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New research in the Bank of Israel: Israel's economy has become more resilient to exceptional changes in the exchange rate.

17/01/2007

New research in the Bank of Israel: "Israel’s economy has become more resilient to exceptional changes in the exchange rate."
17.1.2007

The views expressed in this paper do not necessarily reflect those of the Bank of Israel

The Bank of Israel today published a new study in the Financial Stability Discussion Paper Series. The authors, Yair Haim and Roee Levy of the Bank’s Financial Stability Area, use the balance sheet approach (BSA) to examine the resilience (vulnerability) of Israel’s economy to exceptional changes in the exchange rate, from a purely financial standpoint.
The BSA, which is assuming an increasing role worldwide in the surveillance of financial stability, is a sectorial approach to the analysis of financial risks of the whole economy based on the balance sheet of each sector (the “national balance sheet”). The idea underlying this approach is that differences in the direction and extent of exposure to financial risks and the links and avenues of contagion between the sectors are likely to have an adverse effect on the functioning of the financial system that could even lead to a financial crisis. The study is the first to make use of Israel’s national balance sheet, published recently by the Central Bureau of Statistics, and the data of foreign currency assets and liabilities (the foreign currency balance sheet) published by the Foreign Exchange Activity Department of the Bank of Israel, to demonstrate the use of the BSA for analyzing financial stability in relation to exchange rate risk.
The findings of the study show that the exposure of Israel’s economy to exchange rate risk has changed significantly over the last ten years––that of the economy as a whole, as well as that of the various sectors, particularly the exposure of the business sector. The results show that these changes in exposure, together with the improved financial robustness of the different sectors, made the economy more resilient to exceptional changes in the exchange rate in 2005 than it was in 1997. Nevertheless, it has not achieved immunity, and according to end-2005 data, some sectors may suffer considerable negative impact at times of exceptional depreciation or appreciation, although the economy overall may remain unaffected.
1.	Exceptional depreciation––The economy, which was very vulnerable to exception depreciation in 1997, was far less vulnerable in 2005, due to (a) the switch of the business sector from high exposure to depreciation to low exposure to appreciation, (b) the reduction in the relative exposure to depreciation of the group of companies which are so exposed, and (c) the improvement in the business sector’s financial robustness and in the capital adequacy of the banking system.
2.	Exceptional appreciation––Despite the fact that in 2005 Israel’s economy had a significant surplus of foreign currency assets, and was therefore exposed to appreciation of shekel, it was still fairly resilient to exceptional appreciation, due to the sectorial composition of the exposure and the improvement in the financial robustness of the various sectors. Thus, a significant share of the exposure was focused on households, on whom the impact of an exceptional appreciation was less marked from the aspect of the economy as a whole, as was its impact on the banks.
The results of the study emphasize the central, but not exclusive, role of the banks’ resilience in the financial stability of the economy, and they therefore also support the continued reduction of the banks’ dominance in business sector financing, so that their indirect exposure to financial risks will decline.