Investing in: Israel

Strong shekel changes Israel’s economy and makes investors think twice

Ferry Biedermann, special to CNBC
Ariel Jerozolimski | Getty Images

Israeli manufacturers this week, not for the first time, sounded the alarm bells over the strong shekel, which has been trading at three-year highs against the dollar. Exports are suffering, they say, and plants are closing down, the jobs being moved overseas. And there are concerns too that the strong currency is affecting investment decisions.

The manufacturers' complaint comes against the background of a Bank of Israel (BoI) interest rate decision on Monday. A poll by Reuters shows unanimous sentiment against any prospect of change among the analysts that were consulted. There seems to be very little expectation, at this point, that the BoI will raise its benchmark rate above the current 0.1 percent, which would only compound the manufacturers' woes.

The long-lasting appreciation of the shekel over the past decade, some 30 percent vis-à-vis the basket of currencies against which it weighed, is contributing to fundamental changes in the country's economy, says Gil Bufman, chief economist at Bank Leumi.

"We've seen a major shift in the economy since 2011, including in high-tech, moving away from manufacturing and going into the direction of services, high-tech services," says Bufman. And the underlying trend is not changing anytime soon.

"Looking ahead I think that the fundamentals are going to remain supportive of a strong shekel. If anything, the ongoing discoveries of natural gas, which gradually will more and more come online, for example Leviathan, which is likely to be online by 2020, and the ongoing interest in Israeli tech and non-tech purchases of Israeli companies will continue to bring money into Israel, money that's not interest rate sensitive," he says.

That would confirm the manufacturers' worst fears. In a letter to the government, as reported in the Israeli business daily Globes, the head of the Kibbutz Manufacturers Association, Udi Orenstein, earlier this week warned that: "Israeli companies are moving production business overseas, because exporting from Israel is a money-loser."

In recent weeks, two companies announced that they'd close factories in Israel, resulting in the loss of some 500 jobs; security equipment maker Visonics and sugar company Sugat. The first will move production to China, keeping research in Israel, while the second will import its sugar from abroad.

These manufacturing woes also extend to the high-tech sector, says Bufman: "Even within high-tech we're seeing divergent trends. For example, in high-tech goods, let's say telecom equipment or other manufactured high-tech goods, we're seeing a slowdown in growth, a drop in activity, while the growth is primarily in high-tech services."

Koby Simana of IVC Research Center confirms the trend: "All the manufacturing technologies that are built in Israel, if it's not high-end manufacturing, it's not attractive because of the high shekel. It's less attractive because you can build these factories in other countries where the salaries and the workforce are cheaper."

A trader works at the Israeli stock exchange.
Uriel Sinai | Getty Images

The strong shekel is also starting to affect Israel's vaunted ability to attract foreign investment in its very active startup scene, says Simana: "It's less attractive because the return on investment for investors decreases over time. So the attractiveness of Israeli companies could have been more if the shekel was less strong."

He points out that high-tech startups usually get their investments in dollars while they spend in shekels, which causes a squeeze. "On the one hand you receive on aggregate less because the shekel is getting stronger and stronger but on the other hand you're paying the same amount in shekels or even more as salaries and expenses increase over time," he says.

Leumi's Bufman sees investments patterns shifting because of the strong shekels: "Just following the deal-flow in the media, we can see that most of the activities have been in service-related tech, software, gaming, even when it comes to the latest acquisitions by the Chinese, trying to buy into the Israeli financial sector, that's also a form of services."

This turn towards services and away from the manufacturing and export of goods is not necessarily an inevitable nor irreversible effect of a strong currency, says Bufman. He points at other developed countries with strong currencies, such as South Korea and Singapore, that manage to have both.

The Bank of Israel's attempt at keeping down the shekel is no more than "buying time", he says. In the long-term the government needs to invest in fields like education, human capital and above all, ease of doing business, in which Israel scores low among developed nations. "The better the ease of business is, the better your abilities are to excel in exports despite the fact that you have a strong currency," says Bufman.

This week, Simana's IVC also reported that exits of Israeli high-tech companies were down significantly in the first half of 2017, with both the number and the volume of deals at a five-year low. The first half of the year saw $1.97 billion and 57 deals with an average value of $34 million, well below the 2016 average of $86 million.

Simana says this is a global phenomenon and unrelated to the high shekel, as at this level companies are valued in dollars. He sees the decline as mainly caused by investors and entrepreneurs holding out for higher prices for their companies and not accepting the first bid that comes along.

Follow CNBC International on Twitter and Facebook.