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Credit Risk Resisting War Tops Emerging Nations: Israel Markets

Israeli credit risk is improving while sentiment in the largest emerging markets deteriorates, highlighting the nation’s resistance to regional upheaval and Federal Reserve policy shifts.

Israel’s credit default swaps have fallen 23 basis points, or 0.23 percentage point, this year to 113 today, while contracts for Turkey, Brazil, Russia, India and China all increased as prospects for reduced stimulus triggered an outflow from developing markets. Turkey’s swaps have climbed 54 basis points this year to 181.

The start of natural gas production this year has boosted sentiment toward the nation as it spurs gains in the shekel and strengthens government finances. Investors have also looked past the worsening security environment among Israel’s neighbors. Since May, the civil war in Syria has intensified, with the use of chemical weapons threatening to internationalize the conflict. Political turmoil has also deepened in Egypt, where the army’s takeover in July led to escalating violence.

“The periodic geopolitical crises in the region don’t have significant influence on either Israeli markets or the government’s ability to manage the economy,” said Ori Greenfeld, chief economist at Clal Finance Investment Management Ltd. in Tel Aviv.

Israel’s main stock index has added 15 percent in dollar terms this year, while the MSCI Emerging Markets benchmark dropped 2 percent.

‘Prosperous and Diverse’

The shekel has been the biggest gainer among 31 major currencies tracked by Bloomberg this year, rising 5.9 percent against the dollar. Its strength has been driven by the start of gas output off Israel’s Mediterranean coast, which is poised to turn the country into an energy exporter.

Finance Minister Yair Lapid said today he will work with designated Bank of Israel Governor Karnit Flug to weaken the shekel.

Israel’s economy is “prosperous and diverse,” and the gas output will strengthen its external finances, Standard & Poor’s said last month, affirming its A+ debt rating, the fifth-highest grade. The International Monetary Fund forecasts growth of 3.8 percent this year and 3.3 percent in 2014.

Credit default swaps in Estonia and the Czech Republic, which Standard & Poor’s rates AA-, one level higher than Israel, had climbed six and nine basis points respectively by yesterday since Fed Chairman Ben S. Bernanke’s May 22 comments on stimulus. Israel’s swaps fell five basis points in the period.

Energy-importing countries such as India and Turkey have been among the worst-hit in the emerging-market decline prompted by Bernanke’s comments.

Gas Finds

Credit-default swaps for the State Bank of India, a proxy for the sovereign, have climbed by almost two thirds since May 22 to 285 basis points, while the rupee slid about 10 percent. In Turkey, swaps jumped by about 50 percent and the currency dropped about 6 percent, while the contracts also increased for Brazil, Russia and China. Rising credit-default swap prices signal a deterioration in investor sentiment.

Israel’s credit risk has been shielded from the global concerns over a Fed reversal “because investors believe the shekel will keep appreciating due to the new natural gas finds, Israel’s strong current-account surplus, and the about $80 billion in foreign currency reserves held by the Bank of Israel,” said Ofer Klein, head of economics and research at Harel Insurance & Financial Services.

Political Risks

Israel had a current-account surplus of $1.79 billion in the second quarter. Income from gas production may add as much as $3 billion this year, and for every $1 billion increase the shekel gains about 1 percent, according to the Bank of Israel.

The IMF predicts an Israeli surplus of 3 percent of GDP next year, compared with deficits of 3.8 percent in India and 7.2 percent in Turkey

Regional political risks did push Israeli credit-default swaps higher in August and early September, narrowing the gap with other emerging markets. They reached a 2013 high of 147 basis points on Sept. 5, as the U.S. weighed military action against Syria’s government.

Since Sept. 9, when President Barack Obama welcomed a Russian proposal for averting the use of force, the swaps have dropped 37 basis points as of yesterday.

The prospect of Israeli strikes against Iran, aimed at stopping the country’s nuclear program, has also receded as the U.S. and allies step up talks with the Islamic republic after its new president, Hassan Rouhani, said he’s ready for a deal.

That’s a risk that may return, said Elliot Hentov, the primary analyst for S&P’s Israel report, in a phone interview. “If this diplomatic initiative fails, the proponents for military action will become stronger, and 12 months from now we could be seeing a very different picture.”

For now, “Israel is like an island in the ocean with all sorts of storms raging around it,” Hentov said. “Most of its adversaries are busy with other priorities, thus deflecting much of its risk.”

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