Investment of the Foreign Exchange Reserves

The full report - PDF file ()

The Bank of Israel's foreign exchange reserves grew by $14 billion this year, and at the end of 2008 stood at $42.5 billion.
The growth in reserves this year is mainly the result of purchases of foreign currency by the Bank of Israel since the end of the first quarter of 2008 as part of a program to increase the Bank's foreign exchange reserves. This year, $12.1 billion was purchased.
For the first time in the past decade, the average level of foreign exchange reserves in December 2008 has covered all the short-term external debt of the economy-103%, compared with a level of coverage of around 80% in previous years, and is equivalent to 4.8 months of imports, compared with 4 months on average during the previous year.
Despite the severe global financial crisis this year, Israel's foreign exchange reserves were hardly affected. This is because they were invested in conservative assets as part of the Bank of Israel's policy of managing the reserves. In addition, the Bank took steps during the year to reduce the exposure of the reserves to increasing financial risks. As part of these steps, the banking exposure was reduced to less than one percent, the investment rules were made stricter, and additional restrictions were imposed on the assets permitted to be invested.
The holding-period rate of return on the reserves in terms of the numeraire was 5.9 percent in 2008, up from 4.5 percent on average in the years 1999-2008. This rate of return was affected to a large extent by the decline in yields to maturity in the bonds market of the US government and other governments worldwide, against the background of the deepening global crisis.
The contribution of active management this year was negative and totaled 19 basis points, in contrast to a positive average 9 basis points in the past decade. The negative contribution was affected mostly by the long-term spread assets in the portfolio, whose rate of return were less than those of government bonds because of the widening of the spreads between them. The contribution of active management, as well as its volatility which rose this year, were greatly affected by the dramatic changes that took place in the markets as a result of the global crisis.
In the wake of the low level of yields to maturity which prevailed in the United States from the beginning of 2008, the duration of the dollar portfolio was reduced from 24 months to 14 months. This was due to the concern that a rise in yields could cause large capital losses, greater than the income from interest, leading to a negative holding-period rate of return.
The events that took place this year in the world underscored that beyond the existence of an appropriate level of reserves, it is also of considerable importance for them to be sufficiently liquid in order to be able to cope in times of crisis. This aim was particularly emphasized in the Bank of Israel's management of the reserves this year.