Fighting Inflation Has Hurt TradeBy
After two years of battling rising inflation, the Bank of Israel seems to be winning. But the tight monetary policy has also caused a widening trade deficit and grumbles from manufacturers.
High interest rates, which peaked in February at 18.5%, have pulled inflation down from an onerous 14.5% yearly rate in 1994. In fact, consumer prices unexpectedly fell 0.1% in March (chart). Already, private economists are forecasting that inflation for 1995 will end up below the target of 8% to 11% set by the Bank of Israel and the Finance Ministry. So the central bank is starting to ease. The BOI has cut its discount rate by three percentage points in the past two months, with a 0.8 point cut on Apr. 24.
Because of public spending related to the peace process and immigration, monetary restraint has not slowed the economy much. Real gross domestic product grew 7% in 1994 and a projected 3% annual rate in the first quarter. Israel's economic performance index--also called the "S index"--rose 0.9% in February and another 0.5% in March.
Still, the trade sector is in trouble. Rising private demand has brought in imports, but the shekel's exchange rate with the U.S. dollar has hovered around 3 shekels over the past year. That has hurt exports. After posting a $217 million surplus in 1992, the balance of payments dropped to a $2.8 billion deficit in 1994. And estimates for 1995 call for a further worsening, to $3.5 billion. To reverse that trend, Israel's powerful Manufacturers' Assn. and the Finance Ministry have called for a further interest rate cut of at least 2%. That action would weaken the shekel, making exports more competitive.
For now, the Bank of Israel and the Finance Ministry are only considering altering the basket of currencies to which the shekel is linked. BOI Governor Jacob A. Frenkel has indicated that he is unwilling to risk higher prices by cutting rates sharply. To him, it is too early to claim victory over so stubborn a foe as inflation.
To continue reading this article you must be a Bloomberg Professional Service Subscriber.
If you believe that you may have received this message in error please let us know.