Investment of the Foreign Exchange Reserves

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The Bank of Israel's foreign exchange reserves grew by about $17 billion in 2009, and at the end of 2009 stood at $59.1 billion. The growth in reserves this year, as in 2008, was mainly the result of purchases of foreign currency by the Bank of Israel that started at the end of the first quarter of 2008 as part of a program to increase the Bank's foreign exchange reserves, and of the new policy adopted by the Bank in the foreign currency market in August 2009.
The latest crisis emphasized the importance of holding an appropriate level of foreign exchange reserves as an essential source of liquidity at times of crisis. Many other countries also increased their foreign exchange reserves this year. The increase in the level of Israel's foreign exchange reserves in the last two years strengthens the economy and its financial resilience, and improves Israel's international financial standing.
The change was evident also in the significant increase in the ratio of the reserves to various financial aggregates of the Israeli economy. Thus, for example, the average level of the reserves in 2009 covered Israel's entire short-term external debt, reaching 126 percent of the debt, compared with 80 percent in previous years, and they are more than one quarter of the annual GDP.
As part of the Bank of Israel's reserves management policy, the reserves are invested in conservative assets, but even prior to the outbreak of the global crisis in September 2008, and also during 2009, the Bank took additional measures to reduce the exposure of the reserves to the burgeoning financial risks: banking exposure was reduced almost to zero, investment rules were tightened, additional restrictions were imposed on the exposure to various countries and the assets in which the reserves can be invested, and further requirements were added to ensure a proper level of liquidity in various currencies.
The holding-period rate of return on the reserves in terms of the numeraire was 1.9 percent in 2009, compared with 4.3 percent on average in the years 2000-2009. This rate of return was affected to a large extent by the extremely low interest rates and yields to maturity in the bonds market of the US government and other governments worldwide, levels that persisted throughout 2009 due to the global crisis that erupted at the end of 2008. The holding period rate of return in shekel terms was higher, 3.6 percent.
The contribution of active management in 2009 was exceptionally high, and totaled 110 basis points, compared with a positive average contribution of 19 basis points in the past decade. The high excess return this year was affected mostly by the long-term spread assets in the portfolio, which benefited from significant narrowing of the spreads in yields to maturity between them and those on government bonds. A prominent component among the spread assets this year were bonds and commercial paper issued by banks from the end of 2008 and backed by full government guarantees as part of the unconventional intervention methods adopted by governments and central banks around the world to support the financial system and stabilize the markets.