Israel Risks ‘Dutch Disease’ as Shekel Boosted by Gas

Bank of Israel Governor Stanley Fischer
Bank of Israel Governor Stanley Fischer said the gas discoveries could lead to the “appreciation of the local currency as a result of the export, or reduced import of gas.” Photographer: Simon Dawson/Bloomberg

While Israel celebrates its anticipated emergence as a fuel-producing nation, record offshore gas discoveries are creating an unwanted side effect for the export-reliant country.

Bank of Israel Governor Stanley Fischer is among the leaders and economists expressing concern that the finds may lead to a stronger currency, making the country’s goods more expensive abroad. Investors may already be bidding up the shekel, which is trading close to a two-year high against the dollar, in anticipation, said David Lubin, chief economist for emerging markets at Citigroup Inc. in London.

Emerging market countries including Brazil and Turkey are struggling with strengthening currencies as near-zero interest rates in the U.S., Europe and Japan spur record inflows into developing-nation stock and bond funds. In addition to the interest-rate differentials, Israel’s economy may be undergoing a long-term shift to its current account and exchange rate because of the gas finds, Lubin said.

“The prospect of either substituting gas imports or exporting gas has the potential to make a very positive contribution to Israel’s balance of payments,” he said. That can strengthen the exchange rate, “which in turn might create some Dutch disease risks for the real economy.”

The term “Dutch disease” was coined by The Economist magazine to describe a surge in income from new natural-gas fields in the Netherlands during the 1960s that triggered a currency gain and eroded other exporters’ earnings. The term has since been applied to similar situations from Venezuela to Russia to describe how natural resource finds can hurt industry.

Twice the U.K.

The Tamar and Leviathan discoveries off Israel’s Mediterranean coast over the last two years may hold 24 trillion cubic feet of gas, double the U.K.’s proven reserves in 2009, according to Houston-based Noble Energy Inc., a partner in the finds. Drilling at the Leviathan site started on Oct. 18 and production of the Tamar field is set to begin in 2012.

“The assessments are that the size of the natural-gas fields discovered recently may well be significant relative to the size of Israel’s GDP,” Fischer said in a June speech. The gas discoveries could lead to the “appreciation of the local currency as a result of the export, or reduced import of gas.”

Fischer has suggested possible steps to shield the economy from new currency inflows. One is to adopt the Norwegian method of establishing a sovereign fund that keeps the gas royalties out of the home country by investing them in world markets.

Moderate the Appreciation

Such a plan would moderate the currency appreciation and allow “the government to use only a small share of the royalties on a current basis,” Fischer said in the June speech.

The shekel added 0.3 percent to 3.6129 per dollar at 4:30 p.m. in Tel Aviv today, taking its gain since the start of July to 7.6 percent. It may strengthen to 3.55 per dollar by year-end as the gas finds reduce the country’s imports and bolster the current account, said Rafael Gozlan, chief economist at Leader Capital Markets Ltd. in Tel Aviv.

A higher shekel may hurt profits at technology companies such as Nice Systems Ltd., a maker of digital-recording surveillance products, and developer of voice-over technology AudioCodes Ltd. Both pay their employees in shekels and export many of their products to the U.S., said Gilad Alper, an analyst at Meitav Investment House Ltd. in Tel Aviv.

“In the long term, if we don’t see any improvement in the foreign exchange rate we will have to take some steps to reduce our expenses, such as moving some of our operations elsewhere,” Nice Systems Chief Financial Officer Dafna Gruber said in an Oct. 27 interview. “We are flexible and we can adapt to a stronger shekel, but our flexibility is limited.”

Rising Stocks

As expectations for the size of the gas fields increase, the TA-25 index has surged, rising 27 percent over the past 12 months to a record yesterday. Leading those gains are Tamar and Leviathan partners Avner Oil Exploration-L.P. and Delek Drilling-LP, both of which have more than doubled in the past year. Netanya-based Delek Group Ltd., which controls the two partners, rose 65 percent in the period.

“Investors are being attracted to shiny objects of oil and gas,” said Brenda Shaffer, a professor of energy and politics at the University of Haifa. “I’m worried that a lot of funds and money are being taken away from investments into other places.”

Double the Surplus

The natural-gas discoveries have the potential to double the surplus in the current account, the difference between a nation’s total exports of goods, services and transfers and its total imports, Bank Leumi Le-Israel Ltd. Chief Economist Gil Bufman said. There is already an impact on the investor expectations “for a strengthening in the shekel,” Bufman said in an e-mail.

The finds could be worth “hundreds of billions of dollars,” Finance Minister Yuval Steinitz said in a speech on Oct. 19.

Israel’s current-account surplus widened in the second quarter to $2.3 billion from $1.4 billion a year earlier, the Central Bureau of Statistics said Sept. 14.

UBS AG forecasts the shekel may strengthen to as much as 3.56 per dollar in the next three months.

“This is an unequivocal positive for the shekel,” said Manik Narain, an emerging-markets currency strategist for UBS in London. “The most obvious is by supporting the trade balance -- reducing the trade deficit -- and by increasing the current-account surplus. This is one of the drivers right now of shekel strength.”

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