Emerging

Strong shekel creates monetary policy challenge

st  
17  
EcoEmerging// 1 quarter 2020  
economic-research.bnpparibas.com  
Israel  
Strong shekel creates monetary policy challenge  
Economic growth was still robust in 2019 despite a less favourable local and international environment. Healthy external  
performances fuelled a significant upturn in the shekel, which in turn curbed inflationary pressures. The start-up of natural gas  
exports in 2020 should support this trend. Under this environment, the central bank has few policy instruments available. It resumed  
currency market interventions to try to curb the shekel’s appreciation. After the budget overruns of 2019, however, we do not expect  
public finances to improve significantly given the high level of political uncertainty.  
Robust economic growth  
1-Forecasts  
Despite an uncertain political situation locally and a less favourable  
economic environment internationally, GDP growth remained strong  
in 2019. According to the first official estimates, growth was 3.3% in  
real terms, which is practically the same level as in 2018 (3.4%).  
Household consumption and public expenditure were the main  
growth engines.  
2018e 2019e 2020e 2021e  
Real GDP growth (%)  
3.4  
3.3  
2.9  
3.2  
Inflation (CPI, year average, %)  
Cent. Gov. balance / GDP (%)  
Cent. Gov. debt / GDP (%)  
0.8  
0.9  
1.0  
1.2  
-2.8  
-3.6  
-3.5  
-3.0  
59  
62  
64  
65  
Current account balance / GDP (%)  
External debt / GDP (%)  
2.7  
2.2  
3.1  
3.0  
Two factors bolstered household purchasing power: the  
unemployment rate has fallen below 4% since July 2019, while real  
wage growth is still positive (+2.7% in October 2019) thanks to  
persistently low consumer price inflation (0.9% on average in the  
first 11 months of 2019). Public expenditure continued to increase at  
a regular pace (+4.1% in 2019). In contrast, investment barely grew  
in 2019 (+0.3%) due to a slump in productive investment, while  
housing investment continued going strong.  
25  
25  
26  
25  
Forex reserves (USD bn)  
115  
126  
145  
155  
Forex reserves, in months of imports  
Exchange rate USDILS (year end)  
13  
12  
13  
13  
3.7  
3.5  
3.3  
3.2  
e: BNP Paribas Group Economic Research estimates and forecasts  
2
- Contributions to real GDP growth  
GDP, yoy %, and contributions in percentage points  
Real GDP  Private consumption  Government consumption  
Investment  Net exports  
In 2020, GDP growth is expected to slow slightly, falling below 3%,  
due to the expected slowdown in the global economy and the  
constraints curbing public spending, at least in the first part of the  
year. Moreover, once a new government is formed, general budget  
policy trends are likely to increase fiscal pressure to reduce the  
deficit. This could have a mild impact on household consumption.  
6
4
2
0
2
4
From a sector perspective, new developments in the natural gas  
sector should boost growth. Production started up at the Leviathan  
offshore gas field in late 2019. According to the central bank, its  
contribution to GDP growth is estimated at 0.3% in 2020. Since  
most of the local demand for natural gas is covered by the Tamar  
offshore gas field, Leviathan’s production will be geared mainly  
towards exports to Egypt and Jordan. Production should be ramped  
up regularly through 2022.  
-
-
2012  
2013  
2014  
2015  
2016  
2017  
2018 2019e  
Low inflation  
Source: BoI, BNP Paribas  
Despite quasi-full employment, consumer price inflation is still low  
and is expected to average 0.9% in 2019. Prices of tradeable goods  
are expected to be virtually flat on average in 2019 (+0.11% during  
the first 11 months of 2019), while prices of non-tradeable goods  
rose an average of 1.2% over the same period. Mild inflation can be  
attributed to lower oil prices, the shekel’s appreciation against the  
currencies of its main trading partners (the nominal effective  
exchange rate rose 8.3% in 2019), and the steady deregulation of  
the economy in general. In 2020, consumer price inflation could  
increase slightly, thanks to a mild increase in oil prices, while  
holding near the lower end of the Bank of Israel’s target range (1%-  
3
%). Looking beyond cyclical factors, for the moment it is hard to  
discern what might trigger higher inflation in the short term. The  
expected improvement in the external accounts should bolster the  
shekel, while significant public finance overruns (via a sharp  
increase in current spending, for example) seem unlikely.  
The shekel continues to look bullish  
Israel has reported an almost structural current account surplus  
thanks to ongoing increases in exports of services, buoyed by the  
high tech sector, and tourism, albeit to a lesser extent. The service  
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18  
EcoEmerging// 1 quarter 2020  
economic-research.bnpparibas.com  
sector surplus should offset the trade deficit. In 2019, we estimate  
the current account surplus at 2.2% of GDP (down from 2.7% in  
3-Bank of Israel foreign exchange assets  
2
018). In the short term, the trade deficit could narrow thanks to  
USD bn  
Foreign exchange reserves (lhs) BoI purchase of foreign currency (rhs)  
higher natural gas exports. Even so, this impact should remain  
relatively small since gas exports represent only 1.6% of total  
exports of goods.  
1
1
1
40  
20  
00  
5
4
3
2
1
0
The Israeli market is still highly attractive for non-resident investors,  
especially in high technology. Foreign direct investment (FDI) in  
Israel amounted to more than 5% of GDP in 2017 and 2018, and is  
expected to remain strong in the medium term. Portfolio investment  
flows are more volatile and harder to predict. As of April 2020,  
8
6
4
2
0
0
0
0
0
1
domestic sovereign bonds will be incorporated in the WGBI , which  
should have a positive impact on capital inflows. All in all, the  
balance of payments surplus is likely to be maintained, fuelling the  
shekel’s appreciation. Although portfolio flows risk making the  
shekel fluctuate more erratically in the short term, several factors  
are likely to facilitate the appreciation of the Israeli currency: a  
narrower spread between the Bank of Israel’s key rate and the US  
Fed funds rate, ongoing monetary easing in the eurozone, and the  
US dollar’s downward slide against the main OECD currencies.  
Consequently, structural and short term factors both seem to be  
working to drive up the shekel.  
2016  
2017  
2018  
2019  
Sources: BoI, BNP Paribas  
2
020 elections, the finance bill cannot be adopted and a system of  
provisional twelfths must be set up. Given the high political  
uncertainty and renewed regional tensions, a significant reduction in  
the deficit seems unlikely. Our scenario calls for the deficit to level  
off at 3.5% of GDP this year. Under these conditions, government  
debt should increase to about 64% of GDP in 2020. Most of the  
deficit is financed locally. About 85% of the total debt is local, and  
about two thirds is owned by institutional investors.  
Monetary policy  
As in previous years, the inflation rate is still fluctuating outside of  
the Bank of Israel’s target range. The central bank must decide  
whether to take measures that would let inflation rise towards the  
middle of its target range, without jeopardising the economy’s  
dynamic momentum. According to the OECD, the output gap was  
slightly positive in 2019 (+0.4% higher than the potential growth  
rate).  
The Bank of Israel has maintained its key rate at 0.25% since  
November 2018. The central bank barely intervened in the foreign  
2
exchange market in the first 10 months of the year . Whereas  
monthly purchases averaged more than USD 500 m between 2013  
and 2017, they amounted to only USD 277 m in 2018 and USD 40  
m in the first 10 months of 2019. Given the significant appreciation  
of the shekel during this period and its impact on domestic prices,  
the Bank of Israel began making currency purchases again in  
November and December 2019 (USD 1.3 bn and USD 2.3 bn,  
respectively). To neutralise the impact of these currency purchases  
on money supply growth, the central bank uses open market  
operations and the time deposits of the commercial banks with the  
BoI. These forex market interventions are expected to continue this  
year to ease some of the upward pressure on the shekel.  
Budget uncertainty  
The 2019 fiscal year was marked by a notable surge in the public  
deficit to 3.6% of GDP, from 2.8% in 2018. According to government  
estimates, revenues increased by 2.5% while public expenditure  
rose by 5.9%. In the absence of a government before the March  
1
World Government Bond Index  
The Bank of Israel set up a currency purchasing programme in 2013 to reduce  
2
the impact of natural gas production on the shekel via the trade balance.  
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