January 7, 2021
The Israeli government policy has been to manage affairs “while in motion,” an approach that will be less appropriate for the recovery from the pandemic. Israel should already be planning for a post-pandemic period that, hopefully, is not far ahead. The recovery, left to itself, will be slow and painful. But by taking a forward-looking approach today, Israeli policymakers can help the nation meet its challenges, both on the day after the pandemic and in the longer-term future.
According to the monthly inflation figures from the Central Bureau of Statistics, Israel may be in a period of mild deflation (a decline in the general price levels of a country). While consumers might applaud a drop in prices, it represents a threat to businesses. When firms order inputs to produce a product or service, they agree to pay prices based on the price they anticipate they can receive for the finished goods or services. If, however, the price of the finished good drops between the time they order the inputs and sell the output, they find their anticipated profit either reduced or wiped out.
Why are prices falling? One reason is the strengthening of the shekel against other currencies, particularly the dollar. In an effort to keep the shekel from becoming too strong, the Bank of Israel has bought in excess of $40 billion since the onset of the pandemic. Andrew Abir, the central bank’s deputy governor, told Bloomberg News that the bank is prepared to continue to intervene in the foreign exchange market as necessary to keep the shekel at present levels.
A strong currency means that Israeli exports are more expensive than competing exports from other countries, threatening Israel’s price competitiveness in international markets. If the shekel strengthens too much, Israel may see layoffs in the export sector just when the economy is recovering from the pandemic.
Another looming threat to Israeli exports is the country’s natural gas fields. The expectation is that as the global economy recovers from the pandemic, sales of natural gas will recover, thereby boosting Israel’s foreign currency reserves and pushing the dollar down further. As the economy recovers and imports accelerate, there will be upward pressure on the dollar against the shekel. But if natural gas sales also pick up, there will be downward pressure on the dollar and with it downward pressure on Israeli exports.
In the short run the next three to five years this situation will require Bank of Israel intervention in the foreign exchange markets to keep the shekel at a reasonable level.
The pandemic has pushed Israel into a major economic downturn. After an economic shock, a country’s growth rate can return to pre-shock levels, but the loss in output levels is permanent. During the economic shock, some of the country’s productive capacity is shut down due to the downturn and the drop in sales. While the economy may return to pre-shock levels, the future growth rate reflects a reduced post-shock economy.
Per Dun and Bradstreet (D&B) about 55,000 new businesses open each year in Israel, while 40,000 to 45,000 close. D&B records also show that over 37,000 Israeli businesses closed in the first half of 2020, and as many as an additional 50,000 businesses are on track to close during the second half of the year. D&B expects 2020 to be the first year in over a decade to record more business closures than openings. These numbers are even more problematic when considering the closure of labor intensive businesses such as restaurants and cafes, leisure and entertainment, home remodeling, transportation, and apparel stores.
Coronavirus has also hit real estate, automotive, retail industries, and exports. The Finance Ministry reports that real estate transactions were down 27 percent in the second quarter of this year compared to 2019. Exports are expected to decline by 13% in 2020 and new car deliveries were down 25% in the first half of the year. Each of these sectors contributes substantially to Israel’s GDP and the loss of firms in these industries will affect the nation’ future productive capacity.
What can the Israeli government and the Bank of Israel do to halt the bleeding?
The Bank of Israel’s current policy has been to ensure liquidity in the market: that there is enough cash in the economy to keep things going. Between March and October of this year, Bank of Israel has bought NIS 188.7 billion ($58.4 billion) of government bonds to inject cash into the economy and NIS 6.7 billion ($2.1 billion) in corporate bonds to provide liquidity for the corporate bond market. The moves have helped sustain the economy but do not solve the long-term threat: the loss of employers for Israel’s growing population.
Israel has seen broader unemployment rise past 20%, with many businesses initially closing temporarily due to government order and then closing permanently. The rise in broader unemployment has meant a significant drop in sales for those businesses that are still open resulting in a dramatic increase in businesses that cannot meet their loan payments. Consequently, Israeli banks have become reluctant to extend or roll over loans to small businesses.*
The Bank of Israel has approached the issue of corporate access to credit by buying corporate bonds on the open market, a policy similar to what the US implemented during the Great Recession. This reassures investors that they can sell their bonds when they wish: there is a buyer out there. That being the case, investors are willing to buy new bonds from corporate issuers, providing them with needed credit. However, the real threat to Israel’s recovery from the coronavirus recession is at the small-to-medium sized business level. The net loss of 30,000 small businesses this year represents a threat to Israel’s economy in the years to come, as well as in the present.
In the US, one response of the Federal Reserve to credit tightening was buying the mortgage portfolios of banks. The consequence was two-fold: first, for the banks it provided cash which they then lent out, and reduced the threat to their viability by removing these questionable loans from their balance sheets. Second, it reduced the number of mortgage defaults, as the government was in a better position to restructure the loans so homeowners could maintain ownership. The rationale supporting this policy was the fact that most mortgages in the US were guaranteed by the American government. If homeowners defaulted, the government was on the hook for them.
Israel has avoided a housing crisis, meaning mortgage holdings by banks are not an issue. However, small businesses are dropping like flies and with them, jobs are lost. This forces banks to increase their provisions for questionable loans. Many of these loans are guaranteed by the governments small business loan program: If borrowers are unable to repay them, the government is on the hook for them.
It makes sense for the government or the Bank of Israel to buy these loan portfolios from the banks. Doing so provides the banks with liquidity and reduces the threat to bank stability that a run of defaults would represent. It also allows the government to restructure loans so that businesses can survive the recession. The Bank of Israel can grant a grace period of one year, interest free, to small businesses and extend the repayment period.
Another policy Israel can borrow from the US is the Paycheck Protection Program, which provided small businesses with loans whose payments could later be forgiven if no employees were laid off or those laid off are rehired. If the government or the Bank of Israel buy banks small business loan portfolios, the loans could be restructured to include these provisions. This would encourage businesses to get employees on unpaid leave back to work. Their renewed salaries would reinvigorate the economy.
If Israel acted immediately to implement a plan featuring the above mentioned components the country could reduce its economic recovery period and Israelis could get on with their lives.
The writer is an industrial marketing and management lecturer at the Jerusalem College of Technology – Lev Academic Center and vice chair of the Business Administration Department/Faculty at Touro College Israel.