A better year for Israeli economy?

GAIL LICHTMAN SPECIAL TO THE JEWISH BULLETIN

After three years of recession, 2004 seems to be shaping up as the year for economic recovery in Israel, according to many economists.

Predictions are for an encouraging 2.5 per cent growth in gross domestic product (GDP), increased exports and a recovering high-tech industry. Inflation, too, is expected to be within the government's target range of one to three per cent, tourism is on the rebound and the Tel-Aviv Stock Exchange and Israeli financial markets have been on a bull run.

American-born Dr. Gil Bufman, senior vice-president of Bank Leumi le-Israel and the bank's chief economist and head of its economic sector, is one of the cautious optimists.

A former senior economist in the monetary department of the Bank of Israel and a consultant to the Israeli Ministry of Finance, as well as an economic analyst in the intelligence division of The Economist, Bufman said it is necessary to go back to 2001 to understand the causes of Israel's recession and the reasons for the current optimism concerning recovery.

"There were four main recession triggers," Bufman explained. "Two of these were external factors and two were domestic. The external factors were the crash of global high-tech demand in the second half of 2000 and the global economic slowdown and recession, especially after 9/11. The domestic factors are the security situation beginning in late 2000 and the loss of government economic policy credibility in late 2001 and 2002."

The security situation resulted in reduced confidence among consumers and business owners. Businesses and investors postponed investments or improvements and consumers stayed away from shopping centres and malls following terrorist attacks.

"This all had a very negative impact on domestic demand," said Bufman.

During this period, the Israeli government was sending very unclear messages with respect to the budget, taxes, interest rates, etc. As a result, Israel's financial markets began to lose stability, the shekel underwent relatively rapid depreciation and inflation shot up in the first half of 2002.

In 2003, the seeds of recovery began to appear. The global economy started to stabilize, which had a significant and positive impact on Israel's foreign trade, and the government crystallized its economic policy. This gave the Israeli public, according to Bufman, "a very clear view of where economic policy is headed."

In addition, the sharp depreciation of the shekel greatly improved the real exchange rate, making the shekel more competitive and enabling Israeli firms to compete better in world markets.

"The last time the shekel was as competitive as it is now was in the late 1970s," said Bufman.

On top of that, the recession forced Israeli firms to become more efficient and productive and, while productivity has grown, labor costs have decreased and competitiveness has been boosted further.

"My feeling is that improvement in competitiveness is going to show up in increased exports in 2004/2005," Bufman continued. "Export-led growth boosts economic activity. It draws the attention of foreign investors and helps create an inflow of foreign currency. We are going to see more and more investors considering investing in Israel – not just financial investments but also long-term strategic investments in Israeli companies. The leading candidates for these investments are likely to be in the high-tech sector. However, other lower technology parts of the manufacturing sector, financial services and infrastructure projects may see a surge of foreign interest."

With respect to inflation, substantial reductions over the past year in the Central Bank interest rates – from 9.1 per cent in December 2002 to 4.85 per cent in February 2004 – should mildly influence prices following a gradual increase in demand.

"Inflation in 2004 should not be an eventful factor," Bufman predicted. "In my opinion, 2004 seems to be the year in which high-tech will join the mid- and low-tech sectors [chemicals, plastics, foods, etc.] in recovery."

Even so, the GDP growth rate will probably not be enough to make a substantial dent in Israel's unemployment picture.

"Only when firms feel that the growth they are seeing is an ongoing affair will we see the beginning of recovery in unemployment," explained Bufman. "I anticipate the first signs of improvement in the unemployment picture only towards the end of 2004."

The security situation also remains a problem, noted Bufman, "but there are enough alternative positive factors in the pipeline that will help the Israeli economy return to growth. However, without a stable security situation, it is going to be difficult for the economy to fulfil its full economic growth potential of some five to six per cent GDP growth annually."

Tourism, which was greatly affected by the security situation and plunged in 2001 and 2002, started experiencing a comeback in 2003 with a 25 per cent increase.

"While there was a recovery, it is important to remember that the base numbers of 2002 were extremely low and the absolute numbers of tourists coming to Israel are still much lower than in peak years," warned Bufman. The number of tourists arriving in 2003 was close to one million – a little more than one third of the peak year of 1999.

The Israeli stock market and other financial markets did very well in 2003, with the Tel-Aviv-100 Index rising by close to 70 per cent in dollar terms. The Tel-Tech-15 (the 15 largest high-tech companies traded on the Tel-Aviv exchange) rose by almost 130 per cent in shekel terms (close to 140 per cent in dollar terms) and Israel's long-term bond index had a return of 37 per cent (about 45 per cent in dollar terms). Clearly, the markets have sensed that something has changed.

Many people believe that markets never lie.

"The markets have sensed that three out of the four main recession triggers have changed for the better," said Bufman. "So, there is a strong basis to believe that the rapid recovery of Israel's financial markets was really based on strong fundamentals."

Sweetening the pot for the investors is the recent pension fund reform. Until this reform, pension funds, which hold some $35 billion, had almost all of their money outside of the markets. Now, these funds are obligated to invest in financial markets in Israel and this will constitute, in Bufman's opinion, an important positive factor.

Other factors Bufman sees as positive for 2004 include a decline in the government budget deficit and privatization of government owned companies (with a credible $1 billion privatization target for 2004) and the $9 billion loan guarantees. The companies that are slated for privatization include Bank Leumi, Bank Discount, Bezeq (the telecom company) and the oil refineries. Zim Shipping Lines was fully privatized in January 2004.

With economic growth on the rise, lower interest rates and government economic reforms in place, Bufman believes that 2004 should be a good year for Israeli financial markets. But, he cautions, "The only engine of growth that is really functioning properly at the moment is the export sector. Other sectors have not yet woken up."

For foreign investors interested in investing in Israel, Bufman advised getting good, accurate information before they take the plunge. Any of Israel's leading banks can help investors decide on a course of action and how to implement it. Bank Leumi, for example, maintains two Web sites – a multilingual Israeli site (www.leumi.co.il) and a U.S. site (www.leumiusa.com) – where potential investors can get weekly, monthly and quarterly coverage of what is happening in the Israeli economy, including reports on financial markets, stock markets, in-depth looks at various economic sectors, specific research papers and other information.

Israel has always placed a high priority on encouraging foreign investment due to the important role such investment plays in the country's economic development. The current surge in interest by foreign investors, the renewed confidence of consumers and business owners and the growth in tourism all demonstrate the resilience of the Israeli economy and the Israeli people.

Gail Lichtman is a correspondent with Israel Press Service.

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