Recent Trends in Israel’s Monetary System

Recently, Israel’s monetary landscape has undergone significant changes that extend well beyond typical variations. While the U.S. dollar is exhibiting weakness globally, the Israeli shekel is actually leading the way, gaining strength against many major currencies.

This month, major currencies have gained roughly 2% against the dollar, but the shekel has surged at double that rate, falling below the $1-to-$3 threshold for the first time in 31 years. Over the past year, the dollar has dropped by about 18.83% against the shekel, moving from 3.691 to 2.996.

Various factors are contributing to this rapid rise. Notably, there’s been a considerable decline in Israel’s risk premium tied to recent regional events, such as ceasefires with Iran and Lebanon. There have also been influxes of capital spurred by successes in technology and security, along with a high interest rate differential. Gains in the New York Stock Exchange are also having an impact on the local currency.

All these elements make the shekel particularly robust. However, what many hoped would signify economic strength is turning into a significant drawback for growth.

For exporters and tech firms, a strong shekel can feel like a ticking time bomb. These businesses deal in dollars but operate in shekels, meaning when the dollar weakens, they receive less in shekels for the same amount of work, all while still paying fixed costs in shekels.

The rising value of the shekel tightens profit margins, too. A mere 5% increase over two weeks could drastically lower income in shekels. Sometimes, just a few percentage points can be the difference between a profitable venture and a failing one—this poses a strategic threat to economic competitiveness.

This situation naturally raises questions. Why isn’t the government stepping in to soften the blow of the shekel’s strength?

The Bank of Israel isn’t currently purchasing dollars as the shekel’s rise is part of a broader global trend, which is challenging to influence. While future intervention isn’t off the table, for now, it’s not happening.

This has led manufacturers to look toward the government for support. While they may not stop the increase altogether, perhaps they can slow it down.

So, what tools are available?

One globally recognized solution involves establishing sovereign wealth funds. The idea is straightforward: remove dollars from circulation. Instead of flooding the market with foreign currency, the state can invest a substantial portion abroad, alleviating some upward pressure on the shekel.

Israel does have such a fund focused on managing natural gas revenues, but its effectiveness may be limited, as it’s designed for specific purposes rather than the broader economic changes at hand.

The second avenue is speeding up infrastructure investment. While it might seem unrelated to currency issues, increased spending in areas like transportation, energy, and construction could boost overall economic demand, including that for foreign currency, which may ease some pressure on the shekel.

However, this is a lengthy process, requiring planning and funding, and might increase budget deficits if not managed well. It won’t provide an immediate answer to current exchange rate issues.

The third option is perhaps the most intriguing and feasible. Institutional investors—like pension and provident funds—often invest significant amounts overseas, particularly in U.S. stocks. As these markets rise, their dollar-denominated investments grow, potentially exceeding established currency exposure limits.

To correct this, financial institutions might sell dollars and buy shekels, and in a market like Israel’s, these large transactions can heavily influence exchange rates. Historically, there’s been a strong relationship between the S&P 500’s performance and the shekel’s value: when the index rises, the shekel tends to strengthen, and vice versa.

Manufacturers are suggesting various creative solutions. For instance, they are exploring hedging operations for financial institutions via “over-the-counter” transactions with the central bank. Instead of selling dollars in the open market during every Wall Street uptick, the central bank could absorb these dollars directly. Such strategies could lessen the pressure on the shekel, but the Bank of Israel doesn’t seem inclined to pursue this route right now.

In the absence of these solutions, exporters are seeking government intervention for regulatory relief, financial backing, and incentives for local content.

The government’s silence on these proposals could be seen as leaving exporters and tech sectors to weather the storm alone. The challenge of maintaining the competitiveness of Israel’s economy is not just about currency trading; it’s a test of broader economic resilience.