rise. “Hedging means they are buying shekels,” said Baudot-Trajtenberg.

Bank Hapoalim Ltd. estimated last week that institutional investors had sold this year to date some $30 billion worth of dollars to hedge their investments.

A screen above the floor of the New York Stock Exchange shows the closing number for the Dow Jones Industrial Average, Friday, Nov. 26, 2021. The Dow Jones Industrial Average lost 905 points. The S&P 500 index fell 2.3%, its worst day since September and the Nasdaq composite also had its worst drop in two months. (AP/Richard Drew)

The foreign investment and the hedging trends, due to the “exuberance” of the capital market, have been thus putting “undue pressure” on the shekel, Baudot-Trajtenberg said. But both these trends are “unlikely to continue.” Once foreign stock markets stabilize or if there will be a market plunge, “then a lot of this flow will stop coming to Israel.”

Startups will probably continue to get funding, albeit probably to a lesser degree, she said, while institutional investors will no longer need to hedge their investments.

A strong shekel is good for consumers as it makes imports cheaper, keeps inflation low, and lowers the cost of foreign travel. It puts, however, an immense amount of pressure on the local manufacturing industry and exporters, which pay workers, taxes, and other expenses in shekels, but sell their products in dollars.

If a strong shekel persists, said Baudot-Trajtenberg, “some of these industries will have to go.” But if the shekel’s strength is just temporary, she said, then “it is a pity” to let some of these industries die, when some of them in fact could be “sustainable in the longer run.”

Those industries that are worth saving, she explained, can be taken care of either by having the central bank intervene in the foreign currency market to weaken the shekel, or the government needs to set out specific plans for what industries it wants to help.

The central bank intervention in the forex market — buying foreign currency as it has been doing — to weaken the shekel, albeit recently to a lesser degree, “cannot do a massive amount, but it can at least slow down… a further strengthening” of the shekel, which gives time for these industries to adjust to a changed reality, she said.

Israel’s economy has transitioned over the years from being one based on manufacturing to one that is service-oriented, led by the nation’s booming tech sector.

Governor of the Bank of Israel Amir Yaron attends a Finance committee meeting in the Knesset in Jerusalem, June 23, 2021. (Yonatan Sindel/Flash90)

Regarding what industries are worth saving, she said, the government needs to do some “real work” and take into account a number of factors, including the environment.

“Little thought has been put in Israel about the impact on the environment. And we have a very fragile ecosystem… and we don’t have anywhere else to go,” she said. So, when weighing manufacturing industries that should be saved, the government should assess which ones are more environmentally damaging.

“When you ask about what industries you want to support, we should look at these issues in a broader way. And I think that very often we have not used our tax subsidy system sufficiently to nudge the public and industrialists into behavior that from a social point of view would be beneficial.”

Average temperatures in summer could rise by four degrees, a study published in 2020 found. Israel also emits warming greenhouse gases typical of a medium-sized country, a report by State Comptroller Matanyahu Englman said last month.

Israel’s tech sector has helped the nation emerge from the ravages of the coronavirus pandemic, as the industry not only continued working during the pandemic, with employees plugging into their laptops from home, but also thrived, with demand for technologies surging as businesses, homes and schools all turned online during the pandemic, spurring demand for technologies.

Israel’s economy is expected to grow by 7% this year, according to the Bank of Israel, and 5.5% in 2022, after contracting last year because of the pandemic. The inflation rate is also expected to continue to increase this year, but to remain within the Bank of Israel’s target range of 1%-3%. The broad unemployment rate, which surged last year, is expected to continue to decline and reach 5.2% at the end of 2022, the central bank has forecast.

The demand for tech has caused a surge in the valuations of tech firms globally and in Israel, and the nation has seen the flourishing of multi-billion-dollar firms within its shores, which spells change for the face of the Israeli economy in the coming decades, experts have said.

The fate of tech unicorns is never certain, said Baudot-Trajtenberg. These companies could be big only “because they have a very high stock price… They are a unicorn this year, and next year they may be a tenth of the price.”

View of the Tel Aviv Stock Exchange. on November 29, 2020. (Miriam Alster/Flash90)

And yet, she said, if you look at the long-term trend, discounting the ups and downs of the stock market, there is real change underway in Israel’s economy, as both tech unicorns and smaller startups are starting to employ workers with much broader skills, not just computer programmers and cyber experts.

“We are starting to see a stronger trickling down — or trickling out — of that ecosystem which was pretty much closed. It was always the same 10 guys, and particularly guys, by the way,” she said.

This shift emphasizes even more that Israel needs to “urgently” improve the quality of skills for the rest of the population, including Arab Israelis, ultra-Orthodox Jews, and women.

“We did not have inclusive economic growth during the past 20 years,” she said. There is now “potential” for this, she said. “We are starting to see it. There are more people employed, and there are more people of different skills” being drawn into the tech sector. “But if we want this to really be inclusive, there is even more of an urgency to increase the skills, particularly the digital skills, for the rest of the population.”

“As the economy transforms, we must make sure we don’t have just capital to make that transformation, but we have the human capital to make that transformation. And this is not a question of economic forces. This is a question of ideology. And if we do not ideologically understand that we have to put money there, then the transformation will stop.”

Canadian-born Baudot-Trajtenberg has an MA in Philosophy, Politics and Economics from the University of Oxford in England and a PhD in Economics from Harvard University. After leaving her post at the Bank of Israel in 2019, she spent a few months at the Bank of International Settlements, which along with the World Bank and the International Monetary Fund sets out economic policy, and has now joined the faculty of the Tiomkin School of Economics at Reichman University (formerly IDC Herzliya), a private university.

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