The failure of the administrative measures taken by the Bank of Israel against foreign speculators, by increasing banks' liquidity and reporting obligations, brings Governor of the Bank of Israel Prof. Stanley Fischer back to the question of what can be done about the strengthening shekel.
The first thing that is clear is what must not be done: stop the interest rate hikes. Even though these help drive the shekel's appreciation, and only widen the interest rate gaps between Israel and developed economies, the Bank of Israel must continue fighting actual inflation, inflation expectations, and inflation of assets, which have been affecting the economy for a long time.
Fischer has already wasted a lot of time, and delayed sharper interest rate hikes, because he tried to use the interest rate tool to deal with both inflation and the exchange rate. This delay cost Fischer the capital market's confidence in the Bank of Israel's ability to restrain the steady rise in prices. Fischer's efforts to split the interest rate and achieve two contradictory targets simultaneously did not work and have already caused damage.
With the latest interest rate hike by 50 basis points, which took the market by surprise, Fischer sought to show that he has returned to making his fight against inflation his priority. By law, this is the Bank of Israel's primary mission, and it must go on. Moreover, Israel's ongoing robust growth makes it possible.
It is important to remember that, for the economy as a whole, the macroeconomic consequences of unrestrained inflation are far more devastating than the effects of a low exchange rate. Nevertheless, the shekel's continuing appreciation affects the competitiveness of Israeli products in the short term, and exports account for half of Israel's GDP. The Bank of Israel should therefore extend the measures it has already taken, or, to apply the old adage: "If force doesn’t work, use more force".
The Bank of Israel should use its big guns. Instead of a 10% liquidity requirement on the banks, it should impose a 40% or 60% requirement, as Brazil has done. There are few alternatives, and the Bank of Israel cannot fight the dollar's weakening in the world.
Fischer should urge Minister of Finance Yuval Steinitz to act and bring forward the cancellation of the tax exemption on nonresidents' profits on makams (short-term Treasury notes). The ludicrous situation in which Fischer imposes restrictions, while Steinitz encourages tax incentives, must stop, and stop now.
Published by Globes [online], Israel business news - www.globes-online.com - on April 4, 2011
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