Remarks by the Governor of the Bank of Israel at the press briefing on monetary policy held today at the Bank of Israel
Yesterday and today, the Monetary Committee held discussions at the Bank of Israel in order to decide on monetary policy. In general, we open the talks with a broad discussion with tens of economists who present the picture of the situation to the Monetary Committee, and afterwards the Committee holds further discussions in a smaller format. The discussion this time, like all those held at the Bank in recent weeks, was held by video conference with each member in a different room or at home. This is a situation we would not have imagined but that in recent weeks has already become familiar to all of us. The content of the discussion was also very different than usual. At the end of the discussions, the Committee decided to reduce the interest rate to 0.1 percent. In addition, the Committee decided on two additional steps, unprecedented in Israel: First, the Bank of Israel will put into operation a new monetary instrument that will provide banks with an additional incentive to extend credit at convenient terms to small businesses. In addition, we expanded our repo plan so that it will include corporate bonds as well, in order to strengthen our ability to ensure liquidity in financial markets. I will now describe how we view the situation through the discussions and our decisions.
The economy suffered a considerable shock in recent weeks, due to the rapid spread of the coronavirus, and the drastic steps that governments around the world and in Israel are taking in an attempt to halt the spread of the virus. These steps led to a global economic crisis that is reflected in a shutdown of wide sectors of the global and domestic economies, with a significant adverse impact on activity and employment. In addition, we have seen a shock in financial markets with marked liquidity difficulties, steep declines in equity and commodity prices, an increase in volatility and risk spreads, and a sharp decline in the inflation environment. The crisis is reflected at the same time by a supply shock, as a result of a severe negative impact in the supply chain of many goods and services, and a sharp decline in demand as a result of the restrictions on movement, and the adverse impact to income, financial asset values, and the sharp increase in uncertainty.
The rapid pace of the developments is such that most of the standard data that we generally use to assess the state of economic activity in Israel are still not available, and therefore the assessments regarding the extent of the adverse impact of the crisis on the economy are based on more up-to-date indicators and on new data collected. An analysis of the extent of the shutdown indicates that as of the end of March, total activity that was shut down totals approximately 37 percent of GDP, and 27 percent of private consumption. Over the entire first quarter, a decline of approximately 5 percent of GDP, in quarterly terms, is expected. These are unprecedented declines, which are reflected in the more than 1 million employees who lost their source of income, in addition to a large number of self-employed people whose business was closed or whose volume of activity decreased considerably.
Beyond the shutdown measures in Israel, the economy was also adversely impacted by the freefall in the global economy. The rapid spread of the virus to a large number of countries, closure of borders to travelers, prevention of gatherings and other steps led to a sharp negative impact on economic activity, which is difficult to assess at this stage. When the virus began to spread to several advanced economies it led to declines of about 30 percent in equity markets, and an increase in spreads, volatility, and in risk indices that have not been seen since the global financial crisis. Central banks in many economies responded rapidly by increasing monetary accommodation and supplying liquidity, through the use of a broad range of tools, both familiar and new. Many governments announced fiscal plans of unprecedented scope. These steps moderated, but only to a certain extent, the adverse impact to financial markets.
The magnitude of the occurrences and the uncertainty make it very difficult to forecast the economic developments. The most significant unknown is of course the length of the crisis—which will depend on the ability to gain control over the spread of the sickness, and in the manner in which it will be possible to loosen, apparently gradually, the restrictions on movement and employment. At the base of the forecast published today by the Research Department, it assessed that there will not be a further tightening of restrictions in Israel beyond those imposed to date, and that the main part of the limitations blocking economic activity will be gradually removed by the end of June. The implication is that the marked contraction in economic activity in the first half of 2020 will be replaced by a return to a path of recovery in growth, and a similar trend will take place in the global economy. In accordance with these assumptions, negative growth of 5.3 percent is expected in 2020, followed by growth of 8.7 percent in 2021. As such, the recovery is expected to be rapid, if not complete, and this is reflected in unemployment, which after rising in 2020, is expected to decrease gradually, and only toward the end of 2021 to approach pre-crisis levels. Inflation in 2020 is expected to be negative, and in 2021 the inflation rate is expected to increase toward the lower bound of the target range. It is important to emphasize—although we are presenting the numbers as seen in our calculations, it would not be right to focus on the precise figures, as the forecast is compiled under conditions of tremendous uncertainty and it is difficult to assess the impact of the crisis on economic activity. Regarding inflation, it is reasonable to assume that there will be difficulties in measuring it and its significance, as numerous goods and services are simply not being sold in view of the restrictions, and the consumption basket for households has changed considerably.
The risks to the forecast illustrate the importance in the government formulating an exit strategy that will allow a return that is as rapid as possible by the economy to regular activity, even if gradual and limited. According to Research Department calculations, extending the limitations by an additional month, if it occurs in parallel with an additional adverse impact to the global economy, will lead to a further slowdown in growth and to an increase of an additional 2 percentage points in the unemployment rate—a very significant increase. Therefore, it is important that we learn as soon as possible from the countries that are managing to return their economy to functioning even though complete control over the pandemic has not yet been achieved, and that we adopt the methods that they carried out to the extent that they are relevant to Israel.
The crisis at its source is a health related one, and its economic effect is first and foremost in its negative impact on the real economy, and therefore most of the burden in dealing with the crisis falls on the government’s budget policy. The government announced a plan estimated at NIS 80 billion, of which NIS 50 billion is in direct budget intervention, similarly sized, in terms of percent of GDP, to the assistance plans announced by other governments.. The remainder of the NIS 80 billion is in financing facilities and deferrals of payments that provide cash-flow assistance to businesses that were negatively impacted. These should enable them to smooth, over time, the adverse impact in revenue, which is in fact difficult but hopefully will be mostly temporary. The combination of the direct budgetary assistance, cash-flow assistance and monetary easing policies that I will review right away, create an aid framework whose contribution is greater than the sum of its parts, and it will enable the economy to return to activity more smoothly when the health-related limitations will be eased. Although the implementation of parts of the plan is complicated, operationally and legislatively, it is important that the effort by all the relevant branches of government continues so that everyone who is eligible for a benefit as a result of government decisions receives it as soon as possible. The package of steps provides a response to the main economic issues on the agenda, reduces the uncertainty for the near term, and still leaves future budget space should further expansion be necessary. The allocation of the resources that accompanies the plan is crucial at this time, even at the cost of increasing the deficit and the expected increase in the debt to GDP ratio. The government’s financial robustness enables it to finance the plan without particular difficulty in the domestic and global financial markets, and the policy conducted by the Bank of Israel ensures that the markets on which the government issues debt work in a sufficient manner and that it succeeds in raising the sources for operating the important plan at reasonable and appropriate interest rate terms.
The Bank of Israel put into operation several extremely significant policy instruments immediately after it became clear that the crisis is adversely impacting the orderly functioning of the financial markets. Due to the price declines in equity markets abroad, institutional investors were required to provide additional dollar collaterals against their assets abroad, and they began to sell assets in shekels in order to finance these dollar margin calls. A fire sale of government bonds and a severe shortage of dollar liquidity resulted, against the background of a similar shortage worldwide. The dollar liquidity distress also led to a rapid depreciation of the shekel, which joined the underlying depreciation caused as a result of the adverse impact to real activity. The Bank of Israel worked to stabilize the government bond market by repo agreements and by purchasing bonds on the secondary market, and injected liquidity into the foreign exchange market through shekel/dollar swaps, which were possible due to the high level of the Bank of Israel’s foreign exchange reserves. These activities stabilized the markets, which returned to normal functioning, and they prevented an even sharper adverse impact to long-term savings. In view of the sharp increase in government and corporate bond yields, and the concern that that would lead to a steep increase in the cost of credit for households and small businesses, the Monetary Committee announced that the Bank will purchase government bonds totaling NIS 50 billion. This step led to a marked decline in government bond yields, which we expect will trickle down to credit to the business sector and households. In parallel, as the regulator of the banking system, the Bank of Israel relied on the robust state of the banks and reduced the capital adequacy requirements by 1 percentage point, which enables the system to increase the supply of credit to the economy by tens of billions of shekels, despite the erosion of capital as a result of credit losses that the banks are liable to absorb. This package of steps helps the economy to get through the crisis and its contribution will be no less important during the recovery phase as well.
As we have said more than once, the Bank of Israel has a range of tools to support the attainment of the policy goals. Today, the Monetary Committee made several decisions that together with the steps we took since the outbreak of the crisis, make up a wide spectrum of tools that are working through various channels. The reduction of the interest rate to 0.1 percent will lead to an immediate reduction, even if small, in the costs of credit for households and businesses, and will support the recovery of economic activity in the exit from the crisis. This is a required step in view of the magnitude of the real adverse impact suffered by the economy, and it complements the other steps upon which we decided. First, in order to ensure that the monetary policy pass-through is operating properly and that small businesses are benefiting from the availability of credit at convenient terms, we developed a new policy tool, as part of which the banks will be able to receive credit for 3 years from the Bank of Israel at a very low fixed interest rate, on condition that that they extend new credit to small businesses. In addition, we decided to expand the use of repo transactions so that they will be able, for the first time, to include corporate bonds as collateral as well, in order to ensure our ability to maintain shekel liquidity in the financial system. The Committee noted that it will expand the use of the existing tools, including the interest rate tool, and will be able to operate additional ones, to the extent that the crisis lengthens and it is necessary to achieve the monetary policy goals and to moderate the negative economic impact created as a result of the crisis.
We are experiencing a difficult period. The negative economic impact is considerable, and affects millions of Israelis. The Bank of Israel will continue to do all that is required and all that it is authorized to do to minimize to the extent possible the adverse impact on the economy and citizens, to assist businesses and households to get through the crisis, and to support the recovery and rapid return of the economy to a path of robust growth and full employment.
Happy holiday, and most importantly—stay safe.