Israel & The Global Economic Crisis

Israel is not immune from the global economic crisis set off by the U.S. banking and real estate debacle, but Israel’s economy has fared better thus far than other developed economies. Stock market and real estate prices are down, but they haven’t crashed like they have elsewhere. Israel’s banks also appear to be sound.

Though its future is far from secure, Israel’s high concentration of high-tech companies, proactive government initiatives, and lessons learned from the dot-com era may enable it to emerge relatively unscathed from the global economic recession.

Economic Indicators

The global economic crisis has impacted Israel mainly via the decline in its growth rate, which dropped from 5.7 percent in 2007 to 1.8 percent in the second half of 2008, and then to -.5 percent in the first quarter of 2009. Similarly, export growth contracted from 8.6 percent in 2007 to -44.8 percent in the first quarter of 2009, while import growth dropped about 9 percent in 2008. Other indications of economic malaise include a decrease in public savings due to continued losses in the equity markets, and tight credit markets.

Foreign direct investment in Israel has fared much better than trade, and did not suffer from the year-end economic downturn. Indeed, foreign direct investment in 2008 totaled $10.5 billion, up $500 million from 2007. Israeli high-tech companies raised $2.08 billion from local and foreign venture investors, 18 percent above the $1.76 billion raised in 2007.

However, in the fourth quarter, 109 Israeli high-tech companies raised $394 million. This was 22 percent below the $503 million raised in the fourth quarter of 2007, and 34 percent below the $600 million raised in the previous quarter.

Overall economic growth is expected to slow in Israel as a result of the worldwide recession. The Bank of Israel initially estimated a 1.5 percent growth rate for 2009, down from an average growth rate of 5 percent. Merrill Lynch & Co. is even more pessimistic, expecting zero growth this year, citing Israel’s exposure to the growing global recession. Indeed, with 70 percent of Israeli exports to the U.S. and Europe, and with Israeli exports to the U.S. accounting for almost 17 percent of Israeli GDP, it seems inevitable that Israel’s economy will feel the delayed effects of the economic downturn in the U.S.

Still, as is the case in the U.S., the worst appears to be over. In March, Israel reported an increase in the Consumer Price Index by 0.5 percent, reversing a four-month slide.

Steady…For Now

Key factors distinguish Israel’s economy from the U.S. economy and place it in a relatively favorable position. These include: few complex financial instruments in the capital markets; an active interest rate policy; surplus in the current account of the balance of payments; high and rising foreign exchange reserves; high levels of growth and employment; and a strong banking system.

Israel’s current economic framework is largely the result of free-market reforms and a reduction in public spending that stimulated growth. Israel’s current prime minister, Benjamin Netanyahu, implemented these policies when he served as finance minister from 2003 through 2005.

Perhaps the key factor that has protected Israel was its insulation from the U.S. sub-prime real estate market. Still, while Israel did not invest in the ill-advised securities tied to the U.S. housing market, Israel’s financial system has sustained losses from exposure to other U.S. investments. Indeed, Israeli pension funds have been negatively impacted by investments made through large Israeli-based real estate companies; Israeli pension funds invested an estimated 50 billion shekels in real estate companies.

Two of these real estate companies, Africa Israel Investments Ltd. and Delek Real Estate, have been identified as holding problem loans. These companies invested in assets in the United States and the United Kingdom, and have since lost considerable value. Both Africa Israel, under the leadership of billionaire Lev Leviev, and Delek, run by billionaire contractor Yitzhak Tshuva, plan to sell foreign assets to repay this debt.

The Israeli government supported a bailout of the affected pension funds. Jerusalem has agreed to provide certain guarantees to workers age 57 and above.

Government Response

Jerusalem has adopted additional measures to mitigate the negative impact of the global economic crisis.

The Bank of Israel in the last few months gradually lowered the interest rate, which peaked at 4.25 percent last September, to its current level of 0.5 percent. According to bank officials, “The reduction of the interest rate for April by 0.25 percentage points will help strengthen the economy’s ability to cope with the effects of the global economic crisis. This reduction will serve to encourage real economic activity, [and] is consistent with the stability of the financial system, and will serve to moderate the downward pressure on prices that is likely to pull inflation below the target range of price stability.”

Mizrahi Tefahot Bank, the Manufacturers Association of Israel, and the Mutual Fund of Employers have launched a joint initiative to help mid-sized businesses that employ 20-100 people, to cope with the economic crisis. The parties signed an agreement to set up a loan fund of up to $200 million. The new fund is intended to address the credit crunch faced by a majority of the members of Israel’s Manufacturers Association.

High-Tech Horizon

Another potential Achilles heel is the high-tech sector, which generates $25.5 billion of annual sales in Israel’s $200 billion economy. This accounts for the majority of Israel’s economy, which is dominated by exports. Although the high-tech sector is internally sound, and has continued to receive public and private infusions of capital, it is not immune from a shrinking global market. Trouble in this sector could pull down the rest of Israel’s economy, as it did when the dot-com bubble burst in 2000, precipitating Israel’s worst recession since the establishment of the state.

The high-tech industry employs seven percent of the country’s work force. The government estimates that nearly 8,000 high-tech workers, or 6 to 8 percent of the sector’s work force, have been laid off since October. If the current slump is protracted, Israel runs the risk of losing its most precious resource—a talented workforce and its technological edge in the global marketplace.

Taking Stock

For now, however, Israel’s fundamentals remain relatively strong. This strength is reflected in the performance of the Tel Aviv Stock Exchange amidst a global financial crisis.

As Cliff Goldstein, President of the AMIDEX35 Israel Mutual Fund, observes, “Over the last five years, Israel has endured wars, changes in government, existential threats from hostile nations, and a global recession. During these five years, the Tel Aviv Stock Exchange, as measured by the TA25 Index, went up about 28 percent, while the S&P 500 went down about 27 percent.”

Goldstein points to the strength of some of Israel’s larger publicly funded companies. “Teva [Pharmaceutical Industries], with a current market cap of about $40 billion, is now larger than 451 of the companies in the S&P 500 index. Israel Chemicals is now larger than Goodyear, Sunoco, U.S. Steel, Kodak, and E*Trade, combined.”

“In the old days,” Goldstein adds, “when the world markets got a cold, Israeli markets got pneumonia. Now, world markets were devastated, but Israeli stocks held their value exceptionally well.”

Investor Confidence Continues

Despite some warning signs, investors continue to view Israel as an attractive investment.

In March, Israel launched a benchmark 10-year U.S. dollar denominated global bond issue worth $1.5 billion. The 10-year deal had price guidance of U.S. Treasuries, plus 262.5 basis points (2.625 percent), with a yield of 5.19 percent. Demands for this issue exceeded $12 billion, and were purchased by over 300 investors in 14 different countries.

“It is a sign of the attractiveness of the Israeli Market,” said then-Finance Minister Ronnie Bar-On, “especially in times the global economy is in high turmoil and crisis.”