Israel fights shekel strength with reserves move

From January 27, banks in Israel will have to meet a 10% reserve requirement on the value of foreign exchange swaps and forwards transactions by non-residents, the Bank of Israel said, as it seeks to protect exports and contain inflation.

"In the last few months the volume of foreign exchange derivative transactions by non-residents has increased markedly," the Bank of Israel said.

"A significant part of the increase in non-residents' transactions is in short-term instruments. This measure will strengthen the Bank of Israel's ability to achieve the objectives of its monetary, foreign exchange and financial stability policies."

In December foreigners made swaps worth $76 billion compared with $19 billion by Israelis and up from $59 billion in November.

The shekel weakened to NIS 3.62 per dollar from 3.56 prior to the announcement. The Bank of Israel is trying the reduce the amount of speculative capital flows by imposing a liquidity requirement of 10 percent of the value of the transaction, Ron Eichel, chief economist at Meitav Investment House, said.

"This can change short-term trends and reduce noise in the market but if the economic fundamentals are strong, in the end the currency will strengthen," Eichel told Reuters.

"Israel is like Brazil and other countries, it is trying to help exports and growth."

Brazil, Chile, Peru, Taiwan, South Korea, Turkey, South Africa and others have taken measures to keep their currencies from strengthening or control the flow of money into their economies as investors pour money into higher-yielding markets.

Shekel will continue to gain

The shekel reached a 27-month high of 3.528 shekels per dollar earlier this month and the Bank of Israel has intervened repeatedly to contain the currency's rally. It bought $2.3 billion of foreign currency in December, bringing its forex reserves to a record $70.9 billion.

Eichel said the shekel will continue to strengthen in the long term even without speculators because economic growth is strong, interest rates are expected to rise and there is a surplus in the country's balance of payments. Israel's economy grew a provisional 4.5% in 2010.

"I don't think anyone in the Bank of Israel is innocent enough to believe this will change the trend," Eichel said.

Fourteen of 15 economists polled by Reuters expect the central bank to raise its short-term lending rate by 0.25 percentage point to 2.25 percent on Monday. The rate is expected to reach 3.0-3.5% by the end of 2011.

Michael Sarel, head of economic research at Harel Finance, said even a short-term depreciation of the shekel will enable the central bank to raise rates more rapidly.

"We estimate that in the wake of the Bank of Israel's measure, the chances for a rate hike on Monday have increased considerably and the rate of increases in the interest rate in the coming year is expected to be more rapid," Sarel said.

A Bank of Israel source said the reserves measure will make this type of transaction less attractive for foreign players.

"It makes the transaction more expensive for local banks," the source said, as the banks will not get interest on the 10% reserves and this will carry over to foreign banks.

The Bank of Israel's order follows its announcement on Wednesday that it will require Israelis and foreigners to report on transactions in foreign exchange swaps and forwards of more than $10 million in one day.

Additionally, non-residents who perform transactions in short-term Bank of Israel bills known as makams and short-term government bonds of more than NIS 10 million in one day will be required to report details of the transactions and their balance of holdings of such assets.

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