Israel’s shekel depreciated 6% in February, suffering the biggest loss among the world’s major currencies after the Russian ruble and the Korean won, amid growing investor concern as the government presses ahead with contested changes aimed at weakening the judicial system.
The currency hit a three-year low last week against the greenback as Israeli lawmakers took a first step to approve a bill that makes up a significant part of the controversial judicial overhaul, to cement government control over judicial appointments and revoke the High Court’s ability to review Basic Laws. The shekel continued to weaken even after the Bank of Israel hiked the benchmark interest rate by 50 basis points to 4.25 percent, the highest level since 2008, in an effort to rein in rising inflation.
“Over the past month, the movements in the local market have been affected by the uncertainty of the economic repercussions of the planned legal shakeup,” Alex Zabezhinsky, chief economist at Meitav investment house, told The Times of Israel. “In the past, the shekel’s performance was characterized by a close correlation with US markets.”
Similarly, the Tel Aviv Stock Exchange noted in its monthly report for February that “trading was characterized by price market declines, continuing a trend seen from the second half of January 2023, due to growing disagreements over the impact of the planned legal reform on the Israeli economy.”
In February, the Tel Aviv Stock Exchange’s benchmark TA-125 index dropped about 5%, while the TA-35 index of blue-chip companies fell about 4% after remaining unchanged in the previous month, according to TASE data. The TA-90 index, which tracks the shares with the highest capitalization not included in the TA-35 index, slumped 9% during the same period, after gaining 1.7% in January. Last month, the MSCI Global Index declined by about 2%.
Daily turnover in the equity market, including ETFs, amounted to NIS 2.3 billion in February, about 28% higher than the turnover in the previous month, and similar to the average turnover in 2022.
In recent weeks, former central bank policymakers and leading economists have continued to warn that checks and balances, and democracy in general, could be at risk if the legislation to change the legal system is fully implemented.
Among investors, concern has grown that the proposals being advanced to curtail the power of the judiciary could negatively impact its credit rating, which in turn would harm the country’s prosperous economy and its currency and trigger an outflow of funds.
A number of local firms and startups have, at the request of their foreign investors, already started to shift money out of local bank accounts to diversify risk and hedge their assets before the planned reforms are set to be approved.
Among the firms are US-Israeli cybersecurity firm Wiz, which this week raised $300 million at a staggering $10 billion valuation. The unicorn’s co-founder Assaf Rappaport said that the firm’s funds will be kept in US accounts, citing uncertainty about independence of institutions in Israel.
Zabezhinsky noted that trading volume data shows that foreign investors, or nonresidents, were very active in Israel’s foreign exchange market in February, which he described as having an “excess weight” in the depreciation of the shekel.
“According to Bank of Israel foreign exchange trading data, the share of nonresidents in trading increased to 65% in February, compared with an average of 60% in 2022,” said Zabezhinsky. “There was a sharp increase in conversion transactions, particularly by foreign investors.”
He noted that “foreign financial institutions sharply increased the number of conversion transactions in shekels,” while among Israeli investors, most of the conversion transactions were performed by non-banking bodies.
Daily trading volume in dollar options in February was about 23% higher than the average volume in 2022, and about 35% higher than the turnover in the previous month, according to TASE data.
“Trading was affected by the volatility of the dollar’s exchange rate relative to the shekel,” the TASE wrote in its monthly report.
The shekel depreciated from NIS 3.475 at the end of January 2023 to about NIS 3.67 against the US dollar toward the end of February, the weakest level since March 2020.
The TASE emphasized that shekel weakness relative to the dollar and the euro pushes the cost of imports up and contributes to price increases in the economy. This is also going to be a concern for the Bank of Israel, which is determined to bring inflation hovering above 5% back into its price stability target range of between 1% to 3%.
“The Bank of Israel is responsible for maintaining its inflation target and for financial stability in the country,” said Zabezhinsky. “In case these are threatened the Bank of Israel will not sit idle on the sidelines.”
The central bank intervenes in the foreign exchange market in order to stabilize the shekel against the basket of currencies when there is high volatility in the exchange rate in order to moderate and calm the market.
In 2020, the Bank of Israel intervened in the foreign exchange market by purchasing US dollars in exchange for shekels, in order to moderate the negative impact of an appreciation of the shekel on inflation and economic activity.
“The Bank of Israel has about $200 billion in foreign exchange reserves and can intervene in the market if necessary, although it will not want to do that, and instead we could see more verbal intervention,” said Zabezhinsky. “Therefore in our assessment, the rapid depreciation of the shekel will not continue for long.”