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Israel's foreign exchange reserves grew by $10.2 billion in 2010, compared with
an increase of about $17 billion in the previous year, and at the end of the year
stood at $69.3 billion.2 As was the case in the previous two years, the increase in
the reserves this year was due mainly to purchases of foreign currency by the
Bank of Israel.
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The upward trend of foreign exchange reserves in developed and emerging
market countries continued in 2010, in line with the trend in Israel, as the global
financial crisis, which began in 2008, underscored the importance of maintaining
an appropriately high level of reserves.
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The rise in the level of Israel's foreign exchange reserves in 2010 increased the
ratios between the reserves and various aggregates of the economy, which are
customarily used to assess the adequacy of the level of the reserves. Increasing
these ratios serves the objectives that the new Bank of Israel Law stipulates for
the Bank, and assists it in fulfilling its functions, as doing so strengthens the
economy's resilience to crises and improves Israel's international financial
standing.
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The holding-period rate of return on the reserves in terms of the numeraire was
1.2 percent in 2010, compared with 3.8 percent on average in the years 2001–10.
In shekel terms the holding-period rate of return of the reserves portfolio was
negative, at –7.1 percent, due to the strengthening of the shekel against the dollar
and the euro during the year. The number of currencies in the numeraire was
increased in order to obtain better diversification and to reduce the possible
consequences of the financial crisis for the reserves in extreme scenarios.
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This rate of return in numeraire terms was largely affected by two factors: (a) the
low interest rates and yields to maturity in the financial markets of the developed
countries; and (b) the average duration of the reserves, which was shorter than in
most of the previous years. The decision to shorten the average duration was
taken in light of the high risk of receiving a negative holding period return which
would be taken on by holding the reserves at a longer duration when interest rates
and yields to maturity are so low.
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The active-management contribution in 2010 was 10 basis points––compared
with an average contribution of 20 basis point in the past decade, but similar to
the decade average if the exceptionally high contribution in 2009 is excluded. The
main component of the active-management contribution in 2010 was the excess
yield from asset selection in the portfolio, particularly from short-term spread
assets.
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The background conditions under which the foreign exchange reserves were
managed this year were especially challenging. The global financial crisis entered
a new phase in which the concern of investors in the international markets
focused on uncertainty regarding the debt-service capability of some EU member
countries. While dealing with the implications of the continuing crisis for the
reserves portfolio, the Market Operations Department also dealt with its effects on
the domestic financial markets, as well as with advancing several special projects,
some of which are directly related to managing the reserves, as will be detailed
below.
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In March 2010 the Knesset passed the new Bank of Israel Law, which went into
effect on June 1, 2010. The new Law defines the Bank’s objectives and functions,
one of which is holding and managing Israel’s foreign exchange reserves. The
Law changes the framework in which the major decisions are taken in the Bank,
including decisions on the desired long-term level of the reserves and their
investment policy. The Bank’s new Monetary Committee, to be appointed in
accordance with the Law, will play a central role in this process. As part of the
Bank’s reporting responsibilities, the Law defines the periodic reports on the level
of the reserves and their management that the Bank must present to the Minister
of Finance, the government, the Knesset Finance Committee, and the public.
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The new Law has removed the legal obstacles that in the past prevented the Bank
from investing the reserves in certain financial assets which it viewed as desirable
investment channels in terms of economic worth and risk management. Since the
new Law became effective, the Bank has been studying how to identify and
choose the appropriate ways of using the additional degrees of freedom that the
new Law grants it in selecting assets for investment, including the possibility of
investing in the global equity markets.
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In addition to managing the reserves and examining the option of broadening the
range of assets in which the reserves could be invested, the Market Operations
Department of the Bank of Israel advanced several special projects in 2010:
(a) implementation of a computerized Integrated Treasury Management System,
which is expected to enhance and streamline the management of the reserves;
(b) establishment of a Bank of Israel Representative Office in New York;
(c) preparations to meet the requirements of the new Bank of Israel Law, broaden
the areas of activity as permitted by the new Law, and produce the reports as
defined in the Law; and (d) completion of the organizational restructuring process
with the addition of the state loans management function to the Department.
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