The Effects on Capital Inflow of Israel's Joining the OECD and its Possible Reclassification as a Developed Country by Morgan Stanley Capital International (MSCI)

18.8.2008

The Effects on Capital Inflow of Israel’s Joining the OECD and its Possible Reclassification as a Developed Country by Morgan Stanley Capital International (MSCI)^*

	This study examines the likely effects of Israel’s expected accession to the OECD and of its reclassification as a developed market in the categorization of the global share indices on capital inflow and on other economic parameters.
	Countries that acceded to the OECD in the last decade experienced an improvement in a number of economic parameters in the years leading up to accession. This was apparently due to the steady improvement in their economic fundamentals needed to meet the requirements of the OECD. In addition, a correlation was found between joining the OECD and an improvement in a country's credit rating.
	Accession to the OECD did not lead to a significant change in capital inflows to the countries that joined the organization during the last decade.
	Countries that joined the MSCI list of developed markets benefited from continued foreign financial investment in shares, and in the main from a balance of holdings higher than that derived proportionally from the MSCI index.
A paper written by Shelly Reiss and Nimrod Mevorach from the Bank of Israel examines the effects of Israel’s expected accession to the OECD and the process of becoming reclassified as a developed market according to the global share indices on the size of capital flow into the economy.
Israel’s accession to the OECD and to the list of developed economies would certainly improve its international standing, lower its cost of borrowing, and oblige it to meet the accepted international standards on all matters related to economic policy. In this sense, the commitment itself is likely to lead to a further improvement in Israel’s economic fundamentals and to make it more attractive to foreign investors. The authors found, however, that these processes did not result in a significant change in capital flows to the countries that joined the OECD relative to those that did not (the control group). For some of the variables, the improvement was most evident just in the years prior to their joining the organization, a reasonable result in light of the fact that countries are accepted as members on the basis of continued improvement in their economic fundamentals in the years before their accession. There was a clear correlation between joining the organization and an improved credit rating.
The four countries that joined the MSCI list of developed markets in the last twenty years benefited from continued foreign financial investment in shares, and in the main from a balance of holdings higher than that derived proportionally from the MSCI index. No evidence was found to support the claim that the decline to a share of less than one percent of the market portfolio (in the index of the developed markets) resulted in a significant drop in the volume of investments, and certainly no negative impact on investments was discerned over time. There are likely to be conflicting effects on the net capital inflow from automatic adjustments to their portfolios by"passive" investment funds: an automatic withdrawal of investments by passive emerging market funds, and an automatic increase by passive developed market funds.

*	The views expressed in the paper are those of the author, and do not necessarily reflect those of the Bank of Israel.

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