The Bank of Israel plans to start investing some of its reserves in equities abroad by the end of the year, the central bank’s director of market operations said.
The pilot investment will be through index trackers rather than specific stocks, Barry Topf said in an interview at the bank’s offices in Jerusalem. The bank plans to invest in the largest, most liquid and sophisticated markets through outside asset managers who haven’t yet been chosen, he said.
“We can achieve a higher return on the reserves without incurring higher risks,” Topf said. “It’s been an extremely difficult environment for investors in general, and especially central banks because their natural environment has been government bonds and fixed-income investments and we know that yields are at historic lows.”
Central banks slashed benchmark interest rates in the aftermath of the 2008 global financial crisis in an effort to shore up growth, resulting in a decline in yields on government bonds. Since August 2008, U.S. 10-year note yields have dropped about 1 percentage point and German bunds almost 1.5 points, and both are now trading below 3 percent.
In the past 12 months, the MSCI World Index has risen more than 14 percent, while the S&P 500 Index advanced more than 13 percent.
While the investment by central banks of part of their reserves in equities isn’t widespread, a small and growing number have begun to do so, Topf said. About 11 percent of the foreign-exchange reserves of Switzerland’s central bank were invested in shares at the end of the first quarter, the Swiss bank said on its website.
“This is something which would have been virtually unthought of 10 years ago for a central bank,” said Topf, who has been at the Bank of Israel for 30 years. “It has become more accepted because central banks have grown in sophistication.”
Low yields in the U.S. and Europe have spurred increased inflows into Israel and other countries where lending rates are higher, putting pressure on the currency to appreciate.
Israel’s central bank has been buying foreign currency in most months since March 2008, more than doubling reserves, in an effort to moderate the gains and help exporters compete. Reserves declined for the first time in six months in May and stood at $76.8 billion at the end of the month.
“They’ve increased a lot, we think that’s a good thing,” said Topf, a 57-year-old with a degree in history. “The level of reserves is broadly consistent with what we need. That also allows us to be flexible in terms of intervention policy. We don’t have a need to go out and buy reserves but we also don’t have a need to go out and sell.”
The Bank of Israel’s goal is to return to a situation in which it doesn’t intervene in the market, Topf said. That doesn’t mean that the bank won’t intervene if the exchange rate diverges markedly from underlying fundamentals, he said. Central banks intervene when they buy or sell currencies to influence exchange rates.
“Intervention has trended down,” Topf said, adding that there are “obviously fluctuations from month to month.”
The central bank has been criticized by the Organization for Economic Cooperation and Development for the purchases. Secretary-General Angel Gurria called currency intervention a “new kind of protectionism” in a visit to Israel in November. Bank of Israel Governor Stanley Fischer has said he aims to end the purchases when the markets return to “stability.”
Inflows to Shekel
Koon Chow, an emerging-market strategist at Barclays Capital, said the Bank of Israel will probably keep intervening because the causes of that policy haven’t changed.
“With the interest rate going higher and investors bullish on Israeli fundamentals, inflows to the shekel will continue,” Chow said in an e-mail. “The Bank of Israel will lean against these inflows to prevent export competitiveness from being eroded too much.”
In the past 12 months, the shekel has gained about 11 percent against the dollar. The currency was trading at 3.4763 per dollar at 10:45 a.m. local time.
The government’s plan, announced in January, to cancel the tax exemption for foreigners on profit from short-term Makam bills and short-term bonds will go into effect on July 1. While some of the effects on the shekel have already been “priced in,” not all of them have, Topf said.