Developments in the Foreign-Currency Market

12.02.02

Developments in the Foreign-Currency Market


Against the backdrop of the developments in the foreign-currency market, the Bank of Israel reiterates that neither the central bank nor the government has an exchange-rate target, and even if they had, it would be impossible to uphold it in opposition to market forces. Notwithstanding, local-currency depreciation can bolster economic growth only if it is not accompanied by accelerated inflation. As it has done in the past, the Bank of Israel will continue to maintain price stability, as decided by the government, and will adjust the interest rate accordingly if this is required. Financial and price stability are essential for economic growth.

The central bank states that anyone who decides to alter the composition of their financial portfolio-reducing their NIS investments and increasing their foreign-currency ones-should take the following considerations inter alia into account:

  1. Local-currency interest is higher than foreign-currency interest, despite the recent interest-rate cut.
  2. Experience has shown that exchange-rate fluctuations, in whichever direction, can far outweigh those in the inflation rate, thereby increasing the relative risk of investing in foreign currency.
  3. Most foreign-currency investments are taxable, which is not the case with NIS investments.
  4. Fees have to be paid for investments made via mutual funds, and for any change in the composition of the portfolio.
  5. At present interest rates on negotiable foreign-currency instruments are low, and they are more likely to rise than to fall. Hence, it is also necessary to consider the possibility of incurring capital losses on this kind of investment.
  6. Capital inflow into Israel is at a low level due to the global economic slump in general, and in the US in particular. Once the global economy rallies the supply of foreign currency in Israel may rise, and this could have a moderating effect on the exchange rate.

Consequently, caution and care are required in making decisions about changing the composition of savings, and constant vigilance is needed in monitoring results.

Finally, the Bank of Israel notes that it is vital for the government to dispel doubts concerning its determination and ability to adhere to the decision to reduce the budget deficit to 3 percent of GDP in 2002, with the intention of further reducing it to 2 percent of GDP in 2003. This will have a direct effect on the behavior of the public in the foreign-currency market as well as on the interest rate. The interest that the government pays on long-term (Shahar) bonds has not changed significantly despite the fact that the Bank of Israel has slashed the short-term interest rate. The government’s policy of stimulating economic growth and employment cannot attain its objectives unless interest rates for all terms are reduced, and it will not be possible to keep short-term interest low without harming price stability if long-term interest does not decline.