If Israel’s judicial reform is so bad, why is the shekel doing so well?
For one brief moment, it looked like Israel’s financial markets were about to join the anti-judicial reforms army.
Since Justice Minister Yariv Levin unveiled his plan a month ago, high-tech entrepreneurs, investors, bankers and economists have all come out strongly against overhaul of the justice system. They have written open letters, demonstrated and made their view known in a meeting with the prime minister and in media interviews.
It has all amounted to a very impressive act of protest, but protest is all it’s been. Where was the beef? If Levin’s reforms pose a terrible threat to Israel’s economy, you would expect Israeli share and bond prices to have been heading lower all month. You would expect foreign investors and maybe even some locals to be moving the money out of the country, causing the shekel to depreciate.
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In fact, nothing much happened – that is, until Sunday, after Israel’s top bankers warned Prime Minister Benjamin Netanyahu that the judicial overhaul would cause capital flight and hurt Israel’s credit rating.
Led by bank shares, the stock market tumbled, and bond prices fell, too. The shekel doesn’t trade on Sundays, but on Monday it weakened against the dollar and the euro.
But that was it – crisis over. The stock market rebounded the next day and the shekel later in the week. The Tel Aviv Stock Exchange’s benchmark TA-35 index is, in fact, at about the same level it was when the Netanyahu government was sworn in at the end of December; the shekel is up 2 percent.
It will be a while before official figures on capital movements for this period are released. For now, all we have is scattered reports of money and businesses fleeing. The startup Verbit, for instance, said on Wednesday it was packing up and leaving. Last week, the venture capital fund Papaya Global said it was “withdraw[ing] all of the company’s funds from Israel” and Tal Barnoach and Yorai Fainmesser announced that they were moving $250 million of their Disruptive AI venture capital money abroad. Bank Hapoalim’s CEO Dov Kotler has said there have been some withdrawals of deposits by private customers.
But it’s safe to assume that if lots of money was moving out of the country, the shekel would be depreciating.
The financial markets have earned a notorious reputation for punishing countries that don’t play by the rules of good economics by pulling their capital out. The most recent one to be caught in their crosshairs was British Prime Minister Liz Truss, whose so-called “mini-budget” last September caused British bond prices to tumble and the pound to fall to a record low against the dollar. She was cast out of office after a mere 49 days.
The fact that nothing like that has happened to Israel demonstrates two rules – the first is that not all threats to an economy are the same, and the second is that whatever kind of do-good posturing the businesses and investment communities engage in, in the end, it’s about money, not morals.
Unruffled in Tel Aviv
Truss’ plan called for sharp tax cuts and more government borrowing at a time when interest rates were on the rise and the UK was already heavily indebted. The measures would have had a direct and immediate effect on government finances. Even before Truss had a chance to enact them, the news alone brought the country’s pension fund industry to near collapse.
Israel’s judicial reform doesn’t pose that kind of immediate threat – the package of legal reform measures hasn’t even been finalized, much less approved, and their practical impact will take time to emerge. In terms of timing, there’s no reason why anyone needs to bail out of Israel now.
Then, there’s the money versus morals factor. Tom Livne, Verbit’s founder and CEO, attributed his decision to exit Israel to a refusal to pay taxes to a (wicked) government set on undermining judicial independence. There’s no reason to doubt Livne’s moral outrage, but the great majority of businesspeople and investors will only act when they perceive a concrete danger to their bottom lines.
That hard-nosed approach may dismay those who hoped that the business community was becoming a full-fledged partner in the struggle for democracy. But its bottom-line attitude is one of the struggle’s strongest cards. Here’s why.
Netanyahu has brushed off the opponents of justice reform as a bunch of hopeless leftists whose real agenda is to topple his government. But the prime minister has shown over and over that he takes business opposition seriously. He has sought to address its concerns and even taken the trouble to personally meet with some business leaders.
The report from Goldman Sachs
Netanyahu’s argument that judicial reform will boost the economy is unfounded, but in any case their deleterious effect on the economy – whether it comes in the form of capital flight, a lower credit rating, a weaker shekel or any number of other factors – will emerge slowly.
A Truss-like crisis is not going to come from judicial reform but from political instability. Goldman Sachs, which may be regarded as reflecting the view of the global investment community, hinted at just that in a report last week.
In it, analyst Tadas Gedminas cited local “market participants” as anxious not about judicial reform per se, but about the domestic political uncertainty created by the struggle over it.
“The five most recent elections over the past three-year period have had typically limited read-through to financial markets,” Gedminas wrote before adding cautiously: “This is not to say that the current situation could not have a more meaningful impact this time around.”
What Gedminas meant by “limited read-through to financial markets” was that the Israeli economy and the shekel have held firm over the last three years despite a long run of indecisive elections, because of the country’s excellent financials: Israel has long enjoyed big current account surpluses, large and growing foreign currency reserves and, a low ratio of debt to GDP, despite blow-out spending during the COVID pandemic.
These are the kind of metrics the financial markets care about most. They have prevented the shekel from weakening and have enabled Israel to maintain a high credit rating despite the political turmoil of repeated elections. But for how much longer?
If the government rams through judicial reform without compromise, it risks alienating a great many Israelis, including the country’s best and brightest, whose long-term effect is anyone’s guess. In the shorter run, the month-old Netanyahu government is already beset by major crises – rifts over policy in the West Bank, growing tensions with the Palestinians and the imperative of getting Arye Dery, a minister previously convicted of fraud, back into the cabinet.
Netanyahu’s promise of a stable, right-wing government looks more illusory by the day. If it falls, it will mean that neither a government of the anti-Netanyahu center-left nor one of the religious-right can hold on to power for very long. What does it say about the outcome of Election No. 6? What will it mean for Israeli financial metrics when no government lasts long enough to implement economic policies? When these worries begin to emerge, that’s when the money may begin to flee and the markets to react.